The world has been hit recently by a tsunami of corporate disaster. Then came the LIBOR scandal. Although interest has waned, the full story is yet to come to light. Lawyers, regulators and governments are taking action. Talk of ‘culture change’ is common but what does this mean? And will piecemeal changes prevent the next catastrophe?
An accurate diagnosis of this systemic financial fraud is critical. That means understanding six key drivers:
Lack of concern for negative externalities. Traders and executives had little reason to worry about the possibility of fines paid by the corporation (ie, shareholders) and even less reason to worry about the huge wider costs. Some $800trn (€633trn) of loans and derivatives are based on the LIBOR rate and their validity is now being rightly questioned. Indirectly, the scandal was the nail in the reputational coffin of bankers in general and London in particular.
Narrow conception of risk. The rigging was so complacently engineered – the FSA uncovered many e-mails from traders requesting specific rates – that bankers could not have appreciated the risks. This wilful blindness was clearly a major reason why the practice became endemic.
Regulatory capture. An incestuously close relationship between regulators and bankers is also at the heart of this crisis. Some at Barclays believed the Bank of England had requested lower submitted rates. Other regulators received tip-offs from Barclays’ compliance officers and had discussions about LIBOR manipulation as early as 2007.
Organisational learning disabilities. The global financial crisis has had little impact on the mindsets of the political and banking ‘1%’. At Barclays, for example, investigations into the manipulation of Californian energy prices, the financing of UK tax avoidance schemes and accusations of fraudulent misrepresentation in Canada, was not enough of a wake-up call to boards and investors.
More systemically, action on obvious causative factors including incentive schemes that reward socially irresponsible risk-taking has been pathetic. Warren Buffet has repeatedly warned about the danger of derivatives – the source of incentivised bid-rigging – but decision-makers do not listen, even today.
Leadership and governance failures. The choice of Bob Diamond as CEO at Barclays is a perfect indicator of these learning disabilities. Early in his career, at CS First Boston, he reportedly resigned over an inadequate bonus of $8m (€6.3m). At Barclays Capital he bought Lehman Brothers when Barclays itself could have gone under were it not for the last-minute injection of capital from Qatar. Once appointed, he is said to have berated the board for its 6.6% return on equity target: it should have been at least 13%, he said. Unsurprisingly, the ‘individualistic bonus-driven ethos of the trading floor’ thrived.
Shareholder value fundamentalism. Underpinning much of the above is the ideology of shareholder value maximisation. Since shareholders invest in the most valuable companies, companies do all they can to keep their share price rising. Fully 73% of shareholders voted to allow Diamond’s final pay cheque. And knowing that sell-side analysts did not consider corporate governance an issue, buy-side clients and asset owners did nothing to change this deeply flawed link in the investment chain.
This brief system diagnosis tells us much needs to be changed. While politicians and regulators have been embarrassed by this scandal, it is the general public that has been hit by a triple-whammy, as end beneficiaries of the investment system, bank customers and tax payers. Now, more than ever, investors must learn and adapt, as Andrew Haldane, executive director for financial stability at the Bank of England, says. Investors are the virus that currently enables dysfunctional market behaviour. But investors could, instead, inculcate a long overdue change of culture and help prevent or at least mitigate the next ‘preventable surprise’.
Raj Thamotheram is an independent strategic adviser, co-founder of PreventableSurprises.com and president of the Network for Sustainable Financial Markets. Henry Campbell-Smith is a solicitor at Janes, a London-based law firm