The Extent to which the Global Financial Crisis (GFC) has challenged the shareholder-focused Concept of the Corporation
O’Brien (2014a) argues that financial institutions exist not merely to advance the interests of shareholders, but also to serve the public. This statement holds true with respect to the recent GFC. As fear emerged that the big institutions could collapse, governments sought to intervene, not to protect shareholders but to safeguard public interest. Therefore, GFC has challenged the traditional shareholder-focused approach adopted by the corporation. In the aftermath of the crisis, the government through the Federal Reserve embarked on a mission to restore these financial institutions to their original position. This mission was accomplished to protect the public from possible repercussions in the event such institutions collapsed.
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The enactment of the Dodd-Frank Act and the Volcker rule has further shifted the focus from the shareholder toward protecting the public. The Volcker provision for its part prohibits institutions from engaging in activities that inherently place their customers in the path of risk. One such activity is proprietary trading where institutions engage in high-risk activities motivated by the desire to earn short-term profits. Essentially, the provision prevents banks from speculative investment, which is believed to have caused the 2008 financial crisis. The need to protect banks’ customers from potential risks has become commonly accepted across the OECD economies. In the UK, ring-fencing is the technique used where certain assets are partially separated from the rest of the bank’s portfolio (O’Brien, 2014b). Ring fencing prevents banks from making investments that would result in a conflict of interest between the bank and its customers.
Inclusive capitalism is a belief system, which suggests that the finance sector should be anchored on the needs of the society (O’Brien, Gilligan, Roberts, & McCormick, 2015). As inclusive capitalism is becoming a rather mainstream idea, financial institutions are forced to embrace greater transparency and higher accountability standards following GFC’s challenge to the shareholder-based concept. Additionally, the theory of sustainable development has found its way into the finance industry. Institutions are being urged to adopt socially and economically sustainable measures. Carney, the leader of the Bank of England, has even suggested the integration of the SLO concept into finance (O’Brien et al., 2015). SLO advocates for society’s consent in conducting its affairs. The consent would imply that the financial institution is on the right track. As such, corrupt deeds such as the collusion witnessed in the forex trading would disappear (O’Brien, 2014a).
SLO is not poised to be beneficial to the customers or society alone. The financial institution together with its shareholders stands to benefit in this arrangement. O’Brien et al. (2015) observed the huge costs to pay for institutions that fail to secure the trust of its stakeholders. These costs could come in the form of damaged reputation or even fines. Therefore, by failing to involve the society (customers) in its dealings, the bank is running a high risk of failure. Failure does not only refer to the ordinary risks associated with banking. O’Brien et al. (2015) observe that failure includes the conduct risk, a phenomenon that has become especially pronounced in the post-GFC times.
The regulatory response to the GFC with reference on one specific area of concern and one jurisdiction
The Global Financial Crisis (GCF) resulted in a major concern regarding the role played by the “too-big-to-fail” institutions. Efforts to break down the big financial bodies had been in place since the 1930s, through the famous New Deal, pioneered by the then president, Franklin Roosevelt. Roosevelt and his administration feared that these large institutions would morph into monopolies controlling the country’s economic power. While the regulations proposed and implemented under the New Deal did not succeed, there have been renewed efforts to relook into the position of such key institutions regarding financial crises. The collapse of the Lehman Brothers was a wake-up call for stakeholders. The objective of the regulatory response is clear: to reduce the chances of another major crisis occurring in the future.
A holistic analysis of an efficient response to the GFC should begin with analyzing its cause(s). The actual cause of the GFC has remained the subject of debate because it was the culmination of numerous interlinked aspects. According to Claessens and Kodres (2014), the crisis was major because of the credit boom in the housing market. Credit booms are usually linked to worsening lending standards that make it likely for a financial crisis to occur. The widespread default of housing mortgages resulted in a ripple effect across the international economy. The rising cost of houses in the US and elsewhere contributed tremendously to GFC. The housing market is inherently linked to the GFC since houses are often used as collateral for mortgage credit. Therefore, as their valued increased, credit extensions became possible. People were capable of borrowing more from banks due to their increased value of their houses.
The regulatory response to the GFC has been made both internationally and at the domestic level. The Financial Stability Board (FSB), formed sometime before the crisis, had been meeting to deliberate on vulnerabilities in the global financial system (O’Brien, 2014a). Following the GFC, FSB is now involved in coordinating the operations of national financial bodies, as well as setting the standard for the international arena (O’Brien, 2014a). Mark Carney, who is also the leader of the Bank of England, chairs FSB. Carney has been in the forefront in the push for the regulation of the lending market to prevent a future crisis. Carney has been quoted expressing disappointment at constant collusions that dominate the capital market (O’Brien, 2014a). Changes in the UK have included legislation and institutional reforms. Additionally, stakeholders have also called for cultural changes and professional conduct to accompany the structural adjustments. O’Brien et al. (2015) advocated stringent measures, including the prosecution of corrupt individuals responsible for collusions in the financial market.
