3â New Labour and a new policy

Three weeks after the 1997 general election, Gordon Brown, then Chancellor of the Exchequer, announced that work would begin on the reform of the regulatory structure created under the FSA 1986.28 The government had outlined its intention to reform the system in 1995,29 and proclaimed that ‘we propose to make the SIB directly responsible for the regime broadly covered by the 1986 Act’.30 This was emphatically re-emphasised in 1997 when the Labour Party pledged that ‘as the guardians of other people’s money there needs to be effective supervision and regulation of the industry’.31 However, it must be noted that the Conservative government had previously asked the then Chairman of the SIB, Andrew Large, to conduct a review of its effectiveness in 1992.32 Similarly, in 1994 the Treasury Select Committee also conducted a broad enquiry into financial services regulation.33 Following the announcement in May 1997, the

23A self-regulating organisation was defined as an organisation that ‘regulates the carrying on of investment business of any kind by enforcing rules which are binding on persons carrying on business of that kind either because they are members of that body or because they are otherwise subject to its control’. FSA 1986, s.8(1).

24Fisher and Bewsey above, n 2 at 28.

25For a more detailed discussion of self regulation under the FSA 1986 see Gower above, n 11, at 13–17.

26 Fisher and Bewsey, above n. 2, at 16.â 27â Gower, above n. 11, at 18.

28HC. Debs. cols. 508–11, 20 May 1997. See also S. Bazley, ‘The Financial Services Authority: risk based regulation, principles based rules and accountability’ (2008) 23(8) Journal of International Banking Law and Regulation 422.

29 HC Debs. cols. 1184–5, 14 December 1995, Alistair Darling.â 30â Ibid.

31Labour’s Manifesto: Equipping Britain for the Future (London, 1997).

32Securities and Investment Board, Financial Services Regulation: Making the Two Tier System work (London, 1993).

33Treasury and Civil Service Committee The Regulation of Financial Services in the UK, HC 332-I, 1994–1995 (London, 1995).

In addition to its historical significance, the following statistics highlight the importance of the financial services sector to the economy.45 In 1996, the financial intermediation sector contributed 6.4 per cent, or £42.7 billion to the United Kingdom’s gross domestic product.46 In 1999, over 1.17 million people were employed in the financial intermediation sector.47 In 1998, the typical daily turnover of foreign exchange in the United Kingdom was approximately £380 billion. This was almost more than that of the United States, Japan and Singapore combined.48 It is also interesting to note that more companies are listed on the London Stock Exchange than on the Tokyo or New York Stock Exchanges.49 In 1998, the annual turnover of the London Stock Market was £1,037.1 billion, making it the world’s third largest stock market. In 2003, the United Kingdom produced over 40 per cent of the world’s turnover in crossborder foreign equity trading.50 The UK private equity industry accounted for 47 per cent of the total annual European private equity investment in 2003.51 According to a 2005 study by the Centre for Economic and Business Research, the City of London accounted for ‘41 per cent of all city-type financial services in the EU’.52 In 2005, HM Treasury reported that:

the UK financial services sector also contributes directly to output, employment, trade and productivity in the UK. It accounts for over 5 per cent of UK gross value added, one million jobs and a trade surplus of 1.6 per cent of GDP. Moreover, there is evidence that it is a source of higher-than-average productivity within the UK, and that productivity within the sector is growing faster than in the economy as a whole.53

The British Bankers Association (BBA) reported that ‘the UK’s financial industry has grown faster than any other business sector over the past ten years’.54 The Chief Executive of the BBA, Angela Knight, stated that ‘financial services are the powerhouse of the UK economy: a massive contributor to the Exchequer through tax, an employer of more than a million people directly and one of the UK’s last acknowledged world-leading industries’.55

In light of the above evidence, it is essential that the United Kingdom has an effective financial regulatory environment that protects investors and safeguards a significant contributor to the economy.

45 HM Treasury Financial Services Report, above n. 41, at 5.â 46â Blair, above n. 8, at 14.

47International Financial Services, International Financial Markets in the UK (London, 2004).

