Changing Banking for Good

House of Lords House of Commons Changing banking for good

Report of the Parliamentary Commission on Banking Standards

Volume IV: Written evidence to the Commission

HL Paper 27-IV

HC 175-IV

House of Lords House of Commons Parliamentary Commission on Banking Standards

Changing banking for good

First Report of Session 2013–14

Volume IV: Written evidence to the Commission

Ordered by the House of Lords to be printed 12 June 2013 Ordered by the House of Commons to be printed 12 June 2013

HL Paper 27-IV HC 175-IV* Published June 2013 by authority of the House of Commons London: The Stationery Office Limited £0.00

Parliamentary Commission on Banking Standards

The Parliamentary Commission on Banking Standards is 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.

Current membership Mr Andrew Tyrie MP (Conservative, Chichester) (Chairman) Most Rev and Rt Hon the Archbishop of Canterbury (Non-Affiliated) Mark Garnier MP (Conservative, Wyre Forest) Baroness Kramer (Liberal Democrat) Rt Hon Lord Lawson of Blaby (Conservative) Mr Andrew Love MP (Labour/Co-operative, Edmonton) Rt Hon Pat McFadden MP (Labour, Wolverhampton South East) Rt Hon Lord McFall of Alcluith (Labour/Co-operative) John Thurso MP (Liberal Democrat, Caithness, Sutherland and Easter Ross) Lord Turnbull KCB CVO (Crossbench)

Powers The Commission’s powers include the powers to require the submission of written evidence and documents, to examine witnesses, to meet at any time (except when Parliament is prorogued or dissolved), to adjourn from place to place, to appoint specialist advisers, and to make Reports to both Houses.

A full list of the Commission’s powers is available in the House of Commons Votes and Proceedings of 16 July 2012 on page 266, and the House of Lords Minutes of Proceedings of 17 July 2012, Item 10.

Publications The Reports and evidence of the Commission are published by The Stationery Office by Order of the House. All publications of the Commission (including press notices) are on the Internet at http://www.parliament.uk/bankingstandards.

Commission staff The following parliamentary staff worked for the Commission: Colin Lee (Commons Clerk and Chief of Staff), Adam Mellows-Facer (Deputy Chief of Staff), Lydia Menzies (Second Clerk), Sian Woodward (Clerk), Richard McLean (Lords Clerk), Lucy Petrie (Second Clerk), Jay Sheth (Commission Specialist), Gavin Thompson (Commission Specialist), James Abbott (Media Officer), James Bowman (Senior Committee Assistant), Tony Catinella (Senior Committee Assistant), Claire Cozens (Senior Committee Assistant), Emma McIntosh (Senior Committee Assistant), Rebecca Burton (Committee Assistant), Katherine McCarthy (Committee Assistant), Daniel Moeller (Committee Assistant), Baris Tufekci (Committee Assistant), Ann Williams (PA to the Chief of Staff) and Danielle Nash (Committee Support Assistant).

The following staff were seconded from outside of Parliament to work for the Commission: Philip Airey, Amélie Baudot, Paul Brione, Suvro Dutta, Oliver Gilman, Oonagh Harrison, Sadiq Javeri, Robert Law, Zoe Leung-Hubbard, Mayur Patel, Julia Rangasamy, John Sutherland, Greg Thwaites and Elizabeth Wilson.

Contacts All correspondence should be addressed to the Clerks of the Parliamentary Commission on Banking Standards c/o the Treasury Select Committee, 7 Millbank, London SW1P 3JA. The telephone number for general enquiries is 020 7219 8773; the Commission’s email address is [email protected].

Volumes of this Report

This Report is the Fifth Report of the Commission (and the First Report of Parliamentary Session 2013–14). It has nine volumes:

Volume I: Summary, and Conclusions and recommendations Volume II: Chapters 1 to 11 and Annexes, together with formal minutes Volume III: Oral evidence taken by the Commission Volume IV: Written evidence to the Commission Volume V: Written evidence to the Commission Volume VI: Written evidence to the Commission Volume VII: Oral and written evidence taken by Sub-Committees A and B Volume VIII: Oral and written evidence taken by Sub-Committees C, D, E, F and G Volume IX: Oral and written evidence taken by Sub-Committees H, I, J and K

Lists of witnesses who gave evidence and lists of people or organisations who submitted written evidence are given in the relevant volumes of the Report.

*House of Commons Printing Numbers

This Report is printed under House of Commons Printing number HC 175. It also incorporates papers ordered for printing in Session 2012–13 under the following House of Commons printing numbers:

HC 606-i to –xl, HC 619-i to –ii, HC 705-i to –viii, HC 783-i, HC 706-i to –v, HC 821-i to –iii, HC 710-i to –ii, HC 784-i, HC 881-i to –v, HC 804-i to –ii, HC 860-i to –iv, HC 945-i

Changing banking for good

List of written evidence to the Commission

Written evidence to the Commission is on pages Ev 736 to 1642, FR Ev 1 to 199, and TR Ev 1 to 27. Evidence pages Ev 736 to 1184 are contained in Volume IV of the Report. Evidence pages Ev 1185 to 1642 are contained in Volume V of the Report. Evidence pages FR Ev 1 to 199 and TR Ev 1 to 27 are contained in Volume VI of the Report.

1 Accord Ev 736 2 Advisory Board of the Institute of Risk Standards & Qualifications Ev 1237 3 Affinity Trade Union Ev 740 4 Association of British Insurers Ev 742 5 Association of Corporate Treasurers Ev 1501 6 Association of Financial Markets in Europe Ev 750 7 Bank of England Ev 795, 798, 1380, 1499, 1500, 1539, 1606, 1607 8 Barclays Ev 798, 809, 813, 1502, 1504 9 Bellord, Nicholas J Ev 815 10 Black, Professor Julia and Professor David Kershaw Ev 820 11 Board Intelligence Ev 834 12 Brash, Donald T, former Governor of the Reserve Bank of New Zealand Ev 837 13 British Bankers' Association Ev 840, 852, 864, 870, 872, 879, 880, 1504, 1505 14 British Chamber of Commerce Ev 881 15 British Standards Institute Ev 883 16 Budd, Sir Alan Ev 885 17 Budden, Jennifer Ev 887 18 Building Societies Association Ev 890 19 Burnley Savings and Loans Ev 896 20 Bush, Timothy Ev 899 21 Butler, Cormac Ev 907 22 Campaign for Community Banking Services Ev 912 23 Campaign for Regulation of Asset Based Finance Ev 1508 24 Capie, Forrest Ev 1511 25 Cassidy, Michael Ev 1513 26 CBI Ev 913, 1514 27 Centre for Research on Socio-Cultural Change Ev 667 28 CFA UK Ev 919 29 Chadha, Professor Jagjit Ev 925 30 Chancellor of the Exchequer Ev 1116 31 Chartered Banker Institute Ev 926, 1516, 1517 32 Chartered Institute for Personnel and Development Ev 933 33 Chartered Institute for Securities & Investment Ev 937 34 Chartered Institute of Internal Auditors Ev 942 35 Chartered Insurance Institute Ev 947 36 Christian Council for Monetary Justice Ev 955 37 Church of England Ev 956 38 Church of Scotland Ev 962

Changing banking for good

39 Citizen's Advice Ev 965 40 City of London Corporation Ev 973; 976 41 Clarke, Donald R Ev 979 42 Crow, Malcolm Ev 1520 43 Cruickshank, Sir Donald Ev 981, Ev 982 44 Dalton, Bruce Ev 1522 45 Dorn, Nicholas Ev 983 46 Duijsters , J Ev 989 47 Ecumenical Council for Corporate Responsibility Ev 992 48 FairPensions Ev 1003 49 Professor Stella Fearnley and Professor Shyam Sunder Ev 1633 50 Featherby, James Ev 1008 51 Federal Deposit Insurance Corporation Ev 1489 52 FIA European Principal Traders Association Ev 1011 53 Fidelity Worldwide Investment Ev 1016 54 Financial Conduct Authority Ev 1527 55 Financial Ombudsman Service Ev 1018 56 Financial Reporting Council Ev 1019 57 Financial Services Authority Ev 1037, 1045, 1052, 1054, 1055, 1059, 1060, 58 1061, 1063, 1065, 1066, 1249, 1474, 1530, 1532 59 Financial Services Authority and Royal Bank of Scotland Ev 1068 60 Financial Services Consumer Panel Ev 1024, 1069 61 Financial Services Practitioner Panel Ev 1029 62 Foxley, Ian Ev 1073 63 Fraser, Ian Ev 1077 64 French, Derek Ev 1079 65 Global Witness Ev 1081, Ev 800 66 Goldman Sachs International Ev 1085 67 Goodhart, Professor Charles A.E. Ev 1537 68 Greenham, Tony Ev 1473 69 Harries, C S Ev 1103 70 Harris , Professor Richard Ev 1540 71 Hawkins, I Ev 1104 72 Hermes Equity Ownership Services Ltd Ev 1109 73 Hill, Geoff Ev 1112 74 HSBC Ev 1117 75 Hussey, Simon Ev 1640 76 ICMA Group Zurich Ev 1126 77 IFS School of Finance Ev 1126, 1558 78 Institute of Business Ethics Ev 1129 79 Institute of Chartered Accountants in England and Wales Ev 1131, 1560 80 Institute of Operational Risk Ev 1135 81 Intellect Ev 1137 82 International Academy of Retail Banking Ev 1560 83 Investment Management Association Ev 1155 84 Ipsos MORI Ev 1163 85 Jeffares, Neil Ev 1168

Changing banking for good

86 Jenkins, Huw Ev 1564 87 Johansson, Jerker Ev 830 88 Johnson, Dr Timothy Ev 1172 89 Johnstone, C M Ev 1182 90 JP Morgan Chase & Co Ev 1565 91 Kelton, Erika A. Ev 1185 92 Law Society of England and Wales, and Association of Corporate Treasurers Ev 1572 93 Law Society of England and Wales Ev 1189 94 Leadsom MP, Andrea Ev 1198 95 Legal Services Board Ev1578 96 Liikanen, Erkki Ev 1204 97 Lilico, Andrew Ev 1205 98 Lindsey OBE, Ian W Ev 1208 99 Lloyds Banking Group Ev1216, 1226, 1227, 1581 100 London First Ev 1233 101 Makar, Mira Ev 1239 102 Mayes, Professor David G , University of Auckland Ev 1250 103 Mitchell QC, Gregory Ev 1582 104 Mitchell QC, Iain G. Ev 1256 105 Moore, Paul Ev 1588 106 Lord Phillips of Sudbury OBE, Sir John Banham DL, 107 Tim Melville – Ross CBE, and Sir Stephen O’Brien CBE Ev 1599 108 NAPF Ev 1260 109 New Economics Foundation Ev1473 110 Observatoire Finance Banking Ev 1263 111 Office of Fair Trading Ev 1269 112 Office of the Comptroller of the Currency Ev 1495 113 Oxford Centre for Mutual and Employee-owned Business, Kellogg College, University of Oxford Ev 1275 114 Payments Council Ev 1278 115 Personal Finance Education Group Ev 1280 116 Pope, David Ev 1282 117 Pringle, Robert Ev 1286 118 Pro-Housing Alliance Ev 1294 119 Public Concern at Work Ev 1299 120 Question of Trust in partnership with Financial Services Research Forum Ev 1306 121 Reynolds, John Ev 1309 122 Rippon, Mr Ev 1312 123 Robertson, James Ev 1319 124 Rohner, Dr Marcel Ev 1320, 1321, 1608, 1609 125 Royal Bank of Scotland Ev 1321 126 Santander Ev 1326, 1609 127 Sants, Sir Hector Ev 1333 128 Solicitors Regulation Authority Ev 1614 129 Spottiswoode, Clare Ev 1336 130 Stonehaven (Healthcare) Ev 1337 131 Sturmer, Raymund C. Ev 1340

Changing banking for good

132 Taplin, Ian Ev 1342, 1350 133 TheCityUK Ev 1364, 1614 134 Theos Ev 1620 135 TUC Ev 1367 136 Turner, Nikki and Paul Ev 1381 137 UBS Ev 1394, 1624 138 Unite the Union Ev 1394 139 Universities Superannuation Scheme Ev 1398 140 Virgin Money Ev 1417 141 VocaLink Ev 1439 142 Volcker, Paul Ev 706 143 Walker, Sir David Ev 1443 144 Which? Ev 1443 145 Wilmot-Sitwell, Alex Ev 1613 146 Woods, Martin Ev 1626 147 Worshipful Company of International Bankers Ev 1470

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Ev 736 Parliamentary Commission on Banking Standards: Evidence

Written evidence

Written evidence from Accord 1. ExecutiveSummary — Accord is the union representing the largest number of Lloyds Banking Group (LBG) employees and will remain so when the sale of the bank’s “Verde” business to the Co-operative Bank is completed in November 2013. — Accord believes the failure of the ICB Final Report to address the issue of standards and culture within UK banking—and the UK Government’s acceptance of this—was a serious error of judgement by both of parties. — Accord believes that acquisition of appropriate banking qualifications are a necessary and minimum requirement for those holding senior management positions in UK retail banking institutions. — Accord believes that the replacement of a professional service culture by a sales culture in UK retail banking—and the consequent crises and scandals this has resulted in—has led to a significant drop in public trust in the banking industry and of bank employees. — Accord believes that the country and bank customers both need retail banking to be a professional, advice-based industry, in which product sales flow from best advice to a customer, not a sales culture determining what advice is given. — Accord strongly believes that all customer-facing employees of retail banks should undertake appropriate professional courses to acquire the qualification necessary for them to provide the best professional advice to bank customers. — Accord welcomes the decision made by LBG earlier this year that all of its customer-facing employees will be required to attain the Institute of Financial Services (ifs) Certificate in Retail Banking Conduct of Business. — Accord believes that employee remuneration must be linked to customer service and satisfaction, not product sales. — Accord believes that there should be a fundamental review of remuneration and reward systems which are currently based upon individual performance and driven by sales targets. — Accord also agrees with the TUC that major UK companies, including banks, should be required to have worker representatives on their remuneration committees. — Accord believes that only full separation will provide retail bank customers with confidence that their hard-earned money is not at risk of being lost by highly-remunerated, speculative, short-term investment bank executives.

2. Introduction 2.1 Accord (formerly the Independent Union of Halifax Staff) was the largest union representing members within Halifax Bank of Scotland Group (HBOS). Accord now represents almost 30,000 LBG employees, following the takeover that was completed on January 19th 2009. 2.2 Accord is the union representing the largest number of LBG employees and will remain so when the sale of the bank’s “Verde” business to the Co-operative Bank is completed in November 2013. 2.3 In addition, Accord also represents employees of the Equitable Life Assurance Society. 2.4 Accord welcomes the opportunity to submit evidence to the Parliamentary Commission on Banking Standards. In its response1 to the Independent Commission on Banking (ICB) interim report, the union said: “Accord does not believe that the ICB Interim Report has given enough focus on the need for cultural change within the finance and banking industry.” 2.5 The union’s response also said: “Accord believes that there can be no return to what had been seen before the financial crisis as ‘business as usual’.” “Accord believes that unless sufficient focus is put upon the cultural change required within the financial services industry, and certainly within the retail banking sector—which Accord’s submission will focus on—of it, the necessary lessons will not be learned and the seeds of the next financial crisis will be sown.” 2.6 Accord was therefore extremely disappointed and disturbed that the ICB’s final report2 made no mention of the need for cultural change within UK banking, particularly retail banking. 1 http://accord-myunion.org/6-june-2011-accord-responds-to-icb/ 2 http://bankingcommission.s3.amazonaws.com/wp-content/uploads/2010/07/ICB-Final-Report.pdf cobber Pack: U PL: COE1 [O] Processed: [19-06-2013 15:26] Job: 027059 Unit: PG01 Source: /MILES/PKU/INPUT/027059/027059_w095_027059_w001_Mark_S080 - C M Johnstone.xml

Parliamentary Commission on Banking Standards: Evidence Ev 737

2.7 Therefore, whilst saddened about the revelations surrounding the manipulation of the Libor rate by Barclays and other banks that was the catalyst for the Parliamentary Commission, the union was not surprised that those in senior decision-making positions within those institutions believed that the standards and values to which they operated were acceptable. If the biggest investigation into UK banking in a generation did not challenge them why would they feel the need to change? 2.8 Accord regards the nostrum attributed to the esteemed management consultant Peter Drucker that “culture eats strategy for breakfast” is as true now as it ever was. Therefore, Accord believes the failure of the ICB Final Report to address the issue of standards and culture within UK banking—and the UK Government’s acceptance of this—was a serious error of judgement by both of parties.

3. To what extent are professional standards in UK banking absent or defective? 3.1 The lifting of exchange controls in 1979 and the passing of the 1979 Banking Act led to increased competition for UK banks from both foreign and non-bank institutions.3 Since then UK retail banks, including current and former building societies, have moved from a service-based culture to a sales-based culture. Accord members have seen this change at first hand. 3.2 The change to a sales-based banking culture led to a concomitant change in the training that retail bank employees received and how they were rewarded. Client-handling and sales-technique training increased, whilst the focus on professional banking qualifications diminished. Accord believes that this was a mistake. 3.3 Accord acknowledges that customer service is incredibly important in any competitive sector and banking is no exception to this. However the union’s view is that banking should be seen as a professional service first and foremost. Helping households and businesses to manage their risks and financial needs is the core role of retail banking and Accord believes that appropriate professional qualifications are required to fulfil this role. 3.4 Customers look to bank staff for professional advice on how to manage and invest their money properly, just as they do to other vital professional service providers such as accountants or surveyors. In order to become head of a major accountancy practice or major firm of chartered surveyors an individual has to possess appropriate accountancy or surveying qualifications: any additional service or management qualifications they may possess are ancillary. 3.5 Given the importance of retail banking to the functioning of modern society, Accord believes that acquisition of appropriate banking qualifications are a necessary and minimum requirement for those holding senior management positions in UK retail banking institutions. Like many others, Accord members were shocked when the Chairmen and Chief Executives of RBS and HBOS revealed to the House of Commons Treasury Select Committee in February 20094 that they did not possess a banking qualification between them. 3.6 However it must be acknowledged that the cultural changes and pressure on professional standards is not just a UK phenomenon: a glance at the website of the UNI Global union federation representing bank employee unions—of which Accord is an affiliate—shows that the trend towards prioritising sales rather than professional advice has been a global one. 5

4. What have been the consequences for (a) consumers, both retail and wholesale, and (b) the economy as a whole? 4.1 It is important to say that not all of the consequences of culture change in UK retail banking over the past 30 years have been bad for customers. For instance, the increase in credit available to households and businesses up to the financial crisis fuelled economic growth, increased home-ownership and led to a rise in living standards during this period. 4.2 Therefore, whilst one can say with the benefit of hindsight, that growing reliance upon wholesale funding, derivatives and securitisation of mortgage and loan books to provide mortgages and other forms of credit for UK retail customers was ultimately unsustainable, there is no doubt it provided the platform for the growth in UK home ownership from 57% in 1981 to 71% in 2003.647 This accorded with the policy of successive governments from 1979 until today. 4.3 Nonetheless, it is also undeniably true that this period has seen a series of mis-selling scandals which have devastated the lives of millions of bank customers. These include: — Endowment Mortgage mis-selling—which, by the end of 2008 had seen 1.8 million endowment complaints, and paid compensation in excess of £2.7 billion;7 — High-Risk Precipice Bonds mis-selling—which saw fines levied on UK banks and building societies for mis-selling the products to pensioners; 3 “Evolution of the UK banking system”—page 328, Bank of England Quarterly Bulletin 2010 Q4 http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/qb100407.pdf 4 ..\Documents\Ken's 2012 Folder\Accord\Three Cliffs Treasury Com 100209.mov 5 http://www.uniglobalunion.org/Apps/uni.nsf/pages/finance_campEn 6 http://www.lendingstandardsboard.org.uk/staffdirectors.htm 7 http://www.fsa.gov.uk/pubs/other/me_standards.pdf cobber Pack: U PL: COE1 [E] Processed: [19-06-2013 15:26] Job: 027059 Unit: PG01 Source: /MILES/PKU/INPUT/027059/027059_w095_027059_w001_Mark_S080 - C M Johnstone.xml

Ev 738 Parliamentary Commission on Banking Standards: Evidence

— Payment Protection Insurance (PPI) mis-selling—perhaps the biggest and most expensive mis- selling scandal, that Which? estimates could cost UK banks up to £10 billion in compensation8 and; — The mis-selling of complex interest rate hedging products—so-called “rate swaps”—to small sized businesses which have cost some of them “hundreds of thousands and even, in some cases, millions of pounds”.9 4.4 These sales scandals have had a deeply distressing and costly impact upon millions of ordinary retail bank customers.

