Background on Financial Services Regulation
Regulation is an alternative to free market institutions in the process of allocating, producing and consuming resources. It can be impose based on external demand or selective implementation. The latter case tries to build a learning curve whereby it will allow regulatory failure to emerge as the financial industry matures naturally.
Deregulation does not necessarily follow financial liberalization because performance monitoring under the current system would be impossible. Case studies in the lack of regulation include USA which failed to regulate corporate disclosure and agency relationship, Argentina which failed to stabilize and safeguard its financial system and Australia which failed to apply its experience of banking crisis in 1990s to avoid insurance crises in 2000.
There are opposing views on financial services regulation (FSR) which are summarized in six arguments. First, regulated markets are exceeded in performance by free markets due to absence of discriminatory pricing and promotion of quality. Second, regulation is inefficient as cause the rise in agency costs and distortion of agency relationships between managers and shareholders. Third, assuming that the strong form of efficient market hypothesis is in operation, stock markets can function without regulation.
Fourth, regulation can hamper dispersion of financial service innovations triggering social costs. Fifth, regulatory failure is inevitable in the life cycle of FSR and both private and public entities have tendency to raise their own interest in developing and executing regulations. Lastly, regulation should be applied to individual professionals through appreciation of ethical standards.
On the flip side, these arguments are deficient in applying systems theory which connotes several important considerations. Without regulation, systematic risk of financial markets can rise tremendously and lead to crisis. This is especially true as technological advancements allow financial systems to integrate globally and transact business in a non-stop manner. As an illustration, the banking sector is regulated for the purpose of assuring that deposits made by the public are kept, distributed and invested with moderate risks.
In theory, regulation is necessary due to presence of hidden actions and information which entails risks on morals and selection respectively. The performance of FSR is also dependent on confidence and convenience factors while the propensity of a current FSR to change is based on the levels of innovation and contestability. When confidence factor is low, institutions such as banks are practicing ineffective risk monitoring that contributes to distressed financial industry. When convenience factor is low, the cost and quality of financial services are disruptive to user satisfaction.
Financial Services
By offering services for deposit, loan, commercial paper and letters of credit, banks provide its clients supplementary liquidity and choice of risk-taking. They do this by converting and diverting different kinds of savings (e.g. cash, property, etc.) to more lucrative form of investments. Compared to personal saving, banks can create a savings pool supported by wider information and monitoring systems that enable savers to place investment in less risky (riskier) engagements with stable (higher) returns.
On the other hand, liquidity offered by insurance can provide significant gains for financial as well as legal stability. Insurance plans enable different forms of capital to minimize risks of failure and other shocks leading to accumulation substantial and sudden costs. Life insurance divert savings on non-productive goods to productive ones while property insurance can protect liquidity against disastrous losses.
In most cases, the interaction of banks and insurers are complementary. The specialization is where banks focus on short-term investments for small and large firms while insurers focus on long-term investments for corporate/ government bonds, mortgages and equity. There are also cases that interdependence exists. For example, banks require insurance on top of the credit which will serve as collateral (e.g. loans on residential housing) while insurers place vital concern on periodic payment capacities that are observed in bank transactions.
There is the evidence that banks and insurers are distant competitors. As an illustration, insurance policies are classified as whole life absent to high liquidity offers and payment system services of bank deposits. Even there are fixed-term bank services, they do not come close to life investment services of insurers.
In less developed economies, however, the market situates banks and some insurance companies head-to-head. The high cost of insurance plans in these particular economies disables the interest of the market and sees bank savings as cheaper. These bank savings are then regarded as safety net against future risk on property loss and other potential liabilities. Often, banks and insurance companies have adopted the complementary framework leading to three major types of alliances structural models.
Cross-selling agreement is an alliance model wherein participants confirm to market each other’s products to their respective customers. In most cases, however, banks sell insurance products while few cases involve the vice versa. There are potential problems in cross-selling agreements such as overlapping service channels leads to competition. This is aggravated by the non-cooperation and lack of coordination of the parties leading to conflict and hostile actions.
Further, alliance of independent partners is a structural model where parties confirm to have minority interest in each corporate share. In cases only one party enjoys this benefit, it can evidence its asymmetry and superiority in the alliance. Cross-selling agreement is almost a given provision in this type of alliance and rarely that it is not included. The last type is the control by ownership.
It is a model in which control lies in either bank or insurance and even an interested third party. By choosing to be complementary entities, banks and insurers prevent direct competition as observed in developing economies. But by not choosing control by ownership, they are still at risk of competition in a predatory way. This happens when the product of insurers (banks) compete with the additional offerings of banks (insurance) in relation to the provisions of alliance.
