Justin O’Brien

Letter from Melbourne: the conduct (and cost) of prudential regulation

The public hearings of the Australian Royal Commission into Misconduct in the Banking Superannuation and Financial Services generate voluminous coverage through the logical (if not necessarily entirely persuasive) presentation of an unchallenged final evidential pitch. The Commissioner is invited to take that pitch into consideration in determining the cause and effect of misconduct. It does not constitute a finding in itself. This critical point is sometimes lost. It is an age-old adage of journalism that if it bleeds, it leads. As with all good stories, acceptance of the narrative presented requires a suspension of disbelief regarding competing interpretations. This applies even if the tears are a consequence of avarice or unrealistic assumptions, the centrality of buyer beware in legitimising contracts, or restricted regulatory mandates, itself a consequence of partisan and bipartisan political failure. The recently concluded two-week hearings on the provision of loans to Small and Medium Sized Business was no exception. While Counsel Assisting, Rowena Orr, and her colleagues have been careful to point to individual cases of malfeasance, they have been less than convincing on the underpinning structural conditions that have facilitated such a state of affairs. These conditions include how and why the financial system operates in the way that it does; the power and limits of regulatory capacity (or willingness to use that power to the full, or even on a coherent and cohesive basis). This lacuna is unfortunate. It is not that they do not have the information. Indeed, it is material that the Royal Commission itself has commissioned (along with submissions made by interested parties, the majority of which are not, contrary to standard practice, disclosed). More importantly, the results of independent investigations in the US and Britain, each funded on an exponentially larger scale, raise uncomfortable questions that suggest, inescapably, regulatory and political failure that appear, to date, unexplored, if not ignored. Even more peculiarly, the regular Friday afternoon dumping of background papers by the commission has become a standard operating feature that is often reported on but rarely analysed. As a consequence, much explanatory power is lost. One hopes that Commissioner Hayne, at least, is paying attention; integrating the precis provided by Ms Orr and colleagues (easy pickings to say the least) with both the expert analysis and the bulk of the non-published submissions to help inform a broader, balanced and more substantial narrative. International experience and public distrust in regulatory decision making reinforce what Judge Jed Rakoff of the Federal Court of the Southern District in Manhattan contemptuously derided, in a recent visit to Melbourne, as the privileging of a “facade of enforcement”; the preference for an easy headline over substantive punishment with true deterrence effect. One could argue that Counsel Assisting is making a similar mistake. Funny things are, indeed, happening on the way to the forum. In the most recent hearings inMelbourne, Senior Assisiting Counsel, Michael Hodge, made a boldclaim. There was no evidence, he argued, that Commonwealth Bank of Australia (CBA) attempted to further profit from its acquisition of BankWest from Halifax Bank of Scotland (HBOS) in 2008. It had been suggested continuously but without evidence since the acquisition that CBA may have attempted to offset the purchase price of

Trust and accountability in the digital age: Reporting the dystopian present

2.1 billion by re-engineering loan terms, thereby gouging customers. It is an unmistakable fact of life post-Global Financial Crisis that the off-selling of problematic loans was key to central bank strategies around the world, not least in Ireland, where the National Asset Management Agency (NAMA) became a de facto “bad bank.” As part of its own performance indicators, NAMA, in turn, sold these loans on to private market institutions when politically possible to do so – and pocketed a hefty return. The private market institutions, in turn, tightened restrictions on performing and non-performing loans (something it was politically impossible for NAMA itself to do). These latter institutions, largely private equity firms, were often described as profiteering on misfortune, earning the moniker “vulture funds.” In Australia, the difference was the vulture funds were in fact deposit-taking institutions that held a banking licence. “In any view these [initially at point of acquisition] were already distressed loans,” Mr Hodge intoned, stating little more than the obvious but obviating any need for a case study. So much for any tears; more a question of sparing blushes. And those with most to fear from any detailed exposition was not necessarily CBA or the executives it put in place to run BankWest. These, after all, were profit-making institutions that had both a prudential and commercial imperative to protect the value (or as increasingly became apparent minimise the worthlessness) of its own loan book. Much more problematic, however, was how and why the BankWest loan book was so impaired in the first place. Here the answers were not provided at the time – or since – by the Australian Prudential Regulation Authority (APRA), which had primary regulatory oversight. Ironically the evidence comes from overseas through the British Parliamentary Committee on Banking Standards, which raised significant red flags about Australia’s capacity and complacency at the regulatory level. As is so often the case, the warning was ignored throughout the financial system; swept under the carpet Law and Financial Markets Review, 2018 Vol. 12, No. 2, 53–56, https://doi.org/10.1080/17521440.2018.1485544