5. What have been the consequences for public trust and in, and expectations of, the banking sector? 5.1 Accord believes that the replacement of a professional service culture by a sales culture in UK retail banking—and the consequent crises and scandals this has resulted in—has led to a significant drop in public trust in the banking industry and of bank employees. This has been particularly so since the 2008 financial crisis. 5.2 Where previously working for a bank had been regarded as a “respectable” job in the community, Accord members inform us it now often provokes a negative response. They report that, in the wake of taxpayers’ money being used to recapitalise the incipient LBG, the level of abuse they received from customers increased dramatically. 5.3 The pressure upon retail bank employees to hit product sales targets leads to resentment from customers and employees alike. From discussions with other unions representing retail bank employees, and consumer representatives, Accord believes that this is an industry-wide problem. 5.4 Accord notes that in a survey conducted by Which?10 this summer, 71% of respondents believed that banks hadn’t learned their lesson from the financial crisis. The union also notes that figure has increased from 61% in a similar survey conducted in September 2011. This suggests that the Libor and rate swap scandals— along with the IT system failures at Nationwide, Ulster Bank and NatWest—have further damaged public trust in UK retail banks. 5.5 Accord notes that, in light of the PPI, Libor and rate swap scandals, the LBG Chief Executive António Horta-Osório warned earlier this summer that the banking industry is facing a “deep crisis of confidence and trust” and “needs cultural change”.11 The union agrees with him.

6. What caused any problems in banking standards? 6.1 As stated previously, the lifting of exchange controls in 1979 and passing of the 1979 Banking Act led to increased competition for UK banks from both foreign and non-bank institutions.12 This led to UK retail banks moving from a service-based culture to a sales-based culture. 6.2 As also stated previously, this change to a sales-based banking culture led to concomitant change in the training that retail bank employees received and how they were rewarded. Client-handling and sales-technique training increased whilst the focus on professional banking qualifications diminished. Accord believes that this was a mistake. 6.3 At lower and middle levels of retail banking there has been a significant shift towards increasing variable pay—or bonuses as they are more commonly known—at the expense of core remuneration. Bonuses for staff are supposed to be linked to employees being assessed against a balanced scorecard of benchmarks in their performance appraisals, of which product sales is only one element. However Accord reps—and colleagues from other unions—tell us that all too often managers focus upon hitting sales targets at the expense of other benchmarks. As a result staff feel under constant pressure to sell inappropriate products to customers. Given that managers own pay packets and career prospects depend on this, one can understand the pressure they are under also. 6.4 Dealing with appeals against staff appraisals, particularly failure to hit sales targets, takes up a significant amount of Accord reps’ time. From discussions with colleagues in other unions representing retail bank staff we are aware that this is an industry-wide issue. 6.5 As Accord argued in its evidence to the ICB, the growth in variable pay in retail banking leads to a short-term mind set in all areas of banks and it is likely that, if this is happening in the branches, somewhere higher up and in a back office the same culture is likely be prevalent. Here the consequences for the bank, its customers and the country as a whole can be much more severe. An example of this is the irresponsible lending and speculation by the Bank of Scotland Corporate Banking Division. This Division’s speculation on the Irish 8 http://press.which.co.uk/whichstatements/payment-protection-insurance-ppi-provisions-hit-10-billion/ 9 http://www.telegraph.co.uk/finance/rate-swap-scandal/9364019/Big-Four-banks-admit-to-mis-selling-interest-rate-swaps.html 10 http://press.which.co.uk/whichpressreleases/five-years-on-and-three-quarters-of-people-say-banks-still-havent-learnt-their-lesson/ 11 http://www.ft.com/cms/s/0/b64c756e-d727–11e1–8e7d-00144feabdc0.html#axzz24xyFqQET 12 “Evolution of the UK banking system”—page 328, Bank of England Quarterly Bulletin 2010 Q4 http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/qb100407.pdf cobber Pack: U PL: COE1 [O] Processed: [19-06-2013 15:26] Job: 027059 Unit: PG01 Source: /MILES/PKU/INPUT/027059/027059_w095_027059_w001_Mark_S080 - C M Johnstone.xml

Parliamentary Commission on Banking Standards: Evidence Ev 739

property market, in particular, was instrumental in the failure of HBOS and led to its takeover by Lloyds TSB and bail-out by UK taxpayers.

6.6 Accord also believes that it is no coincidence that, in addition to the structural drivers previously highlighted, the increasing appointment of former investment banking executives to retail banking positions also led to a signiﬁcant change in the culture of UK retail banks.

6.7 Investment banking and retail banking had different and distinct cultures and operational practices. The former was geared to short-term risk taking in the hope of large reward, whilst the latter was geared towards long-term, professional advice that garnered longer-term management fees. As has been stated earlier, this division has now been eroded, with the culture of investment banking becoming dominant.

7. What can and should be done to address the weaknesses identiﬁed?

7.1 Accord is disconcerted that some in the retail banking industry—both some new entrants and established banks—indicate that retail banking is a sales-based industry like other retail businesses. Whilst there is no doubt that banks can and have learnt from the retail sector—as stated previously—Accord does not believe that banking is an industry like any other.

7.2 Accord believes that the country and bank customers both need retail banking to be a professional, advice-based industry, in which product sales ﬂow from best advice to a customer, not a sales culture determining what advice is given. As the ﬁnancial crisis showed, the consequences of mistakes are far too great for this is not the case.

7.3 Accord strongly believes that all customer-facing employees of retail banks should undertake appropriate professional courses to acquire the qualification necessary for them to provide the best professional advice to bank customers. These qualifications provide the bank staff themselves with the confidence to make a professional judgement on which products best suit the needs of individual customers.

7.4 Therefore, Accord welcomes the decision made by LBG earlier this year that all of its customer-facing employees will be required to attain the Institute of Financial Services (ifs) Certificate in Retail Banking Conduct of Business. LBG is the first retail bank to make this step—following discussions between Accord and the ifs—and the union believes that other retail banks would do well to follow its lead. If widely adopted, the promotion of professional banking qualifications will, Accord believes, play a vital role in helping to restore customer confidence in the reputation and standing of bank staff and the industry as a whole.

7.5 Accord would prefer its members to be paid a guaranteed decent wage for doing their job professionally and responsibly. However LBG, like all the other retail banks, wishes to retain a performance-based element of remuneration. Accord believes that if this practice is to be continued that bonuses must be linked to customer service and satisfaction, not product sales.

7.6 Therefore, Accord believes that there should be a fundamental review of remuneration and reward systems which are currently based upon individual performance and driven by sales targets. Many companies within the ﬁnance sector favour rewarding sales ﬁgures which pay little or no regard to customer service. Remuneration must be transparent, accountable and open to independent scrutiny.

7.7 Accord also agrees with the TUC that major UK companies, including banks, should be required to have worker representatives on their remuneration committees. In addition, Accord believes that remuneration consultants should only report to remuneration committees, not to executive directors.

7.8 Finally, in its response to the ICB, Accord indicated a preference for a complete separation between retail and investment/wholesale banking. It is Accord’s view that the case for such separation has increased since then and that the cultures of the two are inimical. Therefore Accord believes that only full separation will provide retail bank customers conﬁdence that their hard-earned money is not at risk of being lost by highly-remunerated, speculative, short-term investment bank executives. August 2012

Written evidence from Afﬁnity

Afﬁnity is the largest independent trade union in the Lloyds Banking Group. We represent 35,000 members working in all areas and at all levels of the Bank from retail banking to wholesale banking and from cashiers to senior executives.

The Commission has raised some interesting questions that go well beyond the Libor rate rigging scandal. We have focused our submission on those of the questions that concern UK retail banking and where we feel we have a meaningful contribution to make. cobber Pack: U PL: COE1 [E] Processed: [19-06-2013 15:26] Job: 027059 Unit: PG01 Source: /MILES/PKU/INPUT/027059/027059_w095_027059_w001_Mark_S080 - C M Johnstone.xml

Ev 740 Parliamentary Commission on Banking Standards: Evidence

1.1 It’s been steady but the decline in professional standards in UK banking can be traced back to the deregulation of the financial services market in the 1980’s. Before then UK retail banks had operated as quasi- cartels with a steady stream of customers coming in to branches to open new accounts and deposit money or borrow money. It was “narrow-banking” but it was very profitable banking. Following deregulation, new entrants who had found it difficult to enter the market before the “Big Bang” could do so more easily and that put substantial strains on the established banks, with their significant infrastructure costs and expensive branch networks to feed. That led the retail banks to seek alternative revenue streams and the one area they focused on very quickly was the highly profitable bancassurance model that had operated on mainland Europe, particularly in France, for many years. The idea of bancassurance was that a bank could “mine” its existing customer base in order to sell new insurance and investment products.

1.2 From the beginning there was always the danger that trying to sell or market two different kinds of products was going to create tensions. Morgan, Sturdy, Daniel and Knights refer to this inherent tension between banking and insurance and say: “Bankers are generally risk averse; they seek to develop a long-term relationship with the client…Insurance sellers are concerned to maximise their commission based earnings… ”. (The Geneva Papers on Risk and Insurance, 19 no 71, April 1994). The introduction of bancassurance also changed the culture of banking from being largely focused on creating long-term profitable relationships with customers to one obsessed with “cross-selling”, “product penetration” and “share of wallet”. In that period it is fair to say that the selling concept became significantly more pronounced with the introduction of ever more complicated incentive schemes for employees and aggressive targeting models designed to drive sales type behaviours. In many organisations at that time a predatory sales culture began to develop in key areas of the banks and the idea of creating long-term profitable relationships was replaced by a sub-culture, developed by senior management, which was, and still is in many organisations, obsessed with sales performance. In an interview in the McKinsey Quarterly, Peter Ellwood, then Chief Executive of Lloyds TSB said: “We don’t talk to them (staff) about warranted equity or economic profit; they wouldn’t know what we were talking about. Instead, what we say to the staff in the branches is that we can generate income only be selling more widgets. We set what we call key sales objectives, and we say “we want you to sell these products and if you sell more, you get paid more”.” Professional standards, which had been the hallmark of the industry before that, began to deteriorate as this new sub-culture took hold and it’s no coincidence that the mis-selling scandals all happened post the deregulation of the financial services market and introduction of the bancassurance model.

1.3 We believe that the decline in professional standards is linked to the decline in professional qualifications in the industry. Historically the conventional qualification for banking was membership of the Chartered Institute of Bankers (and the equivalent organisation in Scotland) but these professional bodies which would also set the standards for the industry have been marginalised over the years and the vast majority of staff working in financial services have no externally regulated qualifications at all. For an industry of such importance to the UK economy and one that can do so much damage, as we have all witnessed over the last few years: that is simply unacceptable.

1.4 Gavin Shreeve, Principal of the ifs School of Finance said: “Modern banking is an increasingly complex, multifunctional industry which requires employees to have diverse skills and knowledge. One size does not fit all in terms of qualifications, but comprehensive knowledge of the industry, its regulatory framework and the risks it faces across different levels from front-line retail to executive level—developed through appropriate study and learning—is extremely important.” Mr Shreeve is right about the complexity of banking in today’s world and we need to be careful to separate retail banking from the kinds of activities conducted by those involved in the Libor scandal and also those involved in the manufacturing and sale of structured products which brought the banks to their collective knees. However, he is wrong when he says that one size does not fit all.

1.5 If doctors, lawyers, accountants, engineers and architects can all have their own professional bodies with demanding qualifications and on-going assessments to determine their fitness to practice then there is no reason why a similar body cannot be given the task of doing the same for the financial services industry. That body would also have the objective of improving professional standards in the industry and a key mechanism for achieving that should be the improvement of training and the requirement for commonly recognised and externally regulated qualifications.

1.6 We would propose the introduction of industry-wide qualifications covering the range of roles undertaken within the financial services industry. The content of those qualifications would be generic but a significant part of the curriculum would be devoted to areas such as compliant selling and treating customers fairly. A number of organisations, including Lloyds Banking Group, make use of some of the existing qualifications in the market but that tends to be on a piecemeal basis and is implemented on a voluntary basis. Under our proposals there would be a clear career path for staff in the industry, with qualifications that were industry recognised and which were portable between organisations. In roles involving the sale of financial products, the achievement of the required qualifications should be compulsory. Without compulsion, any attempt to professionalise the industry will fall at the first hurdle. If customers are to regain confidence in the industry, cobber Pack: U PL: COE1 [O] Processed: [19-06-2013 15:26] Job: 027059 Unit: PG01 Source: /MILES/PKU/INPUT/027059/027059_w095_027059_w001_Mark_S080 - C M Johnstone.xml

Parliamentary Commission on Banking Standards: Evidence Ev 741

and that process is going to take years, then it needs highly trained individuals who work within a strict code of professional standards.

2. What have been the consequences of the above for (a) consumers, both retail and wholesale and (b) the economy as a whole? 2.1 We will focus our attention on the impact of the predatory sales culture identified in our answer to question 1 on consumers and staff who work in UK banks. 2.2 Most customers believe their banks are interested only in selling them as many financial products as they can regardless of whether they need or can afford them. That’s been true for many years. In fact many if not most staff who work in those banks probably feel exactly the same as their customers. 2.3 The consequence of this predatory sales culture for customers has been a series of mis-selling scandals. Each of those scandals, whether it be the mis-selling of pensions, endowment mortgages, bonds, personal protection insurance, dual-amortising swap products and now, potentially, added value accounts, all involve customers being sold products they don’t need, can’t afford, can’t understand and which ultimately benefit their banks more than them. In 1997 the Treasury estimated that in total around 2 million UK citizens could have been mis-sold a personal pension with a compensation bill close to £11 billion. The latest scandal, which involved the selling of personal protection insurance to customers who didn’t need it or couldn’t use it, will cost the industry somewhere in the region of £9 billion, with Lloyds alone setting aside £4.3 billion to compensate customers. 2.4 Now staff in Lloyds Banking Group don’t generally wake up in the morning thinking: “How many customers can I fleece today?” but they do wake up worrying about how many loan appointments they’ve got in their diaries or how many sales they need to make to hit their insurance targets and preserve their jobs. That is the predatory sales culture that exists in most banks today and banks have devised ever more complicated and esoteric bonus and incentive schemes to drive that short-term sales culture. 2.5 The vast majority of bank staff want to do the best for their customers but can’t because they are under constant pressure to hit ever-demanding targets, which increase every year. A failure to hit those targets can result in staff being subject to performance improvement plans and in some cases being dismissed for underperformance. A number of management practices we have been dealing with are based more on humiliation than on positive motivation. Extreme pressure causes desperate people to do desperate things. 2.6 In that kind of environment, it is surprising that there have been so few mis-selling scandals.

3. What have been the consequences of any problems identified above in question 1 for public trust in and expectations of, the banking sector? 3.1 It seems that when it comes to the mis-selling scandals all the UK banks have been tarred with the same brush as far as customers are concerned. The problem is that customers who need financial advice or who would be best served buying certain financial products are reluctant to do so because they don’t trust their banks anymore. According to Gurria “Trust is the spinal cord of economics”. (Gurria, OECD Role in promoting open market and job creation, 21st May 2009). If that trust is lost then according to Tonkiss (“Trust and Confidence and Economic Crisis”, Intereconomics, July/August 2009) the effective economic functioning, which underpins the wider socio-economic system, is also lost 3.2 According to the consumer magazine Which, seven in ten people say that the banking “culture” hasn’t changed since 2007, and that trust in banks has deteriorated even further over the last year. Now it may be that’s not a bad thing given that some well-known non-banking brands such as Tesco and Marks and Spencer are looking to enter the market and provide a wider range of offerings to customers. However, these “challenger” brands, whilst important, will only ever be small in comparison to the main players in the market and if that market is to work in the best interests of consumers and the wider economy then trust and confidence needs to be restored quickly. Alastair Darling, the former UK Chancellor of Exchequer, said: “Banks need to demonstrate to the public that they’ve learned the lessons from recent events” and continued “but in order to rebuild public trust, we also need to reform banks’ culture”. 3.3 Of course banks are in the business of making money and there is no point in being coy about that. One of the ways they make that money is selling financial services products to customers. That’s good for staff, good for customers, good for pension funds and ultimately good for the economy. The UK’s banks employ 1.4 million people between them and contributed about £63 billion in taxes during 2011, equivalent to 21.1% of all UK Government receipts (The City UK, 2012). However, the predatory sales culture which we have described above and which is responsible for the mis-selling scandals needs to be dealt with once and for all. If the Committee fail to address that issue then it will have failed consumers. That means scrapping all the individual incentive and bonus schemes that operate in UK banks and investing part of that money into paying staff decent basic salaries. Where staff rely on bonuses and incentives to make up the shortfall in their earnings then that will inevitably drive individual behaviours that are unlikely to be in the best interests of customers. If we de-couple that link then staff can begin to do their job properly, which is to look after the financial interests of their customers rather than selling them products primarily to protect their own pay and jobs. cobber Pack: U PL: COE1 [E] Processed: [19-06-2013 15:26] Job: 027059 Unit: PG01 Source: /MILES/PKU/INPUT/027059/027059_w095_027059_w001_Mark_S080 - C M Johnstone.xml

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3.4 Lord Turner, the FSA Chairman, Martin Wheatley, Chief Executive designate of the Financial Conduct Authority and Andrew Bailey, Director of the FSA’s Prudential Business Unit, have all suggested in one form or another that free in-credit banking needs to be addressed. The argument they put forward is that free banking has been subsidised by aggressive cross-selling of other products. There are some merits to that argument but any change in the current system should come at a price. The quid pro quo would include the scrapping of “hidden” fees. It will also require banks to stop the aggressive pursuit of cross sales and to change their whole retail sales cultures. Only in those circumstances should the scrapping of free banking ever be considered.

4. What caused any problems in banking standards identified in question 1. 4.1 Affinity will focus on the culture in retail banking and the impact of financial incentives in driving the wrong behaviours. 4.2 We believe the introduction of bancassurance changed the culture of banking from one focused on creating long-term profitable relationships with customers to one obsessed with “cross-selling”, “product penetration” and “share of wallet”. It is fair to say that in that period of change, the selling concept became significantly more pronounced with the introduction of ever more complicated incentive schemes designed to drive sales type behaviours. That change in culture was also reflected in the recruitment of new staff, particularly amongst the management populations. The newer, lower cost replacements were predominantly from sales backgrounds and brought with them a more aggressive approach to sales management. In many banks at that time a predatory sales culture began to develop and the idea of creating long-term profitable relationships was replaced by a sub-culture developed by senior management, which was, and still is in many organisations, obsessed with short term, product led sales performance. In order to drive that sales performance the Banks have developed incentive plans, which drive that short-term behaviour. Moreover, the sub-culture we have identified is reflected in the way staff are managed locally. The kind of behaviours we see on a daily basis, with staff being routinely threatened with performance improvement plans underpinned by the threat of dismissal, as if they are the only motivational tool at the bank’s disposal, or being shouted at and humiliated for alleged under-performance have no place in any organisation. In a bank they are virtually certain to drive the sort of aberrant behaviours we have identified above.

5. What can and should be done to address the weaknesses identified? 5.1 We propose the following solutions: — If trust and confidence in banks is to be restored the industry needs to be professionalised. There should be the introduction of industry-wide, portable qualifications for all staff required to sell financial products to customers. At the heart of that qualification should be the requirement to put the customer first at all time and in all circumstances. This is enshrined already in the outcomes required by the FSA’s Treating Customers Fairly regime. — All financial products should be rigorously assessed to ensure they meet the requirements of customers. The banks should be required to show that their products will meet the needs of those customers to whom they will be marketed. If they don’t meet those needs then they must not allowed to be sold. Again, this is a clear requirement of the Treating Customers Fairly regime. — All short-term incentive and bonus schemes, linked to the sale of financial services products, should be scrapped altogether and that money should be reinvested in increasing basic salaries for staff. — Banks should undergo cultural change programmes to require them to move away from short-term, target driven, predatory sales cultures to ones based on a more relationship management style of banking. That change is going to be very costly and we believe that in exchange for a new, more customer centric rather than product focused banking model, the Commission should look seriously at ending free banking. August 2012

Written evidence from the Association of British Insurers The UK Insurance Industry The UK insurance industry is the third largest in the world and the largest in Europe. It is a vital part of the UK economy, managing investments amounting to 26% of the UK’s total net worth and contributing £10.4 billion in taxes to the Government. Employing over 290,000 people in the UK alone, the insurance industry is also one of this country’s major exporters, with 28% of its net premium income coming from overseas business. Insurance helps individuals and businesses protect themselves against the everyday risks they face, enabling people to own homes, travel overseas, provide for a ﬁnancially secure future and run businesses. Insurance underpins a healthy and prosperous society, enabling businesses and individuals to thrive, safe in the knowledge that problems can be handled and risks carefully managed. Every day, our members pay out £147 million in beneﬁts to pensioners and long-term savers as well as £60 million in general insurance claims. cobber Pack: U PL: COE1 [O] Processed: [19-06-2013 15:26] Job: 027059 Unit: PG01 Source: /MILES/PKU/INPUT/027059/027059_w095_027059_w001_Mark_S080 - C M Johnstone.xml

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The ABI The ABI is the voice of insurance, representing the general insurance, protection, investment and long-term savings industry. It was formed in 1985 to represent the whole of the industry and today has over 300 members, accounting for some 90% of premiums in the UK. The ABI’s role is to: — Be the voice of the UK insurance industry, leading debate and speaking up for insurers. — Represent the UK insurance industry to government, regulators and policy makers in the UK, EU and internationally, driving effective public policy and regulation. — Advocate high standards of customer service within the industry and provide useful information to the public about insurance. — Promote the beneﬁts of insurance to the government, regulators, policy makers and the public.