The US American Depositary Receipts (ADRs)
They are shares of a non-US company that is bought by an investment bank in the foreign markets for the purpose of trading in the US markets. When non-US share purchase is done, investment banks register them to Securities and Exchange Commission (SEC) and have the option to transfer the daily trading operations of the shares to depository banks.
ADRs are also viewed as certificate that evidences the quantity of share ownership of a corporation beyond its own market. They can represent either certificates or real securities and their price are quoted in the purchaser’s currency as well as governed by host country policies. The investment banker also has the option to keep its foreign shares public or private. Typically, ADRs are sold by to wide range of investors and those with minimum investment capability (i.e. 0 Million worth of stocks).
According to several studies, listed-ADRs are exchanged with higher values compared to those that are not listed. Further, cross-listing ADRs also performed positively with regards to value of the firm because of the benefits of forecasting and scope of analysis. In contrast to embryonic stage of ADRs, these two later stages are considered more mature and aggressive giving them the capacity to increase liquidity, shareholder base, information, disclosure and lessen volatility, cost of capital and variability in analysis.
However, these benefits are limited to investment banks under sponsored ADR programs especially to trade in certain US markets such as NYSE. Under these program, investment banks have obtained specific rights of a common stockholder (i.e. right to vote).
For Macquarie Bank, they can provide diversification facility which can minimize investment risks in the home markets. They also adopt the Bank’s local policy and national regulations which enhances upper hand over information and familiarity. As a result, trading issues are more manageable and contracting to foreign companies is relatively easy.
There are also zero custody charges and in fact the foreign company is liable for paying the Bank in its effort and risk to shoulder transaction risks/ costs in issuing foreign stocks in its own market. Foreign securities will also have lower-than-home valuation when traded in the host market making them more lucrative to speculators and as well long-term investors. Under sponsored ADRs, the Bank also receives dividends first before distribution to ADR holders.
Although the Bank has potential benefits, there are also regulatory bottlenecks. For example, in the advent of litigation against the foreign company, a win in US court may not assure compliance and necessary remedy for the case in favor of the Bank. There is a need to settle the matter in the home country of the foreign firm.
However, transaction costs that attached to the process can be substantial to affect not only the financial position of the Bank but also its international portfolio. Further, regulations of foreign countries vary greatly to US environment. Specific issues to consider are the period of clearance and settlement of trading, efficiency of trading reports and rules of safeguarding shares in depository banks.
In currency exchange issues, the value of ADRs is affected by the changes in economic variables of the foreign country. Generally, their value rises when foreign currency dropping while decreases when foreign currency is increasing. Second, there is a tendency for reduced liquidity when ADRs are purchased by an inexperienced investment or depository banks.
The lack of knowledge may cause ADRs to be viewed by the host market as risky and no recourse is applied to minimize such impression. Third, ADR holders must pay tax in US dollar denominations even if they are in the home market. As a result, this increases their risks to currency fluctuations.
ADRs are not commonly traded on large exchanges such as NASDAQ and NYSE rather on bulletins which make their price with larger variance. In effect, establishing investment decision based on data can be difficult especially when the investor has a pre-determined price in mind. For the investors in the host market, information about the foreign company may also take a long time before presentation.
Therefore, there is a risk of outdated data and relevance to timely decision-making. There are also bank charges being implemented by depository banks who are handling the operational processes of ADRs. These fees could reduced the dividends and affect the liquidity of shares. These banks traditionally pass the costs of operations to host investors.
Corporate Governance in the US
In the US, corporate governance is build through a hierarchy which is composed by shareholders, board of directors and the management according to position in the hierarchy. The first can influence the most important corporate actions involving additional issue of securities, revising the charter and electing directors.
The second is responsible to protect the best interest of the former with reference to duties of care and loyalty which includes appropriating executive compensation, delegation of functions to respective committees and approving major corporate action. The third is accountable in the day-to-day operations of the company and must confirm implementation of bigger decisions. Publicly-held companies are told what to do by state laws and listing requirements to exchanges.
To supplement this, SEC requires disclosure of corporate transaction, performance and financial position. The trend in the US is that the objectives of intra- and inter-components of the hierarchy often conflicts. For example, individual shareholders have aims different from each other and management must choose strategies that can address them all.
Also, since 1970s, board independence is increasingly demanded through time with reference to the creation of Sarbanes-Oxley because of corporate scandals. The concerning issue, however, is that the trade-off of independence that can avoid misconduct and performance that can offer managerial efficiency. As a result, the essential qualities of directors such as experience, skills and expertise are undermined with increasing popularity of board independence.
