Can Europe Make It?

The bail out industry finds its new crisis opportunity: Brexit

But there seems to be a remarkable level of amnesia about the role many of these same firms played recently in the financial crisis.

Sol Trumbo Vila
24 February 2017

Chancellor of the Exchequer Gordon Brown and IMF Managing Director Rodrigo de Rato at the 2005 G8 finance ministers’ meeting. Rato was found guilty of embezzlement and sentenced to 4 ½ years' imprisonment on February 23, 2017. Matthew Fearn/ Press Association. All rights reserved.In every crisis, corporations have sought to find opportunities to profit – and the crisis caused by Brexit is no different. Like sharks circling a sinking lifeboat, in this case the UK facing an unprecedented and deeply intractable and complex breakup with the EU, the so-called ‘Big Four’ audit firms ((EY, Deloitte, KPMG and PWC), have stepped forward along with an array of lawyers, trade experts, lobbyists, management and public relations consultancies, to offer the UK government and other companies expert advice and technical support. Promising to help their clients not only manage risk, but also identify new business opportunities, all the Big Four have set up Brexit teams to cash in on uncertainty.

Promising to help their clients not only manage risk, but also identify new business opportunities, all the Big Four have set up Brexit teams to cash in on uncertainty. EY advises its clients, for example,of the risk of challenges to their supply chains, but also heralds the opportunities of enhanced ‘regulatory freedom’. Firms like Marsh and McLennan and Oliver Wyman are offering clients analysis, scenario planning and risk management strategies that will help them 'navigate a changing landscape'.

There seems, however, to be a remarkable level of amnesia about the role many of these same firms have played more recently in the financial crisis.

Given British taxpayers are likely again to bear the costs of their advice; it would seem timely to look at their recent record. A new report by the Transnational Institute, the Bail Out Business, shows to a shocking decree how the auditing and financial advisory firms not only contributed to the financial crisis by giving the banks they advised and audited a clean bill of health, but were then frequently rewarded with contracts to organise the bailouts of the same banks that often ended up racking up additional costs for taxpayers. It exposes the way in which the global financial crisis was not just a boon to many banks that have largely escaped censure for causing the largest economic crisis in decades; it also proved to be a lucrative new profit opportunity to auditing and financial advisory firms called in by governments to fix it.

The case of Halifax Bank of Scotland (HBOS) in the UK is an exemplary one. Prior to the crisis, like many of its banking counterparts, HBOS had indulged in a reckless lending spree that would eventually lead to £45 billion in bad debt and, after the bank was bought by Lloyds Banking Group, a £20 billion  bailout. Several years before the crisis broke, in 2004, one of its employees Paul Moore, a risk and compliance manager had formally raised concerns about the misselling of millions of insurance policies and reckless lending within the company, and was fired for his efforts. Based on his complaints made to the now defunct Financial Services Authority, KPMG was hired to launch an ‘independent inquiry’ into the case.

They had profound conflicts of interests – not only had they been auditing the bank since 2001, they were also regularly receiving high consultancy fees (£45.1 million between 2003 and 2007.) KPMG, perhaps not surprisingly, concluded that HBOS had appropriate risk controls in place and Moore’s concerns were not warranted. The FSA, of which HBOS director Crosby was deputy chairman at the time, accepted these conclusions and did no further investigations.

Of course, if KMPG had agreed with Moore’s findings, they would have had to admit that their audits were seriously flawed. According to a parliamentary investigation, simple and pervasive failures in risk management should have been easily detected by a quality audit. The costs meanwhile were born by householders who lost homes, workers who lost jobs in the ensuing crisis, and taxpayers who ended up bearing the £20 billion cost for the bailout.

Many similar cases involving the same firms can be found across Europe. In Spain, Deloitte was fined by the government for serious irregularities and Lazard accused of making offshore payments to the ex-president of Bankia, Rodrigo Rato. The mess left Spanish taxpayers with a bill of €16 billion. In Cyprus, a secret contract with financial advisory firm Alvarez and Marshall is under investigation after it was revealed that the Central Bank had signed a contract that stipulated that the firm would receive 0.1 percent of the entire recapitalisation costs of Cypriot banks, amounting to nearly €16 million (the total recapitalisation cost of Cypriot banks was €15.7 billion). In the Netherlands, the Dutch government hired Lazard (at a cost of €3 million for a few days work) to advise on the bailout of ABN AMRO, yet the firm somehow failed to mention that the bank had outstanding debts, which should have been deducted from the overall payment. Due to this omission, the Dutch state had to inject another €6.5 billion into the bank to keep it afloat. The controversies surrounding so many bailouts in different EU countries shows that this is a systemic problem.

The controversies surrounding so many bailouts in different EU countries shows that this is a systemic problem. It is due in part to the fact that the very small group of audit and financial advisory firms have effectively become an oligopoly. The Big Four, PWC, EY, Deloitte and KPMG, commonly known as ‘the Big Four’, audit ninety eight per cent of FTSE (London Stock Market Index) 350 audits. Many firms worked with clients for decades – until 2015, 120 years in the case of PWC and the UK bank, Barclays. As well as providing auditing services, the Big Four also offer other financial consultancy services to banks and companies, which discourages audits that challenge a financially lucrative albeit reckless business model.

New EU regulation, approved in 2014 and implemented in 2016, has sought to address this. It prevents auditors providing certain financial consultancy services to the same clients. It also requires banks and listed companies to change auditors periodically. This will reduce the worst conflicts of interests and abuses. However fierce lobbying by the corporations succeeded in weakening the constraints (the required rotation period for banks and auditors was extended significantly from the proposed 6 years to 10 years, with an optional additional 10 years after an open tender for selection, and 14 years in cases of joint audits). Fierce lobbying by the corporations succeeded in weakening the new EU constraints.

The major flaw, though, in the EU proposals is that they do nothing to address the enormous market concentration of the bail out business, nor to tackle the major imbalance of resources (both financial and technological) between the banks and their regulators.

With the financial crisis, the world realised to its costs what happens when huge swathes of the economy are controlled by reckless private corporate actors while the public sector lacks both the political will as well as the financial and technical capacity to regulate. The dark irony is that as governments scrabbled desperately to bailout banks in the late 2000s, wondering how to better regulate a sector they no longer understood, they were forced to turn for advice to the very same oligopoly of auditing and financial advisory firms who had played a role in creating the crisis.

Britain faces the same challenge with Brexit, where public capacity to develop a strategy for a sustainable economy outside the EU is severely limited, forcing the government to turn to the bail out industry for help.

The trouble, as we learnt with the financial crisis, is that when you turn to sharks to save you, there is one likely result: the taxpayer and the public will get eaten.

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