The City of London - after Brexit

City of London - Post Brexit

At present the City of London is the world's leading financial centre. Its origins date back to the Roman conquest of Britain in AD 43 and the settlement of Londinium. The Roman historian Tacitus described London as 'a town of the highest repute and busy emporium for trade and traders'. 

London's development in the Middle Ages as a port resulted in it becoming populated by merchants who became increasingly wealthy. The merchants used their wealth to provide finance. Following the advent of the joint stock company in the 17th Century, the City became a burgeoning financial financial and commodity market place. Names of City streets such as Bread Street, Milk Street and Fish Street indicate the nature of the markets in those areas. The markets today trade commodities, shares, bonds, derivatives on exchanges (usually electronically) as well as a very large range of instruments over the counter. 

Some reasons for the continuing success of the City are:

location between the Far Eastern and American time zones

highly developed infrastructure 

pool of skills 

the ability to adapt and innovate

trading culture

Banks, insurance companies, brokers, market makers and dealers in financial instruments choose to locate in London becuse of the above reasons on the one hand and because, under current EU rules, having located in the UK, they can 'Passport' i.e. offer services in Europe without the need to get regulatory approval from the EU countries they wish to operate in. Therefore it is important that 'Passporting' continues if possible after Brexit.

But Frankfurt, Luxembourg, Paris and Dublin would like to migrate the financial services business that takes place in London to their own centres and will seek to stop Passporting after Brexit. 

Arrangements to mutual advantage of London and the other (hitherto competing) European financial centres will have to be developed.

The UK Prime Minister or senior civil servants speaking to their counterparts in Europe is unlikely to yield sufficent sustainable benefits to London / the UK.

If the UK were to send the European Commission, say five technical advisors, free of charge, the options that would reach senior officials / members are likely to have been constructed with sufficient ingenuity and flexibility to be of mutual benefit.

When the Investment Services Directive was being drafted, I was the sole technical advisor on financial services to the Commission. I was able to help drafting to take account of the greater range and scope and different structure of financial services in the UK.

Subsequently that degree of technical involvement doesn't seem to have taken place. For example the CoREP directive requires even three man proprietary trading firms to fill in the same 27 spreadsheets worth of returns that a major bank does. Moreover the returns have to be converted to XBRL and sent to the European Banking Authority. For Europe, this makes sense because in Europe, banks undertake the business undertaken by brokers, market makers and small proprietary trading firms in the UK. But it does not make sense for the UK. 

Appropriate action does need to be taken quickly to preserve the pre-eminent position of the City post Brexit.

European Union – In or Out?

The reasons for out seem to be: EU regulation that is harmful to the UK’s interests; migration; and the UK’s contribution the EU budget. The principal reason for staying seems to be access to EU markets.

Regulation that is potentially harmful to British interests can be handled effectively. For example: in the 1990s I was seconded (1 to 2 days per week) as the sole technical advisor to the European Commission on financial services. By explaining the nature of financial services in the UK, when proposals came up from the Commission, I was able to ensure that no regulation inimical to British interests emerged in the first Investment Services Directive.

Regrettably that technical engagement was not there for subsequent financial services directives / regulation from the EU and much unsuitable (for the UK) regulation has emerged. This is avoidable. All HM Government (in particular HM Treasury) has to do is to provide technical experts to the Commission who will be effective. The language in most of the committees is English which makes it easier for Brits to influence the regulation for the wider benefit in general and in particular the benefit of the UK.

Potential EU Migration is thought to be an issue. But migration from countries outside the EU seems to have been forgotten. As a migrant myself (from 1922 members of my family have spent time in the UK – most returned to Ceylon though) I have bought into British values. All migrants should be encouraged to do this. Perhaps then migration will not be seen to be such an issue.

The EU budget can be seen on the one hand as a cost, but on the other as providing an opportunity. First for trade but also for the UK to benefit from the various grants and incentives available. To take full benefit, the UK needs to study the regulation and assist British enterprise and the wider community to benefit from these grants.

About half the world is English speaking. Also Britain has historical trading and wider links with many countries. The UK can be the bridge between the EU and the English speaking world and more widely. Trading with EU countries on the one hand and the rest of the world with the other could be of benefit to the UK.

Moreover, the UK is the world’s pre-eminent centre for financial services. Located between the Far-Eastern and American time-zones it is possible to trade with the Far-East in the morning and the US in the afternoon acting as a bridge between these time-zones and also the EU.

All significant participants in the financial markets have a presence in the UK. Historically this developed from London as a port where commodities were traded as they were unloaded from / reloaded onto ships. Financing of business and trading of futures grew also from the position of London as a port and the links with the empire and more widely.

