2Setting up the HBOS review
23.Initially the regulators did not plan to undertake a review into the failures of either RBS or HBOS, despite the significant amount of taxpayer money used to save both institutions. In the case of RBS, the FSA’s first response was to limit itself to a 298-word statement following the conclusion of its enforcement action.49
24.The Treasury Committee at the time viewed the FSA’s approach as inadequate, as it did not acknowledge the significant public interest in the RBS case. Consequently, the Chairman of the Committee wrote to Lord Turner, the then Chairman of the FSA, to seek a commitment from the regulator that it would agree to conduct a more in-depth study into the failure of RBS.50 The FSA accepted the Treasury Committee’s view that it should undertake a full review into the collapse of RBS. In a later evidence session, Lord Turner acknowledged that the FSA should have realised that the case of RBS deserved a “public accountability report.”51
25.Following this change of policy, the Treasury Committee also pushed for the FSA’s report into RBS to be bolstered by the input of independent reviewers. These would be industry experts, appointed by Parliament, with a mandate to oversee the regulators’ work. They would offer guarantees as to its quality and impartiality. The Committee viewed this as necessary because a central component of the reviews would be an assessment of the regulators’ actions, both before and during the financial crisis, meaning that, without this independent review, the FSA would be marking its own homework.52 The FSA agreed to this condition and the Treasury Committee in the last Parliament appointed two experienced practitioners to the roles of independent reviewers.53
26.By calling for both a review into the failure of RBS and the use of independent reviewers, the Treasury Committee established a precedent for undertaking reviews of other major bank failures. In 2011, Lord Turner acknowledged this and its relevance to HBOS in a letter to the Committee, saying “there is therefore a public interest in knowing what happened at HBOS as well as at RBS.”54 This led the FSA to launch a separate review to understand the reasons behind the failure of HBOS.
Appointment of the review team
27.The FSA agreed to conduct a review into the failure of HBOS in 2011. However, Lord Turner indicated that work on the review would not start until the FSA had concluded its enforcement actions in relation to HBOS.55 In a hearing with the Committee in December 2015, following the publication of the final reports, Andrew Bailey (at the time the CEO of the Prudential Regulation Authority) defended this decision, arguing that it was the result of legal advice.56 The consequence was that the FSA did not fully begin work on the HBOS review until September 2012, almost four years after the bank had failed.57
28.In the intervening period the FSA, with Treasury Committee involvement, agreed the underlying terms of reference for the HBOS report.58 The purpose of the review was defined as being to achieve three things:
Explain and describe: why HBOS failed; the supervision of HBOS;
Assess the FSA’s enforcement investigations following the failure of HBOS
[ … ] ;
Inform a wider internal and public understanding of the causes of failure during the crisis (to the extent not already covered by the RBS report).59
29.The regulators’ review was to be overseen by a sub-Committee of the FSA Board chaired by Sir Brian Pomeroy, a non-executive director at the FSA.60
30.The preparation and publication of the review’s final report was complicated by the coming into force of the 2012 Financial Services Act. The Act determined that the Financial Services Authority would be split into two new bodies: the PRA and the FCA. The initial view of the regulators was that the review should be taken on by the FCA. However, the Treasury Committee disagreed with this approach given that prudential policy and banking supervision, which were arguably the most relevant policy areas in relation to the failure of HBOS, would sit within the PRA. As a result, the regulators eventually agreed that the report would be jointly published by the PRA and FCA; responsibility for the production of the report was transferred to a Steering Committee of both the FCA and PRA Boards. As before this Steering Committee was chaired by Sir Brian Pomeroy (who became a NED at the FCA) and included Board members from both the FCA and PRA.61
31.After officially commencing work in September 2012, the report then reached the Maxwellisation stage in July 2014, the process whereby those who stand to be criticised in a public report are given an opportunity to respond to criticisms prior to publication. Following this, the report was then re-Maxwellised in the summer of 2015, a further opportunity for those criticised in the report to respond if the nature of the criticism had changed from the original draft. The report was eventually published in November 2015.62 A full timeline is in box 1 below.