The concept of SLO has also been invoked with respect to holding major financial institutions socially accountable for their actions. Applied in the finance industry, SLO would require major players to seek the approval of stakeholders before carrying forth any programs (O’Brien et al., 2015). SLO operates as a voluntary initiative. It aims to build trust. Carney believes that SLO can help financial bodies to win and maintain public trust (O’Brien et al., 2015). Additionally, SLO can serve as a risk management tool since the framework upholds efficient community involvement, including how to achieve and/or preserve authenticity, trustworthiness, and confidence.
The Legal Response to the GFC
Efforts to tame the finance industry date back to the era of the New Deal when the then President Franklin Roosevelt formed a commission to oversee a legal framework to the effect. At the time, the great depression had threatened to paralyze the finance market. Whereas these legislations were domestic to the US, they can offer an insight into the scenario at the international market following the Global Financial Crisis (GFC). Therefore, it is only natural for policymakers to harbor the desire to regulate the market every time a major financial crisis happens. The recent GFC had dire outcomes, even causing the collapse of one of the largest financial institutions in the world. The collapse of the Lehman Brothers caused stakeholders to question the wisdom of concentrating all financial wealth in the hands of a few key players. This section will examine the legal responses to GFC. It will then proceed to answer the question of whether the industry has grown too big to fail.
The Dodd-Frank Act 2010 was passed to prevent unnecessary bailouts to the too-big-to-fail institutions. There is a belief that the failure of these big financial institutions could result in unbearable outcomes for the US economy and the world over. For this reason, the Federal Reserve has been engaged in assisting large financial institutions that are on the verge of failing by putting them back into the business. Thus, the Dodd-frank Act sets up a stringent procedure to be followed before the Federal Reserve can refinance a failing institution. Fundamentally, the Act aimed at ending the concept of the too-big-to-fail for Wall Street institutions. The legislators felt this move would prevent another financial crisis at a future time. The Dodd-Frank Act was prepared in response to the GFC, as policymakers believed that poor industry practices had orchestrated the recession.
The Volcker proposal also emerged as part of the legal response to the GFC. The provisions of the Volcker plan prevent banks from undertaking two types of activities. First, banks are prohibited from proprietary trading (Tarullo, 2012). Proprietary trading in this aspect refers to activities such as holding securities or engaging in sale contracts with the intention of earning profits from the short-term movement of prices (Tarullo, 2012). Therefore, to this effect, the Volcker rule is concerned with institutions’ engagement in activities that target short-term profits. As such, activities that would appear legitimately focused on long-term profiteering are not covered under Volcker. The second provision declares it unlawful for banking entities to acquire and retain ownership interests in covered funds (Tarullo, 2012). Together, these two provisions are aimed at preventing financial institutions from engaging in activities that are potentially harmful to their customers (O’Brien, 2014b).
In the UK, ring-fencing has been adopted to enhance transparency in the finance market. Ring fencing involves separating the assets of a company without necessarily putting them in a separate entity. Therefore, ring fencing works in the same manner as the Volcker provision since institutions are prevented from using these assets for market speculation. O’Brien (2014b) observes that implementing the ring-fencing as well as the Volcker provisions may be challenging. The guiding rationale according to O’Brien (2014b) is “to be seen to be doing something” (p. 249). O’Brien (2014b) further argues that despite a foolproof framework being available at the global level, thanks to the FSB, the situation at the domestic level is much more complex due to unresolved political economy questions.
Is the Social License to Operate (SLO) any more than an Exercise in Rhetoric?
The question of whether the social license to operate (SLO) bears any effectiveness is a rather legitimate concern. SLO emerged from the concept of corporate social responsibility (CSR), which requires companies, especially those that operate in the global arena, to adopt measures that address the diverse needs of all stakeholders. In other words, CSR is equated to sustainability in the areas of social, economic, and most importantly, environmental performance. Wilburn and Wilburn (2011) assert that CSR is becoming less of a voluntary measure since governments almost invariably require companies to have a CSR plan before they can operate in their territory. In the light of CSR becoming somewhat a requirement of big corporations, the license to operate has emerged as a requisite.
The effectiveness of SLO depends on various factors. The Ethical Funds Company describes SLO as a right that is granted for a corporation to operate smoothly in a given community (Wilburn & Wilburn, 2011). Therefore, the affected community grants the said right. This right is given through what the United Nations terms as “free, prior and informed consent (FPIC)” (Wilburn & Wilburn, 2011, p.4). Thus, SLO and FPIC are frameworks that seek to assume that the people who are directly affected by the activities of the organization are comfortable with the operations. According to Wilburn and Wilburn (2011), the problem arises where the concept of what constitutes an adequate consent becomes elusive because different communities will approach FPIC differently. Because communities are merely porous organizations that consist of different voices, it is difficult to assume that one voice speaks for the entire community. The effect then would be for an organization to proceed to set up camp assuming that the entire community is happy with its presence.
