Monthly Archives: February 2014

Banks: Victims, crooks or conspirators in a cosy cartel?

Banks behaved irresponsibly in the late nineties and the early part of this century , and by their irresponsibility put the whole world at risk in 2008. True or false?

I will argue three things in this article. Firstly, that the behaviour of many banks was stupid and reprehensible but easily explained. Secondly, that this behaviour of some banks was predictable, was anticipated and was an entirely excusable reaction to the incentives the governments had created. Thirdly, that it was the behaviour of governments at the time and since which was really stupid, counter-productive and has put the world’s financial system at risk of melt down.                                                                                      

The easy bit is to identify, with the benefit of hindsight, the mistakes of the banks. Egged on by accountants they had enthusiastically sold their balance sheets for ever decreasing amounts of money to take ever increasing risk. Much of this was transferred off their balance sheets into financing vehicles (SPV). Because, with the encouragement of regulators and accountants they could pretend they had no liability for SPVs, their capital strength was hugely flattered. Whether it was property lending or sub-prime mortgages, ever decreasing margins or even dodgier credits varied between banks but the common factor leading them to perdition was the imposition under the guise of creating a level playing field of very specific detailed regulatory constraints on assets (which for banks approximately equates to lending and most importantly doing this in the same way in every major international banking location. Of course no amount of detailed regulation forced the banks to behave like Gadarene  Swine – but it was a predictable (and predicted) reaction to enforcing uniformity of solvency and accounting rules that all banks would make the same mistakes at the same time as they would have the same experts telling them to react to the regulatory environment in the same way. So when one made massive ‘profits’ by funding SPV at low cost to buy high yield assets off balance sheet they all did. The pursuit of illusory profits (not to mention real bonuses based on the imaginary profits) made them forget Mark Twain’s eternally sound advice that one should be more interested in the return of ones’ principal than the return on the principal.

So the first part of the statement is absolutely true – banks behaved stupidly in the early years of this century – they believed that the profits they were making were real when they were not. But this is nothing new, as long as there have been banks they periodically swing from caution to excess and find creative ways of losing their shirts; most often based around inflated property values induced by their own activity. There are so many historical instances that there is no space to record them here but 1972 and 1992 were recent UK instances. Ironically one of the star players in each were local authorities, ranging from Cambridge to the Highlands and Islands, and Government Departments including the Audit Commission.  It is not normally foolish old ladies who are gullible and place money with fast talking flashy banks offering unbelievably good interest rates as much as their elected representatives: Kent £50m; Norfolk £32m; Cambridge £9m; (and in case you think it is only a blinkered local government accountant who can be so silly, Oxford University £30m) were among the depositors with Icelandic banks named by the BBC in 2008. Little old ladies are more difficult to part from their money than bureaucrats from our money.

But was it this stupidity that put the world at risk, if the world was indeed at risk?

The lemming like tendency of banks to rush together over some financial cliff is one of the first things which any economic historian learns. Every few years banks have a cycle of prudence and difficult credit being gradually succeeded by easier lending, growing profits leading to increased competition and to lending to ever worse borrowers. When the music stops banks go bust, credit tightens and the cycle renews itself. Because such fluctuations do not occur in a vacuum but have (sometimes severe) consequences on the money supply and therefore economic activity, governments have for some time tried to intervene to reduce the fluctuations. There are two significant problems with this. The first is the knowledge that governments will intervene removes market discipline. So if you know you will be protected from bankruptcy, why not deposit with Icelandic banks for an extra few per cent even though they are clearly over extruded?  The second is that when banks are going bust the government will try hard to save them and the only easy way is to persuade other banks to take them over (so Lloyds was pressured into buying Bank of Scotland, etc.). Successive rounds of crisis in the UK (1972, 1992 and 2008) led to fewer banks. The bigger the bank the easier it is to regulate or suborn, and the more complex and detailed the regulation the greater the economies of scale in meeting the requirements. But there is more. Foolish behaviour is unpunished – when Co-op Bank was persuaded to take over a failing bad debt riddled Britannia Building Society who got to run the Bank? There is no managerial reward for caution. Nor is there the profit which should be there for wise bankers when foolish ones are bankrupted. And if by some chance those who ran their business prudently do make extra profits the government will probably invent a special levy to confiscate them. (Somewhat over £2bn a year under George Osborne). Or worse – both in the USA and the UK banks who acceded to the urgent request of the authorities to rescue their foolish competitors have been subjected to massive fines (JP Morgan fined $13bn) for activities of those they rescued which took place prior to the rescue. But the banks do not complain because their boards and executives would be much worse off if there were true competition in the banking industry. The fact is that a cosy cartel suits both governments and banks; the only people who suffer are taxpayers, businesses and future generations.

