The Stock Exchange in the mid-1980s was … seeking to re-integrate itself into the international market – a market that had now more or less returned to the seamless capital flows that had characterised the pre-1914 world.
David Kynaston, City of London: The History (Chatto & Windus, 2011)
If at first you don’t succeed, consult, consult and consult again. The Bank of England is in the middle of a mammoth exercise to ascertain what the banks and others they think about ‘ring fencing’ proposals that would separate their retail banking operations from their investment-banking arms, the purpose being to shield the former from the problems that the latter are prone to encounter, as happened to such spectacular effect in 2008-9.
What the banks think, by the way, is that they hate the proposals, have always hated them and hope and expect to be able to consult the whole idea to death. Here is what City A.M. newspaper had to say on the subject on 28 September:
Britain’s biggest banks are preparing to ramp up their arguments against government proposals to separate high street and investment banking, ahead of a new Bank of England consultation next month. The banks have long criticised so-called ring fencing reforms, intended to separate retail banking operations from other investment practices. The plans are designed to protect savers and taxpayers from any future crises in the financial sector, yet some lenders say that the ring fencing structure – set to go into effect in 2019 – would disrupt business practices and diminish directors’ accountability to shareholders. With the Bank of England set to open a second consultation on the reforms within weeks, some senior banking figures are stepping up their efforts and are confident that they will get their way.
The consultation runs until 15 January and who would bet on the banks being wrong?
In a sense they have won already. In the immediate aftermath of the financial crisis and subsequent UK taxpayer bailouts (which peaked at £1.2 trillion), there was every sign that banks would be forced to split completely their ‘utility’ operations – the retail business that provides the nation’s financial plumbing – from the ‘casino’ operations, the investment banking offshoots that encompass securities dealing, corporate finance, ‘derivatives’ trading and the toxic-waste ‘collateralised debt obligations’ that helped bring the world financial system to its knees.
Then the banks argued that ring fencing would bring all the benefits of forcibly divorcing the retail and investment sectors. (Ministers agreed.) Now the banks are lobbying against the policy.
In a sense, all of this is a legacy of Big Bang, the 1986 package of City reforms whose 27 October anniversary has just passed. Pre Big Bang, retail banks were not allowed to own securities dealing firms, which were all private partnerships, the partners of which were individual members of the stock exchange. Furthermore, the two types of securities dealers, stockbrokers and stock jobbers, were themselves kept separate under a system, dating back to 1908, called ‘single capacity’.
This meant that the brokers would act solely for their clients, either individual or corporate, buying and selling shares at the best obtainable price. They kept no stock on their own books, unlike the jobbers, who would provide liquidity by making a market in shares but could deal only with brokers, not with clients.
Much has been written about Big Bang (quite a lot of it by me) in terms of how it allowed the City, and the financial services industry in general, to assume a grossly distended economic import, thus pulling British capitalism out of shape. Here, I’d like to concentrate on the misconceived organisational changes and the reckless throwing away of a valuable asset: single capacity and the bulwark it provided against conflicts of interest.
Once brokers and jobbers were allowed to merge, the interests of their own share book and their own trading positions could collide with those of their clients, something impossible under single capacity. This was magnified many times over when a third type of entity was added to the mix: the merchant banks, the institutions that advised companies on their financial needs and guided them round the City.
With a merchant bank arranging, say, a major share issue for Corporation X, there was now nothing to stop the joint entity using its ‘distribution network’ (stockbrokers, in old money) to push the shares on to their clients, whether individual or of the fund-manager variety. Nor, if the issue flopped, was there anything to stop the joint entity using its ‘market makers’ (jobbers, as were) to park a chunk of this stock off the market until the price recovered.
Greatly adding to the scope for mischief was the financial firepower of the new owners of these joint entities, which in many cases were the retail banks. Broker plus jobber plus merchant bank, all owned by a big-daddy financial institution, equalled ‘investment bank’.
There are two curiosities about Big Bang. The first is that at precisely the time that single capacity was being consigned to history on the stock exchange, a few hundred yards to the east another institution was imposing it in response to past conflicts of interest. The Lloyd’s of London insurance market had declared that broking firms, which sought out insurance cover for their clients, had to be separated from the underwriting firms, which provided that cover.
The second intriguing feature is that in the City of the early 1980s, it was vaguely assumed that the years of innovation were in the past, in the late 1960s and early 1970s. The age of the ‘secondary banks’, the asset strippers, and the merchant banks’ Ariel electronic share-dealing system (a pre-echo of Big Bang which was closed down in 1973) had ended unhappily; there was nothing inevitable about what followed. Indeed, the Thatcherite revolution in British banking arose from a mixture of political and regulatory choices and happenstance.
For my part, I shall always be grateful to have been in at what turned out to be the fag end of both the old Fleet Street, complete with leather-aproned printers, hot-metal presses and delivery vans roaring away into the night, and the old City, the titles of whose defunct partnerships now resound with the sort of melancholy once attached to the names of pre-Beeching railway stations: de Zoete & Bevan, Pinchin Denny, Wedd Durlacher Mordaunt, Rowe and Pitman, Ackroyd and Smithers…
But this is not primarily an exercise in nostalgia; rather it is an effort to locate the cause of the destruction of what, for all its faults, was a system with in-built firewalls (as no-one would have said back then) to contain conflicts of interest. As Philip Booth of the Institute of Economic Affairs has argued, Big Bang was primarily about tearing down the existing arrangements – single capacity, plus the minimum commission chargeable on share dealings that provided the financial support to sustain the system – on ‘competition’ grounds. To compensate for the loss of in-built protections, a huge regulatory structure was established. Its success can be gauged from the fact that since 1986 it has required fundamental reform no fewer than four times, giving each version a lifespan of just over seven years.
‘Competition’, alongside its homonym, ‘competitiveness’ (which usually translates as ‘lower wages’), is a key plank in the new state ideology. But unlike ‘diversity’, ‘equality’ and the rest, it largely evades scrutiny. It should do so no more.