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”.