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7 Law & Fin. Mkt. Rev. 1 (2013)

handle is hein.journals/lawfinancmr7 and id is 1 raw text is: DOI:10.5235/LFMR7.1.1

Editorial

Professional standards and culture in the banking
sector
The Parliamentary Commission on Banking Standards pub-
lished its first report on 21 December 2012.The Commission
was appointed by both Houses of Parliament to consider
and report on professional standards and culture of the UK
banking sector, taking account of regulatory and competition
investigations into the LIBOR rate-setting process, lessons
to be learned about corporate governance, transparency and
conflicts of interest, and their implications for regulation and
for government policy, and to make recommendations for
legislative and other action.
The first report focuses mainly on issues linked to struc-
tural separation of retail and investment banking, which had
previously been examined by the Independent Commission
on Banking in the UK led by Sir John Vickers and the EUs
Liikanen Report. The Parliamentary Commission views
separation as a key determinant of professional standards and
culture in the banking sector and claims that separation has
the potential to change the culture of banks for the better and
to make banks simpler and easier to monitor.1
A number of preliminary proposals are made by the
Parliamentary Commission. The most far-reaching is that
the proposed ring-fence around retail banking should be
electrified, meaning that the regulator should have reserve
powers to implement full structural separation if there was a
clear risk that the objectives of the ring-fence would not be
met. Moreover, in these circumstances the regulator should
consider the group's adherence to the principles and spirit
of the ring-fence as well as its compliance with the letter of
the law.The exercise of that power would lead to the relevant
banking group being required to divest itself fully of either its
ring-fenced or non-ring-fenced bank.
The Parliamentary Commission also makes several far-
reaching recommendations with regard to the operational
independence of ring-fenced banks. It found that the argu-
ments for prohibiting a non-ring-fenced bank from directly
owning a ring-fenced bank were persuasive, especially with
regard to the need for an arm's length relationship between
the ring-fenced and non-ring-fenced entities. The Commis-
sion recommends accordingly that the regulator be given the
power to require a sibling structure between a ring-fenced
and non-ring-fenced bank, with a holding company acting as
ultimate owner of each entity.
Having noted that [i]t is not possible under current
company law to create a subsidiary which is entirely inde-
pendent, the Parliamentary Commission recommends that
the government insert within the Financial Services and
Markets Act 2000 (FSMA 2000) a legal duty on boards of
directors to preserve the integrity of the ring-fence.That rec-
ommendation ref lects the nature of the duties of the directors
of a subsidiary company in promoting the interests of the

holding company, which include safeguarding the capital and
liquidity of all entities and operations within the group.
Another significant proposal with regard to the independ-
ence of ring-fenced entities is that the basic contours of the
ring-fence should be determined by primary or secondary
legislation so as to provide a clear mandate to the regulator
to police and enforce the ring-fence. That approach has the
merit of avoiding the risk that if the design of the ring-fence
were left to the discretion of the regulator it would be open
to the influence of the banks as well as soft political pressure
and might well in those circumstances compromise on the
degree of independence that was required. The Parliamen-
tary Commission welcomed the Chancellor's acceptance
of the proposals made by the Independent Commission on
Banking for independent governance arrangements within a
ring-fenced bank as well as the so-called Haldane principles
of separate risk management, treasury management and bal-
ance-sheet management.The role of the regulator within that
framework would be focused more clearly on giving effect
to rather than framing the basic contours of ring-fencing,
subject to a statutory duty to ensure operational independ-
ence for a ring-fenced bank.
Two other issues linked to professional standards and
culture were the subject of scrutiny by the Parliamentary
Commission. The first was where proprietary trading should
be located within a banking group and in particular whether
it should be permitted within a ring-fenced bank. The Par-
liamentary Commission's preliminary view on this issue was
that:
There is evidence to suggest that proprietary trading,
which under the current proposals could still take place
within the non-ring-fenced part of banking groups, is
an activity which is incompatible with maintaining the
required integrity of customer-facing banking and which
could have harmful cultural effects if permitted to con-
tinue.2
Recommendations were deferred on this issue pendingffurther
consideration during the next stage of the investigation.
However, on the issue of permitting the sale of derivatives by
a ring-fenced bank as a principal, the Parliamentary Commis-
sion was, despite some reservations,less hesitant: it concluded
that such sales should be permitted subject to controls over
their scale and the nature of the relevant derivative contracts.
In 2013 the Parliamentary Commission will move on to
look at, and report on, what contribution changes in areas
such as competition, corporate governance, supervision and
regulation and the civil and criminal law could make to
enhancing standards and culture in banking.These issues have
been considered to some extent by the Independent Coin-
mission on Banking and have been the subject of analysis in
previous issues of Law and Financial Markets Review. Among
these issues, one in particular stands out as worthy of further

Law and Financial Markets Review

January 2013

1

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