U.K. Lawmakers Call on Regulator to ‘Bear Down’ on Prop Trading

Regulators should “bear down” on banks’ proprietary trading activities and review the case for an outright ban within three years, according to a panel of British lawmakers seeking to make the financial system safer.

The Prudential Regulation Authority should stop banks from engaging in trades that aren’t linked to clients’ activities, while firms should publish their risk exposures and report any “control issues” raised by the regulator, the Parliamentary Commission on Banking Standards said in a report today.

“It is particularly objectionable that the government should subsidise and carry the risk for activities where the benefits might accrue to bank employees and shareholders, much of which would have little or no social utility, and which may pose a threat to banking culture,” the committee said.

The panel stopped short of immediately recommending a ban similar to that required under the U.S. Volcker rule, citing the difficulties of differentiating between risks banks take as part of their market-making activities and stand-alone bets. The London-based committee said the PRA, the regulator that will from next month be responsible for overseeing stability in the banking and insurance industry, should police firms’ trading.

“The main U.K.-headquartered banks have told us that they don’t engage in proprietary trading at the present time and do not wish to do so,” it said. “We recommend that the PRA, with immediate effect, ensure that their regular scrutiny of banks monitors this assertion and holds banks to it.”

George Osborne

The parliamentary commission was set up by Chancellor of the Exchequer George Osborne last year to review the government’s plans to overhaul how Britain’s banks are regulated after taxpayers were forced to bail out Royal Bank of Scotland Group Plc and Lloyds Banking Group Plc. The panel has already called on Osborne to toughen his plans to force lenders to erect firewalls around banks’ consumer units.

Proprietary trading, where traders use a bank’s capital to make independent bets on the direction of securities, generated an increasing proportion of bank profits before 2007 and may have contributed to the financial crisis by pitting traders against their clients and promoting a culture of excessive short-term remuneration, the panel said in its report.

Regulators should “pay close attention to trading units which have characteristics such as large open or arbitrage positions and volatile revenue flows,” the panel said. If a bank can’t demonstrate that such trading activities are related to serving clients, the regulator should intervene, the commission said.

Next Report

The panel said an immediate outright ban would be impracticable because establishing whether banks were taking bets on the market or taking legitimate proprietary positions as a by-product of making markets for clients would be difficult. Plans to set up so-called ring fences between firms’ consumer and wholesale banking operations should reduce the need for a specific law on proprietary trading, it added.

The regulator should publish a report within three years outlining its success or failure in monitoring proprietary trading as well as the outcome of plans by the U.S., France and Germany to curb the activity.

“The progress -- or otherwise -- of the USA, and, to a lesser extent, France and Germany, in establishing a definition of proprietary trading and enforcing their measures should become apparent over time,” the panel said. “This will provide valuable evidence to enable a better assessment of the feasibility and likely effectiveness of similar action in the U.K.”

Liam Vaughan in London at +44-20-3216-4754 or lvaughan6@bloomberg.net

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