Parliamentary Commission on Banking Standards

Key points and our reaction

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Personal responsibility and the Senior Persons Regime

The Commission recommends creating a new Senior Persons Regime in place of the discredited Approved Persons Regime. Within this, all key responsibilities will be assigned to named individuals, even if those responsibilities are delegated or decisions made by committee.

A licensing regime will apply to other bank staff who are in roles that could damage the bank, casting a wider net than the current regime.

Employees covered by both the Senior Persons and the licensing regime will have to adhere to a new set of Banking Standards Rules.

Sanctions

Regulators will be armed with a range of civil sanctions (from fines to an industry ban) to use on an individual basis to those licensed individuals, unless a person can demonstrate that they took all reasonable steps to prevent or mitigate the effects of a specified failing.

The burden of proof is now on the individual not the regulator

New criminal offence: The Commission has proposed that ‘Reckless Misconduct or Reckless Mismanagement’ be a new criminal offence for all those covered by the new Senior Persons Regime, carrying, for the most serious cases, a custodial sentence and compensation claw back.

Our reaction: Banking management are acutely aware of heightened regulatory expectations and individual responsibilities. The proposals for further specific oversight, process ownership and the overriding priority on safety and soundness, will demand more time and place greater expectations on bank directors and senior executives from management in other industries.

The challenge will be to design appropriate accountability regimes that don’t stifle growth or make UK banking less attractive to top talent.

Good decisions can have poor outcomes. Building businesses and economies involves taking risks and not all decisions have happy endings. Pretending that they should, and holding the decision-maker responsible if they don’t, could stifle entrepreneurship and limit growth. The Commission acknowledges these challenges: “banks are in the business of taking risk, and regulators should not create an atmosphere in which normal operations become stifled because of fear of regulatory actions in years ahead.”

Remuneration and incentives

The Commission has not been convinced that a crude bonus cap is the right instrument for controlling pay, but concludes that variable remuneration needs reform.

Proposals underpinned by a new remuneration code, applicable to all licensed staff, bases compensation on a more balanced set of measures, not just return on equity.

Recommended regulatory powers would include:

  • the ability to limit or prohibit the use of sales-based incentives
  • deferral of up to ten years, payable through forms favouring a firm’s long-term performance, such as bail-in bonds
  • deferred compensation to Senior Persons and other licensed staff to be cancelled if a bank needs taxpayer support
  • Non-Executive Directors should be prohibited from receiving variable, performance-related remuneration.

Our reaction: It is now common ground that bankers’ behaviour and remuneration need to be better aligned, but it will be more effective if remuneration controls can be agreed globally. The variety of approaches from individual governments means remuneration rules could become very complex. Countries are creating their own carefully nuanced policies, with different thresholds and claw-back mechanisms, increasing the risk of regulatory arbitrage.

It is now broadly accepted across the industry that proportions of bonus payments will be deferred and subject to claw back; which has in fact now been standard practice in the UK for over two years. If the Commission’s proposal for bonus deferrals of the maximum of ten years were to be implemented unilaterally in the UK, we would end up with the strictest regime in the world.

Competition

The report has called for more to be done to boost competition among banks, including further immediate investigations with deadlines for completion:

  • The Government to establish an independent panel of experts to review the technical feasibility, costs and benefits relating to current account portability. It should report within six months of its establishment on switching, and within 12 months on other issues.
  • The Competition and Markets Authority to conduct a full investigation of retail banking and SME business lending by the end of 2015.
  • Major banks to come to a voluntary agreement on minimum standards for the provision of basic bank accounts (including access to the payments system and money management services, and free use of the ATM network) within 12 months, or be subject to a new statutory duty.
  • Peer-to-peer lending and crowdfunding firms to be supported, with a recommendation to review their tax treatments, to ensure a level playing field with established competitors.
  • The Government to immediately announce a process for considering alternative strategies for the future of RBS, including a ‘good bank/bad bank’ split, and report back by September 2013.

The Commission also proposes that, alongside financial stability, competition should be a strategic objective for the Prudential Regulation Authority (PRA).

Our reaction: There’s no simple solution to creating greater competition in UK banking. Existing regulatory initiatives will encourage new entrants to reduce their capital requirements and the time taken to get authorised. The Commission’s call for existing players to open up access to payment systems will also remove a hurdle, but there are limitations to what regulatory and policy action can achieve.

