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26 June 2012
Senior FSA regulator: 'Can you say no to four or five times your salary?'

A regulator says the FSA needs both outsiders with fresh views and ex-insiders like him who can cut through bullshit

By Joris Luyendijk

He is a softly spoken Englishman in his mid-30s. We meet in Canary Wharf near the office of the Financial Services Authority (FSA), where he's working as a supervisor.

"I find comments about bankers as 'money-grabbing bastards' off the mark. It's not the people who are bad: it's the culture that builds up all these material expectations. People come in, they see that the successful people are the arseholes, and they imitate this kind of bigoted, mouthy person in the hope of getting ahead, too. When I was still working in a bank, sometimes we'd go to the pub and, under the influence of alcohol, a colleague's real personality would come out – a completely different person sometimes.

"Banks are fundamentally amoral places. They are not immoral; morality simply has no part in the decision-making process. They talk about 'reputational risk', not about right and wrong decisions – sanitising vocabulary. I remember from my days in the bank that, if I voiced an opinion based on moral considerations, I'd get looked at as if I was an alien.

"The perception is that the FSA is sort of the B-team, those who didn't make it in, or into, the banks. It really doesn't seem like that at all, on the ground. There is more room to be eccentric at the FSA, certainly, as the culture is less conformist. But B-team? Just ask recruiters – they give us job offers at banks all the time.

"The biggest misunderstanding about the FSA? That we're incompetent, or in the pocket of the banks. True, before the collapse of Lehman Brothers and the undoing of the UK economy, regulation was not as stringent. Regulators work in the framework set by the government. You might say we fell for the temptation to get fixated on details, rather than ask the big fundamental questions.

"On an investigation, the ratio of FSA regulators to internal compliance staff at a bank is 40 to 1, easily. You get fairly junior FSA staff facing panels of very senior officers and bank managers. The banks will always have more resources. I've never experienced attempts at poaching, where banks would signal I'd get a job if ... It wouldn't make sense, anyhow, as I am supervising one particular bank but my skills can get me jobs at a whole range.

"There are perhaps 1 million people working at financial institutions in the UK, while the FSA has 4,200 staff. That's not exactly man-to-man marking, is it?

"I have always been centre-left in outlook and money is not the reason I joined the FSA. There's no one at the FSA who couldn't make 30% or 40% more working for a bank. As I said, I used to work for one. If I had stayed, given the path I was on, my pay would be in the region of two or three times more than what I am now on.

"We're driven by something else, at the FSA. I had become disillusioned at my bank. My friends from university are all teachers, doctors, police offers. I found myself increasingly embarrassed about what I did. I suppose the public-sector background of my social circle kept me grounded. I was always ambivalent, even though I was good at it. Without wanting to fly my own kite, I was always getting reviews saying, 'Exceeds expectations,' and that sort of thing.

"Also, I just wasn't into luxury goods. The way it works for so many is that you fall into this industry, it is high-profile and the money is quite good; you get intoxicated and over time you get trapped. I remember reaching a point when I thought, 'If I don't move out of the bank now, I never will.' Then I thought, 'Where can I use my skills usefully?' Answer: at the regulator. Lots of my colleagues at the FSA have been in banks. You need a mix – outsiders whose fresh perspective allows them to ask the simple big questions, and former insiders like me who can cut through the bullshit that banks feed you.

"What we do is policing work, essentially, which we call 'close and continuous supervision'. We are assigned to a particular bank, and have regular meetings with senior management, usually the managing directors – most people in the industry won't have any contact with us. The goal is to understand the risks they're undertaking. You identify an area of concern, then drill down to the granular-level details. The key is to see whether they themselves understand their risks, then make sure they're addressing them.

"In the past it was too easy to regard the banks – maybe not as our clients, but there was a degree of regulatory capture. These days it's a lot less cosy.

"You have exposure to top people in banks straight away, interacting with them. That's a double-edged sword. You gain experience, but that makes it very attractive to go back to the bank. It's not as if you would need to apply. Recruiters get hold of your CV and make offers on behalf of banks. It's easy to understand why. I know exactly how the regulators work and what they want banks to do. I know precisely how bad it needs to get for a bank to be referred for enforcement, and then I know exactly what happens in that case.