By 2008 OECD governments had brought about a situation where all their major banks were more similar in their balance sheets than ever before. They had encouraged the view that boom and bust had been abolished and had implicitly promised they would write out huge cheques to any bank in difficulties. The crisis was indeed waiting to happen – but the reason it was so close to doomsday for financial markets was simply that when governments were needed to write out cheques their credit had gone. A banking crisis should be followed by a government bail out in the world of cosy cartels. But that requires governmental credit to be good and when financial markets saw the size of the bills they quickly appreciated that in the words of Liam Byrne the Chief Secretary to the Treasury of the last Labour Government “I am afraid there is no money left.”  Quite simply, the rule that deficits in downturn should be followed by a surplus when the economy recovers had been comprehensively flouted. Deficits everywhere had ballooned, and the prospect of huge additions to government debt was met with horror by all financial markets. And it was this lack of credibility which threatened a breakdown of the financial system. It was patently obvious to all that Iceland with a GDP under $10 bn could not bail out banks with liabilities of $50bn and clearly Greece, Spain, Ireland and Portugal came under the same sort of classification. Even in the USA and the UK there were those who doubted whether the credit rating of the Government would stand up to the demands of bailing out the New York and Edinburgh banks, so large was their existing debt.

It was therefore not the banks, not the bad debts or stupid laxity in lending and absolutely not the lack of regulation which made a perfectly normal financial crash into a worldwide crisis; it was the failure of governments to control their own borrowing which meant they were incapable of calming down the markets. A lender of last resort must have total credibility and they had lost that. This added to their previous actions to remove competition which had made banks so large that their failure was too horrible to contemplate, and the introduction of the Basel Accords which led to the same problems in every major international banking sector happening simultaneously. Taken together, the failure to control their own balance sheets and the eagerness to control banks’ balance sheets almost led to financial meltdown. That is the truth of 2008. The scary thing is that today governments are still running immense and unsustainable deficits; they are still encouraging ever larger banks and they still promulgate ever more complex rules rather than putting in place a fiscal and regulatory regime which would promote competition and smaller banks. Until they do this we will be condemned to ever worse crises and a continued risk that next time the UK will not be able to survive them.


Points of View for Week Ending 21/02/2014

This week Oliver Phillips focuses on McColl’s Retail Group…

Stocks in Focus: McColl’s Retail Group

Royal Mail grabbed the headlines at the end of 2013 for being publically floated on the stock market for the first time.  Indeed, whilst not many are as well-known or widely publicised as the Royal Mail, these initial public offerings (IPOs) happen fairly regularly and we often take a closer look at companies coming to the market to see if they are offering an opportunity to long term value investors.

Last week took a look at the McColl’s Retail Group IPO.  McColl’s is the second biggest player (behind Tesco) in the UK convenience store market, which is growing at around 5%pa thanks to demographic and structural lifestyle trends.  Traditionally these have been in the form of newsagents, but as newspapers are a declining business the shops have become orientate towards essential foods and wine.  The business hinges on convenience, as typically prices will be higher than supermarkets; however people would rather walk to the local McColl’s then drive to the supermarket.  In order to grow faster than the market it is adopting a three-pronged strategy: converting some of its existing stock of newsagents into more profitable food and wine convenience stores; converting some of its standard convenience stores into more profitable “premium” stores with a wider variety of products and competitively priced own-brand options; and the acquisition of independents.  Beyond this the group attempts to differentiate itself from the competition through location (its stores are typically located in neighborhoods rather than high streets) and integrated services ((e.g. Amazon collection points, Post Offices, PayPoint) that drive footfall.