Executive Summary Insurers have an important stake in the future of banking—as investors in banks, as users of the services provided by banks, and as investors and participants in the wider economy. The recommendations of this Commission are important to us. A productive banking sector is necessary to the market economy, and the prospects of sustainable economic recovery in the UK are to some extent dependent on banks being able to raise the funds necessary to finance the growth of small and medium-sized companies. From the perspective of institutional investors, it is essential that banks should be an investable proposition. We are concerned that banking regulators are currently focused on financial stability at the expense of economic growth. This has a negative impact on banks’ investability. An extensive programme of regulation has already been undertaken to address the problems in banking exposed by the financial crisis. This should be given time to work. We are particularly concerned by banking regulators’ reliance on raising the level of regulatory capital requirements. Some of the proposed levels of regulatory capital will make it difficult for banks to perform their social and economic function. They will also make it difficult for banks to earn a return on their capital, and therefore to raise funds in the market. We believe that cultural change is the key to further change in banks, and this can only be driven internally from within the institutions. The Commission will therefore be most effective if it focuses on changes of culture in banking that are already underway, and on encouraging those who are trying to lead this. As insurers, we are concerned by regulators’ tendency to read banking solutions across to insurance. In view of the differences between insurance and banking, this will lead to regulation that is inappropriate to insurance, and will create obstacles to insurers performing their economic and social function.

Annex Questions for Consultation 1 To what extent are professional standards in UK banking absent or defective? How does this compare to (a) other leading markets (b) other professions and (c) the historic experience of the UK and its place in global markets? 1.1 The Commission asks about comparison with other professions. Insurance is subject to many of the same fundamental changes and pressures examined in question 4a, as is demonstrated by mis-selling in the life industry, the collapse of Equitable Life, and the LMX spiral at Lloyds. It is nonetheless the case that insurers came through the crisis with much less damage than the banks. We have given some thought to why this might be, and have a number of possible answers: (i) The structure of an insurer’s balance sheet is inherently more stable than a bank. Insurers are obliged to hold reserves against future claims, sometimes stretching decades into the future. Insurers are ﬁnanced by premiums which cannot normally be repaid, and savings policies are subject to penalties for early surrender. Both factors provide defenses against a sudden exodus of capital, making an event such as a “bank run” unlikely; (ii) British insurers beneﬁted from the FSA’s well-conceived Individual Capital Assessment (ICA) regulatory regime, which drew the right lessons from the collapse of Equitable Life. Capital requirements are based on an insurer’s assets and liabilities, are consistent with management practice and controls, take into account all material risks, and use a consistent valuation basis; (iii) Professional standards are taken seriously in insurance, as in banking. This allows initiatives such as the Aldermanbury Declaration13 to emerge. In particular, insurers draw strength from the strong professional backbone provided by the actuarial profession. The role of the actuarial profession goes 13 The Aldermanbury Declaration was published in 2010 by a Task Force of the Chartered Insurance Institute. Further details can be found at http://www.cii.co.uk/about/aldermanbury-declaration cobber Pack: U PL: COE1 [E] Processed: [19-06-2013 15:26] Job: 027059 Unit: PG01 Source: /MILES/PKU/INPUT/027059/027059_w095_027059_w001_Mark_S080 - C M Johnstone.xml

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beyond professional qualifications. It is regulated by the Financial Reporting Council, and disciplinary action is taken against bad practice. Their work is subject to external peer review. The actuary’s role is recognised in the prudential framework for insurers; (iv) Insurance naturally has a longer time horizon than banking. Any life insurer dealing with pensions is obliged to think decades into the future. Long tail risk in general insurance has a similarly long timeframe. In all forms of insurance, the most important experience—the claim—will take place sometime after the sale, and it is claims experience that will in most cases determine the profitability of the firm. Therefore it takes time for insurers’ actions to be translated into profit. In contrast, actions taken by an investment banker can deliver instant improvements to the balance sheet or profit and loss account. 1.2 Some of these factors are intrinsic to insurance, underlining the need for a regulatory regime tailored to the specifics of insurance. Others, we believe, offer helpful insights for the bankers leading the reform process within their institutions. In summary, our view would be that, while professional standards are important in banking and indeed in all financial services, there are other aspects of the banking model which have contributed to the experience of the last ten years.

2 What have been the consequences of the above for (a) consumers, both retail and wholesale, and (b) the economy as a whole? 2.1 The issues associated with the financial crisis, the reputational impact of the recent regulatory scandals and the impact on consumers of mis-selling have been reported at length over recent months, and we have nothing to add on the consequences for consumers. We have additional remarks about the impact on institutional investors and on the economy as a whole. 2.2 Investment banks have taken advantage of a privileged position as intermediaries in the wholesale financial markets, and this has been to the detriment of the markets overall. The ABI contributed to the Rights Issue Fees Inquiry under Douglas Ferrans, which explored the excessive fees charged by investment banks for underwriting rights issues. We believe that their pursuit of transaction-based income has also contributed to the poor quality of the pipeline of new public offerings (IPOs) in the London equity market. In addition, the well- intended liberalisation of the EU MiFID Directive has left the investment banks in a powerful competitive position that they have exploited, at the expense of market end-users such as issuers and investors. While the costs of individual trades on EU equity markets has gone down, the markets have fragmented, and the overall cost of trading has gone up. 2.3 The consequences for the economy as a whole are complex to assess. It is easy to extrapolate a line of GDP growth from before the financial crisis, and attribute the fall in output to failings in financial services. Easy, but inaccurate. The fact is that GDP would never have reached pre-crisis levels if not for an exuberant financial sector. Many states, businesses and households also took advantage of easy credit. Banks can reasonably be seen in this context as victims, along with many others, of central banks’ focus on inflation, and excessive confidence in financial markets as a reflection of confidence and economic activity. Macro-economic policymakers on both sides of the Atlantic ignored the fundamental imbalances in the global economy, rapid growth in leverage, and the development of asset bubbles, particularly in real estate

3 What have been the consequences of any problems identified in question 1 for public trust in, and expectations of, the banking sector 3.1 Financial services are not just a commercial exchange. Sophisticated financial services are essential to life in modern society, and at their best provide a socially useful role in making capital available to business and households, and enabling them to manage risk. Lack of public trust affects the innocent as well as the guilty, making it even more urgent to deal with it. 3.2 Financial services are the natural intermediaries between savings and investment opportunities, and natural sharers of risk with the State. However, this requires both State and public to have confidence in an increasing range of interactions with the financial service sector. Financial services providers whose actions undermine public trust are standing in the way of essential public policy developments.

4. What caused any problems in banking standards identiﬁed in question 1? The Commission requests that respondents consider (a) the following general themes: — the culture of banking, including the incentivisation of risk-taking; — the impact of globalisation on standards and culture; — global regulatory arbitrage; — the impact of ﬁnancial innovation on standards and culture; — the impact of technological developments on standards and culture; — corporate structure, including the relationship between retail and investment banking; — the level and effectiveness of competition in both retail and wholesale markets, domestically and internationally, and its effects; cobber Pack: U PL: COE1 [O] Processed: [19-06-2013 15:26] Job: 027059 Unit: PG01 Source: /MILES/PKU/INPUT/027059/027059_w095_027059_w001_Mark_S080 - C M Johnstone.xml

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— taxation, including the differences in treatment of debt and equity; and — other themes not included above. 4.1 ABI members’ analysis of the changes in banking feed directly through to our remarks on corporate governance in answer to questions 4b. 4.2 The banking sector and its culture are not homogeneous. It is clear that banking has changed markedly over the past thirty years. The factors listed above have all been significant. It is less easy to draw safe connections between these change factors and any problems in banking standards. Changes in culture are probably a consequence rather than a cause, and should therefore come at the end of the list. The extent to which culture is still a negative factor varies from firm to firm. 4.3 Banking regulation has also changed over the period, with increasing reliance on detailed rule books. There is a plausible argument that management focus on regulators’ detailed rules has loosened the hold of personal integrity and ethical standards in some parts of some banks. 4.4 Received wisdom today flags up the risks of financial innovation, but the benefits should not be forgotten. From a retail perspective, banking is unrecognisable from the days when mortgages were rationed, banks were closed on Saturday and there were no ATM machines. Nobody wishes to go back to those days. 4.5 Technological developments have been an important contributory factor to the changes. They enhance the service for retail and wholesale customers, but bring their own challenges as managers have struggled to retain proper oversight and control over diverse and complex businesses. Technology itself compounds that complexity. The speed with which decisions now have to be made is also a serious management challenge. 4.6 We have seen convergence between retail and investment banking. Core banking business has moved away from the traditional management of the two sides of the banking book towards proprietary trading, increased use of wholesale funding, securitisation, and use of derivatives. There is no obvious reason why investment and retail banking should not be able to co-exist in the same institution. However, evidence from the periods when this has been tried—in particular the US, in very different time periods—suggests that there are significant risks. We therefore believe that it is safer for these businesses to be housed in distinct legal entities, backed by separate capital, and we have expressed broad support for the proposals on ring-fencing made by the Independent Commission on Banking led by Sir John Vickers—though we recommend that the execution of the ring-fence proposals could be much simpler. We also believe that universal banks have proved unhealthy for the supply of finance to the real economy. The structure concentrates access to both debt and equity finance in the hands of one industry, which has led to high costs in British and US markets and inflexible financing in continental European markets. 4.7 An interesting insight to the convergence in the financial services sector can be illustrated from the Rights Issue Fees Inquiry. Listed companies took the view that the structural changes caused by Big Bang to create integrated investment banks had not led to an immediate loss of the quality of independent advice and support provided by corporate brokers and other advisers, so long as there remained a strong cadre of individuals who remained in influential positions, but that such a change was evident when those individuals retired from those roles. 4.8 Another consequence of convergence between retail and investment banking is that the investment bank bonus culture has migrated across into mainstream banking business. Historically, British merchant banks’ ownership structure was partnership-based. They paid substantial bonuses for value created during good times, but real downside risks were run and partners’ capital was on the line. Many investment banks are now publicly owned, and this changes the impact of bonuses completely. Risks are now run with shareholders’ capital, and bonuses have become a free option on the upside for banks’ employees, with no corresponding share in the downside. This has been the environment in which institutional culture has been built up, and personal expectations have become established 4.9 Each banking institution is of course different. However, as a generalisation these fundamental changes in the nature of banking in the period leading up to the crisis, including the behavioral influences on those who came into positions of power in that industry, go some way towards explaining why remuneration in banking rose to unsustainable levels, why some shareholders question whether the sector is investable, and why corporate governance checks and balances came to be overwhelmed in some institutions. 4.10 This is the subject of our remarks on question 4(b). and (b) weaknesses in the following somewhat more specific areas: — the role of shareholders, and particularly institutional shareholders; — creditor discipline and incentives; — corporate governance, including: — the role of non-executive directors; — the compliance function; — internal audit and controls; — remuneration incentives at all levels; cobber Pack: U PL: COE1 [E] Processed: [19-06-2013 15:26] Job: 027059 Unit: PG01 Source: /MILES/PKU/INPUT/027059/027059_w095_027059_w001_Mark_S080 - C M Johnstone.xml

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— recruitment and retention; — arrangements for whistle-blowing; — external audit and accounting standards; — the regulatory and supervisory approach, culture and accountability; — the corporate legal framework and general criminal law; and — other areas not included above.

4.11 In answering this section, we have focused on the corporate governance issues, which are an important focus of interest to ABI members as major institutional shareholders.

Corporate Governance 4.12 The Treasury Select Committee’s (TSC) report Fixing LIBOR: some preliminary findings states: “The Parliamentary Commission on Banking Standards’ examination of the corporate governance of systemically important financial institutions should consider how to mitigate the risk that the leadership role of a chief executive may permit a lack of effective challenge or to the firm committing strategic mistakes.”

4.13 A clear distinction needs to be drawn between the use of corporate governance for regulatory purposes, and the use of corporate governance to run the company and to manage relations between shareholders and company management. The two purposes are often met through the same mechanisms. The two purposes will often have objectives in common. For example, the issue set out above by the TSC is undesirable from both angles. However, the two purposes need to be considered separately, as they may conﬂict. As institutional shareholders, ABI members’ primary purpose is to defend corporate governance as a means of running the company.

4.14 Good governance practices should not be seen in the financial services sector as a substitute for proper supervision and regulation, and neither directors nor shareholders should be expected to perform this role. Good corporate governance should supplement the regulation of financial services firms. Corporate Governance exists to help ensure that the company is run in the interests of its shareholders and that it is successful in the long-term. Regulation and supervision exist to ensure market confidence and stability, and to protect the interests of consumers and the wider public. Any reforms that are enacted should be proportionate and effective in delivering both these aims. There are risks that any remedies proposed might not contribute effectively to these aims, and indeed might lead to the unintended consequences of damage to the banks, their ability to create value and employment, and the prospects of economic recovery in the UK.

4.15 ABI members have participated in the debate about the extent to which weaknesses in corporate governance contributed to the weakness of professional standards in banking. At the level of some individual banks, this is undeniably true. But other banks have high standards of corporate governance, and problems in corporate governance are by no means conﬁned to the banking sector. We have not concluded that the general regime of corporate governance in the UK requires radical change. Nor do we believe that banking requires a special corporate governance regime. We have encouraged incremental improvements in the regime, and where individual Boards have failed to meet shareholders’ expectations, we have engaged with them. In general, standards of corporate governance in the UK are some of the highest in the world, and this has served the British capital markets well. The goal should be to make the existing regime work effectively.

4.16 Good governance is about behaviours, not about adherence to rigid rules. In our experience it is not something that can be enshrined or enforced by legislation—indeed the results are often counter-productive. We therefore continue to believe that the most effective corporate governance regime is based on the comply- or-explain principle. ABI members are strong believers in the “comply or explain” framework, and feel that it remains appropriate in the financial services sector. If a company believes that a principle of good governance is not appropriate in their individual circumstances, it can provide an explanation of why this is the case. It is then up to shareholders to take account of the individual firm’s circumstances, and judge the quality of the explanation. If shareholders have concerns with the reasons for deviating from the Code, or if the explanation is inappropriate or insufficient in detail, shareholders can then engage with the company. Shareholders are in the best place to make these judgements on what is appropriate for the company in its individual circumstances.

4.17 We see no evidence to suggest that any other approach to corporate governance would have been more effective in the crisis. The greatest challenge in designing effective oversight of listed companies in general, but in particular for banks and other complex businesses, is to ensure sufficient knowledge of the business and expertise among the independent non-executives, so that they are able to hold management to account. A unitary board structure will have advantages compared to other structures, since the independent non-executives will be closer to the active decision-making organs of the business. We see no evidence that other structures, such as supervisory boards, would have worked better in the financial crisis. European countries with a supervisory board structure also had to support financial institutions, such as Aegon and ING in the Netherlands and Fortis in Belgium. cobber Pack: U PL: COE1 [O] Processed: [19-06-2013 15:26] Job: 027059 Unit: PG01 Source: /MILES/PKU/INPUT/027059/027059_w095_027059_w001_Mark_S080 - C M Johnstone.xml

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Role of Shareholders 4.18 There have been numerous analyses of the role of shareholders in the financial crisis, most notably the Walker Review. The ABI Investment Committee acknowledged that the financial crisis demonstrated that shareholders could have played a more active and responsible role as owners. 4.19 As part of the drive for reform, the Institutional Shareholder Committee produced a Stewardship Code, to enhance standards of engagement between companies and their shareholders; ownership of this Code was then passed to the Financial Reporting Council. Evidence has shown that shareholder engagement is improving following its implementation. The Investment Management Association’s recently published survey of adherence to the Stewardship Code found that there has been a rise in dedicated stewardship resources, prioritisation of engagement on key issues, more integration of stewardship into the wider investment process and an increase in voting levels.14 4.20 However, there is a limit to how involved shareholders can become. Shareholders do not have access to the same confidential information that is available to company management, and do not wish to become insiders, as this would constrain their ability to operate in the market. In addition, the resource implications of intensive engagement are significant, and would add disproportionately to the cost of asset management if this became the norm. Asset managers already carry significant fiduciary responsibilities to their clients, without also stepping into territory better occupied by Boards, Executive and regulators. 4.21 Our assessment is that shareholders in banks, both individually and collectively, already devote more time and resources to their responsibilities in such companies than they might otherwise be expected to do by reference to criteria such as current value of the shareholdings. To expect too much may deter investment. 4.22 Although the implementation of the Stewardship Code has resulted in progress, our experience has been that, even since the financial crisis, some bank Boards have still not always been willing to listen to shareholders’ views. We should be clear that this is not a universal experience, and other bank Boards have devoted considerable thought to sustainable remuneration structures. This has required shareholders to find alternative methods of carrying out their stewardship responsibilities. One example is the letter which the ABI wrote to the five UK listed banks in December 2011 on the structure of bank remuneration. This unprecedented step of writing publicly to the banks was a result of the continued frustration of our members at the low level of engagement by some banks on remuneration matters. The resultant engagement was constructive, but showed how the different banks take differing approaches to engaging with shareholders. Some Boards engaged seriously with the issues raised in the letter, and are making strides towards a sustainable remuneration structure. Others were still only paying lip service to shareholder views. Continued shareholder frustration was seen in the voting outcomes at the AGMs of the banks in question. 4.23 It is not the role of shareholders to micromanage any company, including banks. Ultimately, it is the responsibility of Boards to ensure that they have appropriate corporate governance systems in place, to listen to feedback from shareholders, customers, regulators and market commentators, and to identify issues with individuals and culture. Shareholders will continue to challenge Boards to ensure that they have the appropriate systems in place, but if the Board and non-executive directors do not identify issues with individuals and culture, it is hard for the outside shareholders to be aware of these issues. A shareholder’s ultimate resort is to sell the stock.

Non-Executive Directors(NEDs) 4.24 The role of the Non-Executive director is key to good governance. There have been several examples in banking where the wrong culture has been set by the Executive Directors, and this has not been challenged by the NEDs. 4.25 We recognise the significant challenges faced by NEDs in taking effective oversight of very complex organisations such as banks. Since the financial crisis there has been significant focus on ensuring that they have the appropriate skills and can make the necessary time commitments. The structure of the Board committees, the quality of the management information made available to the NEDs, the transparency of the Executive Directors, and the effectiveness of the Chairman in ensuring full engagement of the Board team is key. 4.26 The role of a bank’s nomination committee is critical to ensure the right balance and diversity of skills and experiences around the board table. Boards and nomination committees should be sensitive to, and where appropriate be proactive in soliciting, the views of shareholders. The FSA’s approval process for Significant Influence Functions (SIF) plays an important role in the recruitment of non-executives. We believe that the interview and approval process should be simplified and expedited. We also believe there should be greater emphasis on personal integrity, and less on professional expertise. Ultimately there is a risk that many suitable candidates will not accept appointment at financial services firms. 4.27 The introduction (on a comply or explain basis) of the annual re-election of directors, although a relatively new provision of the Code, is an important development. We have seen this year that shareholders 14 http://www.investmentuk.org/research/stewardship-survey/ cobber Pack: U PL: COE1 [E] Processed: [19-06-2013 15:26] Job: 027059 Unit: PG01 Source: /MILES/PKU/INPUT/027059/027059_w095_027059_w001_Mark_S080 - C M Johnstone.xml

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are willing to vote against Non-Executive Directors that they do not believe are representing the best interests of shareholders.

Board Effectiveness 4.28 Both the Walker Review and the UK Corporate Governance Code focus on Board effectiveness and evaluation. Institutional shareholders pay particular attention to the quality of disclosures that are provided in this area. The ABI published a report in September 2011 entitled Board Effectiveness—Highlighting best practice: encouraging progress. Our report highlighted the variety of ways in which leading companies currently implement diversity, succession planning strategies and board evaluations. We believe that highlighting best practice will encourage progress, improve Board effectiveness, and provide an important input into a firm’s corporate governance. This will contribute to the development and execution of strategy, and ultimately contribute to the continued long term success of the company. 4.29 There are significant variations in standards of Board effectiveness and evaluation. The Financial Skills Partnership (FSP) has received funding from the UK Commission for Employment and Skills for a programme called Leadership 21C. This programme aims to enhance Board effectiveness in the financial services sector through the development and adoption of standards and guidance for board competence, culture and diversity— including good practice guides and tools to support in their application. This will take forward recent corporate governance activity and review findings to determine standards of competence and behaviours specific to the sector, including regulatory competence requirements. It will include a cultural framework with guidance and examples of best practice which will help employers adopt and achieve these standards and competence requirements. 4.30 One particular area of Board effectiveness is the role of the Chairman. This role is critical in ensuring that the Board is working effectively, and is setting the right direction and culture for the organisation. It is particularly important that the Chairman is able to challenge and manage the Executive Directors, including the CEO. Clearly in some financial institutions this has not been the case. 4.31 We consider that the central role and legal duty of the Board is to help ensure the long-term success of the company. It achieves this by determining the strategy of the company and overseeing its implementation. This oversight should include ensuring that risks are properly managed. However, the Board should not become involved in operational or day-to-day activity. Nor should it become a regulatory tool or be seen as a substitute for proper supervision. If Boards become overburdened with information and responsibilities there is a significant danger that they will not be able to perform the central role of strategic direction, and this will harm the business, its employees and shareholders.