"Banks offer really good people at the FSA a lot of money. We lose some people and retain others. That's the true test of character, if you can say no to earning three, four or five times your current salary. Think about school fees and housing prices in London. By taking this job, I definitely turned away from the lifestyle I was heading towards.

"Ultimately, as supervisors, we rely upon self-declaration, upon what is presented to us by a bank's internal management. But often they don't know what's going on, because banks today are so vast and hugely complex. I don't think I have ever been deliberately lied to – though obviously I might not know about it.

"The real threat is not a bank's management hiding things from us: it's the management not knowing themselves what the risks are, either because nobody realises it or because some people are keeping it from their bosses.

"You hear about traders and salespeople whose bonuses should be clawed back when a complex financial product blows up. But most of the time the sales people have no idea what they're selling. So why aren't more people going after the designers of those complex financial products, the structurers and product management people? They got it past their internal risk and compliance people by presenting them with a sanitised version of whatever they had built, rounding off the risky edges and making it seem simpler and safer than it is. Then these risk and compliance people present it to us.

"The only way to reduce risk is to increase transparency. Without that, the real risks will remain bubbling under the surface. Is the sector fixed, after the crisis? I don't think so. As you saw with the JP Morgan loss recently, there's always a degree of inherent risk.

"From where I stand, the crisis is more cock-up than conspiracy. Bank management is in conflict, as what is good for the long term of the bank or the country may not be what is best for their own short-term career or bonus.

"Also, there's a culture of fear: if you get something wrong, a ferocious blame game follows. If you are regarded as a 'golden boy', the crucial thing is not to drop the ball. You're in the slipstream up towards the top, and the last thing you want to do is commit yourself to risky decisions. People are not managing their bank: they are managing their careers.

"What we have now, that's what you get with free-market capitalism – consolidation of all wealth into fewer and fewer banks, which end up dividing up the market as a cartel.

"And yes, if you threaten to take that down again – assuming this were possible – they threaten to leave the country. 'Regulatory arbitrage' they call it – isn't that another great sanitising term? It means playing off regulatory areas against one another.

"You need to realise that most banks have thousands of corporate entities, spread out over lots of countries. All they need to do is trade as a different entity and it would no longer be in the UK.

"Would firmer regulation physically drive the banks out, depriving London of their spending? I find these threats a form of economic blackmail or terrorism. You can't tax rich people or they'll leave. You can't regulate the banks or they'll pack up. I think we should call their bluff. Britain is a beautiful woman who doesn't know how pretty she is. Bankers have families; they have wives who don't want to live in Dubai or Switzerland.

"Is Labour making this point, as the opposition? Well, it's hampered by the past. For Labour to change tactics now would be to admit they've been wrong. That's very hard. But I'm sure there's more political room to put pressure on the banks.

"Where might the next black swan be swimming? In derivatives, probably. That remains a big problem. No one knows the liabilities with derivatives. When they 'go against you' and you start losing lots of money, you can't just unwind them and close the position by selling, because nobody will want them. Derivatives often have high levels of complexity, meaning you need time to work out what they're worth. Time adds more risk.

"With shares, your maximum loss is that they go to zero. With derivatives, your maximum losses can be almost infinitely bigger. Say, I bet £10 that Munich will beat Chelsea by 1-0. My maximum potential loss is £10. But now I bet £5 for every goal that Chelsea concedes. Obviously, I will have worked out the mathematics, knowing how many goals are scored on average in a match like that. But my potential for losses is almost open-ended.

"What's more – and here the analogy breaks down – events on the pitch between Chelsea and Munich are not influenced by my taking out a bet. But derivatives derive their value from the 'underlying asset'. That asset is traded. When the market discovers that you have placed this bet, and that you want to get rid of it, they will try to make you pay.

"It would be like the players of Chelsea learning about your bet and attacking with extra zeal."

More voices

"We are assigned to a particular bank, and have regular meetings with the managing directors." Read here about those opposite the regulator's table. This managing director is in mergers and acquisitions (buying and selling of companies), this one in corporate finance (helping companies to raise money), and this one used to do Equity Capital Markets (helping companies float on stock market).

"Why aren't more people going after the designers of those complex financial products?" This derivatives structurer was on 800k a year. He says: "structurers are like snakes."

"Then these risk & compliance people present it to us." This risk & compliance officer says: "Arse-covering is a major element if you want to survive in finance."

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