The global financial crisis: ten years on and corporations, markets and morals

The disdain against our institutions seeps across all sectors. From business to government, charitable bodies to media, Fake news, which that master manipulator Orson Welles reminds us, is as old as the Garden of Eden, is emblematic of the age: the corruption of knowledge. If, as Mao Zedong once claimed, power grows out of the barrel of a gun, the capacity to control and manipulate information is the weapon of choice in a changing world order. From meddling in the US presidential election to Brexit and beyond, the capacity to mount credible campaigns have been compromised by communication channels that both amplify and distort. This article explores how finance and its reporting has changed in the interim and suggests we still face an existential crisis.

Letter from Melbourne: a decade of living dangerously

Ten years after the onset of the Global Financial Crisis this analysis assesses how the crisis exacerbated systemic levels of distrust. In examining the causes, it seeks to anchor finance to the societies in which they operate. It articulates and justifies a new theory of the corporation that balances rights, duties and responsibilities within a framework that has global application. It seeks to answer an existential question: how to rebuild trust in distrusting times. Trust can be defined as having firm belief in the reliability, truth or ability of someone or something. The foundation of trust in the western liberal state, however, is disintegrating. So too is warranted faith in two critical components of institutional trustworthiness: competence and honesty. What, then, as Lenin famously admonished, is to be done?

Letter from Sydney: accountability in the digital age

In what is to a year of reckoning, Australia, with one of the most concentrated banking sectors in the world, faces a profound trust deficit. It has been a decade of living dangerously, informed by wasted opportunity, political opportunism and ideational fealty to failed paradigms. Now the sector, its regulators and its political overseers must address an existential crisis. The trajectory of a Royal Commission of Inquiry into Misconduct in the Banking, Superannuation and Financial Services Industry complicates matters further. The Royal Commission was ceded to stave off the implosion of the governing coalition. Accepted by the banks as necessary (thus providing the government with political cover), public hearings have crystallised nagging doubts. It has exposed corporate cultures of wilful neglect that question both internal control mechanisms and the quality of external prudential and market conduct oversight. In the aftermath of the Global Financial Crisis (‘GFC’), Australian regulators and their political leaders luxuriated in the apparent relative health of the domestic banking system. They trumpeted that the primary problem was not a lack of rules but a failure to apply them. They argued prudence, self-restraint and rigorous, effective application of regulation had inoculated the Australian economy from a slow release but nonetheless toxic virus. The Financial Services Royal Commission hearings have rendered this unsustainable. In Sydney, in April, the new chairman of the Australian Securities and Investments Commission (‘ASIC’), James Shipton, finally punctured a flawed narrative. He noted that the current crisis of trust is the culmination of a slowburn 10-year process. Australia, it has turned out to its surprise, is not immune from the chrematistic logic of finance. A globally pervasive emphasis on short-termism in political as well as economic markets, leavened by neo-liberalism, a ragtag of concepts taken out of context and appended to a policy framework riven by its own contradictions, combined to weaken the foundations of the regulatory paradigm. It proved incapable of instilling restraint precisely because of the absence of a strong normative underpinning. Australia was, and remains, no exception. It is one thing to accept past failings; it is another entirely to suggest that the progressive import of failed responses will address the problem. For a capital-importing nation, current levels of national and international scrutiny are most unwelcome. It is counter-productive for those who seek to exploit public unease for shortterm political advantage. Any deterioration of country, state or individual bank credit rating could unleash contagious forces the economy is unable to afford. In short, Australia has left it too late. Its reputational cachet whittled down because of intellectual myopia, deceit and hubris. It is often said that in politics, the cover-up attracts more opprobrium than the initial infraction. As the country lurches towards a general election, levels of public distrust remain at catastrophic levels. In the field of finance, it is easy to see why distrust in both the regulated and the regulator has become so ingrained. As scandal after scandal emerged the significance of each was downplayed. Mr Shipton was correct in informing the Sydney conference that he should not be seen as yet another regulator giving a lecture, judged for the past failure of the regulatory regime. What was surprising, however, was the failure to address how a combination of capture, failure and bad-faith had undermined the regulatory state, not least because the model originated at Harvard Law School, where Mr Shipton occupied a short-term, if primarily, administrative role running an executive programme for financial regulators. What the Royal Commission reveals is that the paradigm is not just dented but demonstrably broken. Reliance on prudential regulation necessitates continued belief that the regulators know what is going on within their charges. Second, that they move beyond a box-ticking reliance on the existence of control systems. Third, when problems emerge, these are dealt with before reaching systemic levels. If these core competencies are not met, it is not rational to trust. In this case, the regulatory settings are part of the problem. Indeed, a systemic review, the Financial System Inquiry explicitly failed to investigate cultural matters. Its final report, somewhat breezily, declared that regulators had no role to play in setting or monitoring culture. Blame was apportioned by individual banks and their trade association with rogue actors, incomplete compliance training or coding errors. The problem, it was asserted, was both contained and containable. Herein lies the rub. Culture matters, even for neoclassical economists, recidivist corporates and neophyte regulators. This was long understood by James Landis, who, as the architect of the disclosure paradigm, never conceived the role of a regulator as being one of a policeman. He did not claim omniscience, nor expressed preference for command and control regulation. He did, however, demand that the financial services sector recognise and warrant their stated commitments to society. In retrospect, notwithstanding his banking eminence and personal integrity, David Murray was an entirely inappropriate choice to chair the Financial System Inquiry. The situation was exacerbated by the supporting cast. Technocrats, industry figures and a sole finance professor are not necessarily well versed in either regulatory theory or the efficacy of associational private sector governance. This is not to say that normative reasoning is impossible. A similar holistic review, dating from 1997, the Wallis Inquiry, for example, contained an entire chapter setting out the regulatory philosophy that underpinned its ethos. The problem for Murray is that the Law and Financial Markets Review, 2018 Vol. 12, No. 1, 1–6, https://doi.org/10.1080/17521440.2018.1466433