Box 1: Key events in HBOS failure and review
|
Timeline of key events |
|
|
Date |
Event |
|
|
|
|
September |
HBOS formed from the merger of Halifax and Bank of Scotland |
|
|
|
|
July |
Andy Hornby becomes Group CEO of HBOS |
|
|
|
|
July |
Sir Hector Sants replaces John Tiner as CEO of the FSA |
|
|
|
|
April |
HBOS announces £4bn capital raising |
|
October |
HBOS seeks emergency liquidity assistance, receives £11.5bn in government support |
|
|
|
|
January |
Lloyds TSB acquires HBOS, HBOS announces pre-tax loss of £10.8bn for 2008 |
|
March |
FSA commences enforcement investigations |
|
|
|
|
December |
FSA publishes report into failure of RBS |
|
|
|
|
September |
FSA begins work on the HBOS report |
|
|
|
|
January - December |
Independent reviewers appointed and begin work, PCBS publishes own HBOS report |
|
|
|
|
January |
Andrew Green QC appointed to lead independent enforcement review |
|
July - November |
Maxwellisation of HBOS reports begins |
|
|
|
|
November |
Reports published |
Source: PRA and FCA, The failure of HBOS plc (HBOS), 19 November 2015
Role of the independent reviewers
32.As in the case of the RBS report, the Treasury Committee insisted on the use of Committee-appointed independent reviewers for the HBOS review. The intention behind their use remained the same: to provide Parliament and the public with the assurance that the regulators’ report was a fair and balanced assessment of the available evidence. In 2013, the Treasury Committee in the last Parliament accordingly appointed Stuart Bernau and Iain Cornish as the independent reviewers - their terms of reference, published on 1 March 2013, were set as:63
To review and report on the extent to which the FSA report on the failure of HBOS is a fair and balanced reflection of the available evidence; [and]
To review and report on whether the FSA’s report is a fair and balanced summary of the [Financial Services] Authority’s regulatory and supervisory activities in the run up to the failure of HBOS.64
33.Although the Treasury Committee appointed the independent reviewers, they remained free to interpret their terms of reference as they saw fit. Both confirmed this in their written evidence to the Committee, noting that they had seen no evidence to support the view that the Committee had “orchestrated” the review.65 They similarly stated that they had received “no direction from the Chairman”, on how to carry out their work or how to reach their conclusions.66 Both independent reviewers also sought to emphasise that, despite the earlier PCBS study into the failure of HBOS, their conclusions were based solely on the evidence that they saw themselves, noting that this “extended beyond that available to the PCBS”.67
34.The Financial Services Authority failed to instigate a full review into the collapse of HBOS and RBS. This is extraordinary in itself. They resisted doing it even after strong prompting from Parliament. The unacceptability - not just to specialists following this issue, but also to a wider public - of their original decision not to undertake a full review eluded them for too long.
35.It is regrettable that the FSA (and subsequently PRA & FCA) agreed to undertake these reviews only following sustained pressure from the Treasury Committee over a number of years. In the case of the HBOS reports, the Treasury Committee insisted on the innovative arrangements originally used for the RBS review, with Committee-appointed independent reviewers given the task of overseeing the regulators’ drafting of the reports.