There can be several reasons why a company may choose to raise money by floating shares on the stock market.  In the recent IPO of McColl’s Retail Group, the main reasons were to reduce expensive debt, allow for increased capital expenditure for its growth strategy, raise the overall corporate profile of the group and provide an opportunity for existing shareholders to realise value. 

So what use is a Chairman and a Board of Directors?

In a recent article ‘The Times’ suggested that Reverend Paul Flowers, the disgraced Chairman of the Co-operative Bank, was selected using the Myers-Briggs personality test. Without necessarily agreeing with the use of a test, in their words “invented by two amateur psychologists who had read the work of Jung” I do strongly suggest that the observation they quote that “I would be a lot more interested in their knowledge of finance and regulatory matters” is complete and utter rubbish.

In my commercial life I have been blessed with several amazing Chairmen of companies I have worked for. Some were successful in their own right at running companies, some even knowledgeable about some aspects of the business they chaired. But I absolutely would not expect any correlation between their knowledge of the detail of the business and their success as a Chairman. Indeed the best Chairman I ever served under was spectacularly bad at talking to employees; he took no real interest in clients or new business and often would scarcely read board papers. But his ability to run a Board (and he was Chairman of a small bank as well) was phenomenal. He could see who wanted to speak – and ensure they did; he could tell when discussion was needed and, just as important, when it was not. He would make the most senior executives quake in their boots if they failed to do what they should on time, and make it clear that nothing apart from top class performance was acceptable. He would see through any attempt to gloss over a problem and unerringly single out the weakest point in a proposal. All of this by observation of the members of the Board and by making others ask questions or point out problems. It would not matter if a company he was chairing was making ball bearings, banking or managing investments – he would hold the Board together and ensure that they presided over a top quality operation. 

Having said the job of the Chairman is not to run the business but to run the Board, I would go on to say that there are probably worse and more dangerous misconceptions about the job of the Board itself. Lord Justice Mummery in the Court of Appeal is quoted as recently saying “A director of a company is appointed to direct its affairs. In doing so it is his duty to use his position in the company to promote its success and to protect its interests”. As one might hope from one of Britain’s best legal brains, this quote covers everything a Board should do – it sets direction, promotes success and protects the interests of the company on behalf of the shareholders who constitute the company. I would observe that many boards, probably the majority, not just the banks, totally fail to do this – and if the company prospers as often as not it is in spite of the Board rather than because of it. And it is the job of the Chairman more than anyone else to try to keep the Board on track – it is only he who can hold directors back from the sort of detailed decision making which is disastrous if taken in committees rather than delegated to decision makers with relevant skill sets. It is the Chairman who should (but all too rarely does in a modern PLC) ask “does this need to come to the Board? Are we going to improve the prospects for the company if we debate this subject?” Only if the Board restricts its discussions to those matters of vital interest to the future of the company can it give those issues the attention they merit.

A Board meeting will never be a useful place to make decisions about anything – it is a place where decisions can be validated and ratified or, on occasion, vetoed. If you belong to or attend a meeting where the Board is trying to make a decision you should consider resigning at once. The saying “the camel is a horse designed by a committee” is one of life’s most useful metaphors because any committee will tend to coalesce around the lowest common denominator. Often it will agree on a second best course of action because the best will always encounter more opposition if it is radical or far reaching in its consequences. Paradoxically this is where a good Chairman can be fatal – because he may have the skill set to help develop a consensus decision – which will almost inevitably be wrong. The search for consensus is a human characteristic to be admired in many private and social circumstances but in a business environment it is the main cause of many established companies’ decline or financial disaster.

A Board can be dysfunctional in many ways but some of the most common are mistaking the interest of the executives for those of the owners, mistaking Pension Fund and Institutional investment managers for representatives of shareholders, mistaking growth in sales for growth in profits and mistaking the world of accounting for the real world. A good Chairman will ensure that the primacy of shareholders interest is at least occasionally remembered and encourage the Chief Executive to keep some check on the proportion of earnings consumed by senior executive remuneration. Good Chairmen are few and far between. 