The FX Global Code: transcending symbolism?

In the 10 years since the Global Financial Crisis, technology has indeed changed our world, and not necessarily for the better. There is an unnerving similarity in the responses of a financially (if not morally chastened) global finance and a resurgent global tech to belatedly acknowledged transparency and accountability deficits. Both sectors have proved impervious to effective control. Expressing regret is not the same as accepting responsibility. Disruption, like innovation, is not a value-neutral noun or concept. Everything has a price. This includes the governance and operational practices of our leading technology corporations. Far removed from complying with generally accepted principles of best-practice corporate governance, these highly mobile, asset-light, corporations are adroit at maximising minimisation strategies that contribute to tax base erosion through profit shifting and sail uncomfortably close to tax evasion. Their competitive advantage enhanced by deft exploitation of gaps provided by the apparent – but not tested – non-applicability of traditional systems of oversight. These gaps are informed by the exercise of power without responsibility for the curation of hosted content, the ideational privileging of innovation and disruption over stability, security and sustainability on libertarian grounds, cavalier approaches to data protection, and technical gaming of regulatory rules designed for an economy destined to history. In seeking to restore warranted confidence in corporations and their governance, we need to keep in creative tension the twin societally beneficial goals of liberty and equality. Maintenance of social order and progress require active balancing. If equality of opportunity is compromised by a privileging of individual freedom, the social contract disintegrates, leading to a corresponding increase in resentment. The resulting distrust damages social cohesion in a downward spiral. The shrill nature of political debate, amplified and reinforced by automated algorithms, create echo chambers that calcify confirmatory bias. Ultimately, the “free service”, provided by the platforms is nothing of the sort. As Kris Kristofferson once sang, “freedom is just another word for nothing else to lose”. When judgment becomes automated and at one step removed, served up on a computer screen, there is no need to exercise one’s mind. The resulting passivity not only dulls the senses by pandering to bias, it is deeply corrosive of what remains of community values. If belonging is deemed a property right exercised more in empty sloganeering than opportunity, the stage is set for confrontation. This is what is happening across the liberal order. All, however, is not lost. Arresting this malaise does, however, require a fundamental change in thinking. In today’s globalised world no physical wall can provide a protective shield. The challenge is as much virtual as physical. As the dislocation caused by technological disruption extends and expands, middle class aspiration becomes unattainable to gain or indeed to hold. We are, in short, witnessing a systemic rise in precariousness. It is the defining dynamic of the age and extends far beyond the inner cities or the rust belt. Anaemic economic growth, the erosion of economic certainty and job security are advanced within and across the “gig” economy as a positive development. It is anything but. The author of the term precariat now sees it as an affliction increasingly impacting on the professions, including law. In a 2017 interview he argued, “the division of labour has changed. For example, the legal profession has silks at the top, then salariat lawyers and a huge growth of paralegals with basic training, but without a career path through the profession, because there are ceilings. It’s the same in the medical and teaching professions. The precariat is not just a reality, it’s grown extremely fast in recent years. Unless something is done to improve security and redress the class-based inequalities arising, you’re going to get a political monster”. The scale of the task ahead was brought home to me reading the “Life and Arts” section of the Financial Times on the last weekend in July 2018. The lead article explored the rise of the far-right in Germany, where in the last federal election no less than 12 per cent privileged a return to the politics of the strongman, not least because of an influx of refugees, many of which, understandably are not fleeing immediate personal persecution but no less catastrophic political and economic chaos. The return of the culture wars demonstrate an upending of past verities, once cherished by the left. Cultural relativism, used to justify opposition to the imposition of bourgeois values, has become the arena of choice for those of the right, who see multiculturalism as the triumph of a moral decay. The book pages were dominated by accounts of the illusory control associated with the populist turn. Take, for example, the Philippines. The blatant denigration of due process in one of the oldest democracies in Asia by a president masquerading on television as a vigilante follows a well-worn rhetorical path. Ayyip Erdoğan in Ankara, János Áder in Budapest and Andrzej Duda in Warsaw, along with Donald Trump in Washington, DC, have used similar tactics to secure the presidential keys of office. In each case, the malleable elasticity of truth has been critical to short-term success. Misrepresenting the size of campaign or inauguration crowds, erroneously claiming the out-going president was not born in the United States, making his very presidency illegitimate, casting doubt on the loyalty of the security services for following due process, these were not opinions. Rather, they were alternative facts. Not surprising the approach forms an increasingly central part of the electoral playbook. Law and Financial Markets Review, 2018 Vol. 12, No. 3, 105–110, https://doi.org/10.1080/17521440.2018.1524233