Remuneration 4.32 As mentioned above, in December 2011, the ABI wrote to the ﬁve UK listed banks to highlight our members’ concern with remuneration across the banking sector. Our members were particularly concerned about the level of returns that shareholders receive compared to the returns given to employees. Members believe that in recent years this balance has been inequitable, with too much value being delivered to employees in contrast to the dividends paid to shareholders. 4.33 We conducted analysis to show how total employee costs and dividend payments have changed over the last 10 years, at the ﬁve UK listed banks; all this data was collected from the Annual Reports of the Banks. At Barclays, for example, total staff costs have risen from £3.755 billion in 2002 to £11.407 billion in 2011. Over the same time period, total dividends fell from £1.206 billion in 2002 (dividend per share of 18.35p) to total dividends of £653 million in 2011 (dividend per share of 5.5p). Likewise at HSBC, total staff costs have increased from US$ 8.609 billion in 2002 to US$ 21.166 billion in 2011. Over this time period, dividend payments have increased from US$ 5.001 billion (dividend per share of 53 cents) in 2002 to US$7.324 billion in 2011 (dividend per share of 39 cents). In neither case has the payout to shareholders kept pace with the payouts to employees. ABI members continue to engage with all UK banks to improve the investment case for the banks by improving the remuneration structure. 4.34 ABI members are supportive of the principle of pay for performance; members are supportive of individuals being rewarded for exceptional performance, but importantly only if it is in the context of an appropriate capital allocation balance. It is our members’ belief that the aggregate level of remuneration for individuals across the banks has been too high.

5. What can and should be done to address any weaknesses identiﬁed? To what extent are such weaknesses subject to remedial corporate, regulatory or legislative action, domestically or internationally? 5.1 The Commission should bear in mind that multiple regulatory initiatives are already in hand to address the banking industry, at national, EU and international level. These initiatives should be given the time they need to deliver results. We believe that the most productive approach would be for the Commission to act as catalyst for the raising of professional and ethical standards in British banks. It is well worth encouraging the initiatives under way in some institutions to deliver this. cobber Pack: U PL: COE1 [O] Processed: [19-06-2013 15:26] Job: 027059 Unit: PG01 Source: /MILES/PKU/INPUT/027059/027059_w095_027059_w001_Mark_S080 - C M Johnstone.xml

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5.2 Expectations of higher standards must be driven from the top—therefore the critical issue is the appointment of the Board and senior executives. We believe that it would be a mistake to develop a dedicated corporate governance regime for banks, as this would further their isolation from the real economy and the business mainstream. The incremental improvements in corporate governance since the crisis should continue. We recommend that the FSA’s Approved Persons Regime should focus more on personal impact and integrity, and less on technical expertise. 5.3 Banks need to attract capital to perform their social and economic function. From insurers’ perspective as investors, banks need to be investable. At present, bank debt and equity is not an attractive proposition from the perspective of insurers as a class of investors. In the financial markets, very few banks have felt strong enough to turn to the equity markets to raise their capital levels. Banks’ issuance of senior unsecured debt has also fallen greatly, balanced to some extent by issuance of covered bonds. Banks need to earn a return on capital that makes them attractive to investors—or alternatively the current mix of deleveraging and exceptional funding from central banks will have to continue indefinitely. We are concerned that the regulatory pendulum may have swung too far. In particular, high levels of regulatory capital will make it difficult for banks to earn a satisfactory return, and will add directly to the cost of extending loans to the real economy. 5.4 We now have several decades of experience of a culture of banking regulation, set by the Basel Committee, based primarily on the tool of capital requirements. We recommend that banking regulators should reduce their reliance on capital requirements, which has too high a cost to society at these levels, and devote greater attention to risk management.

6 Are the changes already proposed by (a) the Government, (b) regulators and (c) the industry sufficient? 6.1 As we have said, there are already a large number of regulatory initiatives. We can have no idea what the cumulative impact will be. If anything, the regulatory reaction may already have gone too far. Any further initiatives need to meet a high burden of proof. 6.2 Regulators’ priorities need to reflect economic reality. Measures now being taken are intended to prevent a repetition of failings that occurred in a period of easy money and loose credit. A narrow focus on financial stability is over-cautious, and inappropriate in a world of tight credit and rapid deleveraging. If financial services cannot perform their social function, there is a real risk of economic stagnation and social detriment. 6.3 We remain concerned how the changes to the regulatory framework in the UK will pan out. The Bank of England lies at the centre of the new structure, and it is crucial that the Bank succeeds in the task it has been given. We are concerned that the recent history of the Bank of England may be an inadequate preparation for the huge responsibility the Bank now takes for the regulation and supervision of financial services. Prior to the crisis, the Bank had narrowed its focus to monetary policy, and wound down its work on financial stability. The greatest risk in the new framework is that it may over-stretch the resources and culture of the Bank, on which the whole structure relies. Has the Bank had the time to develop the framework of judgement required for its new role at the apex of the new regulatory framework? Judgement-based regulation is a praiseworthy ambition, but how will this mesh with the very granular regulatory regime now in force? Above all, is the framework of accountability in the Financial Services Bill strong enough to provide political cover for the far-reaching decisions the Bank will have to make? From an insurance perspective, is there adequate insurance expertise at senior level in the PRA, and in the Financial Policy Committee. 6.4 Flaws also beset the framework of accountability for the Financial Conduct Authority (FCA), which is being set up with inadequate regard to access to financial services and to the social consequences of regulators’ actions, at a time when we need private individuals to take more responsibility for their financial futures (eg through reform of the pensions system). 6.5 There is still time to make amendments to the Financial Services Bill to provide more explicit political direction for all the new regulatory bodies, for example by obliging the Government to set out its policy objectives, and obliging the regulatory bodies to report annually on their progress against those objectives and to ensure adequate insurance expertise in PRA and FCA. 6.6 On the other hand, we welcome the stronger emphasis on competition, both in the new regulatory framework and in the Government’s response to the Vickers report. We support the Vickers recommendations for greater separation between retail and investment banking—though further work is required on the way this is done. For example, we are concerned that the ring fence, as currently designed, includes features that might deter insurers as institutional investors. In particular we have specific concerns relating to the nature of creditors’ claims in the event of resolution or insolvency, even if the actual probability of failure within the ring-fenced institution might be lower. If this option is pursued, ring-fenced banks will have the unattractive characteristics of generating low average returns but imposing high risks in the event of insolvency. This is in turn likely to accentuate volatility in cost of funding, a greater reliance on funding from speculative investors and, generally, reduced financial stability. 6.7 As insurers, we are above all keen to underline that insurance requires regulation tailored to the needs of insurance. The temptation to apply to insurance the lessons learnt from banking should be avoided. Insurers’ balance sheets are more stable than bankers’ balance sheets: premiums are paid in advance, and reserves held to pay the best estimate of future claims. Events such as bank runs or other systemic risks are much less likely. cobber Pack: U PL: COE1 [E] Processed: [19-06-2013 15:26] Job: 027059 Unit: PG01 Source: /MILES/PKU/INPUT/027059/027059_w095_027059_w001_Mark_S080 - C M Johnstone.xml

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Many of the safeguards now applied to banks—counter-cyclical buffers, resolution plans, liquidity ﬂoors— would add to costs for policyholders for little beneﬁt.

7 What other matters should the Government take into account? 7.1 The Government and British regulators should make more of an effort to work with the grain of EU level initiatives. 7.2 The City of London is international. This is not understood properly by British officials and regulators, who believe the City is British, and wish to contain it within a narrow national framework. The UK as an international financial centre needs to attract international capital, or it will flow elsewhere. Nor is the City properly understood by the EU institutions, who believe that it is “Anglo-Saxon,” and try to develop regulation to control it. Neither approach is suited to the continuing health of the UK as an international financial centre, which is very much in the interest of British citizens. 7.3 As regulated bodies, ABI members know that they have to follow EU regulation. Our Government and regulators often behave as if this does not apply to them, launching regulatory initiatives with no reference to the need to reconcile these with thinking at EU level. This reduces British influence over EU initiatives when they emerge, and adds significantly to the compliance cost for British providers of financial services. 6 September 2012

Written evidence from the Association for Financial Markets in Europe Executive Summary — In response to the focus of the Commission’s inquiry—to establish whether there are shortfalls in professional standards and culture in the UK banking sector which have implications for the way business is conducted—the Association for Financial Markets in Europe (AFME) considers that it would be most helpful for us to contribute to the Commission’s deliberations at this stage by providing a high-level preliminary summary catalogue of a range of standards and regulatory measures (both domestic and international) applying to both individuals and ﬁrms and drawing out number of questions that are prompted by this analysis. — This preliminary summary is set out in the Annex to this submission.

Submission to the Parliamentary Commission 1. The Association for Financial Markets in Europe (AFME) welcomes the opportunity to respond to the Parliamentary Commission on Banking Standards’ (“the Commission’s”) initial call for evidence on 26 July 2012. 2. AFME represents a broad array of European and global participants in the wholesale financial markets: our Members comprise pan-EU and global banks as well as key regional banks, brokers, law firms, investors and other financial market participants. Whilst AFME is a European trade association, given the importance of the London markets, both to the European Union as a whole and to the many EU and international firms that have operations in, or provide services on a cross-border basis into London, we consider it important to engage proactively and constructively in debates that determine the environment in which our members undertake their business. 3. We welcome the appointment of the Commission, particularly given the importance of the banking sector to the UK economy.15 We recognise that the theme of the Commission’s work—to establish whether there are shortfalls in professional standards and culture in the UK banking sector which have the implications for the way business is conducted—is now the central question to be addressed against the background of significant regulatory change already underway. 4. Given AFME’s role, we have concluded that at this stage we can best contribute to the Commission’s work by providing a high-level preliminary summary catalogue of a range of standards and regulatory measures—covering both those applying to individuals and those applying to firms (but with application directly relevant to the behaviour of individuals) together with standards relating to the wider corporate/internal governance arrangements: this material is set out in the Annex to this submission and, we hope, provides a fact base to which the Commission might find it helpful to refer in its deliberations. 5. In particular, we hope that this compilation is helpful in highlighting the range of standards designed to shape and, indeed, determine the responsibilities—and therefore behaviour—of relevant staff in firms and also summarising corporate governance standards. 15 The CityUK: Key facts about UK financial and Professional Services March 2011: “Over one million people work across the UK in financial services, nearly 4% of total UK employment. Over 400,000 people are employed in banking. The UK is the world’s leading exporter of financial services, earning more than 10 times US exports of financial services in 2008. The UK’s financial services industry contributed £124 billion to the UK economy in 2009, accounting for 10% of total economic output. UK financial services contributed £53 billion in tax revenue 2009–10, 11% of total UK tax receipts.” cobber Pack: U PL: COE1 [O] Processed: [19-06-2013 15:26] Job: 027059 Unit: PG01 Source: /MILES/PKU/INPUT/027059/027059_w095_027059_w001_Mark_S080 - C M Johnstone.xml

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6. The drawing together of this material has prompted us to consider a number of areas which we think that it would be helpful for the Commission to explore, which we summarise below, but it is important also not to lose sight of the regulatory changes that have already been made or are underway when assessing the degree to which further changes are needed. At the same time it is essential to take into account the importance of achieving international alignment of standards so as to achieve good practice across global markets and remove the risk to good standards that can be posed by regulatory arbitrage: such alignment would also allow regulators to have conﬁdence in each other’s judgments which would help to assist the maintenance of open, competitive markets from which customers beneﬁt.

Issues forConsideration 7. In achieving good risk management, and in achieving the appropriate alignment of personal incentives with this objective, it is clear that firms must embrace the need to ensure that the working environment and the incentive structures in which staff operate are designed to foster responsibility and good personal conduct whilst also recognising, at the same time, the need to avoid environments which act to discourage behaviour with integrity. 8. The appropriate alignment of incentives with prudent risk management is fundamental in fostering an appropriate culture within banking and we believe that the FSB’s Principles and Implementation Standards for Sound Compensation Practices—which include, for example, arrangements for clawback—have set the right framework (indeed, the provisions in Europe as implemented in CRD3 go further). 9. As the Annex highlights, there are a wide range of standards that address standards of behavior, governance and culture and overall, we do not believe that the issues that have threatened financial markets that have arisen are due to the absence of professional standards per se. However, there are questions about the extent to which firms have sought to ensure that standards have been adequately embedded at all levels of the organisational hierarchy and the degree to which in practice, therefore, both individual and corporate standards act to assist firms in creating or maintaining a culture that fosters integrity. 10. Current professional standards for individuals, and the formal requirements of the FSA’s approved persons regime, together with the governance arrangements that apply to firms provide a strong foundation: but there may be questions about the extent to which governance standards at the group/firm level are sufficiently dovetailed with the standards that apply to individuals. 11. Firms recognise the importance of maintaining processes for ensuring good risk management but consideration should be given to the extent to which the arrangements in place give sufficient weight to “people risk” (the risk that people do not follow an organisation’s procedures, practices and/or rules); even in the best managed firms, systems and controls must be designed and implemented to determine whether the arrangements for identifying risks are functioning as intended—and work in Europe and Basel has sought to address the issue. 12. Serious as the shortcomings that have been identified have been, they were far from universal, and deficiencies that have been identified are not common to all firms, or, indeed, to all types of financial services businesses. And, as firms differ, there will not be a universal solution, so targeted supervision will be important in helping to ensure that all firms focus sufficiently on the risks that need to be addressed in their particular business; within this there is a role for enforcement. 13. The Boards of firms are responsible for ensuring that the appropriate cultural environment is established. This entails appropriate processes being in place to ensure that what is sought is achieved in practice as a firm undertakes business day to day. A range of disciplines are involved ranging from recruitment (careful selection of staff) to training and competence (with specific focus on ethics and integrity) together with arrangements for escalation—firms need to instil in their staff the importance of being aware that there can be occasions when the status quo should be challenged; and regulators could enhance firms’ focus on adequate people risk management, through, for example, the provision of guidance to signpost the importance of this (although for well managed firms, such guidance would not be strictly necessary and would have a limited role in consequence).

Conclusion 14. Overall, the Commission will wish to assess the best ways for ensuring that ﬁrms’ management inculcate “ownership culture”—in which people will take responsibility and raise their hands when they see that something is wrong—and for determining the role of governance arrangements at the corporate level in contributing to this. 15. The industry must strive to work with regulators and other market participants to restore conﬁdence and trust in the sector and an appreciation of its important role. 16. We would be pleased, of course, to discuss the issues covered in this submission with the Commission or to provide further information about any of the matters which our members have raised if that would be helpful. (In particular, we would be pleased to share the underlying material that we summarise in the Annex cobber Pack: U PL: COE1 [E] Processed: [19-06-2013 15:26] Job: 027059 Unit: PG01 Source: /MILES/PKU/INPUT/027059/027059_w095_027059_w001_Mark_S080 - C M Johnstone.xml

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or to extend the analysis if that would be helpful to the Commission: for example further work could be undertaken on the standards in other jurisdictions.) 7 September 2012 cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:26] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 753 Annex Status Mandatory Application Directors of UK incorporated companies Observations/further remarks: Used in respect ofStatus certain directors ofMandatory Barings Application Authorised persons, approved personsmore and generally other etc persons appropriate) — — — Status, indicative application and further observations (where — — Table 1 persons from, inter alia,companies being and directors from of beingconcerned otherwise with a company’s affairs. individuals such as s.397:Statements Misleading and Practices andMisleading s.398: the Authority—residual cases. Provisions relating to the disqualification of Disqualifications, by a court,misconduct for in general connection withunfitness companies, (eg wrongful trading)competition and infringements. Includes offences that can be committed by Also provides that thestatements FSA of may principle issue withconduct respect expected to of the approveda persons code and of practicehelping for to the determine purpose whetherperson’s of or conduct not complies a withstatement the of principle. Summary/Key highlights — — — — PRELIMINARY INTRODUCTION TO A SELECTION OF STANDARDS Title and Publication Company Directors Disqualification Act 1986 http://www.legislation.gov.uk/ukpga/ 1986/46/contents Financial Services Markets Act (2000) (FSMA) and secondary legislation http://www.legislation.gov.uk/ ukpga/2000/8/contents LEGAL AND REGULATORY REQUIREMENTS RELEVANT TO THE BEHAVIOUR OF INDIVIDUALS AND OTHER PROFESSIONAL CODES The Annex attempts tothe classify wider the corporate/internal standards governanceStandards, into arrangements, to 1) thematic classified those codes. according applying to toTable their 1 —Legal individuals “natural” and and hierarchy, Regulatory to linking requirements firms Corporate relevantTable but 2 —Table Governance to with 2: Standards, the application Corporate to behaviour Governance/internal to Internal of governance theTable Governance individuals 3 —Other requirements/codes behaviour and ethical with of other Codes/standards application individuals; Professional of to and Codes potential banking 2) interest those relating to — — — — UK—Legal requirements applying toParliament directors and other individuals Author/Source Parliament cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:26] Job: 027059 Unit: PG01

Ev 754 Parliamentary Commission on Banking Standards: Evidence Observations/further remarks: The legal basis for FSA rules Status Mandatory Application Approved persons Status Mandatory Application Approved persons and authorisedStatus persons etc. Consultation—work in progress Application Directors of banks appropriate) — — — — — Status, indicative application and further observations (where — — (and factors relating toprinciple) all applying statement to of theapproved conduct person. of an honesty, integrity and reputation;competence (ii) and capability; (iii)soundness—the financial FSA will considerassessing when the fitness andcandidate propriety for of approval a tocontrolled perform function a and an approved person. persons regime and (ii)seek the disqualification BIS’s of power individuals to directors as under a rangeunder of the circumstances Company Directors Disqualification Act 1986, HMconsulting Treasury on is introducing apresumption rebuttable that a directornot of suitable failed to bank beto is approved hold by a a senior regulator position in a bank APER sets out the statements of principle Includes descriptions of conductdoes which not comply withprinciple; these as statements well of asopinion factors of which the in FSAin the are determining to whether be orperson taken not complies account an with approved aPrinciple Statement of FIT sets out and describes the criteria—(i) In addition to (i) the FSA’s approved Also consulting on thecriminal possibility sanctions of for new themisconduct serious in the management of a bank Summary/Key highlights — — — — — Title and Publication Statements of Principle andPractice Code for of Approved Persons— APER http://fsahandbook.info/FSA/html/ handbook/APER Fit and Proper testPersons—FIT for Approved http://fsahandbook.info/FSA/html/ handbook/FIT Consultation document: Sanctions for the directors of(July failed 2012)—consultation banks closes 30 September 2012 http://www.hm-treasury.gov.uk/d/ consult_sanctions_directors_ banks.pdf Author/Source UK FSA regulatory requirementsFSA applying Handbook to individuals FSA Handbook HM Treasury cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:26] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 755 Status Mandatory Application Approved persons and authorisedStatus persons etc. Mandatory Application Authorised persons Observations/further remarks Retail focus Links to the SYSCcompetency Sourcebook requirements that for sets wholesale highScope markets. level Mandatory Application Authorised persons appropriate) — — — — — — — Status, indicative application and further observations (where — FSMA and the FSA’s gate-keeping functions regarding applications for approval requirements for certain retailincluding activities the need towhere attain relevant a qualification Amplifies the approved persons regime in The TC sourcebook focuses on detailed With respect to training and competence: SYSC 5.1 sets outwith the respect obligations to of employingskills, firms personnel knowledge with and expertise SYSC 5.1 and 3.1level (which responsibility sets of out theand high firm maintain to systems establish andappropriate controls to the business)TC cross sourcebook reference (see belowSYSC18 for provides TC) guidance onInterest the Disclosure Public Act andSYSC whistleblowing 19A sets out the Remuneration Code Summary/Key highlights — — — — — — — Title and Publication Supervision Manual (SUP 10) http://fsahandbook.info/FSA/ html/handbook/SUP Training and Competence—TC http://fsahandbook.info/FSA/html/ handbook/TC/ Senior Management Arrangements, Systems and Controls (SYSC) http://fsahandbook.info/FSA/html/ handbook/SYSC UK FSA regulatory requirementsFSA applying Handbook to firms with relevance to the behaviour of individuals Author/Source FSA Handbook FSA Handbook Other UK Professional codes relating to individuals cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:26] Job: 027059 Unit: PG01