Further, individual shareholders are increasingly consisted by institutional investors such as mutual and pension funds to the rise of institutional activism. The latter type of shareholders is more active in proposing corporate direction and strategy to the management including other reforms. The issue, however, only complicates conflict of interest because institutional shareholders are only obligated to shareholders of their company and less to the company which have their holding.
In effect, good governance is not a critical issue for them rather underlying agendas. In addition, motivated by substantial increases in executive pay compared to ordinary worker’s pay, disclosure is made more comprehensive and clearer. This also included information about stock options such as dates pertaining to award, transfer, expiry and execution.
Another significant development is the prominence of using proxy during voting involvement by shareholders especially in director’s election. Shareholders are given the privilege to indicate their votes in a blank card where the use of proxies is magnified. Proxy voting is claimed to benefit in diversifying the membership of the board. Plurality voting is also destabilized by the new idea of having majority voting.
In the latter method, board nominees that only cast minimal votes will necessarily obtain a board seat. However, monitoring authorities provides an open-policy regarding what companies should use according to their preference. Lastly, due to the adverse effects of recent scandals, effective corporate governance in the US means to restore investor confidence. Sarbanes Oxley offers increased civil and criminal penalties for fraudulent and opaque actions.
Solvency Laws in the UK
The Enterprise Act of 2002 is the second largest move to insolvency issues since 1986. It is designed to limit debt settlement provided by banks and streamline insolvency dispute management that ultimately lead to facilitate company rescue that result to better returns to creditors as a whole. The Act treats insolvency issues in holistic manner, thus, able to recognize the stance of debtor, creditor and position of banks in conflict resolution.
These actors have each of their independent objectives that standardizing application processes and decisions can minimize defaults, avoid litigation and enhance economic activities through diligent execution of contract accountabilities. More specifically, the new Act shifts the corporate insolvency law closer to company law and a distant position to property law.
The Act has several advantages. Based on the earlier Acts, it retains the ability to gather information and kept it secret from debtors but strengthen the current framework because bank appointees can help debtors to pay their obligations to creditors. Such decision will be based on out-of-court proceedings which reduce the tedious work to be done in settling debt conflicts. The framework also works even if the bank and its appointee do not have enough liquidity to help the debtor.
In addition, perhaps one of the most substantial benefits of the Act, the preferential rights of the Crown is abolished. As a result, floating charge is diverted to unsecured creditors instead. The Act also supports check-and-balance among a set of creditors as it includes moratorium in presenting their standing and ability to sustain operations even in the absence of equitable share of debtor’s assets.
Rescue culture is the core attitude of the Act with regards to insolvent companies. This refers to respond expected to authorities to attempt saving a troubled business rather by simply closing it. In this view, the new Act removes the capacity of secured creditors to appoint representatives that able to block insolvency petitions from troubled debtors.
Thus, increasing the number of corporate rescues as authorities can now view the real quantities and qualities of rescue demands from indebted companies. As secured companies are internally independent against the future of debtors, such acts persisted in earlier statutes should be removed because it merely make networks for companies to end-up in greed and unethical position.
The new administration procedure makes CRM flexible and in line in the direction of IPM. The measure of administrator’s (e.g. official receiver or practitioner) performance is within the monitoring radar of government authorities such that the total administration expenses should be less than the cost of the assets to be liquidated. This pronouncement is coinciding with the earlier motivation of creditors to pursue litigation against individual debtors.
In a survey report about the shortening of bankruptcy discharge from three to only one year, only 16% of the respondents are aware of the statutory shift. Forty percent believed that the shift reduced bad connotations about bankruptcy while 65% pointed the shift to reduce their time to financially recover. In addition, most of the creditors that petitioned for bankruptcy are government agencies and local authorities in aspects of tax payments, insurance contributions and other fees. Further, incidences of creditor petitions for 2005-2006 is significantly lower ten years ago. This report concretizes the continuous informal set-up in resolving debt issues in the household level while the legal adjustments have partial results to change household-level debt decisions.
Bankruptcy is applied by and against to individuals (e.g. individuals who have their own businesses) to free them from overwhelming debts and distribute their assets including their homes and business stakes fairly among creditors. As low as £750 receivables, creditors can petition a person for bankruptcy and the debtor has the option to face proceedings or dispute the claim through payment or contractual obligation.