Just when will a corporation be prosecuted to a judicial conclusion

Following two years of negotiations, a pivotal public–private partnership has released a global code of conduct for the foreign exchange industry. Designed to address a trust deficit within and, more significantly, between it and society, the code enunciates key principles of expected behaviour with global application. While ostensibly voluntary and lacking explicit enforcement mechanisms, the foreign exchange (FX) Global Code has a number of innovative features that warrant attention. It explicitly prohibits activity subject to recent negotiated prosecution agreements in the UK, the USA and enforceable undertakings in Australia. Moreover, the (forced) recruitment of financial firms embeds common conceptions of practice within and across institutional actors by leveraging a shaming mechanism. The imaginative component is matched, however, by an almost complete lack of media and academic attention. This, it is argued, is a mistake. The reform initiative is the most significant yet in changing the culture of wholesale markets precisely because of how it interlocks with law and policy within key markets and questions prior enforcement decisions.

Letter from Sydney: Justin O'Brien

Deferred Prosecution Agreements (DPAs), Non-Prosecution Agreements (NPAs) and Enforceable Undertakings (EUs) have emerged as the preferred regulatory tools to deal with international financial institutions in the aftermath of the GFC. In some ways, this is unsurprising. The externalities in terms of potential job losses associated with licence revocation mandate such an approach, notwithstanding the obvious structural compromises. In part because of the revenue raised and the capacity to avoid costly legal battles with uncertain outcomes, the UK introduced a DPA regime, underpinned by the Crime and Courts Act 2013 (the “Act”). The legislation received royal assent on 25 April 2013 and DPAs became an operational reality on 24 February 2014. While the United States has gained prominence in the debate over deferred prosecutions, the alternative approach canvassed by the United Kingdom offers subtle refinements, which may have the effect of dealing with a real accountability deficit. First, only organisations are eligible for DPAs unlike the US, where both individuals and organisations may be eligible. Second, and from the perspective of enhanced accountability, in the US the judiciary plays a limited role. Under the UK regime, an organisation and prosecutor must appear in a private hearing in Crown Court to gain judicial approval for DPA negotiations. The UK DPA Code has four core purposes. It provides guidance on how to negotiate with potential defendants; how to navigate the interaction with the judiciary; how to evaluate whether the mechanism is in fact fulfilling its objectives; and what to do in the event that the agreement is not seen as effective (i.e. should the terms be varied or should the agreement be voided and the case move direct to judicial adjudication). Among the critical questions raised by the code are whether the evidential and public interest tests are appropriate? What factors should a prosecutor consider and is the proposed level of disclosure appropriate? Should an external monitor be deployed and under what circumstances? These remain unresolved although the overriding emphasis on speedy and full disclosure is a key mediating factor. In January 2017, the President of the Queen’s Bench Division handed out the third such agreement in a case involving Rolls Royce, making it explicit that the risk to employment was a decisive feature in allowing a DPA to proceed, notwithstanding the scale of corruption and bribery revealed (and how long it had been tolerated by the then senior management). The judgment provided more granular evidence of when a deferred prosecution would be accepted. The scale of the fine extracted in the Rolls Royce DPA – 497.25 m STG – should give corporations pause for thought. As Sir Brian Leveson points out, notwithstanding that the reporting followed an initial query from the Serious Fraud Office:

