Anthony Hilton: Instead of complaining about Europe, we should become more engaged


Wednesday found me in the elegant surroundings of Saddlers Hall in the City taking part in the annual Candlewick Debate – an event organised by Fiona Woolf of law firm CMS Cameron McKenna. Candlewick is the ward which she represents on the City Corporation.

Every financial crisis since the beginning of time has brought forth regulation designed to stop it ever happening again – inevitably with limited success – and this one is no different. So the point of the evening was to explore what combination of externally imposed regulation and internally imposed ethical standards and competitiveness would best allow the financial services sector to survive and prosper in the future.

There is always a danger that these events turn into a rant against the European Union and the torrent of legislation being developed there which seeks – probably in vain – to exert a much greater degree of oversight and control over the workings of the financial system.

Much of what is proposed will be costly, disruptive and force major changes in methods of working, probably without delivering the desired increase in safety, so the worry is real.

But the issue which no one seems willing to grasp is that complaining is not going to help; we have to get much more deeply engaged in Brussels and build alliances, so that we can win respect for our views. Only then can we hope seriously to influence the debate.

Instead we are reaping what we have sown.

Given the noisy relish with which too many Tory Eurosceptics have celebrated each downward lurch in the euro crisis, coming on top of decades of negativity from senior political leaders and a dogged refusal by the civil service to encourage its high fliers to see time in Brussels as an essential part on their career path, we really should not be surprised if there is a desire over there to stick it to the Brits – the more so because the financial crisis is very much seen in continental capitals as having been brought about by the excesses of Anglo-Saxon capitalism.

It is going to be a long haul back. Yet there seems to be precious little understanding either in Government or in the City on the need for, let alone the scale of, the task.

Accountants' approach to pensions doesn't add up

Over the last 20 years we have destroyed one of the best pension schemes in the Western world by allowing the accounting profession to insist that we assessed risks which were largely irrelevant and then set aside funds to meet them.

When I first became a pension trustee 20 years ago, pension funds were judged by their cash flows. Actuaries calculated how much money would be needed to pay the pensions when they fell due and then judged whether the fund was likely to generate enough income now and in the future to be able to meet its obligations. Fluctuations in the size of the fund as the market moved up or down could be largely ignored.

It was similar to buying a house on a 30-year mortgage. The two things which matter are first that the house provides the benefit you need in terms of suitable accommodation now and into the future, and second that you can meet the cost of this benefit by having sufficient income to meet the monthly mortgage payments. It may be disquieting, but it does actually affect these key issues of benefit and cost if prices crash at some point so the house is valued at £50,000 less than you paid for it.

But the accountants decided it did matter, and in fact that it was the only thing that mattered.

The effect of the mark to market rule for pension funds was that yearly fluctuations in the size of the fund were stuck into the sponsoring company's accounts as a liability which it was then expected to make good.

Returning to the analogy with housing, it was as if in addition to keeping up with the mortgage payments you had also to come up with £50,000 to cover the negative equity. The accountants' justification for this was that you might lose your job tomorrow and not be able to keep up the payments, in which case you would lose your house and have to make good that £50,000 shortfall – so you had better provide for it now, just in case.

Companies have found it as hard to meet that "negative equity" cost of pensions as a homebuyer would, and that is why most of the private sector-defined benefit schemes have been closed. That is the damage which gets done when people focus on market fluctuations rather than economic reality. An entire pensions system unnecessarily destroyed.

This thought was prompted by a lecture at the Cass Business School this week by Lord Turner, chairman of the Financial Services Authority, in which he once again said that one of the principle causes of the financial crisis was the use of mark to market accounting in banks. The reason was it meant temporary fluctuations in prices rather than underlying economic reality became the dominant driver of behaviour – which was great in the boom but left the system defenceless in the bust.

Just to depress you totally, an old friend, Brian Reading of Lombard Street Research, this week produced a paper which sought to put some numbers on the cost of this economic downturn. He, more than anyone, would stress that his numbers are guesses and estimates not facts, but with that caveat he is better equipped than most to make such guesses.

He says the cumulative loss of output – how much we have produced between 2006 and now compared to where we think we would have been without the crisis – is the equivalent of 39 per cent of GDP.

GDP can be thought of as the national total of all our individual incomes. So if you want a crude but emotive measure of what this crisis has cost you personally, then it is 39% of your gross income for this year. Four tenths of one year's income down the drain.

Finally, and quite separately, there has been a howl of protest from sections of the accounting profession following the unveiling this week of proposals to streamline the working of the Financial Reporting Council. One consequence of this would be that the profession could no longer be solely responsible for setting accounting standards.

In the light of the above, I would have thought such a move comes not a moment too soon.

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