Ev 756 Parliamentary Commission on Banking Standards: Evidence Status Membership voluntary but Principlesmember mandatory once a Application Members of the company Status Membership voluntary but Codemember mandatory once a Application Members of the CISI Status Mandatory appropriate) — — — — Status, indicative application and further observations (where — governing the relationship between financial service providers andorganisation, their the financial servicesother industry, market participants, colleagues, clients, customers, counterparties, and themselves as professionals Worshipful Company of International Bankers”. Ethics (the Code); itsparticularly approach well is developed. High level code based on eight principles Follows the “Lord George principles of the The ICAEW has an extensive Code of The Code of Ethicsstudents, applies affiliates, to employees members, offirms member and member firms,professional in and their business activities, remunerated or voluntary egchartered individual accountants are boundCode by of the Ethics—albeit differentthe sections Code—even of when workingaccountancy in roles. non- Summary/Key highlights — — — — Title and Publication The Lord George PrinciplesGood for Business Conduct http://www.internationalbankers.co.uk/ content/business_principles.aspx CISI Code of Conduct http://www.cisi.org/bookmark/ genericform.aspx?form=29848780& url=ethics Code of Ethics http://www.icaew.com/en/members/ regulations-standards-and-guidance/ ethics Also see (for FRCStandards) Ethical http://www.frc.org.uk/ Our-Work/Codes-Standards/ Audit-and-assurance/Standards- and-guidance/Standards-and- guidance-for-auditors/Ethical- standards-for-auditors.aspx) Institute of Chartered Worshipful Company of Author/Source International Bankers http://www.international bankers.co.uk/ Chartered Institute for Securities and Investment (CISI) Accountants in England and Wales (ICAEW) cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:26] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 757 Application Chartered Accountants Observations/further remarks Ethical and auditing standardsprofession for are the set accountancy afterleast due some process public by representationstandards a and, set body in by with the the at members case FRC who of for are auditors, notensure a auditors. acting majority This in of is thestandard designed public setting to interest. bodies The havebut international some not “public a members”, majority,approval and by their a standards Public arechecks Interest subject that Oversight to the Board publicdue which interest process has has been been considered followed; and The ICAEW has ansupport ethics members advisory if service in helpline doubt to as to their ethical position. ICAEW believes that integritybehaviour. is fundamental to ethical The ICAEW has producedReporting several with reports Integrity onand solutions integrity— Real for Integrity: organisations practical seekingencourage to integrity promote(with and Leeds University). appropriate) Status, indicative application and further observations (where — — — — — threats to ethical behaviour should be identified; where appropriate, safeguards may be put in place; if the threat is so great that no safeguards could mitigate theor threat, the safeguards arethen not the sufficient, accountant shouldwithdraw (a) from the engagementthe (in case of anor accountant (b) in resign practice) from(in their the employment case ofbusiness). an accountant in The Code sets outarching, five principles fundamental, which over- constitutebasis the requirements of professional behaviour—integrity, objectivity, professional competence and dueconfidentiality care, and professional behaviour—and gives guidance, via illustrations, on how theapplied principles (ie are what to isspecific be expected situations of that members) commonly in The arise. Code—and those ofaccountancy other bodies—is professional based onInternational the Ethical Standards Board’s Code of Ethics forAccountants, Professional which also formsthe the FRC basis (formerly of APB)for Ethical Auditors Standards and EthicalReporting Standards Accountants. for All ofadopt these a codes “threats andwhereby: safeguards” approach — — — Summary/Key highlights — — Title and Publication Author/Source cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:26] Job: 027059 Unit: PG01

Ev 758 Parliamentary Commission on Banking Standards: Evidence The later report— Real Integrity:organisations practical seeking solutions to for promoteintegrity —examines and the encourage effectiveness oftechnique 10 for different promoting integrity—toneorganisational from values; the open top; culture;advice; whistleblowing; codes of conduct;and training monitoring—and rewards; sets discipline outorganisations recommendations in for the formalso of considers a techniques framework used forand by integrity. makes professional It a bodies number of other general conclusions. appropriate) Status, indicative application and further observations (where — For example, if anto employee act is unethically being then,whatever asked having internal been channels through theywhistleblowing can hotlines), (eg they should resign. The Code requires thatguided members not shall merely be bythe the spirit terms of but theparticular also Code conduct by and does the notthe fact appear list that among of a examplesfrom does amounting not to prevent misconduct. it In the case ofare accountants monitoring in and practice, inspectioncarried there regimes out either byprofessional the body relevant and overseenFRC, by or, the in theinterest case entities, of carried audits out ofIn by public all the cases, FRC. failureapplicable to codes comply (either with discoveredmonitoring by and the inspection regime,result or of as a a complaint)matter. is a disciplinary Members of professional bodiesICAEW such are as also the subjectserious to misconduct a by duty fellowtheir to members body report of and failuredisciplinary to matter; do so is itself a Summary/Key highlights — — — — Title and Publication Author/Source cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:26] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 759 Status Mandatory Application Lawyers Status Membership voluntary but Codemember mandatory once a Application Auditors Status Membership voluntary but Codemember mandatory once a Application Members Observations/further remarks The CB:PSB was establishedindustry-led, in professional 2010 standards to forindustry. develop the UK banking appropriate) — — — — — — — Status, indicative application and further observations (where out outcomes-focused conduct requirements to allow solicitors toachieve consider the how right best outcomestaking to for into clients account theworks way and that its a clientunderpinned firm base. by The effective, Code risk-based supervision is and enforcement. addressing integrity, objectivity, confidentiality and competency ethical awareness, customer focuscompetence and of those working in the Disciplinary arrangements of theand ICAEW other professional bodiesaccountancy for profession the (and, inpublic the interest case entities, of theto FRC), censure, can financial lead penaltiesfrom and the explusion professional bodyor and/or restriction removal of permissionparticular to sort carry of out workregistration, (eg insolvency audit licence). The SRA Code of Conduct (the Code) sets Provides principles and rules of conduct High level code aimed at supporting the banking industry Summary/Key highlights — — — — Title and Publication SRA Code of Conducthttp://www.sra.org.uk/code-of- (2011) conduct.page IIA Code of ethics http://www.iia.org.uk/en/Knowledge_ Centre/global_professional_guidance/ code-of-ethics/Code_of_ethics_ detail.cfm CB:PSB code of conduct http://www.cbpsb.org/professional standards2012b.php Author/Source Law Society/Solicitors Regulation Authority (SRA) Chartered Institute of Internal Auditors (IIA) The Chartered Banker Professional Standards Board (CB:PSB) cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:26] Job: 027059 Unit: PG01

Ev 760 Parliamentary Commission on Banking Standards: Evidence Status Membership voluntary but Codemember mandatory once a Application Banking Compliance officers, loanmanagement officers, experts, risk bank executives,private and banks smaller , CharteredObservations: Accountants CIBIS serves as aorganization “think (NGO), tank” developing style intellectualsupport non-governmental property of in needed bankinginnovative reform, proprietary and tools providing toinstitutions. banking and finance Status Membership voluntary but Codemember mandatory once a Application Compliance and anti-money laundering professionals appropriate) — — — Status, indicative application and further observations (where — — improve the culture andinvestment climate banking of sector, the preventing certificated qualifications and training in The Operational Mission of CIBIS is to abusive compliance practices which undermine national economies, toconstructive promote use of complianceto procedures assist lawful transactionsinternational and economies, boost by promotingincreased the availability of anti-fraudsuccess and banking pro- expertise tosector. the private The Code which cameDecember into 2011, force consists in ofcover 22 topics rules such which asand integrity, cooperation law with abidance enforcement of rules ICA is a global provider of professional anti money laundering (AML),and compliance fraud/financial crime prevention. All members are expectedhigh-level to code abide of by ethicshigh a that level focuses principles on includingcommitment 5 eg to integrity, diligenceprofessionalism and and confidentiality. Additionally there are requirementsmembers for to undertake CPDrecords and online. submit Summary/Key highlights — — — — Title and Publication CIBIS Code of conduct http://www.bankingstandards.org/ code-of-conduct Code of Ethics http://www.int-comp.org/CodeEthics The Consortium of Author/Source Investment Banking Institution Standards (CIBIS) International Professional Codes ofInternational Practice Compliance Association (ICA) cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:26] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 761 Status Membership voluntary but Codemember mandatory once a Application Investment professionals appropriate) — Status, indicative application and further observations (where — 1960 to promote theinstitute integrity members of and CFA servedfor as measuring a the model ethicsprofessionals of globally. investment Violations of the Code and Standards may The CFA global standards were created in result in disciplinary sanctionsInstitute by and the can CFA includemembership, revocation revocation of of candidacyCFA of programme the and rightdesignation. to use the CFA Summary/Key highlights — Title and Publication Code of Ethics andProfessional Standards Conduct of http://www.cfapubs.org/doi/pdf/ 10.2469/ccb.v2010.n14.1 CFA Institute Author/Source cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:26] Job: 027059 Unit: PG01

Ev 762 Parliamentary Commission on Banking Standards: Evidence Status Mandatory Application UK incorporated companies etc Status Mandatory Application UK Listed companies andto companies listing seeking admission Status Mandatory under UK Listing“comply Rules or but explain” applied basis on a Status, indicative application andappropriate) further observations (where — — — — — Table 2 Provides the legal basis for, inter alia, corporate governance and governance(risk of governance) risk Under sections 172, 173of and company 174 boards members haveresponsibility a to clear be attentiveof to shareholders the interests Requirements for UK listed companies. Requires publication of complianceCorporate with Governance UK Code — Summary/Key highlights — — — The ﬁrst version ofGovernance the (the UK Code) Code wasthe on produced Cadbury Corporate in Committee. 1992 Itsthe by paragraph classic 2.5 deﬁnition is of still the context of the Code: Companies Act 2006 Title and Publication UK Disclosure and transparency The UK Corporate Governance Code (accounting periods beginning on or after 29 June 2010)—formerly http://www.frc.org.uk/getattachment/ b0832de2–5c94–48c0-b771-ebb249 fe1fec/The-UK-Corporate- Governance- Code.aspx http://www.legislation.gov.uk/ukpga/ 2006/46/contents UK Listing Rules Rules http://www.fsa.gov.uk/Pages/Doing/ UKLA/index.shtml the “combined code” CORPORATE GOVERNANCE/INTERNAL GOVERNANCE REQUIREMENTS/CODES WITH APPLICATION TO BANKING UK legal framework governingParliament companies and UK Corporate Governance and Stewardship Codes Author/Source (UKLA)(part of FSA) Financial Reporting Council (FRC) UK Listing Authority cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:26] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 763 Application UK listed companies Observations/further remarks Code is not specificfinancial to regulation BOFI, under so theMarkets complemented Financial Act by Services 2000 and andCodes Companies includes Act principles 2006. relatingand to internal risk control, management asrole well of as the the auditcorporate establishment committee, governance and so to the riskThe code governance FRC helps is to consulting link Corporate on Governance proposed Code revisions andon to International Auditing the Standards (UK UK andEffective Ireland) Company to Stewardship give proposals. effectStatus to its Voluntary Status, indicative application andappropriate) further observations (where — — — — — “Corporate governance is the system by review of this code to reflect 2011 which companies are directedBoards and of controlled. directors aregovernance responsible of for their the companies.shareholders’ The role in governanceappoint is the to directors andsatisfy the themselves auditors that and angovernance to appropriate structure is inresponsibilities place. of The the boardthe include company’s setting strategic aims,leadership providing to the put themsupervising into the effect, management ofand the reporting business to shareholdersstewardship. on The their board’s actionsto are laws, subject regulations andgeneral the meeting.” shareholders in Sets out standards ofrelation good to practice board in leadershipeffectiveness, and remuneration, accountability and relations with shareholders. FRC is currently undertaking a limited discussions concerning the rolein of determining the the board naturesignificant and risks extent they of are will to take. Summary/Key highlights — — Title and Publication Internal Control: Guidance to Directors (Oct 2005)—formerly “the Turnball report” http://www.frc.org.uk/getattachment/ 5e4d12e4-a94f-4186–9d6f- 19e17aeb5351/Turnbull- guidance-October-2005.aspx Author/Source Financial Reporting Council (FRC) cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:26] Job: 027059 Unit: PG01

Ev 764 Parliamentary Commission on Banking Standards: Evidence Application UK listed companies Observations/further remarks Helps to strengthen theinternal link control of and corporate risk governance governance. to Status Voluntary Application UK listed companies Status, indicative application andappropriate) further observations (where — — — — management and control ofrisk-taking risks business in a effectiveness and efﬁciency of operations reliability of internal andreporting external responsibilities of the boardmaintaining in a system ofreviewing IC its and effectiveness elements of a soundthe system process of for (IC) reviewingeffectiveness its Elaborates on Section C.2—Risk Management—of the UK Corporate Governance Code which statesboard that should “the maintain ainternal sound control” system of Identiﬁes the role ofthe: internal control (IC)— in — — High level guidance identifying— the: — the UK Corporate Governance Code Guidance primarily on Sections A and B(suggestions of for Good PracticeReport from withdrawn Higgs on issue of guidance). Summary/Key highlights — — — — Title and Publication Guidance on Board Effectiveness (March 2010) http://www.frc.org.uk/getattachment/ c9ce2814–2806–4bca-a179- e390ecbed 841/Guidance-on-Board- Effectiveness.aspx Author/Source Financial Reporting Council (FRC) cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:26] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 765 Status Voluntary Not guidance but “capturescompanies, contributions investors from and advisersthese in may the be belief helpfulabout that to their other own companies approaches in to thinking risk.” Application UK listed companies etc. Status, indicative application andappropriate) further observations (where — — — The role of theresponsibilities Board for), (and Committees it and Management 6 The Company’s approach torisk risk appetite (ie and risksetting) tolerance The changing nature ofdistinguishing risk between (eg operational and strategic risks andcategories identifying such as projectcatastrophic and risks; and the interconnectedness and sequential nature of some signiﬁcantManaging risks) the quality andinformation use that of boards risk canact use on and Sources of risk assurance Risk and control culture Public reporting A summary of theseries FRC’s of ﬁndings meetings from with a major listed companies to learn morewere about approaching how these boards responsibilitiesrapidly in changing markets. One conclusion was thatFRC’s a guidance review on of Internalneeded. the Control was Findings cover: — — — — — — — — Summary/Key highlights — — Boards and Risk: A summary of Title and Publication discussions with companies, investors and advisers http://www.frc.org.uk/FRC- Documents/FRC/Boards-and-Risk- A- Summary-of-Discussions-with- Comp.aspx Financial Reporting Author/Source Council (FRC) cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:26] Job: 027059 Unit: PG01

