Banking StandardsWritten evidence from Barclays (V001)
Call for Evidence on Proprietary Trading
The Parliamentary Commission on Banking Standards published its First Report on pre-legislative scrutiny of the Government’s draft Financial Services (Banking Reform) Bill on 21 December 2012. The Commission identified the need for further consideration of the implications of introducing a prohibition on groups containing a ring-fenced bank from engaging in proprietary trading.
The Commission requests responses by Friday 11 January.
The Commission would welcome responses to the questions below. It is not necessary to address every question, and those submitting evidence should feel welcome to address other relevant matters not raised in the questions.
Introduction
The definition of proprietary trading is fundamental to this issue generally, as well as the specific questions posed by the Commission.
Defining “proprietary trading” is notoriously challenging. Most commentators define it as “principal trading” (or taking a position for the purpose of profiting on the position itself), but activity that could be regarded as “principal trading” arises from a range of activities in banks, particularly in the context of a client-facing/market making business. Any debate about the appropriateness of proprietary trading must clearly distinguish among three different instances or examples where a bank may assume a principal trading position:
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It’s important to stress that trading as principal in the latter two categories, in particular, is beneficial to the liquidity of the market, so any definition should give full regard to this.
For context, it is worth noting that the FSA also employs a definition of “Proprietary Trading”—substantially for the purposes of the UK’s “Approved Person” regime—as follows:
“(in SUP 10 (Approved Persons) and APER) dealing in investments as principal as part of a business of trading in specified investments. For these purposes dealing in investments as principal includes any activities that would be included but for the exclusion in Article 15 (Absence of holding out) or Article 16 (Dealing in contractually based investments) of the Regulated Activities Order.”
This is a very broad definition that does not make the distinctions noted above. For the sake of capturing individuals who could be involved in “proprietary trading”, this broad definition is appropriately conservative, but it would not be appropriate for the purposes of making decisions about whether or not to prohibit any activity.
Any new statutory framework or prudential regulations would need clarity in what the UK wants to capture within its definition, and where this aligns with/diverges from international standards that exist at the moment or may develop over time. The Basel Committee on Banking Standards could play a role in defining this, to ensure a harmonised playing field.
Stability
1. What prudential concerns does proprietary trading within banks give rise to? To what extent are any concerns being addressed through existing measures and proposals, including ring-fencing?
Barclays has made previous submissions on the prohibition of proprietary trading, for instance to US authorities in the context of the Volcker Rule.
Our position was, and still is, supportive of a prohibition, providing that the definition of proprietary trading is suitably narrow and concise. More specifically, we support a prohibition on proprietary trading desks that are established by a bank for the specific purpose of trading for the firm’s own account. These desks tend to be set-up with segregated capital and with separate teams of people whose compensation structure mirrors those of hedge fund managers, rather than other traders within the bank, and have minimal or no interaction with client business. These “stand-alone” proprietary traders typically sit apart from traders who serve clients as a part of steps taken to address the potential for conflicts of interest.
A wider definition could bring considerable limitations. Both ring-fenced banks and non-ring- fenced banks need to take some proprietary positions to prudently hedge their risk (eg, Interest Rate in the Banking Book). The Government’s Draft Bill made important exemptions in this regard for “Treasury hedging activity”, and these should remain. A similar case can be made for market marking activity, which provides a stabilising effect; government bond trading is a good example of the importance of this facility within a well risk-managed non-ring-fenced bank.
Prudential concerns can be generated by any concentration of risk which is not appropriately managed by a combination of eg, internal governance and control tools (including the Board- approved risk appetite framework, and the three lines of defence which include independently managed and incentivised control and control functions) within a firm as well as wider prudential regulatory controls that gauge risk appetite, as applied and monitored by the regulator, whether that risk is generated by trading on “own account” or purely to facilitate client facing business. Our expectation is, therefore, that to the extent that other reforms are not appropriately addressing these prudential risks, simply prohibiting “proprietary trading”, however defined, will not address this gap in the reform process.
Standards
2. To what extent does the presence of proprietary trading activity alongside client-facing activity in banks create the potential for conflicts of interest and affect remuneration practices, culture and banking standards?