Impact of the independent reviewers
36.As detailed in their written evidence to the Committee, the independent reviewers had a significant impact on the content and direction of the PRA/FCA report. First, they noted that early on in the review process they were quick to identify the need for additional analysis and material for certain sections of the report, including submitting over a thousand detailed comments on the preliminary drafts.68 This covered a significant range of topics such as the requirement for a more detailed analysis of loan quality within the Corporate division and an assessment of the extent to which the Capital Requirements Directive (CRD) IV framework might have prevented HBOS’s failure.69
37.A second area of focus for the independent reviewers was testing both the process by which the PRA/FCA review team reached its conclusions and whether the Maxwellisation process was fair. In the case of the latter, the independent reviewers noted the processes adopted by the review team had been “reasonable and robust”.70 On the former, the independent reviewers identified more problems in the early drafts of the review, particularly in section four of the report, which covered the FSA’s supervision of HBOS. This included instances when the early drafts were structured in a way that appeared inappropriately to “soften” the report’s conclusions regarding FSA supervision.71 The independent reviewers also highlighted that the evidence-gathering process for the section on FSA supervision was not always consistent with that for the sections on HBOS. One example was the fact-finding interviews, conducted by the PRA/FCA team working on the HBOS review, with former FSA staff. The independent reviewers felt these interviews had a more “sympathetic” tone compared to those conducted with former HBOS staff by a third party for the other sections of the report.72
38.The third area of intervention by the independent reviewers was in the part of the PRA/FCA report covering the original enforcement action taken by the FSA against HBOS executives following the bank’s failure. Both reviewers noted in their written evidence to the Committee that this was the part of the report over which they had “greatest concerns”.73 This reflected their disquiet over the proposed scope of the chapter on enforcement and concerns over whether it would address the central issue of whether the original enforcement process had considered a wide enough range of HBOS executives for potential investigation. In evidence, Iain Cornish stated:
The first draft was very superficial. Even a cursory look at the underlying raw material highlighted the issues that Andrew Green has highlighted. It was not obvious at all why decisions had been reached. That was the only section of the first draft that we saw that had been written not by the review team but by members of the enforcement team, so we felt very queasy about that.74
39.Having reached this conclusion, the independent reviewers recommended that this part of the review should be run independently of the regulators and should include an assessment of the reasonableness of the FSA’s enforcement actions.75
40.In evidence to the Committee, Sir Brian Pomeroy suggested that concerns with the early drafts of the enforcement section may have reflected the fact that the initial terms of reference only asked for an explanation, not an assessment, of the FSA’s enforcement actions; he added that the drafts had also not yet been reviewed by the HBOS report Steering Committee. Nevertheless, Sir Brian accepted, with these caveats, that the initial drafts of the enforcement section had been “self-exculpatory”.76 The independent reviewers’ initial concerns were evidently justified.
The Green report
41.The Treasury Committee and regulators acted on the recommendation of the independent reviewers to have an independent person undertake the review of enforcement.77 Andrew Green QC was appointed to lead the enforcement review in January 2014, which was subsequently turned into a separate report.78
42.The terms of reference stated that Andrew Green’s report should “assess the reasonableness of the scope” of the FSA’s original enforcement investigations, and also offer an opinion as to whether the “regulators should consider afresh whether any other former members of HBOS’s senior management should be subject to an investigation with a view to prohibition proceedings”.79 A protocol agreeing the details of the management of the Green report was shared with the Chairman of the Treasury Committee.80 Andrew Green’s report was eventually published alongside the PRA/FCA report in November 2015. Its findings are discussed more fully in Chapters 3 and 5 of this report.81
43.The decision to appoint Stuart Bernau and Iain Cornish as independent reviewers proved to be of great value. The independent reviewers revealed that the first drafts of the HBOS reports had been superficial. In the case of the enforcement section, they had such grave concerns that they argued this particular section should be written independently of the regulators. An impartial assessment of the FSA’s actions with respect to enforcement has been essential. Without it, the regulators would have been marking their own homework.
44.The independent reviewers also made numerous requests for further analysis and detail. They carried out quality assurance on both the regulators’ report and the Maxwellisation process. Consequently, their input was crucial, both in raising the standard of the HBOS reports and in providing assurance that the reports’ findings are a fair and balanced reflection of the available evidence. Parliament and the public can now have more confidence that these final reports give a full summary of the causes of the failure of HBOS.
45.The Committee would like to reiterate its thanks to the independent reviewers and Andrew Green for the considerable time and effort that they devoted to the HBOS review.
Delays to publication
46.The publication of the HBOS reports occurred seven years after the bank’s failure. Evidence seen by the Committee suggests there were a number of reasons why it took so long.
47.The first reason was that the regulators chose to wait until after they had concluded all HBOS-related enforcement action before starting the report. Andrew Bailey supported this decision, saying that the “very strong legal advice [ … ] is not to carry out a report of this nature while enforcement proceedings are taking place”.82 Nevertheless, this decision had consequences. The independent reviewers in particular emphasised that the long delays in starting the report led to a deterioration in the available evidence.83
48.The independent reviewers also noted that another cause of delay in the early drafts was that the regulators had not “dug into sufficient detail to reach meaningful conclusions” on the reasons behind the failure of HBOS.84 The independent reviewers reflected that, having already done a report into RBS, the regulators “felt that they had covered a lot of this ground and understood a lot of the issues.”85 The consequence of this was that the independent reviewers had to request significant additional analysis, adding time to the reporting process. They also requested the creation of the separate enforcement review led by Andrew Green QC. In short, efforts to ensure a more objective and thorough report added more time to the reporting process.