Ev 766 Parliamentary Commission on Banking Standards: Evidence Status Voluntary—applied on comply orHowever, explain firms—other basis than venturemanaging capital investments firms— for anot professional a client natural that personof is are commitment required to to theStewardship provide Financial Code a Reporting required disclosure Council’s under FSA rules (COB 2.2) Application Firms who manage assetsshareholders on (such behalf as of pensioncompanies, institutional funds, investment insurance trusts andinvestment other vehicles) collective and InstitutionalObservations/further investors. remarks Code is not specificto to UK banks banking but inFRC is light is particularly ofcurrently relevant the consulting Kayon review changes in theStatus code Mandatory Application Authorised persons, individuals etc. Observations/further remarks: The legal basis forservices FSA industry. rules, applying to the financial Status, indicative application andappropriate) further observations (where — — — — — — — — Aims to set outengagement good with practice investee on companies shareholder thereby enhancing the quality ofbetween engagement institutional investors and companies to improve long-termsshareholders returns and to the efficienttheir exercise governance of responsibilities Under the code shareholderschoose are whether free or to notinvestee to company engage but with thisa the choice considered should one be basedapproach on their investment Sets out the frameworkbanks for and the other regulation firmsactivities. of carrying on regulated Specifies the FSA’s “gate keepingie functions” the authorisation ofof firms individuals and to the performfunctions. approval controlled Specifies the FSA’s enforcement powers. Sets out the thresholdauthorisation conditions and for continuing authorised. — Summary/Key highlights — — — — — Stewardship code Title and Publication (July 2010) Financial Services Markets Act http://www.frc.org.uk/FRC- Documents/FRC/The-UK- Stewardship-Code.aspx (2000) (FSMA) and secondary legislation http://www.legislation.gov.uk/ukpga/ 2000/8/contents Financial Reporting Author/Source Council (FRC) UK legal framework governingParliament financial services cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 767 Status Mandatory Application Authorised persons Status Mandatory Application Authorised persons Status Mandatory Application Authorised persons Status, indicative application andappropriate) further observations (where — — — — — — Amplifies threshold conditions set out in FSMA Requires firms to havethe adequate FSA resources— “will interpretas the meaning term sufficient ‘adequate’ inquality terms and of availability, quantity, andincluding ‘resources’ all as financial resources,financial non- resources and meansits of resources; managing for example,against capital, liabilities, provisions holdings ofcash or and access other to liquidresources assets, and human effective meansmanage by risks.” which to Requirements a firm toit satisfy is the “fit FSA and“conducting that proper” its (this business includes withcompliance integrity with and proper in standards”having and “competent and prudentand management exercising due skill,diligence”). care and Set out the fundamentalfirms obligations under of the all regulatory system. Principles express the mainthe dimensions “fit of and proper”the standard threshold set condition for 5 firmsIncludes (Suitability). in a requirement thatits a business firm with conduct integrity. Senior Management Arrangements specified in SYSC2 SYSC3 sets out Systemsrequirements and Controls — Summary/Key highlights — — — — — — — Threshold Conditions (COND) Title and Publication http://fsahandbook.info/FSA/html/ handbook/COND Principles for Business (PRIN) http://fsahandbook.info/FSA/html/ handbook/PRIN Senior Management Arrangements, Systems and Controls (SYSC) http://fsahandbook.info/FSA/html/ handbook/SYSC Key requirements in theFSA FSA Handbook Handbook relating to Corporate Governance/Internal Governance Author/Source FSA Handbook FSA Handbook cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 768 Parliamentary Commission on Banking Standards: Evidence Status Work in progress Application EU listed companies Observations/further remarks Note also existing ListingStatus and Company Law Directives Statutory/mandatory since 2008 (accordingAustrian to Business the Code Amendment Act 2008) Status, indicative application andappropriate) further observations (where — — — — association (Institut Österreichischer Wirtschaftsprüfer (IWP) and thefinancial Austrian analyst and assetassociation management (Österreichische Vereinigung für Finanzanalyse und Asset Management (ÖVFA)) SYSC5—sets out the requirementsknowledge for and skills, expertise SYSC6—High level rules requiringestablishment the of a complianceaudit function, function, and financialand crime the function baseline requirementsfunctions for all three SYSC7—High level rules requiringhave firms effective to processes tomonitor identify, and manage, report theactivities) risks that (relating it to is its SYSC18—Guidance or on might Public be Interest exposedDisclosure to Act: Whistle-blowing SYSC 19A Remuneration Code As part of acorporate longer governance term framework review of companies of at the large, thefocused public on consultation how companies,institutions, not work. just financial Corporate Governance roadmap expected autumn 2012 This was prepared by the Austrian Auditors’ Summary/Key highlights — — — — — — — — Title and Publication Austrian Code of Corporate Governance (January 2012) http://www.corporate-governance.at/ Corporate governance framework for European companies: what needs to be improved?http://ec.europa.eu/commission_ (April 2011) 2010– 2014/barnier/headlines/news/ 2011/04/20110405_en.htm Author/Source Austrian Working Group for Corporate Governance (Österreichischer Arbeitskreis für Corporate Governance) http://www.corporategovernance.at/ EU Corporate Governance EU Commission cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 769 Application Austrian listed companies includingEuropean exchange-listed companies registered inof Austria. commitment Declaration to thecompanies Code that is want mandatory toMarket for be of Austrian admitted the to Vienna the Stock Prime exchange Status Complementary to existing law,explain” based principle on “comply or Status, indicative application andappropriate) further observations (where — — established in 2004 basedthe on Banking, an Finance initiative andCommission, of Insurance the Federation ofBelgium Enterprises and in Euronext Brussels.Code In received 2009 legal the recognition The Code is availableEnglish in German and It was ﬁrst publishedamended in a 2002 number and of hasIt times been is supported byinstitutions a including number the of Austrianministry, organisations/ Finance the Austrian CentralVienna Bank Stock and exchange the The Code focuses onshareholders 5 and key the areas: generalcooperation meeting, between supervisory and management board, management board, supervisory board and transparencyauditing) and The Code clearly distinguishesmandatory between Legal requirements, “complyexplain” or provisions and recommendations (non-compliance requires neither disclosure nor explanation). Interpretations ofprovisions certain of the CodeGermany are only also available in The most recent revisiondevelopment has of focused the on diversityrules the rule to and improve new cooperationand between auditors boards The Corporate Governance Committee was Summary/Key highlights — — — — — — — Title and Publication Corporate Governance (March 2009) http://www.corporategovernance committee.be/library/documents/ ﬁnal%20code/CorporateGovUK Code2009.pdf The 2009 Belgian Code on Author/Source Governance Committee www.corporategovernance committee.be Belgian Corporate cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 770 Parliamentary Commission on Banking Standards: Evidence Application Companies incorporated in Belgiumadmitted whose to shares trading are oncompanies”) a regulated market (“listed Observations/further remarks Study on the complianceGovernance of Code the 2009 Belgian ofFrench Corporate the and BEL Dutch 20 only.compliance is Overall with available suggestion the in is Code that is “quite high”. Status Based on “comply oraccount explain” and principle. complements Takes Bulgarian into restating legislation it without Status, indicative application andappropriate) further observations (where — — — boards, Audit and Internal Control, The Code is availableDutch in French, EnglishThe and Code is basedprinciples on such 9 a overarching “theclear company governance shall structure” adopt orshall a “the have company an effectivethat and takes efficient decisions board ininterest”. the The corporate Code alsorecommendations contains and provisions/ guidelines. The Code also containsappendices a such number as of criteriaor for disclosure independence, requirements The Committee states thatreasons there why are the 5 codecorporate will governance: achieve expression better of commitment from Belgian leaders,faster more transparency, and higher levelscompliance of as it willdeviations, be greater harder flexibility to comparedlaw, justify to complements existing legislation. The 2009 revision advocatestransparency complete re remuneration andpay severance towards shareholders andworld the outside The Code contains 5 chapters: Corporate Protection of shareholders’ rights,of Disclosure Information, Corporate GovernanceStakeholders. and Summary/Key highlights — — — — — — Title and Publication Corporate Governance Bulgarian National Code For http://download.bse-sofia.bg/ Corporate_governance/CGCode_ EN-2012.pdf Author/Source http://bse-sofia.bg/ Bulgarian Stock exchange cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 771 Application All Bulgarian public companiesplanning including to those become that public.applied are Should by also Bulgarian be companiesand adopted with municipal and predominant ownership. state “AccordingRules to and BSE-Sofia Regulations, issuerstrading willing on to the be BSESegment, admitted Main are to Market, obliged ‘Premium’ toconformity Equities carry with out the their NationalCode, activity Corporate approved in Governance by theimplementation Exchange. of Adoption the and Codeon by the the other companies, marketsrecommendable traded and and market depends segments, on is Status their own choice” The Code is voluntaryor for explain the disclosure listed required. companies. Comply Application : Companies listed on the Cyprus stock exchange Status Recommendation/“Soft law” Status, indicative application andappropriate) further observations (where — — — — role of the boardcompanies, of protect directors small in shareholders,greater listed adopt transparency and provideinformation timely as well assafeguard [to] the sufficiently independence ofdirectors the in board decision of making” The Code is available in Greek and English (Role of shareholders andwith their the interaction management ofof the shareholders company, including Role CSR,and Openness Transparency, Tasks and responsibilities of the supreme andComposition central and governing remuneration bodies, ofgoverning supreme body, Remuneration ofbody, governing financial reporting, Riskinternal management/ control and audit) The Code sets outtier provisions and for two-tier both systems The one- Code is availableEnglish in Bulgarian and The Code was developedand in approved October by 2007 theGovernance National Committee Corporate (NCGC) andamended was in February 2012decision by by virtue the of NCGC a The Code aims to “strengthen the monitoring The Code contains 4Directors, main Directors’ sections: Remuneration, BoardAccountability of and Audit andwith Relationship shareholders The recommendations cover 9 key topics — Summary/Key highlights — — — — — — Title and Publication Corporate Governance Code (March 2011) http://www.cse.com.cy/en/MARKET DATA/DATA/CORPORATE% 20GOVERNANCE%20CODE%203rd% 20ekdosi.pdf Governance (August 2011) http://www.corporategovernance.dk/ graphics/Corporategovernance/ 20110816_Recommendations_on_ Corporate_Governance.pdf Recommendations on Corporate Author/Source Cyprus Stock Exchange (CSE) http://www.cse.com.cy/ en/default.asp Companies Agency (DCCA) http://www.corporate governance.dk/ sw58113.asp Danish Commerce and cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 772 Parliamentary Commission on Banking Standards: Evidence Application Danish companies whose shareson are a admitted regulated to market.services trading NB companies as are the regulatedrecommendations activities by for of law, the financial no financial specific been services made sector have Status Recommendation/self-regulation but should betogether viewed with Dutch andwith European existing legislation. legislation Overlaps areprinciple acknowledged. corresponds If with a amean statutory the rule rule this needsor will to explain” be followed otherwise “comply Status, indicative application andappropriate) further observations (where — — factor in the operationstrict of compliance the with Code the(box is letter ticking) not of but the theconcerned Code extent act to in which practicethe all with Code. the spirit of The Code is available in Danish andThe English Recommendations were firstin published 2001 and haveoccasions since to been keep revised inon on line corporate 3 with governance developments The DCCA believes thatthe self-regulation best is form ofobligation regulation on but society, this companiesinvestors places and to an get involvedtake in a the positive dialogue attitudegovernance and to corporate The current Code stresses that the decisive Compared to the previousCode Code has of been 2003, amendedemphasis the eg on to the place importancemanagement, greater of the integral importance risk ofsocial corporate responsibility and executive remuneration Summary/Key highlights — — — — — Title and Publication Principles of good corporate governance and best practice provisions (December 2008) https://docs.google.com/viewer? url=http://www.mccg.nl/download/? id%3D606 Dutch Corporate Governance Code: Author/Source Governance Monitoring Committee http://www.commissie corporategovernance.nl/ news/item/Monitoring_ Commissie_presenteert_ geactualiseerde_ corporate_governance_ code/150?mid= Dutch corporate cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 773 Application Applies to all companiesthe whose Netherlands registered and offices whosehave are shares been in or admitted depositary totrading receipts listing on on a a regulatedcompanies stock market. (balance exchange It sheet or also > Euroregistered applies 500m) offices to whose are all in large shares the are Netherlands admitted and tofacility whose trading on a multi-lateral trading Observations/further remarks The Corporate Governance CodeCommittee Monitoring was established bythe the State Minister Secretary of forMinister Finance, Economic of Affairs Justice and in the publishes 2004. reports The about Committee complianceof also regarding specific a provisions number aselements well of as the specific Code. surveysStatus on Statutory—enforced by the regulationsStock of Exchange. the “Comply Tallinn orApplication Explain” principle Issuers admitted to tradingoperating on in a Estonia regulated (exceptas market investment public funds limited registered companies).companies Optional that for may other wish to comply Status, indicative application andappropriate) further observations (where — — — — help structure the workboard, of supervisory the board, management cooperation between the two boards,financial general reporting meeting, and audit. English The Code consist ofbest a practice preamble, provisions principles, andon an certain explanation terms usedcontains in 5 the chapters Code. eachboth The of principles Code which and contains bestThe practice Chapters provisions. are: 1)Code compliance 2) with the the managementsupervisory board board 3) 4) the thethe shareholders general and meeting of5) the the shareholders audit and ofand financial external reporting, audit. internal The Code is basedseparate on supervisory the board system existsthe in alongside management which board, a whetherstatutory under two-tier the rule orThe otherwise code is available in Dutch and English High-level objectives which are designed to The Code is available in Estonian and Summary/Key highlights — — — — — Title and Publication Corporate Governance Recommendations (January 2006) http://www.ecgi.org/codes/ documents /cg_recommendations_2005_en.pdf Author/Source Estonian Financial Supervision Authority and Tallinn Stock Exchange http://www.fi.ee/?lang=en http://www.nasdaqomx baltic.com/market/?lang= en cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 774 Parliamentary Commission on Banking Standards: Evidence Status “Comply or explain” principle—several recommendations in the CodeApplication are based onCompanies legislation listed at theObservations/further Helsinki remarks stock exchange The Securities Market Associationself-regulatory is body a established cooperation inConfederation and 2006 of by Finnish the Industries,Chamber the of Central Commerce andHelsinki the NASDAQ OMX Status Recommendation—intended to set shareholdercriteria voting for resolutions butlegislation not intended as basisApplication for new Companies whose shares area listed regulated for French trading marketplatform. either or The on on principles a alsomade multi-lateral apply aboard trading to by all investment investments Observations/further managers remarks AFG established a CodeStatus of Ethics inVoluntary 1997 but may betheir designated legally by required listed reference companies code as . Status, indicative application andappropriate) further observations (where — — — — — — — The Code provides 55recommendations detailed covering the general meeting, board, board committees, managing principles of corporate governance:AGM the must foster shareholderappropriate democracy, and transparent compensation, one share/one vote, cleardefences, anti-takeover independent, efficient andboard effective of directors, muststrategic take direction into and account environmentalemployment and policies The Recommendations are divided into 2 director and other executives,internal remuneration, control, risk managementinternal and audit, “insider administration”,and audit communications. The Code is availableand in English Finnish, Swedish As a rule Finnish“one-tier” listed governance companies model. use Verycompanies a few have listed supervisory boards. The AFG believes that there are 6 key main sections on I)shareholders’ the meeting General and ii)directors The or Board supervisory of board. The Code is availableThe in 2012 French edition and represents English of the the tenth Code edition — — Summary/Key highlights — — — — — Finnish Corporate Governance Code Title and Publication 2010 (15 June 2010) Recommendations on Corporate Governance (January 2012) http://www.afg.asso.fr/index.php? option=com_docman& task=doc_ download& gid=1427& lang=en http://cgfinland.fi/files/2012/01/ finnish-cg-code-20101.pdf Finnish Securities Author/Source Markets Association www.cgfinland.fi French Asset Management Association (Association Française de la Gestion Financière) (AFG) http://www.afg.asso.fr/ index.php cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 775 Application Companies whose securities area admitted regulated to market tradingStatus on Declarations of conformity requiredexplain on basis) a complyApplication or German listed companies (recommendationlisted that companies non- also adoptObservations/further the remarks code) Not a banking codeinclude as Deutsche such, Bank although andHas signatories Commerzbank a legal basis in German Corporate law Status, indicative application andappropriate) further observations (where — — — — — inadequate focus on shareholder interests the two-tier system ofand executive supervisory board board inadequate transparency of German corporate governance inadequate independence of German supervisory boards limited independence of financial statement auditors The Code consolidates aall number which of have reports beeninitiatives based with on the business objectiveprinciples of of defining good operationtransparency and with a viewinvestor to and enhancing public confidence The Code sets outspecific recommendations areas in as 21 wellinformation as on providing the implementationrecommendations of the The Code is availableDeveloped in to French address and the English especially major from criticisms— the international community—of German corporate governance, namely: — — — — — Explains the dual boardout structure the and relationship sets ofand the the supervisory management board board[codes] as relating well to as theirresponsibilities, the respect compensation roles and and composition and conflicts of interest — Summary/Key highlights — — — — Corporate Governance Code of Title and Publication Listed Corporations (April 2010) http://www.ecgi.org/codes/ documents/ afep_medef_cgcode_listed_ corporations_20apr2010_en.pdf German Corporate Governance Codex (Adopted in 2002 and2010) updated in http://www.corporate-governance- code.de/eng/download/kodex_2012/ D_CorGov_final_May_2012.pdf (2012 version of the code) Association Française des Author/Source Entreprises Privees (AFEP) and MEDEF (Mouvement des Entreprises de France) http://www.medef.com/ medef-corporate/le-medef/ quisommes-nous.html Commission of the German Corporate Governance Code cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 776 Parliamentary Commission on Banking Standards: Evidence Status Voluntary but some corporateenshrined governance in requirements Greek Law Application All Greek SAs asregistered defined offices in are law in 2190/1920 Greece whose Status Recommended but not mandatoryon for the companies stock listed exchange Status, indicative application andappropriate) further observations (where — — — to promote the continuousthe enhancement Greek of corporate institutionalas framework well as improvemembers the and competitiveness the of Greek its economy an addition to relevant(predominantly Hungarian Act legislation IV ofassociations, 2006 hereinafter on Company business Act).Recommendations The contain recommendations, suggestions and related explanations.issues Those regulated by lawthe are Recommendations. not covered by Sets out the managementinformation board’s disclosure insider requirements and obligations to report anddealings disclosure share Sets out the requirementsand for auditing the of reporting financialThe statements Code is availableEnglish in German and Prepared by the SEV as part of its mandate Until the publication ofno the “comply Code or there explain”governance was corporate code which wasmost at other odds EU with states The Code is availableThe in Code Greek is and divided English which into are general addressed principles towhether all listed companies, or notwhich and concern special only practices listedThe companies Recommendations are considered to be Summary/Key highlights — — — — — — — — Title and Publication For Listed Companies (March 2011) http://www.ecgi.org/codes/ documents/ sev_cg_code_listed_companies_ greece_ 21mar2011_en.pdf Recommendations (May 2008) http://www.ecgi.org/codes/ documents/ cg_recommendations_bsu_mar 2008_en.pdf SEV Corporate Governance Code Corporate Governance Author/Source Enterprises (SEV) http://www.sev.org.gr/on line/index.aspx?lang=en Committee of the Budapest Stock Exchange http://bse.hu/topmenu/ issuers/corporate governance/cgr.html? pagenum=1& query=corporate%2520 governance Hellenic Federation of Corporate Governance cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 777 Application Public limited Companies listedExchange on and the registered Budapest in stock Hungary Status Intended to provide guidanceprescriptive. without Based being on too “complyComplementary or to explain” Luxembourg principle. law Application Principles apply to allshares Luxembourg of companies which the aremarket admitted operated for by trading theNB on Luxembourg Focus a Stock on regulated Exchange Limitedstructure companies of with governance. a Fordual unitary other structured forms of of governance,interpreted company the eg principles must be Observations/further remarks The Bourse also publishesapplication regular of reports the on principleslisted the by for Luxembourg trading companies onExchange the regulated market of the Stock Status, indicative application andappropriate) further observations (where — — — — — governance has the followingcreates characteristics: a proper balance between The Recommendations replace anversion earlier published in FebruaryThe 2004 Recommendations are availableHungarian in and English The recommendations are dividedareas: in The 4 shareholders’ key rightsof and shareholders, treatment responsibilities ofManaging the Body and theCommittees Supervisory and Board, Transparency and disclosure. The text of theinto recommendations R is (Recommendations), divided Sand (Suggestions) E (Explanations). The Bourse states that good corporative entrepreneurship and control, facilitates performance driven management, determines the company’s objectives, theobtaining means them of and providesevaluating tools performance for “The 10 corporate governancecover principles the role andof composition directors of of the companies,committees boards as which well may as emanateboards, from such the as audit,nominating remuneration committees, and and thesenior companies’ management. They alsorelations deal to with be the maintainedand with investors.” shareholders The Principles of Corporatecontain governance the general principlesthe (“comply”), recommendations (“Comply orand explain”) the guidelines. The Principles are availableEnglish in French and Summary/Key highlights — — — — — — — — Title and Publication Principles of Corporate Governance of the Luxembourg Stock Exchange Corporate Governance: The Ten (October 2009) http://www.bourse.lu/application?_ ﬂowId=PageStatiqueFlow& content= services/CorporateGovernance.jsp Author/Source http://www.bourse.lu/ Accueil.jsp Bourse de Luxembourg cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 778 Parliamentary Commission on Banking Standards: Evidence Status Voluntary—“comply or explain” principle Application Companies listed on the WSE Observations/further remarks The Warsaw stock exchangewebsite has with set a up view aeffective to specific application creating of an thebest active best practices dialogue practices; through for promoting informationother on initiatives conferences including and educationalcertified programmes so-called by “Edupartners” Status Recommendation Application Not stated Status, indicative application andappropriate) further observations (where — — — — — Intended to strengthen thethe competitiveness market of and intendedinnovation to and promote international competitiveness general meeting, the boardsupervisory of board, directors Information and andand auditing conflicts of interest The Code is splitRecommendations between for 4 best sections: practicecompanies, for best listed practice forboards management of listed companies,supervisory best board practice members for andpractices best for shareholders The Code is available in Polish and English The Code focuses on arrangements for the Available in Portuguese and English The Consolidation document intendsprovide to an integrated andoverview accessible of the rulesgovernance on through corporate a consolidationnational of sources the of bothrecommendatory legal rules and — Summary/Key highlights — — — — — Code of Best Practice for WSE Title and Publication Listed companies (effective January 2012) http://www.corp-gov.gpw.pl/assets/ library/english/regulacje/ bestpractices%2019_10_2011_en.pdf CMVM Corporate Governance Code 2010: Recommendations (January 2010) http://www.cmvm.pt/EN/ Recomendacao/Recomendacoes/ Documents/2010consol.Corporate% 20Governance%20Recommendations .2010.bbmm.pdf Also: Consolidation of the Legal Framework and the Corporate Governance Code 2010 http://www.cmvm.pt/EN/ Recomendacao/Recomendacoes/ Documents/20122010.Cons.MM.BB. Cons%20Fontes%20Norm%20%20e% 20CGS%202010%20trad%20inglês.pdf Warsaw Stock Exchange Author/Source (WSE) http://www.corp- gov.gpw.pl/? Portuguese Securities Markets Commission Comissão do Mercado de Valores Mobiliários (CMVM) jezyk=angielski http://www.cmvm.pt/en/a %20cmvm/apresentacao/ Pages/defaulta.aspx cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 779 Status Voluntary—issuers that adopt thepartially Code shall wholly yearly or submitCorporate to Governance the Statement. stock “Complyprinciple. exchange or Recommendations a explain” are supplementary provisions to legal obligations under Romanian law. Application Companies admitted to tradingof on the the Bucharest regulated Stock market exchange Status Voluntary/not binding but “comply or explain” Application Companies listed on the Slovene regulated market Observations/further remarks Also supported by theMinistry Ministry of of Finance Economy and Status, indicative application andappropriate) further observations (where — — — — — The Code contains 11Principles. Articles The and Articles 19 coverissues a including range the of needtransparent for corporate a governance clear framework, and guidelines, principles of businessinternal and bylaws of thewell three as institutions internal as standardsgovernance on corporate Code does not containboards principles of governing directors duedominance to of the two—tier relative systemgovernance pre- of English formal, rigorous and transparentfor procedures appointing directors andof the corporate importance social responsibility The Code is availableEnglish in Romanian and In March 2010, Implementationfor guidelines the corporate governanceissued code which were provide asuggestions non-exhaustive for set the of implementationrecommendations. of These the are basedinternational on good practice. Incorporates Slovene legislation, EU Compared to the previous version (2005) the The Code is available in Slovene and — Summary/Key highlights — — — — — Corporate Governance Code (2008) Title and Publication http://www.bvb.ro/companies/ CorporateGovernance.aspx Code (December 2009–effective January 2010) http://www.ljse.si/cgi-bin/ jve.cgi?doc=8377 Slovene Corporate Governance Bucharest Stock Author/Source Exchange http://www.bvb.ro/Home Page.aspx Exchange, http://www.ljse.si/cgi-bin/ jve.cgi?doc=1468& sid= 7VsGzUNmThDA4uyt Slovenian Directors’ Association http://www.zdruzenje- ns.si/zcnsweb/vsebina. asp?s=381& n=1 The Managers’ Association of Slovenia http://www.zdruzenje- manager.si/en/ Lljubljana Stock cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 780 Parliamentary Commission on Banking Standards: Evidence Status Voluntary/self-regulation. “Comply or explain” principle. Acts as complementregulations to by legislation specifying and normgovernance other for “at good a corporate higherstatutory level regulation”. of ambition than the Application All Swedish companies whoseregulated shares market are in traded SwedenStockholm on (NASDAQ and a OMX NGM Equity) Observations/further remarks The Swedish Corporate Governancein Board 2005 was in set orderin up to Swedish promote stock good exchange corporate listed governance companies. Status, indicative application andappropriate) further observations (where — — — The Swedish Corporate Governancestates Board that Swedish corporatediffers governance in certain signiﬁcantthe areas, Anglo-Saxon both one-tier from modeltwo-tier and model the which is more typical in Europe. “The differences includeconcerning matters attitudes to thethe role division of of owners, powerbetween and the responsibilities different governanceformation bodies, of the boards andauditor”. the role ofThe the Code sets outgovernance rules in for 10 corporate keyrules areas. in Most the of Codenon-compliance the are to formulated be to identiﬁedand allow objectively explained, however, itcertain also rules contains for “pedagogicalwhich reasons” non-compliance for is unlikelyreported. to be The Code is availableEnglish in Swedish and — Summary/Key highlights — — The Swedish Corporate Governance Title and Publication Code (February 2010) http://www.corporategovernanceboard.se/ media/45322/svenskkodbolagsstyrn_ 2010_eng_korrigerad20110321.pdf Swedish Corporate Author/Source Governance Board http://www.corporate governanceboard.se/ about-the-board cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 781 Status Voluntary subject to theThe “comply Code or does explain” not principle. rules. replicate legal duties or binding Application All listed companies regardlesscapitalisation of size or market Status, indicative application andappropriate) further observations (where — — In addition to thefirms, recommendations the for working Groupspecific has recommendations also for made the government, CNMV and financial institutions specifically. With regardfinancial to institutions there arerecommendations 2 relating specific to thevoting exercise rights of by institutional The report is available in Spanish and English — — Summary/Key highlights Report of the Special working group Title and Publication on the good governancecompanies of listed (May 2006) http://www.cnmv.es/DocPortal/ Publicaciones/CodigoGov/Codigo_ unificado_Ing_04en.pdf Spanish Comisión Author/Source Nacional del Mercado de Valores (CNMV) http://www.cnmv.es/ portal/home.aspx cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 782 Parliamentary Commission on Banking Standards: Evidence Status: See below Application Supervisors and regulators Observations/remarks EBA guidelines underline EU’scorporate attempt governance to to link theenvironment risk of and the control firm In EU Member Statesgovernance usually structures—a use unitary one orstructure, of a so two dual the board EBAaccommodate guidance both adopts structures language referringbody to to which a has management afunction. management The function management and bodyfor supervisory proposes the the institution direction andthe the management supervisory function function andIncorporated oversees provides in advice FSA’s supervisory to approach it. Status, indicative application andappropriate) further observations (where — — — — the functioning and compositionthe of management body management responsibilities such as “know-your-structure” the qualifications, appointment and succession of its managementspecialised body committees (ie RiskAudit) and of the managementthe body institutions’ framework for business conduct corporate governance. Differentiates internal governance from The EBA states thata corporate broad governance concept is thatset can of be relationships described betweenmanagement, as an its the institution, shareholders its andstakeholders other (see para 28Guidelines of on the IG). EBA’s Restates that the definitiongovernance of is internal in accordanceof with Directive Article 2006/48/EC 22 (asCEBS’s specified high in level principlesmanagement for principles risk (above)). Enhances the CEBS’s high(Feb level 2010) principles with guidelines— concerning: — — — — EU Internal [risk] Governance standards Summary/Key highlights — — — — Title and Publication EBA Guidelines on Internal governance (Sept 2011 came into2012) effect March http://www.eba.europa.eu/cebs/ media/ Publications/Standards%20and%20 Guidelines/2011/EBA-BS-2011–116- final-(EBA-Guidelines-on-Internal- Governance)-(2)_1.pdf Author/Source European Banking Authority (EBA) cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 783 Status, indicative application andappropriate) further observations (where transactions with related parties strategy and decisions complexity in legal structure material changes measurement and assessment monitoring unapproved exposures the institutions’ out sourcingremuneration and policies the institution’s risk culturemanagement and framework risk the institution’s new products approval policy the institution’s internal control framework and its riskfunction control and improved principlesdealing for with internal controlits covering role in: — — — — — — — the need for a(CRO Chief should Risk be Ofﬁcer appointed the need for Compliancefunctions and should Audit be establisheda (with deﬁnition of complianceInformation tabled) systems and business continuity Internal and external transparency — — — — — — — — Summary/Key highlights Title and Publication Author/Source cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 784 Parliamentary Commission on Banking Standards: Evidence Status Consultation—Work in process Application EU banks Status, indicative application andappropriate) further observations (where — — The proposed Guidelines set out the process, criteria and minimum requirementsassessing for the suitability ofmanagement members body of and the keyof function a holders credit institution. Similar to FSA’s approach — Summary/Key highlights — EBA Consultation Paper on draft Title and Publication Guidelines For assessing the suitability of members ofmanagement the body and keyholders function of a credit2012) institution (April http://eba.europa.eu/cebs/media/ Publications/ Consultation%20Papers/ 2012/CP03/CP-on-GL-on-the-assess ment-of-the-suitability-of-directors- and-key-function-holders.pdf EBA Author/Source cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 785 Status See below Application supervisors Status, indicative application andappropriate) further observations (where — — confirms the need tooutcome promote based an approach underlines the importance for jurisdictions to regularly reviewsufficiency the of supervisory, regulatory and enforcement resources and promote forward looking capacities suggests that authorities makeof fullex use ante and impactex assessments post whenregulatory decidingintroduce to new regulation suggests that where jurisdictionsvoluntary use corporate codes (in conjunction with public lawsother and public regulation) adequate monitoring and compliance mechanisms are important reinforces the responsibility ofboard the underlines the importance of connecting the structure of compensation to the company’s strategic goals and risk appetite Report represents the thirdOECD phase Steering of Group the onGovernance Corporate action plan ongovernance corporate and the financialVia crisis the publication ofand emerging conclusions, practices the reportencourage aims and to support thealready implementation agreed of international andstandards national On the gap betweenimplementation, existing the standards report and — — — — On the governance ofincentives, remuneration the and report — — Summary/Key highlights — — — — Non-EU/International Corporate Governance Standards Title and Publication Corporate Governance and the Financial Crisis: Conclusions and emerging good practices toimplementation enhance of the Principles’ (Feb 2010) http://www.oecd.org/daf/corporate affairs/corporategovernance principles/44679170.pdf http://www.oecd.org/daf/corporate affairs/ corporategovernanceprinciples/ corporategovernanceandthefinancial crisis.htm Author/Source OECD cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 786 Parliamentary Commission on Banking Standards: Evidence Status, indicative application andappropriate) further observations (where confirms the importance of transparency strongly concludes that theresponsibility board’s for defining strategy and risk appetite needsto to establishing be and extended overseeing enterprise risk management systems confirmed that independent riskcontrol and functions is goodthat practice chief and risk officersshould (or report equivalent) to theconfirmed board that the processmanagement of and risk the resultsassessments of should risk be appropriately disclosed underlined that the riskand management reporting functions systemconsider should risks that maythe be company’s related remuneration to and incentive (eg promotion) systems underlines the importance ofChair the in ensuring thattackles the the board most importantfacing issues a company underlines the need tocompetent promote boards, with fortraining, example periodic evaluations, andextension the of “fit andthe proper” technical tests and to financial competence of board members, including general governance andmanagement risk skills — On improving the governancemanagement of , risk the report — — — — On improving board practices,— the report — Summary/Key highlights — — Title and Publication Author/Source cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 787 Status See below Application Supervisors Observations/remarks Has a wide definitiongoes to beyond corporate bank governance shareholders)connects (which and corporate arguably governance conflates/ withEBA’s guidelines internal are governance similar toof the ways BCBS’s including in thestructure” a adoption concept number of the “know your Status, indicative application andappropriate) further observations (where — — — — is defined as “abetween set a of company’s relationships management,board, its its shareholders andstakeholders” other seen as providing thethrough structure which the objectivescompany of are the set andattaining the those means objectives of and monitoring them are determined the role of theestablishing board the (including “tone atthe the qualifications top”) and compositionthe of board the importance of independent(including risk a chief riskequivalent), officer compliance or and audit functions where each hasauthority, sufficient stature and resourcesaccess to the board board oversight of compensation functions board and senior management’s understanding of the bank’s operational structure and risks On the exercise ofreport shareholder examines rights, a the numberthis of question dimensions noting, to ingood particular, practice that for it investors is records to to disclose control voting forinterest potential conflicts of Reinforces the OECD (2010)governance corporate principles. Corporate governance: — — Based on lessons learntprinciples during set the out crisis, bestorganisations. the practice Areas for of banking focus— include: — — — — Summary/Key highlights — — — — Title and Publication Principles for enhancing corporate governance (Oct 2010) http://www.bis.org/publ/bcbs176.htm Author/Source BCBS cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 788 Parliamentary Commission on Banking Standards: Evidence Status See below Application Supervisors Status Work in progress Status, indicative application andappropriate) further observations (where — — — Builds on the BCBS’s (2010) Corporate Implementation (SCSI) agreed to undertake a Governance principles that stateshould that have banks an internalwith audit sufficient (IA) stature, function independence, resources and access toAddresses board supervisory members expectations forIA the function, the relationshipsupervisory of body the with IAsupervisory and assessment the of thatEncourages function internal auditors tonational comply and with international professional standards (such as theAuditors) Institute of Internal The FSB Standing Committee on Standards peer review on risk governance. There is currently noset single of comprehensive principles andaddress standards and that integrate fully corporategovernance and requirements. risk The review therefore will not assessany compliance specific with standard, butstandards will and use recommendations existing (as appropriate) in order towell evaluate as progress identify as goodremaining practices gaps and in firms’frameworks, risk and governance in theframeworks assessment by of supervisory those authorities. “The peer review willinterplay focus between on the the firm’sthat roles Board oversee and members risk management,risk the management enterprise function andaspects relevant of the processgovernance for framework, assessing processes the and practices, risk either by internalparties” audit or by third — Summary/Key highlights — — — — — The internal audit function in banks Title and Publication (April 2012) (June 2012) http://www.bis.org/publ/bcbs223.htm Thematic review on risk governance http://www.financialstabilityboard.org/ publications/r_120404.pdf BCBS Author/Source (FSB) Financial Stability Board cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 789 Status Recommendation Application Financial institutions Observations The Group of Thirty,non-profit, established international in body 1978, composed isrepresentatives of a of very private, the senior privateacademia. and It public aims sectors tointernational and deepen economic understanding and of financialthe issues, international to repercussions explore ofpublic decisions and taken private in sectors,available the and to to market examine practitioners the and choices policymakers Status, indicative application andappropriate) further observations (where — — — Drawing lessons from the financial crisis, the G30 calls on boardsinstitutions of to directors do of moregovernance. financial to strengthen The report stresses thatbehaviour values of influence those the withresponsibilities. governance The key topromote reform changes is in to theindividuals ways think in about which theirThe these responsibilities report focuses onessential 7 question key of themes: function,Risk the the governance, Board, Management, Supervisors, shareholders and values and culture. — Summary/Key highlights — — Toward effective governance of Title and Publication financial institutions (April 2012) http://www.group30.org/images/ PDF/ TowardEffGov.pdf Group of Thirty (G30) Author/Source cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 790 Parliamentary Commission on Banking Standards: Evidence Status Guidance Application Auditors but COSO alsoacted suggests upon) it by: will Boardother be of personnel read directors, within (and senior theorganisations management, firm, and regulators, educators professional Although COSO is notis aimed used, specifically to at varyingand BOFIs, degrees compliance it by professionals BOFI andexample, risk auditors inform management to, (i) for enterpriseframework risk design management (ii) approachesmanagement to or operational (ii) risk thecontrols testing [addressing of its the prudentialrisks] BOFI and internal non-prudential Status, indicative application andappropriate) further observations (where — — — premise that every entityvalue exits for to its provide stakeholdersmaximised and when that management value setsand is strategy objectives to strikebetween an growth optimal and balance returnsrelated goals risks, and and efficientlydeploys and resources effectively in pursuitobjectives of the entities COSO framework is underpinned by the The COSO ERM frameworka is matrix illustrated that by depictsbetween the the direct objectives relationship of(specifying the four firm categories—strategic, operations, reporting, compliance), theunits firm’s (subsidiary, business unit,entity division, level), and and its(specifying internal eight environment components—objective setting, event identification, riskrisk assessment, response, control activities, information & communication, and monitoring) Summary/Key highlights — — Non-EU/International Enterprise Risk Management/Internal [risk] Corporate Governance Standards Executive summary Framework Application techniques Title and Publication COSO Enterprise Risk Management framework (2004) Three documents: (i) (ii) (iii) (Obtainable with the purchasedlicense of at a a reasonable fee— http://infostore.saiglobal.com/store/) 1 Author/Source PwC for The Committee of Sponsoring Organisations of the Treadway Commission (COSO) http://www.coso.org/ guidance.htm cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 791 Observations/further remarks The adoption of theits framework documentation has of been detailedcan facilitated application be by techniques used that toframework help or inform measure the itsIntegrity building robustness. and of ethics an values ERM the are framework explicitly and discussed inrespectively in the in application terms standards ofand the objective overall setting. internal Integrityby environment and products ethics of are theCorporate viewed corporate culture as culture. is statedbehavioural as standards encompasses and ethical howwith and they top are management—starting communicated witha the key CEO—playing role in30) determining the corporateArguably culture its (page emphasis onstructures internal reveals control its and accounting internal Status and auditing origins Guidance Application Not specific to anyused industry by or any sector, public, soassociate, private intended group or to or community be individual. [Although enterprise, AS/NZS ISO 13000:2009specifically is at not BOFIs, aimed theused predecessor by standard BOFI has riskprofessionals been management and and auditors compliance torisk help management inform framework (i) designoperational enterprise (ii) risk approaches management to orBOFI (ii) internal the controls testing [addressingnon-prudential of its risks] the prudential and Observations It is intended that the Standard should be utilised to Status, indicative application andappropriate) further observations (where — — — — — — — — principles and guidelines forin managing a risk systematic, transparentmanner and and credible within any scope and context internal and external factorson and the influences achievement ofobjectives the (or organisation’s whether they exceed them) The standard provides a generic set of It defines “risk” as the uncertain effect of It states that allorganisations activities manage involve risk risk byunderstanding and anticipating, and deciding whethermodify to it. And thatorganisations throughout communicate this and processes consultstakeholders with and monitor andand review the the controls risk thatSo are the modifying Standard the describesdetail. risk. this process in The Standard establishes aprinciples numberthat of need to be satisfied before Summary/Key highlights — — — — Title and Publication AS/NZS ISO 13000:2009 Risk management—Principles and guidelines (2009) (Obtainable with the purchasedlicense— of a http://infostore.saiglobal.com/store/) Note: supercedes AS/NZ 4360:2004 2 Author/Source Joint Standards Australia/ Standards New Zealand Committee 0B-007 http://www.standards.co.nz /default.htm (New Zealand Standards) http://www.standards.org. au/Pages/default.aspx (Australian Standards) cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 792 Parliamentary Commission on Banking Standards: Evidence harmonise risk management processesfurther in standards, existing thereby and providingapproach “a in common support standardsrisks dealing and/or with sectors”. specific Nevertheless,intended it to is promote also uniformityacross “not of organizations” risk management Status, indicative application andappropriate) further observations (where risk management will be effective. It recommends that organizations shoulda have framework that integratesmanaging the risk processinto for thegovernance, organizations strategy overall and planning, management, reporting processes, policies, values and culture Summary/Key highlights Title and Publication COSO is a joint initiative of give private sector organisations dedicated to providing thought leadership through the development of frameworks and guidance on enterprise risk Standards Australia—http://www.standards.org.au/Pages/default.aspx—is a non-government organisation charged by the Commonwealth Government of Australia to meet the country’s Author/Source needs for contemporary, internationallyCouncil, aligned an Standards autonomous and Crown related entity services. operating Standards under New the Zealand—http://www.standards.co.nz/default.htm—is the [New operating Zealand] arm Standards of Act the 1988. Standards Table Notes: 1 management, internal control and fraudInstitute deterrence. of The Certified supporting public organisationsto are: accountants sponsor The (AICPA), the institute Financial of [US] ExecutivesGeneral Internal National International Auditors Commission Counsel, (FEI), (IIA), on the and Paine Fraudulent AmericanCurrently, the Financial Accounting Webber the Institute Reporting. Association COSO Incorporated of (AAA), The Chairman the Management first and is American Accountants chairman2 a David of (IMA). Landsittel. the former COSO National was Commissioner Commission originally was of formed James in the C. 1985 Treadway, U.S. Jr., Executive Securities Vice and President and Exchange Commission. Hence, the popular name “Treadway Commission”. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 793 Status Voluntary Code Application German industry representatives Observations: Not a banking codesignatories as include such, Deutsche although Bank,and Allianz HSBC Trinkhaus & Unicredit Burkhardt AG and The Wittenberg Center foran Global independent, Ethics international is and interdenominational initiative of individuals and organizations from government, business, academia, churches andsociety. civil The founders (formerMinister Foreign Hans-Dietrich Genscher, and retired UN Ambassador Andrewformulated Young) the basic ideathe of fall the of centre 1998. in Status, indicative application andobservations further (where appropriate) — — — — Requires competition that is(profit fairs may not bedamaging made third by parties) Is based on meritperformance (recognition must that be rewarded,demand the for other waysis of increasing, working the roleproviding of for business the in welfarethe state role and business playsin-house in training offering and related opportunities) Takes place globally (soreliable fair rules and are neededthat “to all ensure people [acrossmarkets] global gain an advantage”) Must be sustainable (“iean passing intact on ecological, socialeconomic and fabric to future generations”) Table 3 The Code of Responsible Conduct establishes verifiable standards which are supposed to become anparticipating integral companies’ part organizational ofculture the The code is motivatedfrom by a a social concern perspective,has that, the limited larger confidence public inentrepreneurs that and actions managers of Signatories to the codeestablish commit the to code withinThe their codes firms principles statemust that serve business the goodthis: of the people— and that — — — Summary/Key highlights — — — — OTHER ETHICAL CODES/STANDARDS OF POTENTIAL INTEREST Title and Publication Code of Responsible Conduct for Business (Nov 2010) http://www.wittenberg- zentrum.de/ download/120604_leitbild-eng_ Unterschriften_o.pdf (English version of the code) Author/Source Wittenberg Centre for Global ethics (http://www.wittenberg-zentrum.de/ html/en/529.htm) cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 794 Parliamentary Commission on Banking Standards: Evidence Status Research Scope Swiss and international organisations, academics Status Best Practice Advice Scope Firms in the UK and internationally Observations The Institute was foundedto in advance 1986 public and educationethics aims in and business related subjectsreference with to particular the studyethical and standards application in of theconduct management of and industry andin business the generally United Kingdom and elsewhere Status, indicative application andobservations further (where appropriate) — — — — — Demands responsible conduct by decision makers (ie [decision markers] are reliable andpromises keep which means keepingthe to rules, pursuing any infringements of the rules,new demand rules when theseand are participate absent in thethese drawing rules) up — The Institute for Business Ethics (IWE) was founded in 1989 and is an internationally known centre focusingresearch on and teaching inbusiness the ethics ﬁeld of It aims to offer a holistic view on corporate responsibility, including the political role of business,and business strategies, models as wellresponsible as consumers the and role civic of The duties. document sets out to provide a practical and comprehensive guide to producing, implementing and maintaining an effective code ofAdditionally business the ethics. Institute has published a wide range of othertopics publications on ethical Summary/Key highlights — — — — Title and Publication Various publications Developing a Code of business ethics: A guide to best practice (2003) Author/Source University of St Gallen, Institute for Business ethic http://www.iwe.unisg.ch/en/Ueber+uns/ IWE-Geschichte.aspx Institute of Business Ethics http://www.ibe.org.uk/userﬁles/ developingsumm.pdf cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 795