The market participants in London and UK financial infrastructure are valuable national assets. I note here as an aside, ownership of the infrastructure, which are national assets, should remain in British hands. But if the UK left the EU the market participants could leave for other centres. It would be very difficult to bring them back once they are established elsewhere.

I believe the UK has much to gain by remaining in the EU.  

Migrating to the UK

Migrating to the United Kingdom

Ranil Perera

There has been much debate recently about migration. Some of it in connection with the vote on EU membership. As a migrant I thought it might be helpful if I contributed to the discussion.

As migrants my wife and I have bought in to British Values. We judge that we have integrated into the local community also. Given our colonial origins – Ceylon – now known as Sri Lanka it wasn’t difficult. She and I communicated with our parents, grandparents, relations and friends, principally in English. We were both educated entirely in Sinhalese but understood English culture from parents.

When I arrived in the UK to attend university and quoted English dramatists, poets and authors, e.g.

·        (when bored) from Shakespeare - Macbeth’s soliloquy–

‘Tomorrow and Tomorrow and Tomorrow,

Creeps in this petty pace from day-to-day

To the last syllabus of recorded time’

·        (when impatient) Andrew Marvell[1]-

‘Had we but world enough and time

This coyness lady, were no crime’

I was surprised to find that I had a better grasp of English literature than some my British born, English fellow students. I note here I studied science at ‘A’ level and then engineering. I acquired the grasp of English literature and British values from my parents their friends and my classmates.

I heard on BBC Radio’s ‘Today’ programme (19^th June 2016) someone advocating that migrants ‘interact’ with their local communities but remain as separate communities: I wonder whether the emphasis should be more on integrating rather interacting? Perhaps we migrants should see ourselves as citizens of the UK first and then as members of the local community rather than members of a separate migrant community? If migrants keep themselves separate, all will be the poorer for it – and this approach may foster inter-communal tensions and strife even. As migrants we should be committed to the country we are in, and perhaps more widely to Europe, and even more widely the world community – but first to the country we live in and have allegiance to.

The first member of my family to migrate was my maternal grandfather, Thomas David Jayasuriya MBE, OBE. He came to the UK in 1922 to study at the University of London and returned to Ceylon when he had completed his studies.  

My father came to the UK with his mother in the later 1940s and studied law at Chart’s Chambers, Lincolns Inn. Jeremy Thorpe, the Liberal politician was a fellow pupil. My mother who had graduated from the University of Ceylon and was private secretary to the Minister of education (Mr Eddie Nugawela), gave up her job, migrated to the UK and married my father at St Barnabas Church, Kensington, in January 1950.

I was born however in Ceylon. But later lived in the UK between the ages of two and four years. Then we all migrated back to Ceylon. But my father returned to the UK and worked for J H Vavasseur and Co in the City[2] before returning to Ceylon at the end of the 1950s.

My paternal grandfather T D Perera CMG retired to a flat he had bought in Hammersmith. But after many years, returned to his wife in Ceylon.

My wife Romie’s forbears are more interesting than mine. Some of her father’s ancestors were migrants from Cornwall to Ceylon. Other members of her father’s people had Dutch origins – and perhaps may have been part of the Jewish exodus from Europe. Her maternal great-grandmother Amy was presented at Court in 1897 – but on the way to London, during her European travels, married Eduardo Roversi in Rome in 1894. My wife’s grandmother Elena, great-aunt Hilda and great-uncle Neville were all born in Rome but educated in England. In 1922 (perhaps because of the rise of Mussolini) Amy returned to Ceylon with her three children who were now aged around 20.

I came to University (Downing College, Cambridge) in the 1970s. My mother migrated to Cambridge at the same time – parents were not getting on. She became a civil servant. I did do some rowing at Cambridge, representing my college at the Henley Royal Regatta.

Having worked in banking and financial services (asset management, insurance and for financial infrastructure) as a consultant or employee, I found myself seconded (1 to 2 days per week) as the sole technical advisor to the European Commission (in the early 1990s) on financial services. By explaining the nature of financial services in the UK and the rest to the EU, I was able to ensure that no regulation inimical to British interests emerged in the first Investment Services Directive. Regrettably that technical engagement was not there for subsequent financial services directives / regulation from the EU, and, consequently, much unsuitable (for the UK) regulation has emerged.

I believe that proper technical engagement with the European Commission can ensure that EU regulation inimical to the UK can be avoided. Even post-Brexit.

My wife and I were married at St Margaret Lothbury, in the City of London. The vicar, Tom Farrell, had been a hurdler. Duncan White[3] a Ceylonese hurdler, known to my father and father-in-law was known to Tom, as Duncan had trained with the British team. I had met Duncan when I was a boy, at the Ceylon University sports grounds.

