Banking Reform Bill Bulks Up

H.M. Treasury yesterday published 86 proposed amendments to the Banking Reform Bill. The bill is due to enter its committee stage in the House of Lords on the 8th October 2013. The proposed amendments were widely-flagged and broadly mirror the 11th March 2013 recommendations of the Parliamentary Commission on Banking Standards.  Highlights are as follows:

  • Payments: the introduction of a wholly new and distinct payment systems regulator, the intention being to stimulate competition by facilitating access to payment systems for new market participants, as well as decreasing the costs of account portability. A special administration regime to deal with cases where a key element in a payment fails or is likely to.
  • Misconduct: an extension of the FSMA approved persons regime. If passed, the amendments will allow the regulators to: make the approval subject to conditions or time-limits, extend time limits for sanctions against individuals, impose “banking standards rules” on all employees , and to hold senior managers responsible for regulatory breaches in areas which they control. PCBS chairman Andrew Tyrie, (perhaps confusing Ford Open Prison with Guantanamo), had previously advocated putting “guilty bankers in bright orange jump suits”; as widely expected, the proposals introduce criminal sanctions for reckless misconduct in the management of a bank.
  • Electrified ring-fence:  proposed new powers to formalise and streamline the “electrification” power introduced at the Commons report stage. The electricity in the ring-fence is the regulator’s power to compel separation of a banking group which breaches the boundary between retail and investment banking. The effect of the new powers is to make the ring-fence into a “variable-voltage” device. Under the proposal, the regulator will:
  1. issue a preliminary notice, the affected party will have a minimum of  14 days to reply and 3 months to make necessary changes to its behaviour/structure
  2.  failing this and with the consent of the Treasury, a warning notice will then be issued, itself triggering a minimum of 14 days for representations by the affected party
  3. a decision notice is then issued, which may be appealed before a Tribunal
  4.   a final notice is issued which set s a dead line by which a bank must separate its activities

The whole process will take approximately 14 months and the various notices will be issued in accordance with general FSMA principles.

Bail-in:  the introduction of a bail-tool as initially mandated by the European BRRD and recommended by the domestic ICB and PCBS. The Banking Act of 2009 will be amended to include a “stabilisation option” (bail-in), covering banks and investment firms and to be applied by the bank of England as lead resolution authority.  The conditions for its use are identical to those of the Special Resolution Regime:

  1. the regulator must determine that the bank is failing or is likely to fail
  2. it is not likely that any other action can avoid the failure
  3. The BoE determines that application of the bail-in power is in the public interest

The bail-in option includes the right to modify existing contracts for the purpose of mitigating the liabilities of a bank under resolution. There are a number of liabilities which will be excluded from the provision: client money, FSCS protected deposits, employee pension schemes, payment system liabilities, debts to a creditor who is critical to the bank’s daily functioning etc.

In short- the electric ring-fence is reconnected to the mains and bail-in is set to become a reality. These and other less fundamental proposed amendments represent a significant extension of regulatory powers. It remains to be seen if they will be rigorously and consistently applied to their full extent.

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The Tyrie Report: Now it’s Personal

On 21 June 2013 the Parliamentary Commission on Banking Standards (PCBS) published its Final Report “Changing Banking for Good”, widely referred to as the “Tyrie Report” after its chairman Andrew Tyrie MP.  The PBBS was established in July 2012, with the broad brief to conduct an enquiry into the standards and culture of UK banking and to make recommendations.  Whilst highly critical of just about everyone – the government, regulators, banks, and individuals – its final 571 page report contains surprisingly little in the way of strategic regulatory proposals.

Instead, its recommendations are strongly focused upon the senior individual, effectively imposing financial penalties and/or criminal culpability for (potentially) less pay. The substantive recommendations may be broadly grouped under two headings: people and pay.

People

  • The FSA’s “Approved Persons” regime to be replaced by “Senior Persons”.  The new regime would only apply to senior management; however they would have to accept responsibility for specific areas; and
  • Junior employees would be subject to an enhanced licensing regime.

Pay

  • A new remuneration code more closely aligning risk and reward, with emphasis upon more extensive deferment of pay.  A recommendation that bonuses may be deferred for up to 10 years;
  • Regulatory powers to cancel deferred pay/unvested pensions and/or dismiss senior management in the event of their bank requiring taxpayer support; and
  • A new criminal offence of “reckless misconduct in the management of a bank”.

The only macro-prudential elements of the report are the suggestion that the UK consumer is ill-served by lack of competition in retail banking, that this may be ameliorated by the break-up of RBS, and a characterisation of the government’s management of Lloyds and RBS as “interference”.

During Prime Minister’s Questions on the 19 June 2013, David Cameron affirmed his intention to append at least the bonus clawback and new criminal offence proposals to the Banking Reform Bill, which is currently making its way through Parliament.

PCBS asks PRA to “bear down” on proprietary trading

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”.

PCBS Itching to Ban Proprietary Trading

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”.

PCBC Publishes Second Report on UK Banking Reform

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.