Letter from Andrew Haldane, Executive Director, Bank of England Thank you for your letter of 19 November about central counterparties (CCPs). You asked for the Bank’s views on the following questions: 1. What conduct and prudential concerns do CCPs present to the financial system? 2. How might the increasing use of CCPs affect innovation, the location of financial activity, and banking standards? 3. What remedies are there for these issues? In what follows, we have focused chiefly on prudential issues as these will form the core of the Bank’s new responsibilities for the supervision of CCPs next year. This picks up the points raised by Baroness Kramer in questions during my hearing. We also suggest some places in which the Commission support could be important in helping strengthen CCP resilience. As background, it is already clear that the landscape for CCPs has changed fundamentally and is set to change further in the period ahead. The G20 commitment in 2009 means that, in the near future, all standardised OTC derivatives will be centrally cleared. So too, prospectively, might an increasing range of non-derivative products. That will result in CCPs becoming an ever-more important node in the international financial network. The key challenge will be to ensure risk management, at the level of individual CCPs and across the system as a whole, adapts itself to this new financial landscape. Otherwise we will have simply created a new, and potentially even more virulent, strain of the “too big to fail” problem. So what is being done to avert this outcome? Conceptually, it is possible to think of CCP risk management operating along three key dimensions: — risk management ahead of stress; — recovery plans during stress; and — resolution by the authorities if both of the first two prove inadequate. All three dimensions are captured in the new international Principles for Financial Market Infrastructures (PFMIs), issued by the Basel Committee on Payments and Settlement Systems (CPSS) and the International Organisation of Securities Commissions (IOSCO) earlier this year. These standards are embodied in the European Market Infrastructure Regulation (EMIR) which takes effect at the start of next year. The Bank will apply the PFMIs, acting under EMIR, when it assumes responsibility for supervising CCPs next year.

Risk Management The first line of defence for a CCP is risk management. At a CCP, unlike a bank, this takes three forms— there is a “waterfall” of protection against potential losses. First in the waterfall are margins payments by clearing members to the CCP against cleared trades, both initial and variation margin. Second, there is a paid- up CCP default fund financed by clearing members. And third, there is the capital of the CCP. As Baroness Kramer noted, the capital of CCPs is generally small in relation to the volume of transactions that they clear. That is because the prime protection that CCPs maintain against member default are the other elements of the waterfall—the margin and default fund contributions. Generally, these are many times greater than CCP capital. The new PFMIs strengthen official policy in relation to CCPs’ margin and default fund contributions. At the same time, new regulatory requirements proposed by the European Banking Authority have also increased the amount of capital that EU CCPs will have to hold in future. A number of infrastructure groups have since announced plans to raise more capital. Taken together, this means that all three elements of the CCP risk management waterfall have been substantially strengthened over the past year. This is recognition of their increased systemic role. Unlike banks, CCPs do not engage in maturity-transformation—borrowing short and lending long. Instead they run an entirely matched book. So in ordinary circumstances CCPs should not face significant liquidity risk. But if a large clearing member were to default, the CCP’s book becomes unmatched. The liquidity demands on a CCP could then be very large, particularly in physically-settled markets such as repo. The first line-of-defence here, as with counterparty credit risk, is the resources that CCPs themselves maintain. International standards have been tightened here too, ensuring CCPs resources are held in a sufficiently liquid form. But to backstop these arrangements, a group of major central banks, including the Bank of England, announced earlier this year that they were “working on how they could ensure that there are no technical obstacles impeding them from providing liquidity assistance to a CCP that is fundamentally sound but faces a shortage of liquidity at very short notice”.16 Baroness Kramer observed that a particular challenge arises in the case of CCPs that operate cross-currency. There are good economic reasons for CCPs operating on a cross-currency, cross-border basis, as this delivers 16 Financial Stability Board, OTC derivatives market reforms: third progress report on implementation, June 2012, Statement of the BIS Economic Consultative Committee page 48: http://www.financialstabilityboard.org/publications/r_120615.pdf cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 796 Parliamentary Commission on Banking Standards: Evidence

netting benefits. Reflecting that, the Financial Stability Board (FSB) earlier this year identified effective international cooperative oversight arrangements, and appropriate liquidity arrangements for CCPs in the currencies in which they clear, among its “four safeguards” for a global framework for central clearing.17 The Bank is working to ensure these four safeguards are in place for UK-operating CCPs. There will be many authorities internationally with a legitimate interest in the UK’s CCPs, including the regulators of the markets they clear, the prudential supervisors of their clearing members and the central banks of the currencies in which they operate. Once the Bank takes on responsibility for the supervision of UK CCPs next year, it will aim to deliver a sea-change in cooperative oversight with these other authorities, to ensure the resilience of globally operating CCPs with a home in the UK.