As mentioned at the start, my wife and I have both bought in to British values and seek to contribute either through voluntary work (my wife teaches English to migrants, I have worked voluntarily on projects / articles to promote the UK as the world’s leading financial centre) or in other ways to the benefit of society as a whole. We do not seek to impose other values on British society but are ready to share our experience where we judge that it would be helpful.

I believe that migrants to the UK should be encouraged to buy-in to British values. Also integrate into and contribute to British society. After all, as migrants we have a choice. If we choose to stay in the UK we should buy-in to British values. Also contribute to British society as a whole. This could be done by making suitable voluntary activities / service available to migrants.

Noting that English is spoken by about half the world, I believe that the UK could still play a leading role in Europe on the one hand and the world community on the other. Perhaps acting as a bridge between the EU and the English speaking world.

The UK is the world’s leading centre for financial services. It must continue as such.

Whilst manufacturing in the UK can and should revive (there was a time when Austin and Rover were considered high quality cars and ‘continental cars’ mass produced) perhaps current emphasis should be on the high technology industries? 

Britain’s position in the world community must be pre-eminent. Migrants can contribute to this.

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[1] ‘To his Coy Mistress’

[2] I had the privilege of meeting the son (Dr David Hay) of my father’s boss (Andrew Mackenzie – Hay) at the City University Club in the early 1990s.

[3] Silver medallist in the 1948 Olympics.

FT article 30 Dec 2015 noting end of 'Banker Bashing’

Perhaps a question that should have been addressed is should 'banker bashing' have started at all? The UK arrangements for regulating financial services,as it happens put in place by the Labour Party, seemed to be excellent: combining prudential, conduct of business and anti-financial-crime regulation in a single regulatory authority. Also there was monitoring of banks and building societies (deposit taking institutions) via the FSA Financial Risk Analysis and Monitoring unit – FRAM, to identify individual institutions at risk, groups of institutions that could be vulnerable and threats to the system as a whole. 

The US system of bank regulation, on the other hand, was flawed. Its 'on-balance-sheet' leverage ratio focus encouraged securitisation. The rating agencies, perhaps relying on models whose parameters were based on benign financial conditions, gave the securities containing the securitised loans a rating that did not hold up in times of financial stress. This exacerbated the potential for problems.

There was a failure of execution rather than design in the UK. The balance sheet return the BSD3 (launched by the FSA in 1999) would have shown that RBS (whose accounts showed a reduction in bad debts of around £1 billion in 2002) and HBoS were both potentially short of capital. In 2002/3 these two should have been asked to freeze their balance sheets until they shored up their capital.  Equally returns from Northern Rock and others would have shown a reliance on wholesale funding although having more than enough capital. The lender of last resort, the Bank of England, should have provided liquidity to these. Whilst it did not provide liquidity for Northern Rock, it must have done so for the others.

London, located between the Far-Eastern and American time zones is geographically in the right place to be the world’s leading financial centre. Financial services grew out of its role as a port: first the commodities that were unloaded were traded (initially in coffee houses); then financing and related services evolved. The evolution of London as the world’s leading financial centre resulted in a trained workforce for financial services and until recently a regulatory framework that balanced risk management and consumer protection on the one hand with fostering financial innovation and financial business on the other. 

The changes to the regulatory arrangements following the crisis which include increasing capital and liquidity requirements for banks, are addressing a failure of execution via a redesign of the system. If the regulators focus on identifying assessing, monitoring and managing risk, the redesign of the system in the UK to the extent it has been done, would be unnecessary. This redesign probably is being viewed with glee by other financial centres - who want to business to migrate from London to their own centres.

Potential consequences of the increased capital and liquidity requirements could be on the one hand a reduction in available finance to foster Britain’s prosperity and an encouragement of shadow banking’ i.e. non-bank lending, with possible threats to financial stability, on the other.

Many with the interests of the UK at heart, are hoping that HM Government and in particular HM Treasury and the Bank of England would restore a regulatory framework that balances stability and consumer protection on the one hand with the continued success of the UK as the world’s leading financial centre on the other.

LIBOR and Foreign Exchange rate manipulation

In some ways this was an accident waiting to happen.

It seems to me there was an inherent flaw in the way LIBOR and FX rates were fixed.

LIBOR was set by the British Bankers Association (BBA) asking a group of banks the rate at which they would lend to each other.  – London Inter- Bank Offered Rate - for the particular currency that the quote was asked for. 