Fixing the Fix: Governance, Culture, Ethics, and the Extending Perimeter of Financial Regulation

The level of public unease at the relationship between the corporation and society shows no sign of abating. Across the world, there is evidence of tension, suspicion and distrust, reawakening questions of political economy, distributive goals and purpose. A growing corruption scandal in Brazil involving the country’s most influential company, Petrobras, and its links to the incumbent president, has brought thousands onto the streets. In Europe, instability informs political discourse in countries as varied as Spain, Portugal, Greece and the Republic of Ireland. Distrust against the establishment informs both the Republican and Democratic primaries. The recent release of the Panama Papers raises questions of professional complicity in the design of sophisticated tax strategies that may (or may not) prove to cross the line between avoidance and evasion. Nevertheless, the outcry has forced the resignation of the Prime Minister of Iceland and the remarkable release of detailed financial information by his British counterpart. All of this suggests there is a fundamental problem with the underpinning social contract between business, intermediating professions and the societal good each pledges to uphold. Corporations and professions are accorded a range of privileges by the communities in which they operate. These range from limited liability and easy incorporation; to monopolies in areas of professional practice; to government funding of some professional and corporate activities; to rights to resources; and, for some industries, like banking, invaluable government guarantees. The Global Financial Crisis and its aftermath, including widespread and systematic manipulation of financial benchmarks suggest not only structural but also cultural problems. Seen in this context, the financial scandals are not the result of a failed and failing culture but the triumph of a particular kind of culture, one that has deep ideational rather than rational roots. Given this baleful reality and rising public unease, it is inevitable that there be a questioning of whether these privileges are warranted and to what extent should society recalibrate the complex interaction between rules, principles and social norms? Addressing these issues requires the contribution of legal regulation, ethical standard setting and institutional design (utilising the skills of political scientists, sociologists, lawyers, ethicists and economists as well as management theorists, practitioners and policymakers). The conundrum is, therefore, not only a pressing public policy but also a corporate priority. It is also fundamental to academic inquiry, across a range of disciplines. These include but are not limited to law, political science, philosophy and applied ethics, economics and management. As such, the agenda for change provides an unrivalled opportunity to build capacity to inform and influence debates on the balance between corporate rights, duties and opportunities. As this journal has consistently argued, structural reform is insufficient to change the cultural settings of the finance sector and its governance. Equally, this journal has sought to advance an agenda based on evidence rather than political posturing. As such it has been supportive of the Fair and Effective Markets Review in the United Kingdom and its exhortation to industry to integrate a normative dimension to corporate mission that is other-regarding. Indeed, this integration has been pivotal to securities regulation from its outset, as detailed in the author’s biography of James Landis, the intellectual progenitor of the modern regulatory state. Landis always conceived the regulatory role as not being a policeman but as a beneficent facilitator of industry’s capacity to secure societal development, a view he also inculcated in a revision to the Harvard Law School teaching curriculum in terms of what constitutes professional obligation. For Landis what was required was not just the teaching of technical excellence but also the enculturation of the public interest; the social licence that informs professional obligation. As we have progressively moved from command and control regulation to market mores, legitimated by associational governance and actor network theory as well as law and economics, we have lost sight of that normative goal. As such we have been pauperised both intellectually and practically. It is to the enormous credit of the Governor of the Bank of England, Mark Carney, that he has placed the social licence to operate at the forefront of policy calibration in the United Kingdom and, crucially, through his leadership of the Financial Stability Board, international discourse. Now for the first time, Carney’s agenda has received overt political backing. This has come in the unlikely form of a former Goldman Sachs investment banker (like Carney himself), who is now Prime Minister of Australia. Malcolm Turnbull used a high profile speech at the 199 anniversary of the establishment of Australia’s oldest surviving bank, Westpac, to castigate the nation’s cash starved but highly regarded banking sector for its myopic approach to social obligation. His remarks are worth reflecting at length.