48Blair, above n. 8, at 7.

49HM Treasury Financial Services Report, above n. 41, at 9.

50Ibid.â 51â Ibid. 10.

52Centre for Economics and Business Research, The City’s Importance to the EU Economy 2005 (Corporation of London, 2005) 35.

53HM Treasury Financial Services Report, above n 41, at 18.

54British Bankers Association Press Release, ‘Financial services sector tops UK growth tables’; 18 January 2008, available at www.bba.org.uk. See also National Statistics News Release ‘Financial services top growth sector 1996 to 2006’, Economic and Labour Market Review, 14 January 2008, available at www.statistics.gov.uk.

55BBA Press Release, above n. 54.

417 3â New Labour and a new policy

banks rapidly expanded their lending to property companies in the early 1970s’.90 However, the growth was short lived when the government decided to implement a restrictive financial policy in 1973. As a result, the public’s confidence in the secondary banking sector began to wane, and depositors began to withdraw their savings. The Bank of England responded by creating the ‘Control Committee of the Bank of England and the English and Scottish Clearing Banks’, which provided financial support and became known as the ‘lifeboat’.91 In practice, this meant that any lending risks were equally shared amongst all members of the Committee. Dale pointed out that ‘by August 1974 total lifeboat support approached £1.2 billion, representing 40 per cent of the participating banks’ capital. Beyond this, the banks were not prepared to go, with the result that any further assistance had to be provided by the Bank of England at its own risk. During this period some banks that had received liquidity support now faced insolvency.’92

(ii)â Johnson Matthey Bank

Johnson Matthey Bank faced collapse in 1984 and highlighted the inadequacies of banking regulation under the Banking Act 1979.93 This bank began to have financial problems in 1984 after it decided to lend to a small number of customers who faced financial problems.94 The Bank of England became aware of the difficulties in 1984 when it was informed that the bank needed extensive financing to prevent its collapse. The Bank of England decided that this bank could not be allowed to collapse and it formulated a financial rescue package of £245 million. Additionally, Johnson Matthey Bank was able to raise £130 million from its own diminishing resources.95 The light-touch approach adopted by the Bank of England had resulted in Johnson Matthey Bank being able to breach the safeguards put in place by the Banking Act 1979 by distracting the Bank of England’s attention away from its financial problems.96 Ellinger et al. took the view that ‘if JMB had been subjected to the more stringent supervision which applies to licensed deposit-takers, its financial difficulties would have been discovered earlier’.97 They added that ‘following the JMB affair, the question of bank supervision was reviewed by a Committee set up by the Chancellor in 1984 and chaired by the governor of the Bank of England’.98 It is important to note that Johnson Matthey Bank’s difficulties led to the enactment of the Banking Act 1987.

90R. Dale, ‘Bank crisis management: the case of the United Kingdom’ (1995) 10(8) Journal of International Banking Law 326, 327.

91Ibid.â 92â Ibid.

93E. Ellinger, E. Lomnicka, and R. Hooley, Ellinger’s Modern Banking Law (Oxford University Press, 2006) 33.

94 Dale, above n. 90, at 327.â 95â Ibid. 328.

96D. Lewis, ‘The Banking Bill: between Charybdis and Scylla’ (1987) 2(1) Journal of International Banking Law 49, 50.

97Ellinger et al., above n. 85, at 98.

98Ibid. 33.

(iii)â Barlow Clowes

A graphic illustration of the inadequacies of the approach towards financial regulation was the collapse of Barlow Clowes. The company was created in 1973 by Peter and Elizabeth Clowes,99 and operated out of Jersey due to a loophole in the UKs tax regime. When the loophole was closed by the Finance Act 1985, the company was renamed Barlow Clowes International and moved to Gibraltar. Barlow Clowes International offered investors a tax efficient and low risk scheme which proved to be extremely popular, more so than its predecessor. A large percentage of the money that was invested in Barlow Clowes International ‘found its way into loans made to companies connected with Clowes and his associates or was used to buy yachts and property’.100 The Department of Trade and Industry (DTI) appointed inspectors to investigate the operations of Barlow Clowes International when it became disturbed about its activities.101 The evidence collected by the inspectors resulted in the SIB obtaining a court order that compelled Barlow Clowes International to be wound up and it was subsequently placed into liquidation in 1988.102 Johnson described the incident as ‘a sorry tale of how thousands of investors, many of them elderly and retired, stand to lose substantial sums of money’.103 The two companies had amassed £190 million from approximately 20,000 misled investors.