LIBOR, the London Inter-Bank Offered Rate, is, I understand, calculated by taking the average of the rates that each member a panel of banks says it could borrow funds at, were it to do so by asking for and then accepting inter-bank offers in reasonable market size, just prior to 11.00 London time. The top four and the bottom four are discarded and then the average of the others is set as LIBOR. The process was handled by British Bankers Association (BBA).

It is important to note that no Bank actually has to deal at the rate they submitted. 

The members of the panel of banks are drawn from the world’s leading banks.

The interest rates are fixed for the world’s leading currencies for periods from one month to one year.

The FX rate fixing has similarities to the above process.  WM Reuters publishes rates from buy-and-sell quotations from a group of “reference banks”.  Whilst the banks probably will buy and sell at the quoted rates, front running or manipulating transactions can take place. FX rates are ‘fixed’ by taking the rates published in the Reuters display.

No institution has to have dealt at the quoted FX rate.

By contrast for exchange traded securities (stocks and bonds) and derivatives (futures and options) the daily closing prices are fixed on the basis of actual trades.

If there is an attempt to manipulate securities or derivatives prices, the price feed will track and display the change in price. Market monitoring staff and / or regulatory transaction monitoring staff will identify suspicious price movements / manipulating transactions and the trade reporting systems will enable identification of the traders who can be investigated. Front running and other manipulating transactions and devices can be traced back to individual traders as all trades are recorded.

Neither LIBOR nor FX rates are fixed on the basis of actual transactions.

In Shakespeare’s play ‘Julius Caesar’ Cassius said to Brutus “The fault, dear Brutus, is not in our stars, but in ourselves.” In similar vein in could be said of LIBOR and FX Rate fixings that the fault lies more with the nature of the benchmark rather than the people manipulating it. 

                      

Perhaps the systems for setting LIBOR and FX rates need to change?

Perhaps the benchmark could be the rate at which the central bank, the Bank of England will provide liquidity / deal in foreign exchange?

UK Financial Services Regulatory Reform

All the studies that underlie the new UK Financial Services regulatory arrangements implemented in 2013, assumed that the problem with the previous regime was a failure of design rather than a failure of execution.

It is generally held that the relevant UK authorities could not have foreseen the 2007 crisis. But the returns (BSD3, LR) launched around the turn of the century taken together with the BT, were designed for effective macro and micro prudential analysis. It is believed that such analyses were undertaken by the FSA’s Financial Risk Analysis and Monitoring unit (FRAM); they would have shown the trends that resulted in the 2007 UK financial system problems.

For example following the RBS / Natwest merger, the reductions in bad debt provisions, would have signalled a warning; institutions over-reliant on wholesale funding should also have been apparent. Equally, those institutions over-lent on property, short on liquidity, short on excess capital or all three should have been identified also. It was generally believed that quarterly reports on potential threats to the system were prepared and circulated to the executive chairman and senior management.

It is believed that first FRAM and then the equivalent department in the Bank of England were shut down, a possible argument being the banks had PhDs looking at risk whereas what was being undertaken in FRAM was simply stress testing at a micro and macro prudential level and identification of trends in capital adequacy or liquidity that could pose threats to individual institutions, groups of institutions or the systems as a whole. The PhDs would see that there were no such threats.

But this reliance on risk modelling in individual institutions ignored a common thread running through the 2007 crisis; the 1997 financial system problems associated with LTCM about 10 years earlier; and the 1987 market correction / crash a further 10 years earlier. The common thread is the reliance on pricing models based on the normal distribution.

Although since 1987 there have been references to ‘fat tails’ and ‘black swans’, each generation of pricing and risk management specialists has relied on models based on the normal distribution¹

Before the 1987 crash, Leland, O Brien and Rubenstein popularised the technique they named ‘portfolio insurance’ based on dynamic hedging of positions using derivatives priced on the basis of the normal distribution. Similarly before the 1997 problems, LTCM took on large, highly leveraged positions based on pricing models which indicated that they were fully hedged. A key contributor to the current financial systems problems is thought by some to be that the risk associated with securitised mortgage and other debt obligations was mis-valued on the basis of statistical formulae.

At the second Turner Review Conference, Shyamala Gopinath, Deputy Governor, Reserve Bank of India, said that their off-site risk analysis and monitoring arrangements enabled them to identify and manage threats to the Indian Financial System. But Neena Jain of the Reserve Bank, was trained by the FSA’s FRAM in 1999 (at the request of deputy governor Aditya Narain – now at the IMF). John Turner of APRA the Australian Prudential Regulator also had his training at the FSA’s FRAM.

