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25 Jun 2013

Corker Binning partner comments on Banking Standards Report

David Corker, partner, Corker Binning comments in International Financial Law Review on the Banking Standards final report.

UK banking standards report: the market responds

Author: Danielle Myles, Lucy McNulty | Published: 25 Jun 2013

  • The UK Parliamentary Commission on Banking Standards’ final report is set to be quickly implemented;
  • The market broadly agrees with many recommendations in isolation, as they codify governance and behavioural changes already taking effect;
  • But there are fears the recommendations simply add another layer of regulation on an already burdened industry;
  • A criminal offence for recklessness would be almost impossible to prosecute, but it’s valued for its deterrent effect;
  • Others warned it may inflict so-called brain drain on the City, or create ultra-conservative management;
  • Giving financial safety and soundness primacy over shareholder rights is fraught with problems.

Recommendations in last week’s UK banking standards report are tipped to be implemented more quickly than the Wheatley Review, Vickers Report and Liikanen Report.

But market participants fear the report risks eroding the competitiveness of the UK banking system.

Ambitiously titled Changing banking for good, the UK Parliamentary Commission on Banking Standard’s final report emphasises better judgement, governance best practice, and personal responsibility.

Established in July 2012 in the wake of the London Interbank Offered Rate (Libor) rigging scandal, the Commission’s final recommendations to change UK bank culture have been primarily well-received by the public.

But Allen & Overy partner Bob Penn – who gave evidence to the Commission in November 2012 – warned the report illustrated that the regulatory pendulum had now swung too far in the direction of worshipping at the altar of
financial stability. That poses risks to the UK’s standing as a financial centre.

“More consideration needs to be given to the impact of this,” he said.

Even so, Dr Richard Reid of the University of Dundee Business School said there was a lot of pressure on the government to not just pay lip service to the report’s findings.

Chancellor George Osborne has already indicated the next steps.

“The Banking Bill currently before Parliament will be amended to ensure the recommendations can be quickly enacted,” the Chancellor said in his Mansion House speech last Wednesday, the same day the Commission’s
report was released.

He will respond more fully next month.

IFLR sources spanning several sectors were broadly supportive of the vast majority of the report’s recommendations. The findings essentially codify many measures already being taken. These include initiatives
regarding remuneration, criminal sanctions, and the suitability of individuals holding senior positions within banks.

“Much of what they say would put a structure behind the changes being discussed already; to make them more to the point and more transparent to the public,” said Reid.

“It was exactly the type of post mortem we should have had in the wake of the crisis,” said one former-City banker. “It went beyond the Turner Report and addressed the behavioural issues that have only been touched on
in reform discussions to date.”HSBC chairman Douglas Flint said in an emailed statement: “This is a comprehensive and hard-hitting report and most importantly is forward looking as well as forensic in its analysis of the root causes of lapses in banking standards.”

“The Commission’s conclusions contain many constructive proposals to help fix the issues which have afflicted the industry,” he added.

But others warned that the report risked over-regulating an already burdened industry.

“Unilaterally flagellating ourselves and each other more is not helpful as a way forward,” said one UK-based law firm partner, speaking on the basis of anonymity. “In fact far from getting things done, I think it fuels
dissatisfaction because another group then calls for more fixes and more rules get added in.”

Penn said the report should be commended in its ambition. But warned it was a very lengthy footnote to a colossal reform process. “The really substantial issue here is how this fits in with everything that’s gone before,”
he said.

The market’s response to the report’s key recommendations are below.

Criminal sanctions

Commission recommendation

A new criminal offence should be introduced for senior officials within banks who carry out their duties in a reckless manner.

An associated change would see key responsibilities officially assigned to those individuals in a transparent manner.

“A lack of personal responsibility has been commonplace throughout the industry,” said Commission Chair Andrew Tyrie in a comment accompanying the report. “Senior figures have continued to shelter behind an
accountability firewall.”

Market’s response

The new individual offence is in line with moves over the past decade to widen the scope of corporate criminality.

Section 7 of the UK Bribery Act 2010, known as failing to prevent bribery, is one example of an increasing number of crimes committed on the basis of lax controls and system failures.

“This is appearing more and more in corporate criminality,” said criminal lawyer David Corker of Corker Binning.

“And the Commission is trying to extend this concept of negligence and recklessness into individual criminality.”

It is rare for a parliamentary commission to recommend a criminal offence, and he expected it to be passed into law largely unopposed.

But he agreed with other sources that its limited circumstances of application means it’s unlikely to ever be prosecuted and enforced. Two years after it took effect, no one has been prosecuted under section 7 of the
Bribery Act.

“Criminal charges for wilful recklessness is difficult territory, and I think the Commission recognises that they are unlikely wind up with many people going to jail,” said Reid. “But perhaps the real intention is to be a stick in how the industry behaves.”

“It’s not simply a token measure, but its not about prosecution and enforcement. Instead it is about deterrence,” said Corker.

The former banker indicated the offence would have the intended effect, describing it as the “ultimate nuclear deterrent” which was long overdue.

Penn, however, believed the suggested changes would have an unintended impact on the behaviour of senior bank managers.“It’s a political gesture, prompted by a popular desire to see these people put under pressure,” he said. “The consequences have not been given enough consideration.”

“Behaviourally, I see two risks coming out of this,” he said. “First, there’s risk of a brain drain as incoming talent look to opportunities elsewhere. Second, there’s a risk that the raft of changes proposed will foster the
development of ultra-conservative management.”

“While that seems like an attractive outcome today, it may not be so five years from now,” he said. “Ultraconservative bank managers will erode the competitiveness of the UK banking industry and thereby harm UK’s
standing as a financial centre in the long-run.”

Primacy of financial stability

Commission recommendation

The Companies Act 2006 should be amended to ensure the financial safety and soundness of the company ahead of the interests of its members. This would remove shareholder primacy, as it relates to banks.

Market’s response

The effectiveness of such a change depends on the wording. According to Herbert Smith Freehills’ Karen Anderson, a bank’s safety and soundness ought to be aligned with shareholder interests in any event.

Directors are already required to take into account likely long-term consequences in discharging their duty to promote the success of the company, and she said it would be relatively easy to add safety and soundness as a
factor which must be given due regard.

Penn said the Commission had taken the right point about the lack of discipline, which shareholders have bought to the running of banks. “We’re going to see bondholders flex their muscles much more,” he said.

But going a step further could bring unintended consequences.

“Abolishing shareholder primacy for banks would be trickier to achieve and one wonders what the impact would be on shareholder interest in investments in banks,” Anderson said.

According to the UK law firm partner, playing around with a topic as conceptually significant as shareholders’ rights must be done solely on a global level. “A purely domestic solution to an international problem is unhelpful,”
he said.

Approved Person Register changes

Commission recommendation

The Approved Person Register should be scrapped and replaced with two registers.

First is a Senior Persons register, which ensures that key responsibilities are officially assigned to appropriate staff. Second is a Licensing Regime, which applies to other staff whose actions could seriously harm the bank’s
operations or reputation.

The Licensing Regime would essentially require employers to verify the fitness and propriety of the relevant employee.

Enforcement capabilities have been limited because the Statements of Principle and Codes of Practice can only be enforced against those listed on the Approved Persons Regime

Market’s response

Reid warned that the Licensing regime risks becoming overly-prescriptive and introducing bureaucracy at noncore levels.

“If you can get institutions themselves to realise what must be done, then how far down the scale of a bank does something like this need to go? I’m not sure licencing per se is the answer.