The Board as a body does best if it restricts itself to allocating responsibility for decisions to the right executives or, in extremis, delegating a decision to a very small group of those most qualified to decide. The full Board can then review, ask questions and make suggestions – or indeed send the proposals back for further development – but it should always recognise it is there to direct, not to make decisions or execute them. Directing is the process of pointing people in the right direction – not of telling them how to get there. The best Chairmen will always guide the Board away from detail, will try to keep conversation about the wood not about the individual trees, and will keep directors focused on discussion which will make a difference to the future of the company. He needs a certain personality to do this, not a detailed technical knowledge, and criticism of the Reverend Paul Flowers’ appointment on the grounds that it was made because of an assessment of his personality is completely wrong. He may or not have had the capability to run a board well, and the circumstantial evidence is that he did not, and the Myers-Briggs tests may be out of date and ineffective but I would back a psychologist’s assessment against financial services industry exams as evidence of suitability to chair a bank any time, even though I chair an exams board.

To view the article on Cambridge News please go to page 72 & 73 

Who is responsible?

Is it fair for a landlord to be held responsible for something their tenant has done?

In 2008, a contractor visited a rented property to carry out emergency work on a boiler. He made his way upstairs to work, but on hearing a loud noise he quickly made his way downstairs, but unfortunately he fell and hurt his ankle.

The tenant had removed the stair banister in 1991. There had been several visits by contractors to the home to carry our maintenance without any incidents. No reports were made to the landlord regarding the hazard and no action was taken to replace it.

This was the case known as Hannon v Hillingdon Homes Ltd 2012. Hillingdon defended the action taken against them under the Defective Premises Act regarding Mr Hannon’s injuries. They claimed that the Act did not apply to them because:

  • The banister and handrail were not part of the building structure 
  • They were under no duty to replace 
  • The tenant removed the handrail and banister *they were not notified of the defect

The ruling went against Hillingdon because the court decided that the staircase and banister form part of the building structure. It was consider that the landlord should have been aware of the fault due to the number of visits over the years, and they should have arranged its repair.

How can insurance help?

Insurance can help protect a landlord in the event of an incident that could lead to a third party taking action against them. In some cases, agencies can also take legal action, such as environmental health.

A landlord is expected to protect tenants and the public against injury or damage to their property, by maintaining their premises. A property owner is expected to manage the risk of accidents in order to prevent them. Once notified of a defect, the landlord is expected to make arrangements for the repairs to be carried out by a competent person. If the tenant is aware of the defect but does not report it, courts have reduced claims made due to the contribution of negligence on the tenant. 

Property Owners Insurance will generally provide protection in respect of the landlord’s legal liability for accidental injury to tenants and other individuals and accidental damage to property belonging to third parties. If the landlord is employing anyone, Employers Liability insurance will be required. Property Owners Liability will not provide cover for employees when carrying out their duties as an employee. 

The landlord needs to ensure the limit of cover selected is adequate for any claims that may be brought against them.

It is important to select the correct level of cover. A Property Owner’s Liability policy would pay claims up to the limit of indemnity selected per event. Due to the potential cost of awards for personal injury rising, it is usual to select a £5M limit. If an incident happened and the claim went beyond the limit of cover selected, the owner of the property would be liable to pay the excess.

Things to consider in selecting the limit would include the type of tenant occupying the property and the number of people who may be affected by a single incident. 

If the property attracted high profile tenants such as professional footballers or other high earning individuals, the cost of loss of earnings and other damages that could be claimed from injury would potentially mean a claim on excess of £5M. 

An incident that involved many individuals at the same time would also mean a larger claim that would exceed lower limits such as £1M and £2M limits. 


It is also important that you ensure contractors working on your property are adequately insured. A faulty boiler could cause an explosion that potentially could be catastrophic in terms of damages. Any claim brought against you for injury in an incident like this, would result in your insurer claiming from the contractor’s insurer. This is known as ‘subrogation’ in insurance terms. 

We always advise using a broker to help you choose the right level of cover. If you consider after reading this article you wish to increase your limit of indemnity mid-term it can be organised easily and is often much lower in cost than you may think. 

