Bankers cooking with Gas?

The separation of retail and investment banks is back in the news following the Chancellor’s recent Mansion House speech. Ever since the Government bail-out of Royal Bank of Scotland and Lloyds in 2008, there has been a pressing desire to ensure that tax-payers are never again called upon to rescue the financial system. The Independent Commission on Banking, chaired by Sir John Vickers, is looking at alternatives. The Chancellor has endorsed their interim report and awaits the final report in September.

Compulsory separation of business entities is not new. It has been used as a solution to behavioural business problems in many contexts, usually after a period of fierce debate during which the business(es) argue that separation is unnecessary and unworkable, or a combination of both. We are certainly seeing those arguments advanced in the case of the banks. Not just from the bankers: many commentators are unconvinced, too.

Faced with these challenges, sometimes the best solution isn’t for the regulator to devise a separation. The solution is to put in place onerous protection mechanisms and let the company figure out for itself that separation would be preferable.

In 1993, the Monopolies & Mergers Commission – forerunner of the current Competition Commission – recommended the separation of British Gas’s customer supply division from the group’s production and transport businesses, British Gas objected and John Major’s Government backed away from legislating to bring it about.

This left Ofgas, the industry regulator, in a quandary. On one side, the MMC had agreed with Ofgas that British Gas needed to be split up. On the other side the government was reluctant to follow the MMC’s advice. To break the deadlock, the regulator imposed a series of tough operating and administrative conditions on the company, designed to ensure that the integrated businesses could not disadvantage customers or competitors.

To achieve this, the regulator needed to make the company behave as though the component businesses were operating as separate entities. The regulator’s onerous requirements included a compliance officer working inside British Gas to ensure the regulations were as effective as a legal separation.

No doubt, this would have been effective, but it would have been hard work for everyone. Within a matter of months, the company decided it would be better to split itself up than to work with the regulator’s alternative mechanisms. Interestingly, British Gas chose a different separation from the MMC’s proposal, but a separation which achieved the regulatory goals nonetheless. Satisfaction all round.

At the turn of the millennium, Microsoft faced calls for its break-up. Not, as was often said, because it had grown too big or too profitable. But because it was using a combination of its different business units to act in a manner which obstructed its competitors from selling their own software. Findings of anti-competitive behaviour were made against Microsoft by the US courts (and also by the European court on different issues).

The penalty was a matter for the courts to decide. In the US case, the government, as prosecutor, had the opportunity to ask the court to impose a break-up of Microsoft. Not surprisingly, there was heavy lobbying from both sides: those in favour of a break-up and those against. While all this was going on, an election replaced the Clinton presidency with Bush. The new administration backed-down from seeking a break-up, settling for behavioural change. (The EU imposed massive fines.)

Views differ as to whether that approach has worked. In 2009, the European Commission expressed the view that Microsoft’s proposed bundling of Internet Explorer with Windows 7 would, once again, violate competition law. Faced with the risk of more large fines, Microsoft backed down. But, if the Windows business had been separate from the browser business, Microsoft would not have wanted to bundle the products in the first place.

So who should decide on the best way to structure a business separation: the company itself, or someone else, such as a regulator? The wily gas regulator who got the result she wanted without enforcing the break-up was Clare Spottiswoode, at the time, Director General of Ofgas.

Where is Clare Spottiswoode now? She is working with Sir John Vickers as a member of the Independent Banking Commission. Watch this space …

This is an extended version of an article published in Financial News, 27 June 2011