Afternoon:
10°c
There is an inconvenient truth that may eventually get in the way of the good story about HBOS and its sacked whistleblower. Ignored in the frenzy of the witch-hunt is that the bank failed not because it ignored Paul Moore's concerns, and treated him badly - though it appears to have done both those things - but because liquidity in the wholesale markets dried up. Moore had nothing to say about this. His concerns were elsewhere. What worried him turned out to be not the most pressing problem.
It is not widely known, but is relevant, that senior executives of HBOS had sought to engage the Financial Services Authority for three years prior to its collapse in an effort to get the regulator to take liquidity seriously. The board of the bank understood it would be vulnerable if its ability to roll over up to £12 billion of loans in the wholesale market somehow became impaired, albeit there had been no major dislocation in the wholesale markets since before the First World War.
But the FSA just did not get it. According to the HBOS executives, the regulator was not interested in liquidity - its obsession was with solvency, and the risks the bank was taking in its retail lending.
This appears to tie in with Moore's concerns. His comments since this came into the public domain relate almost entirely to the aggressive sales culture of the bank in the retail area. In this, he may well have been right to be worried, just as one was concerned at that time with Northern Rock offering 125% mortgages.
But this is part of the wider explanation of why so few people saw the crisis coming. It underlines how we - regulators, compliance officers and the media - were looking at the wrong end of the business, at the flow of money out, not at the security of supply of the money flowing in. We thought the failure would come from the way the banks were lending money. In fact, it came from the way they were borrowing it - from their reliance for funding from other banks in the wholesale market rather than from traditional retail deposits.
That said, HBOS surely has some questions to answer about Moore and about the quality of its audit committee and its processes. One of these could focus on the appointment as an adviser to the audit committee of John Ormerod, managing partner of Arthur Andersen in the UK when the firm was brought down by Enron. The committee was chaired at the time by Charles Dunstone, joint founder of Carphone Warehouse and a man who by his own admission was not an expert in the risk control of banks.
The irony is that neither was Ormerod well-versed in such matters. He was not a financial services group partner in his time at Andersen, and was described by one of his colleagues from that time as "never having done a bank audit in his life". However, he was, and is, a close friend of Sir James Crosby.
The other peculiarity is that Moore's complaints were referred to KPMG for further investigation. This was odd because KPMG was HBOS's auditor, and would therefore have been highly embarrassed if any of Moore's allegations were proved to be true, because it would have reflected badly on the auditor's own assessment of internal controls and suchlike. For this reason, best practice is not to appoint the auditors to review the effectiveness of what amounts to their own work.
The desire not to avoid such a conflict of interest may have accounted for the other oddity: the KPMG review was allegedly not carried out by the main team in the KPMG financial services practice but by others less versed in the ways of the bank, and might or might not have been as thorough as a result.
All of which underlines why it would have made far more sense for the audit committee - under the guidance of Ormerod - to have appointed a different firm.
Pre-emptive action needed
It keeps being suggested by people who really ought to know better that institutional shareholders are being somehow unreasonable in these troubled times when they insist on the maintenance of their pre-emption rights.
This is the requirement that any board seeking new equity capital should give its existing shareholder base first refusal on whether or not to subscribe.
One thing we should have learned in recent months is that management cannot always be trusted to do what is in the best interests of their shareholders. Another is that boards need to be more responsive to shareholder criticism.
Pre-emption underpins both these principles. Conversely, the more casually boards try to ignore pre-emption — as Rio Tinto is currently by raising money from China — the less likely they are to listen to shareholders on anything else.
It's time for a simple addition to the corporate governance code. Any chief executive trying to ignore the pre-emption principle in future should automatically be dismissed by his colleagues.
