Speech by Callum McCarthy at the The City Banquet, The Mansion House, London 18 Sept

[Amethyst]

Mansion House speech

There is a good poem by the Irish poet Seamus Heaney which has the title “Whatever you say, say nothing”, which is I think a good mantra for the present times.

oh really?

For financial institutions I would draw three particular lessons. The first is the need for greater realism – some would say modesty – about their risk management capability.

The second is the need for greater openness about the position of each bank.

The third............. .....understand the limitations, as well as the strengths, of ratings; recognise that failure to conduct due diligence will have a price; recognise that covenants have a purpose, and loans without covenants carry increased risk.

My very last public duty as FSA chairman is a particularly happy one. It is to recognise the contribution which you, my Lord Mayor, have made through your indefatigable travel, through your incisive pressing of the case for the City and for UK financial services more generally and through your personal embodiment of the great traditions of the City. I ask all my fellow guests to rise to drink to the health of the Lord Mayor and Lady Mayoress.

[TANZARELLI]

Chairman of the FSA Mansion House Speech 18th Sept 2008

Speech by Callum McCarthy at the
The City Banquet, The Mansion House, London
18 September
My Lord Mayor, My Lords, Aldermen, Mr Recorder, Sheriffs, Ladies and Gentlemen. My Lord Mayor, you have been overgenerous in your comments on the fact that, if I can translate your kind and diplomatic remarks into more realistic terms, I am fast approaching my sell-by date. This evening, is positively the last occasion for me to make public remarks as chairman of the FSA. All of you here tonight will be pleased to know that I have no intention to attempt to survey the past five years – the four of plenty and the one of lean – in any detail. Indeed, given the speed of events in the last few days, you will be pleased to know that I do not intend to attempt to review even the past week in any detail. That has already occupied many column inches, and is part of a fast‑moving stream of events which continues to flow rapidly. Any comment runs the risk of being rapidly overtaken by new events. I will simply welcome the decision of the Boards of both Lloyds TSB and HBOS to form a new bank of a size and nature designed to be well equipped to deal with both present and future events. We at the FSA wish the new bank well.
Nor do I wish to join the ranks of those who are confidently predicting the long‑term effects of what has been a sea change in the environment for financial services. In a time of uncertainty and fragile confidence, there is a cost of musing aloud about long‑term issues which are important and uncertain. There is a good poem by the Irish poet Seamus Heaney which has the title “Whatever you say, say nothing”, which is I think a good mantra for the present times.
What is clear is that we now face a sea change in circumstances, and there are undoubtedly immediate, practical and important changes which the financial services industry – and those who supervise it – need to make.
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Let me start with a specific FSA action announced earlier this evening. We have been much concerned – as have many – at the volatility and what I would describe as incoherence in the trading of equities, particularly for financial institutions. There is a danger in a trading system which allows financial institutions to be targeted and subject to extreme short selling pressures, because movements in equity prices can be translated into uncertainty in the minds of those who place deposits with those institutions with consequent financial stability issues. We have seen acute examples of this phenomenon in both London and New York this week. The FSA has therefore decided to introduce a rule which will take effect from tomorrow, to require both the disclosure of short positions on a daily basis in respect of financial institutions; and a prohibition in any active increase in a net short position in a financial stock by whatever instrument. There will be an exception for market makers to enable them to meet client demand.
We intend this prohibition to run in the first instance for some 120 days, during which time we will review both its effectiveness and the general policy we wish to adopt in respect of short selling more generally. This is a measure which reflects the present turbulence in markets. It is designed to have a calming effect – something which the equity markets for financial firms badly need. I hope that practitioners will support both the ambition and the chosen means of achieving it.
Let me turn to what the industry should do. For financial institutions I would draw three particular lessons. The first is the need for greater realism – some would say modesty – about their risk management capability. The present troubles have exposed the fact that very many of the best regarded among the world’s financial institutions had risk management which was not up to the expectations placed upon it. The roll call of firms – banks, broker dealers, insurance companies – whose risk management has been found to be deficient is a long list, and a list that involves many of the finest names in finance. This is not a problem of cowboys, or fringe players. It is something which affects firms at the very core of our financial system, and it is something which requires deep and urgent attention. The industry itself recognizes the changes that need to be made. There is no shortage of diagnosis – by for example the International Institute of Finance or by the Counterparty Risk Management Group under the chairmanship of Jerry Corrigan and Douglas Flint, both of which have made a raft of sensible and practical suggestions. What is now needed is action – implementation, not further diagnosis.
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The second is the need for greater openness about the position of each bank. A central feature of the present difficulties has been a pervasive doubt about the position of counterparties, and a corresponding reluctance to continue to extend credit on the basis that had previously been thought appropriate. We need a more robust framework of transparency, in place and accepted before a crisis develops, which gives counterparties and commentators a fuller and more confident understanding of risk exposures, provisions, margins and reserves. I recognise that some uncertainties will prove difficult to eliminate. But we should aim, before a crisis develops, to have much improved transparency and disclosure, not, as we have had to do this year, catch up after the crisis has developed. I think considerable progress has been made over the last year. We need to build on this.