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The effectiveness of the license to operate will also depend on how the community in question views the project. Wilburn and Wilburn (2011) enumerate several instances where companies lost profits or were even ejected from the community because of failing to properly obtain the SLO. One such example is Coca-Cola, which was forced to shut down its plant in Kerala, India, because the immediate community blamed the company for water shortage in the area (Wilburn & Wilburn, 2011). Therefore, when community members perceive that a lot of damage is being incurred by the presence of the company in their region, they are more likely to demand the suspension of the operations. There is also the case of De Beers, which went ahead to put up a dam in Canada without obtaining the proper consent from the community. The affected community retaliated by suspending operations on the plant. It is interesting to note that Canada is one of the few countries that voted against the UN Declaration on the Rights of Indigenous Peoples that was adopted in 2006 (Charters & Stavenhagen, 2009). This declaration is a codification of the notion of FPIC.
The attitude of the country in question also plays a key role in determining whether SLO to operate will be effective. This claim is illustrated by the case of De Beers where the government showed reluctance in assisting the local community to enter into meaningful negotiations with the company (Wilburn & Wilburn, 2011). Therefore, such a company may get the impression that it is not necessary to seek consent from the affected community. Thus, the reaction of this community will depend on whether the country is democratic enough. In other words, in a democratic country, the affected community is more likely to oppose the move by the government to grant the company a pass to operate without consulting the community first.
The Fair and Effective Markets Review
Transformative Nature of the Review and the Underlying Barriers
The Fair and Effective Markets Review was conceived as part of the move to restore confidence in the areas of fixed income, currency, and commodities (FICC). The misconduct that had brought forth the GFC had also led to the erosion of public trust in these key areas. Because FICC markets span across the globe, the effects of the GFC were felt all over the world. The Fair and Effective Markets Review would additionally seek to influence international trading practices. The Bank of England launched the initiative in mid-2014. This section asserts that the review is potentially transformative based on its application in the international arena.
According to FEMR (2015), fairness implies that standards are applied in a clear, consistent, and proportionate manner throughout the market. As such, the knowledge of the market should be fairly and equally available to all key players. The information would help in building trust among stakeholders, which in turn would lead to the creation of strong markets. Additionally, by ensuring that acceptable market practices are implemented, professionalism and openness would become entrenched in all the market practices. The financial markets are often riddled with the challenges of collusion, leading to some parties being dealt unfairly. The customers of financial institutions are likely to be hurt most in the event that such arrangements backfire. O’Brien et al. (2015) argue that fair markets create a level playground for all stakeholders, a characteristic, which is absent in the informal arrangements where collusions rein.
The Fair and Effective Market Review also integrates technical and prescriptive dimensions, which are coupled with clarifying duties performed by senior key players. By defining roles, the review eliminates opportunities that may encourage abuse (FEMR, 2015). It also promotes soft governance techniques as a way of enforcing cultural change while at the same time allowing the industry to adopt higher standards. Therefore, Fair and Effective Markets Review hopes to create markets that foster continuous professional development within the existing framework. Another aspect of the Fair and Effective Markets Review is market liquidity. Liquidity is the ability to transact without the risk of price discontinuation. According to FEMR, (2015), liquidity is important to both the issuer and the investor. The issuer wishes to borrow at competitive terms at any given time while the investor would wish to be free to move in out of position in a rather smooth manner (FEMR, 2015).
Barriers to the application of fair and effective market reviews exist because of cartels within the market. These cartels would rather fight any meaningful change since the review denies them their lifeline. According to FEMR (2015), the cartels operate by disclosing confidential information on pricing and engaging in discriminatory behavior. They also hoard services to customers with the aim of making a profit later. Certain laws are in place in the UK and the EU that are aimed at fighting breaches to the Fair and Effective Markets Review. Individuals suspected of collusion and other forms of misconduct may be jailed for up to 5 years. A fine of an unlimited amount may also be imposed.
Charters, C., & Stavenhagen, R. (2009). Making the declaration work: The United Nations declaration on the rights of indigenous peoples. Copenhagen, Denmark: IWGIA.
Claessens, S., & Kodres, M. L. E. (2014). The regulatory responses to the global financial crisis: some uncomfortable questions. Washington, DC: The International Monetary Fund.
FEMR. (2015). Fair and Effective Markets Review: Final report June 2015. London: Bank of England.
O’Brien, J. (2014a). Too big to fail or too hard to remember? Lessons from the New Deal on dealing with systemically important institutions. Law and Financial Markets Review, 8(3), 249-259.
O’Brien, J. (2014b). Fixing the fix: governance, culture, ethics and the extending perimeter of financial regulation. Law and Financial Markets Review, 8(4), 373-388.
O’Brien, J., Gilligan, G., Roberts, A., & McCormick, R. (2015). Professional standards and the social license to operate: a panacea for finance or an exercise in symbolism? Law and Financial Markets Review, 9(4), 283-292.
Tarullo, D. (2012). The Volcker Rule. Testimony before the Subcommittee on Capital Markets and Government Sponsored Enterprises and the Subcommittee on Financial Institutions and Consumer Credit, Committee on Financial Services. Washington, DC: The US House of Representatives.
Wilburn, K. M., & Wilburn, R. (2011). Achieving social license to operate using stakeholder theory. Journal of International Business Ethics, 4(2), 3-4.