49.Concerns have been raised about the length of time it took to reach publication of the HBOS reports. Beyond the FSA’s initial reluctance to conduct a review at all, the primary cause of this delay was the decision by the FSA not to start the HBOS review until it had concluded enforcement action in 2012. The regulators have indicated that this was a result of legal advice.
50.It is likely that a future bank failure would result in subsequent enforcement action, which may be a lengthy and complex process. It is unacceptable, however, that the public should have to wait so long for an explanation of what went wrong in cases of major bank failure. In the light of legislative changes since HBOS’s collapse, the Treasury and the regulators need to explain to the Treasury Committee what steps they can take to ensure that reviews of this type - which in future will be led by independent persons - can be run, at least in part, alongside enforcement investigations. An arrangement where the public must wait several years for a review even to start would be wholly unsatisfactory.
Maxwellisation
51.One of the most significant reasons the reports were only published in November 2015 was the process of Maxwellisation. Andrew Bailey pointed out that the regulators received 1,425 representations from 82 parties in the first round of the Maxwellisation process and then a further 227 representations in the re-Maxwellisation.86 Andrew Bailey claimed that the latter process was partly necessary because criticism of certain individuals was intensified as a result of the original Maxwellisation process.87
52.Evidence taken by the Committee on the effects of the Maxwellisation process was mixed. Andrew Bailey noted that in certain instances it led to the regulators uncovering additional evidence. This was because sometimes, in the process of making representations, a person would reveal additional information relevant to the inquiry.88
53.Andrew Bailey noted, however, that Maxwellisation was an intensive process, requiring significant periods of prolonged attention from the Steering Committee overseeing the reports, and that “it all took a hell of a long time”.89 Sir Brian Pomeroy stated that those who were Maxwellised had made full use of the facility provided by the law.90 When asked whether there was merit in a closer examination of Maxwellisation, Andrew Bailey added that:
What I do not know is how long Maxwellisation is taking in these other inquiries; I have no idea about that. It would be interesting to know the answer to that question.91
54.Andrew Green also acknowledged that Maxwellisation had consequences, accepting that while he “found the Maxwellisation process really quite helpful and relatively painless”, with a broader public inquiry he could see that things “can easily get out of hand”.92
55.The Maxwellisation process has attracted considerable controversy. It is clear that a balance needs to be struck between the rights of those criticised and the need for the timely publication of important reviews. This is vital to ensure that the public receives the explanation they deserve in cases of major financial failure.
56.Recognising this, in March 2016 the Treasury Committee commissioned a review into Maxwellisation. This is being conducted by Andrew Green QC, focusing on inquiries and investigations of a financial nature. The aim of the review is to set out what the law requires and the typical problems caused by Maxwellisation. It may also attempt to establish a set of principles, or make recommendations, to help guide future financial inquiries and investigations in their use of Maxwellisation, to ensure that the process is fair and proportionate.
Future reviews
57.At the time of the collapse of HBOS and RBS there was no statutory provision for the commissioning of the reviews. Instead, the combination of the regulatory reports with independent oversight was an innovation, devised by the Treasury Committee, as a means to ensure that the public at least received some explanation as to what went wrong at HBOS and RBS.