Following the collapse of the company, many MPs referred complaints from local constituents to the Parliamentary Commissioner for Administration (Ombudsman).104 The nature of the complaints related to actions by the DTI under the Prevention of Fraud (Investments) Act 1958.105 The report by the Parliamentary Ombudsman highlighted several areas ‘in which there had been significant maladministration by the DTI’.106 These included an error by the DTI, who on four separate occasions allowed Barlow Clowes to continue operating without a licence as required under the Prevention of Fraud (Investments) Act 1958.107 By 1984, when the DTI had finally accepted that Barlow Clowes

International had been operating without a licence, its decision to allow the company to continue trading also amounted to maladministration.108 In

99G. Drewry, and R. Gregory, ‘Barlow Clowes and the Ombudsman: Part 1’ (1991) Public Law (Summer) 192, 193.

100Ibid.

101The inspectors were appointed under the FSA 1986, s.106.

102Drewry and Gregory, above n. 99, at 193.

103H. Johnson, ‘The Barlow Clowes affair and government regulation’ (1989) 7(8) Journal of International Banking Law 114 114.

104V. Younghusband, ‘Financial regulation: the Barlow Clowes affair’ (1990) 5(3) Journal of International Banking Law 7676. For a full commentary on the findings of the Parliamentary Ombudsman, see Parliamentary Commissioner for Administration, Second Report of the PCA: the Barlow Clowes Affair, HC 76 (London, 1989/1990).

105For a more detailed discussion of the potential liability of the DTI, see S. Vaughan, and P. May, ‘The Barlow Clowes affair’ (1988) 7(3) International Banking Law 34, 36–7.

106Younghusband, above n. 104, at 76.

107Prevention of Fraud (Investments) Act 1958, s.1.

108Younghusband, above n. 104, at 76.

419 3â New Labour and a new policy

December 1989, the then Conservative government, without admitting liability, announced that it was prepared to make significant payments to those people who had lost money after investing in the two companies.109

(iv)â BCCI

One of the most infamous banking collapses in the United Kingdom was Bank of Credit and Commerce International (BCCI) in 1991. The bank was established in Pakistan, incorporated in Luxembourg in 1972 and in 1976 it opened its first office in the United Kingdom.110 BCCI applied to the Bank of England to be legally recognised as a bank under the Banking Act 1979. The Bank of England refused to do so, but nonetheless granted it a licence as a deposit-taking institution under the Banking Act 1979.111 The Bank of England mistakenly relied on regulation provided by the Luxembourg regulatory authorities and decided not formally to regulate BCCI itself.112 Arora pointed out that during this period further memoranda passed between the officials of the bank, drawing attention to the fact that the real place of business of BCCI SA was London and that the Bank of England should be its primary supervisor.113

The first concerns regarding the operations of BCCI were raised by an international group called ‘the College’. According to Arora ‘this group expressed concerns about a large concentration of exposures due to the group’s lending and the effect on the group’s activities of the arrest of seven of its officials in Tampa, Florida, in October 1988, on charges of drug trafficking, conspiracy and money laundering’.114 The Bank of England was informed by Price Waterhouse Coopers (PWC) that the auditors were unable to sign BCCI’s 1989 accounts due to financial irregularities.115 Towards the end of 1990, PWC became aware of the fraudulent activities of BCCI’s directors and were asked by the Bank of England to investigate the allegations.116 Some seven months later, the Bank of England sought to close down

BCCI,117 and in 1991 the bank collapsed, leaving a vast amount of debt under a shadow of allegations of fraud. Hemraj noted that ‘BCCI was deliberately rigged to avoid effective regulation. Generally speaking, despite being an

109For a more detailed commentary on the government’s response to the findings of the Parliamentary Ombudsman, see G. Drewry, and R. Gregory, ‘Barlow Clowes and the Ombudsman: Part 2’ (1991) Public Law (Autumn) 408, 415.