For more information on our insurance services please contact Debbie McIntyre on 01223 720214 or email or visit

Points of View for Week Ending 14/02/2014

This week Oliver Phillips focuses on Rolls-Royce…

Stocks in Focus: Rolls-Royce

In light of its poorly received full year results announced last Thursday, I am this week focusing on Rolls-Royce, the world’s second largest manufacturer of aircraft engines.  Alongside the 2013 results, chief executive John Rishton warned that Rolls-Royce will see flat revenues and underlying profits for 2014 year (the first time in a decade).   This disappointing guidance for 2014 was broad-based across its Civil, Defence and Marine divisions, although guidance for the Defence segment, which is being hampered as western governments continue to curb back on their defence spending, was particularly gloomy.

On top of this, the results came a day after news that an investigation by the Serious Fraud Office – which has been in talks with Rolls-Royce since December 2012 regarding some of their intermediaries’ activities in Asia over the past 20 years – has resulted in the arrest of two suspects on bribery and corruption charges.   This matters to investors as, if prosecuted, Rolls-Royce may be required to pay a heavy fine and/or overhaul its compliance procedures.  The short-term outlook has therefore turned somewhat sour and investors reacted with their feet on the day of the results, causing the share price to tumble by 14%.  The longer-term story remains intact though; double-digit earnings growth is expected to return from 2015 on the back of strong prospects for its Civil Aerospace division, which contributes nearly 50% of group profits. This is another scenario in which investors must weigh up long term attractions against short term problems that may yet worsen.

Boom-time for IPOs

Recently the press has been full of articles about companies looking to raise money by coming to the market and listing on a Stock Exchange.  These are known as Initial Public Offerings (IPOs) or “Floating” on the Stock Market, and 2013 was the year when IPOs made a huge comeback.  For the UK it was the best year since the start of the financial crisis with bullish equity markets underpinning IPO demand.  Two of the most high profile listings were Royal Mail in the UK and Twitter in New York.

This trend looks set to continue into 2014 with a large number of companies looking to float including high street names like Poundland, Pets at Home, Game Group, Fatface, House of Fraser, and Phones 4 U to name but a few.  The first quarter of the year is a popular time for retailers to come to the market, after the crucial Christmas and New Year trading periods have finished.  Reportedly there are about 60 companies looking to raise about £15bn by April this year.

For fund managers this is a challenging time with the sheer number of companies looking to float putting strain on time and resources.  Fund managers have to analyse the companies, judge whether they want to invest in the new issue and if the IPOs are keenly priced.  They also often have to consider whether to sell established, existing investments to fund purchases of new shares. 

So far this year equities haven’t sustained their 2013 rally, as evidenced by the recent market set-back.  Although signs of economic recovery are encouraging, companies now need to focus on growing their revenues so this can feed through to employment and wage growth to support the recovery going forward.  It remains to be seen whether the appetite for IPOs will be maintained in light of a less buoyant stock market backdrop. 

Points of View for Week Ending 07/02/2014

This week Oliver Phillips focuses on BG Group…

Stocks in Focus: BG Group

This week I am discussing BG Group, which began life as an offshoot from the then recently privatised British Gas in 1997.  Since then it has been transformed into a leading international energy business focused on oil exploration & production and LNG (liquefied natural gas).  In the medium to long term the company looks well-placed to begin reaping the rewards of heavy investment in its world class assets in Australia and Brazil.  In the short-term, however, there is much uncertainty.  First, investors have grown impatient waiting for production from these star assets to come through.  Second, the group’s sizeable Egyptian operation has been impacted by the recent problems there.  Indeed, the shares took a sharp dip in late January when CEO Chris Finlayson issued a statement declaring “force majeure” in the region due to violence resurfacing and the authorities starting to divert more and more gas to fuel domestic electric power generation (away from servicing BG’s gas export contracts).  The unrest has also led to maintenance problems and issues of late payment by the Egyptian government for the gas they are using.  As a result, production guidance for 2014 has been reduced and impairment charges taken against the assets.  The question for investors is whether the medium to long term attractions of BG’s portfolio outweigh the danger of these short term uncertainties becoming more problematic.