58.Among the witnesses seen by the Committee there was agreement that, in future, inquiries of this type should be conducted differently. In their written evidence the independent reviewers noted:
We would not agree that the Review has got to that point in anything like an optimal way. Indeed the exercise has been a good illustration of why any report of this nature should be produced independently, under the framework of the specific provisions in the Financial Services Act 2012.93
59.The independent reviewers codified this view by making a formal recommendation that future reviews be conducted independently.94 This point of view was also endorsed by Andrew Bailey, who noted in evidence that:
Our very strong view is that future reviews should not be done on the basis that these past reviews have been done; they should all be done by independent people. It is a much better way of doing it.95
60.The Financial Services Act 2012 now makes provision for future inquiries to be commissioned by the Treasury. Section 68 of the Act, provides that the Treasury may arrange independent inquiries when events have occurred in relation to:
Listed securities or an issuer of listed securities … which posed or could have posed a serious threat to the stability of the UK financial system or caused or risked causing significant damage to the interests of consumers96
61.Section 69 of the Act confers on the Treasury the power to appoint a person to hold the inquiry. However, the Treasury can also, through direction of the appointed person, control the scope, length and conduct of the inquiry. These directions also allow the Treasury to suspend or discontinue an inquiry.97
62.Both the regulators and the independent reviewers supported the view that future inquiries into major bank failures should best be conducted wholly independently of the regulators. The Committee agrees. The Government has already partially addressed this in the provisions contained in the Financial Services Act 2012. In theory, the Act goes some way towards providing what is needed. In practice, the legislation remains defective. It is far from satisfactory that the Treasury retains the authority to prevent an inquiry under the Act, even when both the regulators and the Committee may have concluded that one is necessary. There may be a case for a Treasury override in the national interest in exceptional circumstances, accompanied by an obligation to report to the House. However, the current legislation has gone too far. The Treasury has arrogated to itself full control over the scope and continuation of any inquiry. The case for an amendment to the Act, overriding this blocking power, is therefore strong.
63.In the meantime, steps must be taken to ensure that the independence of such inquiries is safeguarded in future. At a minimum, the Treasury should be required to gain agreement to the terms of reference from the person appointed to chair the inquiry and from the Treasury Committee. Such permission should also be sought if the Treasury seeks to discontinue an inquiry under the Act.
49 Treasury Committee, Fifth Report of Session 2012–13, The FSA’s report into the failure of RBS, HC 640, 16 October 2012, Para 1, p 5
50 Ibid, Para 2-3, p 5
51 Oral evidence by Lord Turner of Ecchinswell to the Treasury Committee, Independent review of the Financial Services Authority’s report on the failure of RBS, 30 January 2012, Q 88-89
52 Treasury Committee, Fifth Report of Session 2012–13, The FSA’s report into the failure of RBS, HC 640, 16 October 2012, para 3, p 5
53 The independent reviewers were Sir David Walker and Bill Knight
54 Letter from the Chairman of the FSA to Chairman of the Treasury Committee, 11 July 2011
55 Ibid
56 Q 136
57 PRA and FCA, The failure of HBOS plc (HBOS), 19 November 2015, p 9
58 Ibid, pp 354-56 [Appendix 2]
59 Ibid
60 Ibid, p 352
61 PRA and FCA, The failure of HBOS plc (HBOS), 19 November 2015, p 352. The Steering Committee included Andrew Bailey and Charles Randell from the PRA, and Amelia Fletcher from the FCA, as well as Sir Brian Pomeroy
62 Ibid, p 9
63 Iain Cornish and Stuart Bernau were reappointed by the current Committee in 2015 following the May 2015 General Election.
64 Treasury Committee, Independent Review of Financial Services Authority’s report on the failure of HBOS – Terms of Reference, 1 March 2013
65 HBO001
66 Ibid
67 Ibid
68 Ibid, p 2
69 Ibid, pp 3-4
70 Ibid, p 5
71 Ibid, p 6
72 Ibid, p 7
73 Ibid, p 6
74 Q 59
75 Qq 59-62
76 Qq 105-108
77 Qq 105-109
78 Q 42
79 PRA and FCA, The failure of HBOS plc (HBOS), 19 November 2015, p 354-56 [Appendix 2]
80 Andrew Green QC, Report into the FSA’s enforcement actions following the failure of HBOS, 19 November 2015, Annexe 2
81 The main findings of the Green report are summarised in Appendix 2, while its recommendations are in
Appendix 4.
82 Q 135
83 HBO001
84 Q 59
85 Q 57
86 Qq 124-26
87 Qq 126-7
88 Qq 127-9
89 Q 129
90 Q 133
91 Q 134
92 Q 47
93 HBO001
94 Ibid, p 10
95 Q 111
96 Financial Services Act 2012, Part V, Section 68
97 Ibid, Part V, Section 69
© Parliamentary copyright 2015
22 July 2016