Banking StandardsWritten evidence from the CBI
The Provision of Derivatives by Ring-fenced Banks
1. The CBI contribution to the ring-fence debate focuses on the “business user” view of the banking system, helping to align the stability and resolvability objectives of the ring-fence with the need for banks to continue to provide the services businesses need to grow.
2. This submission makes the following points:
Businesses should be able to hedge risk from price fluctuations directly with a ring-fenced bank.
Good progress has been made to define a “simple” derivative but further work is needed.
Requiring full validation of the purpose of a derivative contract is too restrictive.
The FCA has an important role to play in determining the appropriateness of individual products and policing their market deployment.
Businesses should be able to Hedge Risk from Price Fluctuations Directly with a Ring-fenced Bank
3. When appropriately marketed and sold, the ability to manage normal business risk arising from fluctuations in currency, interest rates and commodity prices, for example, is important for businesses seeking to grow. This is particularly true of those looking to export to new overseas markets.
4. Small and medium-sized businesses in particular greatly value a single, comprehensive relationship with their principle provider of banking services and this relationship should include the provision of hedging products.
5. Indeed one of the implicit aims of the ring-fence, in comparison to full structural separation, is to preserve certain aspects of the universal model including a diverse product range.
6. Excluding the sale of simple derivatives from inside the ring-fence would increase costs on business. A split banking proposition involving dealings with a ring-fenced bank (RFB) derivative contract from a non-ring-fenced bank (NRFB) would result in additional costs for the business, given that the NRFB will require collateral to cover the risk in the derivative contract, whereas the RFB is likely to have existing security that may already cover the transaction.
Good Progress has been made to Define a “Simple” Derivative but Further Work is Needed
7. The CBI welcomes the good progress made towards a concise and durable definition of a “simple” derivative. The CBI is supportive of the requirement that only simple derivatives be sold to customers from the RFB. However the proposed restriction based on BIPRU 7.10.21(1) seems unduly restrictive in that it would prevent customers purchasing some relatively simple derivative products such as interest rate caps or foreign exchange options which may be better suited to customer needs.
8. The limitation to offer products only if there is evidence available to assess fair value in accordance with IFRS 13, where that evidence would be considered to constitute a level 1 or a level 2 input, is intended to ensure products or their component parts are traded on liquid markets, with observable prices. While the CBI supports this approach in principle, the application of these rules is complex and this proposal would benefit from further analysis to ensure that it does not inadvertently limit business access to appropriate products.
Requiring Full Validation of the Purpose of a Derivative Contract is too Restrictive
9. Attempting to validate the specific purpose of a derivative contract, including distinguishing between its “main” or “sole” purpose, seems too forensic an approach. The differing circumstances applying to the use of derivatives contracts by different businesses makes determining their purpose beyond doubt extremely difficult. For example, a bank cannot see a client’s order book/outgoings, which would be necessary to fully validate the purpose of a foreign exchange hedge that they would like to place.
10. A more balanced approach would be that a RFB be required to take reasonable steps to satisfy itself that the hedge is consistent with a business’ commercial needs and not for speculative or other purposes.
11. This broader approach to determining the purpose of a derivative contract would be supported by a strong conduct framework, policed by the FCA, such that the bank could satisfy the regulator it has taken the reasonable steps set out above (paragraph 10).
The FCA has an Important Role to Play in Determining the Appropriateness of Individual Products
12. In evidence previously submitted to the Parliamentary Commission, the CBI called for a greater focus from the regulator on product governance. We stated that, “the Financial Conduct Authority should therefore focus on product governance throughout the product life cycle, rather than the products themselves. This would include focussing on the process of designing new products including the approval process; financial promotions and marketing; the sales process; and customer satisfaction and complaints monitoring.”
13. It is important that the FCA has strong powers to police individual products. Indeed the FCA now has these powers under the Conduct of Business regulations. These powers ensure that banks are effectively assessing the suitability of a product for a particular business and should be exercised in relation to the sale of derivative products by RFBs.
27 March 2013