Whilst consumers are willing to shop around for secondary banking services like loans, they remain reluctant to move current accounts to newer players. To really win customers, new entrants will need a compelling proposition on fees, better service quality and, even in this digital age, outstanding branch and telephone service.

We need to weigh up the net benefit to the customer of further changes to account switching. The Commission is right to ask for more work to be done to understand the technical difficulty and economic case of full account portability.

The industry has spent a lot of time and energy working together to make account switching in seven days possible by September. Quicker account switching would make life easier for consumers, but has to be weighed against the pressure it will put on banks’ systems and technology. If more efficient account switching actually puts customer data at risk, we would question the net benefit to the customer. If even after September not many customers move, the independent panel will also need to understand why, and differentiate between customer inertia, banks’ reluctance and poor customer experience.

As an important step in increasing competition from new and alternative providers, we support the proposal to alter individuals’ tax treatment through peer-to-peer and crowd-sourcing lenders.

Governance

The Commission proposes greater individual and direct lines of access and accountability to the board for the heads of risk, compliance and internal audit functions, as well as much greater levels of protection for their independence. This is in line with the new Internal Audit Standards.

The Commission also proposes individual responsibility for a named Non-Executive Director to oversee fair and effective whistle-blowing procedures. This individual will be held personally accountable for protecting whistleblowers from detrimental treatment and satisfying the regulator that the firm acted appropriately in the event of an allegation. In addition, a Senior Independent Director will be required to assess the Chairman and demonstrate that the CEO has been held accountable.

The Government is being called to consult on a proposal to amend part of the Companies Act 2006 to remove shareholder primacy in respect of banks, requiring bank directors to ensure a company’s financial safety and soundness beyond its members’ interests.

Regulation

The Commission advocates a focus shift from box ticking to judgement-based regulation, supported by more effective oversight and empowerment tools.

In particular a new “Special Measures Power” tool would give the FCA and PRA a broader range of regulatory powers and controls if they are concerned about systemic weaknesses of leadership, risk management and control.

Special measures regime can be deployed when systemic weakness identified by the Financial Conduct Authority (FCA) and the PRA.

The Committee repeated its demand that the Chancellor allow regulators to set a more conservative leverage ratio for banks. The Chancellor has said the limit should be set at 3%, in line with a new international requirement from the Basel Committee.

The Committee has said the figure should be much higher. It is deemed that the Financial Policy Committee should publish its own assessment of the appropriate leverage ratio.

Audit

The Commission recommends that the Court of the Bank of England commission a periodic report on the quality of dialogue between auditors and supervisors. For the dialogue to be effective, both the PRA and the FCA would need to meet a bank’s external auditor regularly, and more than the minimum of once a year which is specified by the Code of Practice governing the relationship between external auditors and supervisors.

Our reaction: We support this, and agree that, for the dialogue to be effective, both the PRA and the FCA would need to meet a bank’s external auditor regularly. Whilst this already happens in most cases, formalising the need will be helpful.

Accounting for regulatory needs

The Commission proposes that banks should prepare and publish a separate set of accounts according to specified, prudent principles set by the regulator. This second set of accounts should be externally audited and reconciled to the IFRS accounts.

Our reaction: This is an interesting proposal that will help address the varying needs of different users of banks’ accounts, and needs to be carefully evaluated.

Conclusion

The Commission’s report, combined with that of the Independent Commission on Banking and the current Banking Bill, are important steps towards creating a post crisis financial architecture. There is still, however, significant work to be done, with new regulations and standards to be drafted e.g., Banking Standards Rules, New Remuneration Code, “Special Measures” regime, changes to Companies Act and the UK Corporate Governance Code. In addition to further studies and investigations into RBS’ future, current account portability and utility, compensation, leverage payments, roles, and more. Whilst this may create some uncertainty, the direction of travel is becoming clearer.

If you would like to discuss any of the above, or need more information, please contact us:

Omar Ali
UK Banking and Capital Markets Sector Leader
+44 [0]20 7951 1789

John Liver
Head of Global Regulatory Reform
+44 [0]20 7951 0843