Are we trying to bolt the financial stable after the money has gone?

This morning I joined a discussion about how to mitigate the risks of financial firms failing. This was prompted by the recent default of MF Global, but there is a growing list that will continue to extend. Other names include Lehman Brothers, Bear Sterns, etc.

In our increasingly complex and joined up world this is becoming more of an issue as the numbers and impact seems to grow day by day. Not long ago the failure of a company was largely a local or national issue, now it is rarely less than an international concern and many are truly global. While the complexity of modern derivatives definitely adds to the worries, the simpler, cash markets ( ie simple trading of straight forward assets such as stocks and bonds for cash settlement) are far from sorted.

The group was drawn from the "post trade" community ie those concerned with recording and settling (ie completing) the deals that have been done. As such it was not surprising that their focus was largely infrastructural ie rules, responsibilities, checks and balances.

I took two things away from this session. The first was the acknowledgement that the rules differ across the world. What may appear to an outsider to be two similar trades (or contracts) may well be governed by very different rules and require intervention by different people. Compounding this is the reality that not even the two parties to the trade may not see the situation in a similar way. These differences are often encased in local legislation and embedded regulation. Changing it is not easy and will take time.

Anecdotally, when the administrators stepped in to mop up at Lehman's, they were surprised(!) to find that their activities would be constrained by a myriad of local rules, regulations and contract law rather than a single over-arching framework.

The call from these post trade practitioners was for a unified set of rules and processes. While this may be the "pure" answer, it is not likely to happen quickly or in my lifetime. Undoubtedly better communication and co-ordination on the event of failure will improve matters and that may be the best interim objective.

The second point was that we are talking about a very smart business community where if a particular rule is seen to impede the realisation of profit, both corporate and personal, then it is likely some bright person will find a legitimate(?) way around that rule. Rules only wok if they are well understood and everyone follows both the intent and spirit of them. That is not the case in the more creative aspects of the financial world, rules can be considered a temporary impediment.

Not matter how good the intent and execution of the post trade practitioners, reliance on the rules seems to me to be an act of to bolting that proverbial stable after the horse has bolted.

Looking back on my career we had earlier "failures" such as BCCI, Robert Maxwell's midnight swim and Leeson's rape of Barings. While I recognise that the world was simpler then, it is true that many businesses, including ones I was involved with, made early judgement calls to either limit or avoid business with certain counterparties. We knew who the less "stable and reputable" brokers were, which banks fell short in terms of professionalism and management was ready and able to act upon market intelligence, most of which proved to be very accurate in hindsight. They did not rely on a computer or a crefit rating agency to say "No" or for the day after to act.

Somewhere we have lost these prudent and good practices, albeit in the name of making it fair for all. In practice we have once again come down to the lowest common denominator not the highest.

HSBC's threat to move its headquarters out of the UK because of what they consider to be unduly harsh capital requirements is interesting they cite the impact of the additional requirements on their already huge profits. As a modern investor do I really want a firm that is seeking to be less secure?

I applaud the attempts to improve matters, but wonder if we are aiming at the wrong target? If so how can we bring the contribution of good and sound judgement back to the fore of our increasingly troubled world?



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