On 3 April 2013, the Parliamentary Commission on Banking Standards (PCBS) published a letter sent to Andrew Bailey, Chief Executive Officer of the Prudential Regulation Authority (PRA), regarding proprietary trading by banks.
In the third report of the PCBS, a summary of which can be found here, it was concluded that, whilst it was not a suitable activity for UK-headquartered banks, it would not be appropriate to attempt immediately to prohibit proprietary trading. Instead, the PCBS recommended that the PRA should monitor indicators of whether banks appear to be engaging in proprietary trading and, if necessary, use existing supervisory tools to “bear down” on such activity. Accordingly, the PRA is asked to confirm how it intends to respond to this recommendation, in particular:
how it will conduct heightened monitoring of trading activities and judge whether these are ultimately conducted to serve customers;
what processes it would expect to follow and what measures it would take if its monitoring activities raised concerns;
how it will report, and require banks to report, on the outcomes of monitoring and any actions taken; and
whether legislative change is needed to give it the authority and tools to carry out these actions.
In an accompanying press release, the PCBS Chairman, Andrew Tyrie MP noted that a Volcker-style bank may ultimately be required, but that the UK would be in a better position to determine whether this was actually the case in a “few years”.
On 15 March 2013, the Parliamentary Commission on Banking Standards (PCBS) published its Third Report on proprietary trading within banks.
The PCBS considers that there is no commonly-accepted definition of proprietary trading and recognises that most activity undertaken by banks results in some form of proprietary position. However, it is primarily concerned with trading in which a bank uses its own funds to speculate on markets, without any connection to customer activity. It accepts that proprietary trading results in risks which are not necessarily any different from those associated with other banking activities, many of which actually made a greater contribution to the financial crisis. Nonetheless, it considers that the argument that proprietary trading can have harmful cultural effects within a bank has been “convincingly made”, creating a conflict of interest between a bank’s attempts to serve its customers and the trading of its own positions and, as such, being “incompatible with maintaining the required integrity of customer-facing banking”.
Despite its in-principle opposition to proprietary trading, even outside of a ring-fenced bank, the PCBS recognises the practical difficulty in establishing a definition of “proprietary trading” which is capable of being effectively enforced, given its similarity to other activities such as market-making. Even alternative metric-based approaches, such as those being considered in the US, which track patterns of trading activity remain unproven, relatively complex and resource-intensive. Consequently, the PCBS believes that it would not be appropriate to attempt immediate prohibition of proprietary trading through the Banking Reform Bill (BRB). However, it does recommend that the current legislation require the regulators to carry out, within three years of the BRB being enacted, a report to include, inter alia, a full assessment of the case for and against a ban on proprietary trading. This report would be presented to the Treasury and to Parliament and serve as the basis of a full and independent review of the case for action in relation to proprietary trading by banks. In the meantime, the PCBS recommends that the Prudential Regulation Authority (PRA) monitor the main UK-headquartered banks’ assertion that they no longer engage in proprietary trading, and should use its existing tools such as capital add-ons or variations of permission to “bear down on such activity and incentivise the firm to exercise tighter control”.
On 11 March 2013, the Parliamentary Commission on Banking Standards (PCBS) published its second report on banking reform in the UK.
The second report addresses the UK government’s response to the first report of the PCBS and specifically the suggestions made therein in relation to banking reform. It makes a number of recommendations and observations, including:
Independent Review: the PCBS encourages the government to implement a fully independent review of the workings of the ring-fencing mechanism, and not just a regulator review as currently proposed. This, the PCBS claims is “wholly inadequate” and amounts to no more than the “regulator marking its own examination paper”;
Full industry–wide structural separation: despite the government’s rejection, the PCBS continues to believe that the Banking Reform Bill should include legislation which would enable full structural separation of the banking industry if the independent review of the workings of the ring-fencing mechanism proposed above concluded that this were necessary;
Ownership structures: the PCBS is ‘disappointed’ that the government has chosen not to restrict the ability of an investment bank to own a ring-fenced bank; and
Leverage Ratio – the PCBS regards the case for maintain the acceptable leverage ratio of a bank at 3% (i.e. 33 times leveraged) as “extremely weak” and continues to press for a 4% (i.e. 25 times leveraged) limit.
The PCBS intends to publish its final report by mid-May 2013.
The FSA has published an update to its Recovery and Resolution Planning (RRP) guidance dated 20 February 2013.
It expects to publish formal RRP rules “soon” after the FSA hands responsibility over to the Prudential Regulation Authority on 1 April 2013. An updated RRP information pack for firms can be expected soon thereafter with subsequent updates aimed at aligning UK domestic requirements with Financial Stability Board guidance and the EU Recovery and Resolution Directive also expected.
In light of the experience of RRP submissions to date and international policy development, the FSA update also details the following two policy changes:
firms will be required to update recovery plans annually as part of their normal risk management procedures and submit it to supervisors for review when requested; and
firms will not have to update their resolution information pack (RRP Modules 3-6) on an annual basis as a matter of process. Instead, they should respond to requests for resolution planning information from their supervisors.