When bankrupt order has been made, the debtor is legally liable to provide financial information to either official receiver or licensed insolvency practitioner including handing down original copy of financial records, bank statements, insurance policies. In addition, the debtor cannot use bank, building society, credit card and obtain credit from other accounts exceeding £500 without disclosing the fact of his bankrupt status. After bankrupt order has been issued, the debtor should not transact directly to creditors to settle payments.
There are inconvenience problems when a person undergo to bankruptcy orders. Records can be destroyed, arrest can be implemented and there are several implications that reduced debtor actions. If the home is confiscated for the purpose of creditor sharing, the debtor has to continue payment of home services and rents. The debtor is indeed in a very problematic state but this state can be avoided if the debtor can maintain debts not exceeding the amount of litigation that creditors would pay out of the debtor assets.
Loss of asset control is another consequence which is passed to official receivers. Income will also be held by creditors and the debtor has to work without holding his compensation. The list continues about negative consequences of being individually liable and receipt of bankruptcy quotation. As a result, individuals are relatively afraid with the catastrophic events of bankruptcy.
Insolvency procedures can rescue companies if they have a viable business and initially accept the financial problem. At this state, they are ready for rehabilitation. The creditor’s stance to agree in deferring the due amount can also help the survival of the debtor company. This can be done through combined administration and company voluntary arrangement (CVA).
However, in the current statistics, only few cases support this framework which entails follow-up implementation. In effect, the two critical features of CVA; namely, realistic proposal and creditor support cannot be enforced. Administration is in the shoulders of a third party which can implore asymmetrical provisions in administering insolvency issues. With this, creditors will continue their pursuit for debtor assets and its sale for disposal. As a result, rescue mechanisms for troubled companies cannot be realized.
The shift to old-style administration to receivership does not result to concurrent changes in settlement methodologies as most business insolvency cases are end-up on sold assets. In effect, business rescue is not enhanced. This is because the framework cycle of the two alternatives is similar such that when the company is not saved, jobs will be lost and banks accumulate the returns. On the other hand, it is, jobs will be saved and banks will produce negative outcome.
Receivership has its loopholes like it can easily overtake the management of the indebted company in the absence of cooperation. However, the increase in authority from the receivership deters the contracting parties in thinking about funding the settlement because the banks will make it happen. The trade-off that the current legislation about CRM indicates the vast issues and models those parties in a settlement can use to arrive at different outcomes. Current CRM model is not perfect and traditional or informal models have their merits based on individual objectives of settlement actors.
One of the significant developments of Companies Amendment Act of 2006 is about voluntary administration. It is a type of CRM in which consent to overtake administration of the in-troubled company is consented by its board of directors as well as 75% in value of company’s creditors. Its objective is to bring back financial health or deliver better results prior to liquidation for the benefit of creditors and the company itself.
UK government did not adopt the Australian lead instead continued to transform the Inland Revenues as administrator and preferential creditor during CRM as well as release directors from personal liability in case the company is discovered to have tax liabilities. Experts said that the model makes the Inland Revenues at risks to recover the debt of the company as a preferential creditor and makes directors less reliant on administrator option due to less adverse consequences.
Personal debtors can be classified as those that cannot pay, would not pay and could pay. The former position is constrained to enter bankruptcy petition due to £310 required deposit before enforcement. In effect, debtors that experience short- to medium-term illiquidity and absence of income cannot have voluntary settlement. In addition, debtors under cannot pay group faces enforcement proceedings which unable them to settle the debts in installment basis rather on stringent means. The remaining creditors are not forced to participate in the majority decision of other creditors that makes settlement issues and additional contracts problematic. The court’s obligation to provide long-term debt management plans to debtors can also be sub-optimal to the point that debtors may not receive maximum use of their assets. It is suggested that the private sector and other voluntary organizations can be or relatively better help to debtors in debt management issues while the court on its core function to enforce the necessary laws.
As far as 1571, there are already court bankruptcy proceedings. However, the dogma that debtors would conceal their assets in the absence of coercion (e.g. imprisonment) lingers creditor’s motivation. As time passed by, experts such as (1980) recommended bankruptcy process as last recourse for individual debtors and in extreme cases. In alternative, the machinery to be used in settling debts is their future wages and income including other properties with exemption. This is aimed to help them to recover and also for rehabilitation. On the contrary, if fraud or misconduct exists, bankruptcy can be enforced. In the UK, personal over-indebtedness is not prohibited unlike other Scandinavian countries that have obligatory debt counseling. If any, UK has government-funded organizations and private banks that entertain consumer debt relief problems. In this view, it is proposed that obligatory debt counseling be installed in UK to provide to basic benefits; namely, alleviation of court debt payment scheme functions and prevention of overly-increasing uncollected debts of the country.