The extent to which the presence of proprietary trading activity alongside client-facing activity creates the potential for conflicts of interest depends on the nature of the risk involved. This, in turn, is determined by whichever type of proprietary trading is taking place (see the introduction section above, on definition).
Certain trading activity, including trading activity undertaken to support client facing business, has the potential to generate conflicts of interest. Firms are under a clear obligation to manage these risks fairly and expressly to address such conflicts as they might apply between a firm and its clients.
The risk of any proprietary trading influencing broader remuneration practices, culture and standards depends entirely on the specific scale and nature of the proprietary trading, especially in relation to other activities undertaken by the relevant firm. We would posit, based on our experience, that any proprietary trading (even broadly defined) would have to be unusually large in order to have any discernable influence on any of these.
3. How adequately do current conduct rules manage any potential for conflicts and harm to standards? To what extent could stronger conduct rules address any problems?
This question is best answered by the FSA.
4. Are there stronger grounds for concern about proprietary trading when it is conducted in a group which contains a ring-fenced bank than if it is conducted by a standalone wholesale bank? If so, why?
There is nothing unique about the risk created by proprietary trading compared to other forms of risk present in a non-ring-fenced bank, apart from the difference in objective of the trading (ie, creating profit for own account rather than only facilitating client activity). Furthermore, there is no greater risk presented in a group that contains a non-ring-fenced bank, over a standalone non-ring-fenced bank, so no special interventions would be required for such a group.
Practical Considerations
5. How, if at all, would prohibiting proprietary trading by banking groups affect the case for implementing a ring-fence? Would there be any practical benefits from implementing both such measures at the same time?
There would be no noticeable effect. The two are very different actions, serving different purposes. The purpose of the ring-fence is to facilitate resolution of critical economic functions, whereas a ban on proprietary trading would simply prohibit certain forms of risk that are otherwise present inside a non-ring-fenced bank.
That said, this also therefore implies that a ring-fence and a prohibition on proprietary trading could function alongside each other, if both are defined appropriately.
6. What powers does the regulator already have that could be used to prohibit banks from conducting proprietary trading? What are the constraints on any such powers?
Proprietary trading itself is not a specific regulated activity under the Financial Services and Markets Act (Regulated Activities) Order 2001. However, the FSA does have OIVOP (Own Initiated Variation Of Permission) powers—under s.45 of the FSMA, although these have been used sparingly in practice. It might be worth encouraging the FSA to use their powers to validate risk limits more actively. We expect the FSA could comment more fully on the practicality and benefit of doing so.
7. What are the main challenges in defining proprietary trading, and how could these best be addressed?
This question has been answered in the introduction.
Overall Assessment
8. Given the factors above, how would you assess the case for:
(a) Including a prohibition on groups containing a ring-fenced bank from engaging in proprietary trading within the Banking Reform Bill
As covered in the answer to Q4, we see no distinction in terms of the risks to financial stability between a proprietary trading entity that sits within a group containing a non-ring-fenced bank, and one on its own, especially if ring-fencing has been completed. So no particular benefit would be gained from applying such a prohibition only to a non-ring fenced bank within a group containing a ring-fenced bank.
(b) Implementing or creating reserve powers for a proprietary trading ban through some other form
To an extent, reserve powers already exist; as such, it’s unclear what an additional power would add and what its objective would be.
(c) Requiring that future reviews of the operation of the ring-fence have an explicit mandate to consider and report on the case for such a prohibition
As set out in the answer to Q5, we do not believe that a ring-fence and a prohibition on proprietary trading are related, so there would be no need to review these separate issues together.
(d) Using the Banking Reform Bill to give the regulator a reserve power to impose such a prohibition on individual banks if it concluded that it was necessary
As with part (b) above, we do not think there is a clear purpose behind such a power given the other observations we have made within this evidence. In particular, if the Authorities were to determine that proprietary trading was too risky for one particular firm, it would seem odd not to make a similar determination for all firms generally. If that is because of deficiencies within the particular firm, with respect to governance, tools and/or capabilities, it would surprise us to understand that the FSA does not already have the power to prohibit any individual institution from undertaking any activity in such circumstances.
14 January 2013