110A. Arora, ‘The statutory system of bank supervision and the failure of BCCI’ (2006) Journal of Business Law (August) 487, 490.

111Ibid. 490.

112This was permitted under the Banking Act 1979, s.3(5). This was amended by the Banking Act 1987, s.9(3), which however, continued to allow the Bank of England to rely upon the regulators in Luxembourg.

113 Arora, above n. 110, at 490–1.â 114â Ibid.â 115â Ibid. 490–2.

116Price Waterhouse Coopers were asked to investigate the activities of BCCI under the Banking Act 1987, s.41.

117Arora, above n. 110, at 492.

(v)â Barings Bank

The collapse of Barings Bank in 1995, one of the United Kingdom’s oldest banks,126 with approximately £927 million in losses, is associated with the illegal actions of Nicholas Leeson, otherwise known as the ‘rogue trader’. Nicholas Leeson opened the famous ‘88888’ account to offset losses and unauthorised transactions he made whilst undertaking unlicensed trading on the Singapore, Osaka and Tokyo Stock Exchanges between 1992 and 1995.127 Kane and DeTrask took the view that proprietary trading by Nicholas Leeson destroyed Barings Bank.128 Kornert stated that ‘the Barings crisis of 1995 is regarded as one of the most spectacular international events in the banking world in recent years’.129 According to Dale, ‘[a]t the end of February 1995 Barings, an old-established United Kingdom merchant banking group with total assets of around £6 billion and deposits of some £3 billion, faced collapse, having incurred massive losses on unauthorised derivatives transactions undertaken through its Singapore trading unit’.130 The outcome for Barings can be contrasted with the collapse of Johnson Matthey Bank because the Bank of England refused to bail out the bank. Following its collapse it was sold to the Dutch bank ING in 1995 for a symbolic £1.

Barings Bank was regulated by the Bank of England under the Banking Act 1987 and although it was not directly responsible for regulating the overseas subsidiaries of Barings, the Bank of England had to rely upon the reputation and the financial stability of the parent company.131 The Bank of England can be criticised because it ‘knew about Barings’ extraordinary profitable activities in Asia, [but] it accepted the bank’s explanation of volatile arbitrage trading between the Asian Exchanges’.132 Dale argued that ‘there could be no doubt that the collapse of Barings, with ensuing losses to depositors, would inflict considerable damage both on London’s reputation as a banking centre and onÂthe credit standing – and therefore competitiveness – of UK merchant banks’.133 TheÂcollapse of Barings Bank clearly demonstrated fundamental weaknesses in the regulatory approach of the Bank of England.

(vi)â Equitable Life

The near collapse of Equitable Life straddles the regulation of the Bank of England and the FSA. The firm misled its policy-holders over a ten-year period

126J. Kornert, ‘The Barings crisis of 1890 and 1995: causes, courses, consequences and the danger of domino effects’ (2003) 13(3) International Financial Markets, Institutions and Money 187, 189.

127Ibid. 197.

128E. Kane, and K. DeTrask, ‘Breakdown of accounting controls at Barings and Daiwa: benefits of using opportunity-cost measures for trading activity’ (1999) 7(3–4) Pacific-Basin Finance Journal 203, 206.

129See Kornert, above n. 126, at 196.â 130â See Dale, above n. 90, at 330–1.

131See Kornert, above n. 126, at 204.

132Ibid. 204. For a more detailed discussion of the regulatory failure behind the collapse of Barings Bank, see L. Proctor, ‘The Barings collapse: a regulatory failure, or a failure of supervision’ (1997) 22 Brooklyn Journal of International Law 735.

133See Dale, above n. 90, at 330–1.