The Governor of the Bank of England gave four reasons for not lending to Northern Rock, amongst these the Companies Acts and the Market Abuse Directive. It seems these obstacles prevented the Bank from fulfilling its function as lender of last resort effectively. But the tri-partite agreement made when the FSA was set-up did indeed envisage the authorities working closely to identify, assess and resolve potential UK financial system difficulties. Other institutions short on liquidity (not capital) must have had (covert) funding. 

Much has been made of the way the state rode to the rescue of banks. But scrutiny of any liquidation / administration is likely to show that in these situations decision making is defensive and vast amounts of money spent on professional fees to justify / defend decisions, little effort being made to restore profitability. Public ownership of banks (UKFI) can result in the same outcomes. Whereas strengthening capital by means other than the state acquiring equity may have been more beneficial.

What should have been done? First, the results of the regulatory return analyses giving early warning of threats to individual institutions, groups of institutions or the system as whole, should have been acted on. Second, the Bank of England should have fulfilled its obligations as lender of last resort. Third where banks needed additional capital this should have been provided by means other than acquiring equity.

Some look back to the (apparently) halcyon days of supervision by the Bank of England, when, it is said, the merest twitch the ‘Governor’s eyebrows’ sent banks scurrying to put right what was wrong. But it may be worth recalling that the Bank of England was in charge of supervision when Barings Bank, BCCI, Johnson Matthey Bankers and earlier the fringe banks, collapsed. These took place during in relatively benign financial conditions compared with 2007. Care needs to be exercised in implementing the new regulatory framework to avoid a repetition of these previous problems.

Separating prudential from conduct of business regulation as is now the case, can create competing governance requirements. Regulation of conduct of business: the regulation of the selling process to ensure that suitable / appropriate products are designed and promoted, and customers treated fairly overall, best execution, etc., requires satisfactory governance arrangements. Prudential (capital adequacy and liquidity) risk management also requires governance arrangements which may be different. Moreover inadequate conduct of business controls can create operational risk which is considered a prudential risk.

It has been argued that the FSA with its ‘common platform’ approach to governance, systems and controls seemed to have recognised and handled correctly this interaction.

It could be argued also that given its stated wish to focus on all risks (including off balance sheet and operational risks) The UK had a better regulatory framework than the US with the latter’s focus on (on-balance-sheet) leverage ratio.

Will the new framework be as good? Have we designed a new framework to address a failure of execution in the old framework rather than a failure of design? Is the journey really necessary? Of course there are strong arguments for prudential regulation being with the Central Bank. Hopefully the new regime will work well and preserve London’s pre-eminence.

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¹Based on the work of Fischer Black and Myron Scholes, "The Pricing of Options and Corporate Liabilities", Published in the Journal of Political Economy in 1973 and Robert C Merton’s development of this, also in 1973, "Theory of Rational Option Pricing", published in the Bell Journal of Economics and Management Science

The Archbishop and Wonga

The Archbishop of Canterbury has rightly drawn attention to the high interest rates charged by Wonga. He should focus also on other lenders,including 'doorstop lenders' operating under very respectable sounding names and charging high interest rates. 

The alternatives to Wonga and doorstop lenders probably are loan sharks and other even less savoury people. So the Archbishop's idea of encouraging Credit Unions seems good.

But the funds Credit Unions have to lend are drawn principally from their members. So the amount they can lend is restricted to the wealth of their members. Unlike other lenders who can get their funds from a wider range of sources.

Should state institutions such as the National Savings Bank also start lending to meet the needs of those that are starved of credit?

The Archbishop is a member of the Banking Commission. The new regulatory arrangements which demand higher capital requirements from banks may constrain lending even more. Perhaps he should ask whether the changes really are necessary. Some have argued that the UK regulatory arrangements at the time of the crisis were sound (unlike the US with their focus on leverage ratio which encouraged the securitsation of loans which is believed to have fuelled the crisis). But although the design of our arrangements may have been sound, there may have been a failure of execution.

Perhaps we should ask whether the banks themselves and their regulator at the time were aware that certain banks were running out of capital and others were potentially requiring liquidity support from the lender of last resort, the Bank of England. If such action, for example strengthening capital resources or liquidity support from the Bank of England, were taken in time, perhaps we would have come through the crisis better and perhaps there would be cheaper loans available more freely now? 

It would seem likely that there were banks other than Northern Rock that needed liquidity support; presumably they received it without publicity. Perhaps Northern Rock should have received it too? 

Some common sense and open discussion about our financial industry may help us with making arrangements for a financial system that meets the people's needs as well as preserving London's position as the world's pre-eminent financial centre.

The early Christians tried to help their brethren in need. Apart from helping directly, perhaps we should pay attention to financial system arrangements also?