According to authorities, personal debt levels are high but not high enough to affect the economy. Bankruptcies increased but this is because of changes in the legal framework that makes application for insolvency relatively easy. In addition, the substantial increases in insolvencies for mid-2006 are not primarily caused by economic indicators (e.g. unemployment, utilities and interest rates) rather excessive growth of consumer spending without checking their debt levels. Even though unsecured debt is falling, many experts indicated that continuously increasing insolvency levels make every family feel the pressure of varying macro-economic indicators. Private Banks which are most affected conceded that changes in legal framework only drifts individuals to borrow excessively and then declare themselves bankrupt to avoid legal pressures.
C & A Automotive is a Dutch company connected to the utilities of Essent. There is an earlier agreement that whenever the former induce non-payment, disconnection will be applied. However, the former put itself in English administration and argue that Essent cannot enforce the agreement and implement disconnection as C & A is under insolvency proceedings. In the contrary, Essent countered this admonition by saying that there is an earlier contract as well as the law of Netherlands would be an appropriate legal framework as they are located in such country.
In this regard, the English Court decided that the underlying of the previous agreement between the companies is undoubtedly the scope of their respective laws. However, as C & A applied for insolvency administration, the issue of disconnection should be settled based on the English law in which the option is engraved.
C & A must answer its shortcoming to the laws of Netherlands as a result of enforcing the previous contract while Essent must concede relating to decisions regarding insolvency. The final verdict under English law is that Essent has no right to disconnect C & A due to non-payment of old debts as well as considered Essent a public body being a monopolistic utility company that the principle of creditor equity is applied. The latter decision makes Essent a less priority in the payment scheme.
Conclusion
Ethics applied in managerial opportunism and injecting this element in the culture of the firm could be minimized, if not erase, self-vested interests wrapped in a managerial decision. It can also address the problem of monetary claims attached to diversification endeavors also satisfying the manager that serves as detrimental to shareholder’s value. With ethical practices fostered in the firm, managers and employees alike increases the value of performing organizational duties outside monetary rewards.
In this state, managerial monitoring and employee turn-over can be kept at low levels because they are not only motivated but also are inspired in their work which results to shareholders’ savings. On the other hand, the same intensity, only on the extreme case, is applicable when a firm practices unethical behavior which can become a chronic organizational ailment.
Another intangible source of competitive advantage, firm’s reputation is an evaluation tool used by stakeholders to communicate the company its attributes in relation to them such as respect, knowledge, awareness, emotional and affective regard. Southwest Airlines has emotional appeal and unique approach to airline business that prevented it to loose money in a year sine 1978 and saved from fare wars, oil crises and other economic disasters.
Dupont invested heavily to be flawless in its products’ environmental impact giving it the formidable position in social responsibility. Merck and Company had emphasized innovative employees by selectively hiring better-skilled people to contribute in building intellectual capital in the company enhancing its workplace environment attribute. The brand name of Coca-cola and Microsoft are the world’s famous and most valuable brands due to superior products and service.
As firm’s reputation takes years to built, just like any other intangible resource, it could be lost in an instant. This is what Exxon experienced when Valdez oil tanker happened including poor product quality of Coca-cola in Europe and Microsoft’s antitrust case of its complex technology. During these times, the CEO should take the front stage to develop and maintain his firm’s reputation.
of General Electric, for example, gave years of prosperity in the firm due to its exemplary financial performance due to his visionary outlook and leadership. On the other hand, Cisco CEO stick in his conviction to obtain existing business model despite 78% dropped in the value of its stock. These leaders are the key to obtain and retain billions and billions of global companies’ valuation of reputation. They serve as the mirror of how the firm would look like in the future.
Effective stakeholder management is primarily an outcome of top-level managers’ ability to build, maintain and rebuild culture, ethics and reputation within the firm. These activities, as a prerequisite, should be in line with organizational intent and mission that ultimately serve the purposes of stakeholders in general and shareholders in particular. Installing sound stakeholder platforms will give managers the required flexibility and leverage to minimize the adverse impacts of trade-offs between the general stakeholders and shareholders.
As shareholders are also part of the broader society, it is indispensable for the firm to act according to the boundaries of the society reflecting in their culture, ethics and reputation. Otherwise, the firm could place its shareholders in societal liabilities that can be formally legal or symbolically “bad”. Corporate image can obviously affect the performance of its products, transactions, strategies and structure because several stakeholders are in continuous observance and monitoring of the firm’s legitimacy to operate.
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