As night follows day, any financial crisis is followed by the sound of stable doors being shut and the hum of a thousand brains as the world’s financial regulators seek to ensure that ‘this will never happen again.’
And indeed it may not. The particular combination of recklessness, gullibility, naivety, greed and blind faith in the wisdom of the market that brought the financial world down around our ears two years ago may indeed never be repeated.
It will just be different next time.
But anyway, ‘light touch’ regulation is now being replaced by a more vigorous approach. The job of reining in the bankers falls to the public servants of the Financial Services Authority, soon to be replaced by the Bank of England.
In the old days things were different. Banking was all about the exercise of human judgment and anybody thought to be sailing a little bit too close to the wind would be invited to have a quiet word with the Governor of the Bank of England.
Not today. Banking, as well as fund management, is now all about computers. Human judgment has been cast aside as super-powerful computers devise trading strategies, judge risk and allocate capital. Now the world’s regulators will be relying upon these same number crunching machines to prevent another financial catastrophe.
The founder of one penny share company is excited by the prospect. This is what he said last week:
“The board sees no end to the increase in bank and securities firm regulation and is optimistic that this will have a positive effect on the group’s regulatory compliance business… the board believes that the climate for the next few years is likely to be for mandatory additional spend on regulation.”
Those were the words of John Wisbey, now chief executive and 49% shareholder of Lombard Risk Management (LSE:LRM). When I spoke to him last week it was no surprise to find him full of confidence.
Why? Because Lombard is offering something that every bank and insurance company is desperate to get their hands on…
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It’s profitable, it’s cheap, and the bankers can’t do without it
Lombard provides software that enables financial institutions to monitor risk and comply with regulations.
Demand has never been greater. The turmoil of 2008 exposed the extent to which all traders of financial instruments failed to truly understand the risk of the complex instruments that they were holding. Believe it or not, some of the many hedge fund managers that jumped aboard the gravy train back then were still using spreadsheet-based software. After the failure of Lehman, it took weeks to unwind its many trading positions. Much to the consternation of creditors and counterparties.
Now financial firms are grappling with a whole new array of rules and regulations. They have to know their counterparty, they must not be accused of money-laundering, they must frequently reconcile their trading positions, they must control their securities lending, correctly price derivatives and meet the demands of regulators.
Following a debate in which banks argued that the imposition of excessively high capital ratios would restrict lending, and regulators countered that without robust financial ratios a new crisis could occur, the latter finally endorsed a package last month known as ‘Basel III’.
Designed to ensure that the financial system cannot suffer the type of collapse seen in 2008, Basel III is replete with arcane terminology. Bankers must attend to the ‘unweighted leverage ratio’, ‘the conservation capital buffer’ and ‘the countercyclical capital buffer’. There will be new charges for ‘non-cleared derivative and other financial market transactions’ and significant revisions to the rules on the types of instrument that can count as bank capital.
While bankers are getting to grips with this, the insurance industry is also coming under the rod and must comply with ‘Solvency II’, a new EU-wide regime covering capital adequacy and risk management.
All this is excellent news for Lombard.
Lombard could double under the new regime
Lombard provides the systems that monitor all these financial criteria and provides reports for managers and regulators alike. Despite being a penny share with a stock market valuation of just £9m, Lombard Risk Management has been around for twenty years, is eminent in the field, and works for 130 of the UK’s 350 banks as well as some leading names overseas.
The business has tended to move in cycles, but Wisbey believes that 2011 will be “an exceptionally good year”. Despite the costs of an office move and heavy spending on research and development, Lombard recorded a small profit in the latest six months.
Broker Hardman is forecasting a profit of £1.1m in the year to March 2012. Noting that Lombard is valued at around one times sales while other providers of financial software such as Brady and Statpro are valued at twice turnover, Hardman thinks that the share price could easily double.
• This article was first published 28th October in Tom Bulford’s twice-weekly small-cap investment email
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