The third lesson is not for those financial institutions who originate or distribute financial products, but for those who invest in them. Most of the last year’s work has concentrated on the sell side, and the responsibilities of the buy side have attracted less attention. But the lessons for the buy side are of central importance: understand what you are buying; understand the limitations, as well as the strengths, of ratings; recognise that failure to conduct due diligence will have a price; recognise that covenants have a purpose, and loans without covenants carry increased risk. All these are obvious truths. The sadness is that they have so often been ignored by those who are deemed – perhaps surprisingly – to be sophisticated investors.
I think there are equally lessons for central banks and supervisors. Throughout the world there have been regulatory failures which have made the necessary process of reappraising and repricing risk more painful than it need have been. In part these have been general inadequacies in the setting of capital standards, some of which were already being corrected by the transition to the new capital rules established by Basel 2 and the Capital Requirements Directive, and others which are now being addressed by the Basel Committee. In part, these regulatory failures have been specific: a failure to understand the vulnerabilities of particular institutions.
I would add that those failures have occurred in many countries; they have occurred irrespective of whether the regulatory system was operated by the central bank, a separate supervisor or through shared responsibilities; and they have occurred at least as much in countries where the regulatory regime is based on detailed rules as in countries, like the UK, where a more risk-based and principles-based approach is used.
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Let me draw three lessons for regulation from the present difficulties. The first relates to capital adequacy. If, as I believe to be the case, we have placed too much reliance on the ability of managers in individual firms to manage risk, we have therefore underestimated the capital those firms should be required to hold relative to those risks. We need to revisit the question of the capital banks – and, where they exist as separate entities, broker:dealers as well – must hold. And we need to reflect on the fact that, as the economic cycle has turned, capital was not used as a buffer which could properly be eroded but rather was regarded as a measure of bank solvency which in a time of doubt had to be maintained. Now, when banks face pressures of a considerable scale, is not the time to make very significant changes. But, once the present difficulties are behind us, there will be a need to re-examine – and I believe inevitably increase – regulatory capital requirements.
The second lesson is that regulators need to address questions of liquidity (which are more intractable than capital issues) much more closely than hitherto. This is a difficult area, where the policy of different central banks towards what they will accept as eligible collateral when acting as the provider of liquidity both is important, and also varies significantly. For that, and other, reasons I expect national rather than global solutions to be advanced to solve liquidity problems. The FSA is already tackling this, in a way compatible with the Basel Committee’s June recommendations on best practice in liquidity management. But we are pressing ahead on a UK basis, since delay would be costly.
The third lesson for regulators relates to the way in which we conduct our business. The FSA has been determined to up our performance. Supervision of firms has always been at the heart of the FSA's work. Since last August there has been a greater intensity of work being done, particularly in the areas of liquidity and capital information. Supervision teams continue to challenge robustly the assumptions made by Boards and senior management, ensuring that the stress tests they are applying can withstand the most extreme economic shocks. Security of consumers deposits is at the heart of this work as it has always been.
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We have worked hard to implement the lessons we have learned from the review of our supervision of Northern Rock and made changes as to how firms are supervised. I am grateful, my Lord Mayor, for your acknowledgment of the FSA’s determination to set out the facts, and publicly draw lessons, uncomfortable though that may be. We are currently engaged in implementing the supervisory enhancement programme announced as part of the outcome of that review. Our internal processes around supervising high impact firms, including the vetting of the suitability of candidates for the most important posts, have been strengthened, and additional resources have been applied to all deposit taking firms. All this represents a significantly deeper and more intense supervision. It requires supervisors to be proactive, directive and brave in their decision making with firms on a day to day basis. I have no doubt about the determination of Hector Sants and the FSA executive team to deliver the changes in performance which are needed. And I also have no doubt about the rigour with which the FSA Board will monitor progress.
My Lord Mayor, I have set out actions which can – and should – be taken now, by financial institutions to improve risk management, disclosure and investment practices; and by supervisors to change capital treatment, the supervision of liquidity management and our own performance. We at the FSA – a remark which I make in public for the last time – are committed to rapid implementation of what lies within our power to change. I think it essential that those in financial services show equal commitment to prompt improvement. A sea change has occurred. The fact that the full impact of its consequences cannot yet be predicted should not stop any of us from doing those things which are clearly sensible, capable of being implemented and necessary.
My very last public duty as FSA chairman is a particularly happy one. It is to recognise the contribution which you, my Lord Mayor, have made through your indefatigable travel, through your incisive pressing of the case for the City and for UK financial services more generally and through your personal embodiment of the great traditions of the City. I ask all my fellow guests to rise to drink to the health of the Lord Mayor and Lady Mayoress.

http://www.fsa.gov.uk/pages/Library/.../0918_cm.shtml
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Thanks Ame I hadn't realised that you'd already posted it :-)