An Opes Prime example

The disagreement between the current ANZ chief executive Mike Smith and his predecessor John McFarlane over who was to blame over the Opes affair raises deep questions over cultural problems in Australian banks and what should be the role of the chief executive.

There are now at least three commentaries on what went wrong at ANZ in the Opes mess – from Mike Smith, John McFarlane and Robert Gottliebsen. Naturally, I favour the Gottliebsen version written some eight months ago (ANZ's data flow problem, August 25, 2008), but each adds additional material to the tale and the combination provides a text book lesson for chief executives.

ANZ chief Mike Smith claimed that Opes Prime exposed "serious cultural and ethical problems" within the bank. Not surprisingly John McFarlane came back hard via the ABC program Lateline Business (Former ANZ chief defends risk management record, June 26).

I am not in a position to dispute the Mike Smith's statements on the cultural problems in ANZ under John McFarlane. However, in my view McFarlane did a fantastic job changing ANZ to make it a much better retail bank and to lower its costs and lift its profits. But as the boom rolled on there is no doubt that ANZ and other local and global bank executives became over-confident. In the case of Opes, the weakness was the fact that the ANZ (and Merrill Lynch) security was over the combined portfolios of a series of investors. If some of the portfolios went bad, ANZ had the power to sell out shares of another investor even though that particular investor might have plenty of cover in their loans and be servicing them properly. In addition there were strange goings on in Opes in the last days as Alan Kohler described in Hunting for Opes Assets (April 1, 2008).

Mike Smith instituted an inquiry into ANZ's involvement in Opes and it showed that John McFarlane did not know anything about Opes which is what he confirmed on Lateline Business. McFarlane said Opes was unknown to him because the exposure was on the books for a tenth of its value. In other words it was too small to come on his radar.

McFarlane said the ANZ's risk management operation had perhaps made a misjudgment in trusting junior management to treat the Opes exposure as a derivative rather than as a loan.

"If I'd known about it, I would have closed it down. But I didn't know about it, so I couldn't”, he said.

"You can't take responsibility for things that you weren't aware of even though you were at the top. You can't be responsible for something that happens well after you leave," he said.

McFarlane is right on his second contention but wrong about the first. Part of the ANZ Opes loss may have been caused because when Opes blew up the ANZ began selling shares and many believe the losses now facing the bank would have been far less had they taken more time over the situation and gave clients a greater chance to arrange alternative finance. McFarlane is clearly not responsible for those decisions nor are other ANZ executives who were involved with Opes but are no longer ANZ executives. But in many circumstances a CEO can be held responsible for not knowing a key fact. That's where my commentary of eight months ago is important, although the material at the time was aimed at defending the role of ANZ chairman Charles Goode who had no hope of knowing about Opes given his CEO did not know.

It is no secret at ANZ that one of John McFarlane's mistakes was to go close to anointing Steve Targett as a possible successor when recruiting him from Lloyds TSB, then Britain's fifth largest bank, to manage ANZ's institutional banking division. Once Targett was in the saddle the two did not hit it off. It was not a question of fault on either side. It just happened. John McFarlane spent a lot of time discussing detail with many of his department heads, but he rarely did it with Steve Targett. Whether Targett knew of the hazards of Opes is hard to know given the problem of the derivatives but, according to ANZ veterans, had McFarlane spent more time with him on the detail there is a good chance the Opes facts would have come out. And there is also no doubt that had McFarlane discovered how Opes worked he would have shut it down.

ANZ chairman Goode was an enthusiastic supporter of John McFarlane in his first term, and in the early part of his second term. But he believed McFarlane had made his contribution and did not think he was the person to take the bank forward. It was a great call because Mike Smith an outsider was able to handle the Opes and other problems from detached viewpoint.

What this crash has shown is the bank CEOs need to spend a lot more time quizzing their direct reports about what is behind their key transactions. They need too be doubly careful about derivative transitions. The exercise will take a lot of time, but the simple fact is that if the CEO had understood the nature of Opes or of Storm (in the case of CBA) alarm bells would have rung. They were the Australian version of the sub-prime crisis and we were very fortunate that they were relatively small. But they are warnings to all CEOs. Decentralisation is great but you still need to kick the tyres.