FSA seeks deal veto rights, sanctions for errant bank chiefs

U.K. financial regulators should have veto powers over major banking deals with a domestic component, while bank executives who run their institutions aground should face sanctions, the Financial Services Authority said Monday in its long-awaited report about the near-failure of Royal Bank of Scotland Group plc.

Royal Bank became the U.K.'s largest casualty of the financial crisis in November 2008 and remains 83%-owned by the state after £45 billion ($70 billion) in bailout funds. Missteps at the bank culminated with the disastrous €71.1 billion ($94.4 billion) purchase of ABN Amro Holding NV in October 2007 following a bid battle with Barclays plc as markets peaked.

The FSA called the ABN takeover a "misjudgement of catastrophic consequences," though it acknowledged that Royal Bank may have imploded even without the purchase.

The FSA noted that it has no legal power to bar takeovers by U.K. regulated institutions of peers outside its jurisdiction and said that awareness shaped its oversight of Royal Bank's consortium purchase of ABN Amro.

Responsibility for change in control at the Netherlands' institution lay with De Nederlandsche Bank, the FSA noted, but the U.K. regulator conceded it should have done whatever it could to intervene more aggressively because of "the unprecedented scale of the proposed acquisition."

As lead consortium member, Royal Bank stumped up financing for the deal equivalent to 61% of its Tier One capital as of Dec. 31, 2006, it noted.

"Even under existing powers the FSA has, since the crisis, changed its approach to the oversight of major acquisitions, demanding, for instance, that firms prove that they have the capital resources to meet large and uncertain risks," it said. "We believe, however, that there would be merit in making it a formal requirement that banks obtain regulatory approval for major acquisitions (relative to the size of the acquiring bank)."

Addressing the subject of hostile bids, the FSA added that "there remain public policy issues about whether contested takeovers by banks should require the FSA's formal approval, indeed whether contested takeovers by banks should be allowed at all."

The FSA also called for greater regulatory powers to police advisers to major acquisitions. "The recommendation here is that the FSA should consider whether and how the board of a firm considering a major acquisition should obtain independent advice, from an adviser whose remuneration is not linked to successful completion of the transaction."

The FSA noted that Royal Bank's once-feted former CEO, Fred Goodwin, has in material terms gone largely unpunished for missteps at the Edinburgh institution, as has Royal Bank's former investment banking chief, Johnny Cameron.

"The fact that no individual has been found legally responsible for the failure begs the question: if action cannot be taken under existing rules, should not the rules be changed for the future?" asked FSA chairman Adair Turner in a statement accompanying the report. "In a market economy, companies take risks on behalf of shareholders and if they make mistakes, it is for shareholders to sanction the management and board by firing them. But banks are different, because excessive risk-taking by banks, for instance through aggressive acquisitions, can result in bank failure, taxpayer losses, and wider economic harm. Their failure is a public concern, not just a concern for shareholders."

The FSA slammed the structure of the ABN transaction and the inadequate due diligence that allowed it to happen. The regulator noted, though, that Royal Bank had warned at the time that it had only limited access to information at its target.

After the purchase, Royal Bank of Scotland, whose auditor was Deloitte LLP, was too slow and too tentative about writing down collateralized loan obligations, including those inherited from the Dutch bank, the FSA found.

As expected, the report concluded that Royal Bank's near-collapse was "ultimately" caused by poor board and management decisions, but the regulator also acknowledged flaws in its own supervisory role, including "incorrect assumptions about the stability of the financial system." It attributed these in part to "a backdrop of political pressures for a 'light touch' regulatory regime" under the leadership of Prime Minister Gordon Brown.

The FSA said Basel III regulations, which will come into force by 2019, would have made Royal Bank unable to launch the bid for ABN Amro. It also said the U.K.'s new regulatory regime, which from the end of next year will separate regulation of banks' conduct from so-called prudential regulation, including oversight of capital adequacy and liquidity, will address the fact the FSA had earlier last decade focused on the former at the expense of the latter.

Its policy recommendations are likely to feed into the Financial Services Bill, a draft of which was pubilshed for consultation on Dec. 6.