The Volcker Rule and Barclays’ UK Bear Hug
On Nov. 3rd, I attended the inaugural BBC Today Business Lecture, given by Bob Diamond, the chief executive of Barclays. The man who told the UK Treasury Select Committee that it was time to stop apologising for the financial crisis had been given an image makeover. Taking an ingratiating tone towards his audience of BBC worthies, MPs and journalists, Diamond used words like ‘trust’, ‘citizenship’ and ‘responsibility’. Oozing contrition and sincerity, he peppered his speech with well-calibrated examples of Barclays helping business clients.
Diamond seemed hurt when I stood up at the end and pointed out that Barclays’ track record of selling over-complex products and exploiting opaque balance-sheet tricks made it hard to believe him. The more I thought about it, aside from the change in tone, there was not a great deal of difference between the unrepentant Diamond addressing the Treasury Committee and the contrite version lecturing the BBC. What did nag at me after the lecture was why he was taking the trouble: in particular, publicly disavowing any threat to move Barclays to the US.
The answer came to me last week, when I visited Capitol Hill in Washington DC to give a presentation of my own on the implementation of the Volcker Rule, which bans proprietary trading by US banks. I was invited by the legislative counsel for Sen. Jeff Merkley, one of the architects of the original Volcker Rule bill, and a lobby group called Americans for Financial Reform.
Having read The Devil’s Derivatives, they wanted me to take a look at the detailed version of the Volcker Rule as proposed by the US regulators charged with implementing it. They wanted me to talk about how financial innovation might find ways round the rule, as had happened with other well-intended financial regulations in the past.
In my presentation, I pointed out some loopholes in the Volcker Rule: repo trading, securities lending and spot FX and commodities trading were three examples. Perhaps more dangerous than these three was the portfolio hedging exemption. That allows a single transaction on one side of the trading book to hedge a portfolio of positions on the other. That allows a great deal of hidden proprietary risk to be taken, and was responsible for billions in synthetic CDO losses during the crisis. Although the Volcker Rule tries to eliminate this possibility, the burden on regulators is considerable.
However, the key people I met in Washington DC last week are aware of these issues. Merkley, his Volcker Bill co-architect Sen. Carl Levin and their staffers are trying to close the loopholes and tighten the rules before they come into force. It’s no surprise that investment bankers in the US loathe them with a passion.
Now let’s return to Barclays. The closest thing the UK has to a Volcker Rule are the recommendations of the Independent Commission on Banking, which calls for the ring-fencing of retail banking from commercial banking, investment banking and everything else. For Barclays, which earned about 15 percent of its 2010 revenues from UK retail banking, the recommendations if implemented would be irritating, but they would not be catastrophic. Businesses on the non-retail side of the fence at Barclays would carry on pretty much as they do today.
However, if Barclays switched jurisdictions to become a Fed-licensed bank holding company, the Volcker Rule would apply. Given the relative importance of investment banking to Barclays as a group, the impact of the kind of toughened Rule envisaged by Levin and Merkley would be far more challenging. Better to remain outside of the US and avail oneself of the foreign bank exemption to the rule.
If I was in Diamond’s shoes, I would have made a rational choice as chief executive to keep Barclays in the UK. I accept that this is a question of probabilities. It’s possible that the final version of the Volcker Rule will remain riddled with exemptions. And it’s also possible that the UK law implementing the Commission’s recommendations will be tougher than what Sir Paul Vickers envisaged. Having seen the UK lawmakers in action, and comparing them to Levin and Merkley with their grasp of detail, I wouldn’t bet on it.
Given that Barclays has a balance sheet roughly equal to Britain’s annual GDP, I suspect that the Treasury would prefer to leave the investment bank powerhouse alone, and it might well act to protect Diamond’s franchise from Brussels interference. So Diamond does not have a regulation problem. He does have an image problem, hence his BBC lecture, and his preposterous assertion that British economic growth relies on Barclays’ £1.5 trillion risk-laden balance sheet. The unanswered question is: does the UK have, or will it have in the future, a Barclays problem?