Jeremy Warner's Outlook: Compensation rulings will make us all poorer

The Financial Services Authority has threatened them, cajoled them, pleaded with them, even begged them, but all to no avail. The City regulator's attempt to persuade 21 fund managers and brokers caught up in the split capital investment trusts débâcle voluntarily to cough up £350m in compensation finally fell apart at the seams yesterday. The opportunity for an industry-wide solution has now been withdrawn, and while the door remains open for mediation on an individual basis, it is already plain that a sizeable portion of the 21 plans to face down the regulator through lengthy enforcement and disciplinary procedures.

The Financial Services Authority has threatened them, cajoled them, pleaded with them, even begged them, but all to no avail. The City regulator's attempt to persuade 21 fund managers and brokers caught up in the split capital investment trusts débâcle voluntarily to cough up £350m in compensation finally fell apart at the seams yesterday. The opportunity for an industry-wide solution has now been withdrawn, and while the door remains open for mediation on an individual basis, it is already plain that a sizeable portion of the 21 plans to face down the regulator through lengthy enforcement and disciplinary procedures.

In the FSA's opinion, this will eventually end up costing the industry far more than if it had gone the voluntary route, the more so as the ringleaders in the rebellion can expect double punishment for their lack of co-operation. Like naughty schoolboys, detention is no longer an option. They are to be caned for their obstinacy as well. For both sides, a hugely costly, fractious and distracting couple of years lie ahead.

Yet the voluntary solution was always in truth a non-starter. The FSA insists that the industry would have been able to walk away from signing such a deal without any admission of guilt. The distinction would seem a fine one when there were to be heavy financial fines imposed on top of the compensation.

Nor would the deal have stopped disciplinary proceedings against individual officers. Nobody emerges well from the split-caps débâcle, but there is a world of a difference between accepting that these products were an ill-judged disaster, and admitting to illegal collusion and falsification. All of the 21 think they are innocent of these charges. Hardly any of them accept there is any legal liability at all. This has made the voluntary payment of compensation extraordinarily difficult.

The point of principle involved is not so different from that which has prevented the Bank of England from settling with the liquidators for BCCI. The Bank can accept that it might have been negligent in its regulation of BCCI, but it cannot legally be held liable for negligence. The only thing it can be held liable for is malfeasance, or deliberately setting out to disadvantage depositors, and this it cannot accept.

The split-caps industry was prepared to pay a certain amount, for the commercial purpose of getting shot of the problem, but collectively it is not prepared to accept any degree of guilt. There was also a world of a difference between what the FSA was demanding, and what the split-cap managers and brokers were prepared to pay.

The FSA's failure to bring about a voluntary solution to the split-caps débâcle is indicative of a growing stand-off between regulator and regulated. The chorus of complaint from the long-term savings industry over allegedly oppressive regulation grows louder by the day. Already some of our biggest savings institutions are voting with their feet, with capital increasingly allocated to overseas expansion rather than growth at home. Who can blame them, when seemingly any loss results in a tsunami of compensation claims? The industry asks only to be judged by the standards, practices and assumptions of the time, yet the regulator seems intent on applying the wisdom of hindsight. We'll all end up the poorer for it.

Public versus private

For those interested in the long- term health of the British economy, there were some worrying figures published by the Office for National Statistics yesterday. These show that public sector employment grew at its fastest rate since the mid-1970s in the year to the end of last June. Given the backdrop of continued growth in public spending, chances are that public sector job creation has been rising even more strongly since then.

The number crunchers at the ONS, public sector workers all of them, are at pains to point out that despite this growth, the private sector still accounts for nearly 80 per cent of all jobs and that, furthermore, there was some growth in private sector employment over the same period too.

However, all the private sector growth and some was generated by an increase in the number of self employed. The number of employee jobs in the private sector fell by more than 100,000 at a time when the number of employee jobs in the public sector rose by 162,000.

All this may seem predictable enough. The Government has been deliberately compensating for the business downturn with increased public spending, thereby helping to protect the wider economy from recession and rising unemployment. Even so, the bald statistics paint an alarming picture.

Public sector work is not uneconomic work. Much of it is vital to the functioning of the wider economy and in any case generates further activity in the private sector. Yet the public sector doesn't directly create any tax revenue; it only spends it. The money to pay for that expenditure can only come from one place ­ the private sector.

In some respects, the fast-growing number of self employed is an encouraging sign, yet again it's unlikely of itself to create significant quantities of extra tax revenue. Much of the growth in self employment is in "micro-services" ­ gardening, massage, decorating and anything else the time-rich but cash-poor can sell to their opposite numbers among the cash-rich but time-poor. By definition, a substantial proportion of such earnings will be undeclared. Meanwhile, the great engine room of tax generation ­ private sector employees ­ is continuing to shrink.

The Government thinks that eventually private sector employment will start growing again, but the Treasury would be unwise to count on it. Rising tax, social costs and red tape is fast undermining Britain's hard-won position as a relatively favourable place to do business. Indeed at least a part of the growth in the public sector is in greater regulation, which further adds to business costs and restricts freedom of movement.

Just as worrying, fast-growing public sector employment will eventually create some awesome long-term liabilities.

Once taken on, public sector workers are much more difficult to get rid of than their private sector counterparts. Most of them are also employed on final salary pension schemes, funded by the Government on a pay as you go basis. Great swathes of the private sector have decided they can no longer afford occupational pensions. Yet it is the shrinking private sector that will have to fund the "affordable" pensions of the growing public sector with higher taxes. Not a happy state of affairs.

Electricity flop

Believe it or not, around a third of Britain's electricity generating capacity is owned not by companies or other equity holders, but by banks. This bizarre state of affairs dates back to the time when wholesale electricity prices were so depressed that they forced many generating companies into administration. Collectively, the banks still have about £5.5bn of debt tied up in the electricity generating industry. For some years now, they've been looking for a way out.

The scheme dreamt up Lazard Brothers and Greenhills potentially offered a quite neat solution. The idea was to persuade bankers to crunch their unwanted power stations into a single company. Much of the debt would be converted into equity. The scheme would have involved big write-offs, but a largish and potentially quite valuable generating company would have been created which eventually could have been floated on the stock market, allowing the banks to claw back at least some of their capital. Unfortunately for CGE's Jim Forbes, he was just a little too late.

Wholesale prices have recovered strongly over the last year and a half, making some of the stations potentially quite valuable properties again. Cash offers from Centrica and ScottishPower for two of the stations has caused sponsoring banks to break ranks. Lazards and Greenhills will have to confine the whole thing to the filing cabinet marked "good, but obsolete, ideas".

jeremy.warner@independent.co.uk