Recovery As Baroness Kramer rightly pointed out, even if risk management standards for margin and default funds are high and rising, it is impossible to rule out tail events which could exhaust these resources. Indeed, it would be imprudent not to plan for dealing with such events, given the importance of ensuring continuity of CCP services. CCPs are in many respects a set of rules that determine how any loss will be allocated between members in the event of one or more of them defaulting. Except for some products, CCP rules only cover losses up to the point at which the default fund is exhausted. But in principle CCP’s rulebooks could be enhanced to cover a loss from member default of any size, with the gap allocated amongst the surviving members in a way that kept the CCP solvent and able to continue clearing. For more than a year now, the FSA and the Bank have been pressing UK CCPs to introduce rules that do precisely this. Usefully, the new international PFMIs now require it.18 Domestically, the Bank’s Financial Policy Committee has supported this work.19 These rules are now starting to be introduced, albeit not yet comprehensively, among UK CCPs. Work is also commencing among other major global CCPs. There is more inevitably to do in this area given the recent introduction of the PFMIs. To reinforce this effort, the government recently announced that it will consult on changes to the rule-making (so-called Recognition Requirements) for UK CCPs. In future, if these changes are passed, having loss- allocation rules will be mandatory for UK CCPs.20 That would be a signiﬁcant step forward. Having the Commission support such efforts would be powerful and important.

Resolution Even with such loss-allocation rules in place, we cannot be certain that they will necessarily always succeed in their objectives—or at least not without consequences that could be undesirable to systemic stability, such as the cancellation of large volumes of transactions or contagion between loss-bearing member ﬁrms. In order to reduce the potential impact of such outcomes, the authorities need backstop powers in respect of CCPs. The FSB’s requirements for resolution regimes apply to CCPs21 and CPSS-IOSCO have also consulted this year on what those requirements mean for CCPs.22 As you may know, legislation to grant those powers is currently proceeding through Parliament. One issue we face there is that EU legislation introduced before resolution regimes were contemplated, notably the Financial Collateral Arrangements Directive (FCAD), would conﬂict with the ability of a resolution authority to write-down members’ collateralised claims. This prevents the resolution authority from being able to assure continuity of CCPs services in a situation of extreme stress. The support of the Commission in removing this impediment, in circumstances where stability is at stake, would be extremely valuable. If all of these changes were to be implemented, which will by itself be a major challenge, they would deal with many of the more obvious sources of CCP stress. We would have, in effect, capital, liquidity, recovery and resolution plans for CCPs. But even these rules will then need to be kept under review. As capital markets evolve and adapt to the new centrally-cleared environment, so too will CCP risk management tools.

Conduct Questions of conduct are principally for FCA, but some dimensions are common across prudential and conduct authorities. The role of CCPs is not in general to initiate transactions, but rather to concentrate the risk-management of such transactions. That tends to limit the extent to which pure conduct of business issues arise at CCPs. Nonetheless, it is clearly important that CCPs’ rules on membership (“access”) and its fee 17 Financial Stability Board, OTC derivatives market reforms: third progress report on implementation, June 2012, page 3. 18 CPSS-IOSCO, Principles for ﬁnancial market infrastructures April 2012, page 37: http://www.bis.org/publ/cpss101a.pdf 19 Financial Stability Report, December 2011, pp20–21 and 52–53: http://www.bankofengland.co.uk/publications/Documents/fsr/ 2011/fsrfull1112.pdf 20 Financial sector resolution: summary of responses, October 2012, paragraphs 1.7 and 2.25: http://www.hm-treasury.gov.uk/d/ condoc_ﬁnancial_sector_resolution_broadening_regime_responses.pdf 21 FSB Key Attributes of Effective Resolution Regimes for Financial Institutions, November 2011 22 CPSS-IOSCO Consultative Paper on Recovery and Resolution of Financial Market Infrastructure, July 2012 cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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schedule are clear and reasonable, particularly once central clearing of some products is mandatory. The PFMIs will require that. Many CCP issues have both a prudential and conduct dimension. Access is one example, since a CCP’s assessment of the creditworthiness of potential clearing members is a critical risk control. Disclosure is another. We believe that CCPs should routinely disclose more information about their risk policies and models so that their participants are better informed about the CCP’s approach. This is especially important if in future those participants will bear the consequences of inadequate CCP risk management. Another issue spanning conduct and prudential issues is the segregation of client assets. This was a problem in the cases of the failure of Lehman Brothers and MF Global. The FSA are undertaking a review of the UK client assets regime; at international level, they are being reviewed in a regulatory context by IOSCO and by FSB in a resolution context. It will be important to ensure that it is perceived as being at least as robust as client asset regmes in other international ﬁnancial centres if business is not to migrate abroad. Currently, that is not always the perception. Mandatory central clearing will require more market participants to use CCPs, many of them end-users such as funds which are unlikely to join as direct members. For indirect participants, two important beneﬁts of central clearing are the potential for transferring (“porting”) positions to another clearing member if their own should default and for protecting the collateral supporting the client’s positions. EMIR requires that CCPs offer individual clients segregation arrangements.

Innovation, Locationof Financial Activityand Banking Standards As we saw during the financial crisis, OTC derivatives can become a source of systemic risk. It was for that reason the G20 mandated clearing of “standardised” OTC derivatives. This ought to strengthen efforts to standardise financial products in ways which support financial innovation while curbing bad outcomes—for example, the creation of non-standardised, overly complex, structured products, which proliferated ahead of the crisis. Central clearing does not of course prevent non-standardised products emerging. But those non-standard transactions will in future attract higher capital charges and will be subject to collateral requirements. While international work in BCBS/IOSCO is continuing, this work programme is likely to create stronger incentives for central clearing, and hence for standardisation, of financial instruments. All of these efforts rather put the onus on regulators to ensure that regulatory requirements of CCPs are calibrated broadly correctly and are directed at those institutions and instruments which bring the greatest systemic risk. That work is underway, with exemptions for institutions and instruments deemed not to generate systemic risk—for example, some non-financial companies and pension funds. Even once complete reform is complete, it will be important to review the impact of these regulatory measures as they take effect. Inevitably given such comprehensive reform, there will be some unintended consequences and places where regulation may have under or overshot. For what it is worth, so far there is little evidence that the derivatives market is being stifled by these efforts, with outstanding notional volumes of interest rate swaps and FX derivatives, the two largest categories, larger now than at end-2007.23 But it is early to judge. Regarding the location of financial activity, there will be countervailing forces at work. Much of the risk benefit of central clearing is achieved through the process of multilateral netting. These benefits are greater the more of a market is cleared through a given CCP. So the economics of central clearing will tend towards a concentration of activity in a small number of CCPs. Currently, CCPs operating cross-border on a large scale tend to be based in the major international financial centres, including London. Working against this is the preference of some market participants to transact through a locally-based CCP. This may reflect factors such as a desire to operate under the local legal framework, notably local bankruptcy and client asset protection arrangements, or simply familiarity and operational convenience. In a few jurisdictions, regulators have established “location requirements” in respect of clearing.24 The intention of the PFMIs, and the FSB’s “four safeguards”, are to provide as far as possible a level international playing field. It would be tremendously dangerous if CCPs were to begin competing for international business by trimming on their risk management requirements. This was the fatal path banking followed and we all know how that ended. That makes implementation of the PFMIs, alongside arms-length reviews of countries’ compliance with these standards, crucial in avoiding a race to the bottom. It is too early to say how fast this race will be run, but early signs are not uniformly encouraging. Finally, you asked about the impact of the increasing use of CCPs on banking standards. One intention of the reforms to central clearing are to improve transparency and standardisation in cleared markets. If successful, that would tend to reduce a little the scope for mis-selling, rent-seeking and other inappropriate forms of banking behaviour. 23 BIS, OTC derivatives statistics at end-June 2012: http://www.bis.org/publ/otc_hy1211.htm 24 Financial Stability Board, OTC derivatives market reforms: fourth progress report on implementation, October 2012, table 7, page 92: cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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There is a massive agenda of work, internationally and domestically, not all of which I have done justice to here. We are very aware that the systemic stakes are high. Over the course of the next few years, we will be trying to prevent this becoming the most likely source of the next systemic crisis. 28 November 2012

Written evidence from Graham Nicholson, Chief Legal Adviser and Adviser to the Governor, Bank of England In my evidence to the Parliamentary Commission on Banking Standards on 29 January, I offered to revert to you on the whistle-blowing arrangements being planned for the Prudential Regulation Authority. We recognise that whistle-blowing can be a valuable source of intelligence for a regulator. The PRA will maintain its own confidential line for whistle-blowers. Information from callers, but not the source, will be shared with the lead supervisor of the relevant firm. The PRA will be a “prescribed body” under the Public Interest Disclosure Act (PIDA) and so those who blow the whistle on their employers may benefit from statutory protections when speaking to the PRA about their employer. This confidential line could also be used by a firm or its employees to raise concerns regarding another firm, although it may well be the case that sensitivities about confidentiality may be less relevant in such a case so that other channels of communication may be used. I understand from the FSA that only a small minority of correspondence (calls, emails and letters) received by the FSA, and which may be regarded as “whistle-blowing” in the broadest sense, would be relevant to the PRA and its responsibilities. We cannot expect whistle-blowers necessarily to identify the appropriate regulator to whom they should address their concerns and therefore we will have arrangements in place for the FCA to pass over information and contacts that are relevant to the PRA (and vice versa). At least initially, we expect that the majority of correspondence and calls relevant to the PRA will go to the FCA, so the PRA will indirectly benefit from calls to the FCA confidential line. There will also be instances where, following further investigation by the FCA, an issue may be indentified as having implications for prudential supervision where this was not apparent at the outset. In such cases we would expect the FCA to inform the PRA in accordance with arrangements for sharing information made under the Memorandum of Understanding between the two regulators (and as required by the Act). More broadly, the PRA will review intelligence about firms and individuals that may be relevant to its responsibilities as a prudential supervisor received via other channels including interaction with firms and from the FCA. The PRA will also pass intelligence it has received to the FCA where relevant. If I may, I would also like to take the opportunity to amplify my response to Lord McFall’s question (Q3048) about the potential for “underlap” between the two regulators in enforcement cases. As I indicated in my reply, there will be cases where both regulators decide to take action—where they will act jointly and ensure cooperation between them—and there will be cases where only one regulator decides to take action. Each regulator will make its own decision, on a case by case basis, by reference to its own statutory objectives, its assessment of the strength of the case against the firm or individual concerned and its priorities. There will be cases that have a bearing on “safety and soundness” of an institution and the competence or integrity of its senior management which the PRA will be keen to pursue, but which may not give rise to issues of concern to the FCA; the PRA would pursue such cases on its own. The PRA will have its own enforcement capability to enable it to act on its own where this is necessary, drawing on external expertise as required. There will be cases relating to conduct which are clearly for the FCA to pursue and which to not raise issues for the PRA; the FCA will pursue these cases on its own. And there will be cases which concern both regulators where they will act jointly. 13 February 2013

Written evidence from Barclays 1. Introduction 1.1. The industry has much work to do to restore trust with customers, shareholders, and the general public. Banks have undergone signiﬁcant reform since the beginning of the credit crisis, but in certain areas, further change is required. 1.2. Barclays welcomes the establishment of the Parliamentary Commission on Banking Standards and looks forward to engaging with it constructively. 1.3. We note that the Commission intends to report on: a) professional standards and culture in the UK banking sector; and, b) lessons to be learned across a range of areas. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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1.4. With this in mind, we have constructed this response to address the key issues set out in the initial questions as part of the Commission’s Call for Evidence. We provide information on the origins of the current crisis, followed by consideration of what has changed, and what still needs to change. 1.5. The document is therefore structured as follows: — Section 2 largely follows the opening questions in the Call for Evidence and aims to address: why professional standards are perceived to have been absent or defective; the experience and impact on the customer; and the causes of the breakdown in trust. — Section 3 focuses on changes already made, underway or proposed, addressing question 6 in the Call for Evidence. — Section 4 sets out proposals for further reform as requested in question 5 in the Call for Evidence. We believe that the Commission can make a signiﬁcant contribution by proposing reforms on this basis.

2. The UK BankingIndustry Historical context: crisis and change 2.1. To address the Commission’s first question on the extent to which standards in UK banking are either absent or defective, it is important to consider the historical circumstances which inform the current position. 2.2. The economy today is fundamentally different to that of 50 years ago and banking has had to adapt during that period at considerable pace. 2.3. The economy went from being local to global, requiring huge changes in the way in which banks conduct their business and in the capabilities and competence of their staff and leadership. The “Big Bang” of 1986 was not simply about deregulation. It included the professionalisation, computerisation, and globalisation of financial markets that enabled the City of London to earn its status as a primary global financial hub. 2.4. Today, 55% of financial assets managed in the UK are international, compared with 22% in New York. 2.5. The UK has been able to benefit from the private and public sector revenues of this international trade, which has created one of the country’s most significant net exporters with bases across the UK, including Edinburgh, Leeds and Birmingham. 2.6. With the benefit of hindsight, these advantages were delivered alongside systemic flaws which would have a lasting impact. Regulatory oversight and the risk management of some banks proved insufficient to cope with a major collapse in market confidence; and, the taxpayer was exposed to the risk of systemic bank failure. 2.7. As has been analysed in detail by a range of informed commentators, the credit crisis included a catastrophic failure in markets following the build-up, over many years, of unsustainable credit flows at a personal, institutional, and state level, and a fundamental restructuring of the shape of the global economy. 2.8. The credit crisis demonstrated that industry risk management, in some cases, and regulation of the industry in some jurisdictions, had not adapted and kept sufficient pace with the new global order. It was unable to recognise and address the spread of systemic risk across borders and at speed. 2.9. Not all banks required taxpayer rescue during the last crisis. But there is no doubt that the aggregate impact on the economy has been widespread and indiscriminate. Despite significant distinctions in the way different banks fared through the credit crisis, the public’s verdict was clear: banks made mistakes and taxpayers have paid the price. 2.10. The credit crisis exposed the need for significant reform. Much change has already taken place, or is underway, in the way in which banks are governed and regulated. In Appendix B, we provide an outline of change that has occurred or is underway in case it is of use for the Commission. However, broadly the challenge of delivering a safe, sustainable and effective banking sector has two major aspects: — First, banks must be resilient, in order to greatly reduce the probability of failure in the event of a future crisis. Significant reform has already been undertaken in this area: banks are considerably better capitalised; they hold much bigger, and higher quality, liquidity buffers; have reduced leverage ratios; supervision and prudential regulation is being strengthened (with the UK playing a lead role in international negotiations as well as through unilateral action); and the wholesale markets in which banks operate are becoming more transparent and better regulated. The result is that banks are much less likely to fail than they were pre-crisis. Further reforms are still in the process of being finalised and implemented that will make that likelihood even lower. — Second, banks must be resolvable, so that in the event that they do fail, they can do so without recourse to taxpayer funds and with minimal systemic impact. An end to “too-big-to-fail” will only be achieved when banks are truly resolvable. Whilst there is still some way to go, a combination of the Independent Commission on Banking’s recommendations in the Banking Reform Bill, alongside the European Recovery and Resolution Directive proposals, and steps some banks have been taking themselves through work with the international colleges of local regulators to develop recovery and resolution plans, will mean that resolvability will, and must, be achieved in the near future. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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2.11. Measures to improve resilience and resolvability are clearly vital to ensure that any future crisis does not impact the domestic and global economy. 2.12. It is also clear, however, that public trust in banks has not eroded as a result of the credit crisis alone. A number of additional factors, ranging from mis-selling issues to concerns about transparency in the way some products have been sold, have further undermined trust. 2.13. Customers have been let down, and that must not happen again. 2.14. Additional reforms required to address many of these issues are underway, including changes to the nature of regulation in the UK through the creation of the Financial Conduct Authority (FCA) and its more assertive approach to the regulation of conduct matters. We hope Parliament will continue to monitor the effectiveness of these new structures as they evolve. 2.15. However, the Commission is rightly asking whether or not these in-ﬂight, planned, and expected reforms are sufﬁcient to address the underlying issues.

Consumer Experience and Impact 2.16. Customer demands have changed materially in the last decades. The percentage of customers in Great Britain with a current account has gone from 75% in 1992 to 97% in 2012, with the vast majority of the population banked.25 2.17. Access to banking services is now 24/7 with phone, internet, and mobile banking all advancing significantly. Call centres and internet banking represent a leap forward and a revolution in convenience in retail banking, and UK banks are among the leaders in the world in their provision of these services—both in terms of the pace of their adoption and the quality of the service delivered. UK bank customers in 2012 expect to be able to access cash at ATMs or use their credit and debit cards worldwide. They expect online banking 24/7, and have access to products which are unavailable in many other jurisdictions (eg, offset mortgages). 2.18. Similarly, consumers’ requirements are now far broader and more complex than they were even a few decades ago. For example, as the number of individuals that enjoy the safety of a defined benefit pension has reduced, so the importance of savings has increased. As people are required to take greater care planning for their retirement, a number of different and increasingly complex products are required. Banks and financial services companies have innovated and developed new products to meet these changing customer needs. There remains a significant gap in the market for the provision of these services that will not be filled unless banks and other providers are able to innovate. 2.19. As considered above and as highlighted in Appendix B, there has been considerable reform of banks since the onset of the credit crisis. Whilst there were some obvious flaws in banks’ resilience and resolvability, we do not believe that “principles based” regulation meant that banks had a free hand to do as they pleased pre-crisis. Even before the credit crisis, the banking industry was one of the most heavily regulated sectors subject to complex international agreements (negotiated and monitored by the Basel Committee on Banking Supervision) and detailed local rules (for UK banks, European Directives are enacted into UK law via the FSA Handbook). 2.20. Importantly, the sector has never been regulated on a purely principles based approach. It would be more accurate to think of the system as “principles plus rules”, reflecting the need for regulation to avoid providing a menu of prohibited activities which can be avoided with “clever” legal support. The Commission will be aware that the US had a largely rules based approach, and is broadly recognised as the site of the birth of the credit crisis. 2.21. For business customers and wholesale markets, the increase in complexity has been even more pronounced, largely as a result of the need for clients to operate effectively in highly globalised and specialist markets. Investors’ demand for “alpha”, or risk-adjusted returns, is another reason for increasing complexity in financial services products. 2.22. Additionally, as Lord Turner noted in a recent speech, the UK’s almost unique model where current accounts are offered below cost of production through “free-if-in-credit” banking, may have unintended consequences: “one important barrier to competitive entry into UK personal sector banking is obvious—the fact that the core product, the current account, is usually given away for free, sold at below cost of production. Which means that it may be difficult for a new entrant to make a business plan stack up unless they assume the sale in some future year of high margin ancillary products—products which if we are not careful may be for both the incumbents and the new entrants, the next PPI.” 2.23. Millions of customers benefit from, and value, free-if-in-credit current accounts, and so any move away from the current model will need careful consideration. What is important is that consumers have choice and customers of Barclays can choose from a range of basic, fee paying, specialist (eg, student and youth accounts) or “standard” current accounts. 25 GfK NOP Financial Research Survey (FRS) 12 months ending June 1992/2012, 69,628/59,424 adults interviewed respectively. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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2.24. As banks have innovated to develop products to meet the more complex needs of customers with increasingly sophisticated ﬁnancial requirements, issues have arisen as products, designed to meet the needs of certain customers were sold, in some cases, too broadly.

A Crisis of Trust 2.25. The historical context outlined above is important in understanding where banking stands today in terms of public perception and trust. The credit crisis and some high profile cases have created the perception that banks have adopted inappropriate risk appetites and that product sales, rather than customer service, are the drivers of bank incentive structures. 2.26. Some commentators have suggested that, as well as contributing to this trust deficit, market instability, mis-selling, and other failings are symptoms of fundamental weaknesses in the standards, values, and culture of banking. 2.27. This is a serious suggestion that must give the banking industry pause. It is important that the industry acknowledges and repairs areas where flaws in the norms and standards to which the industry operates have been exposed. 2.28. But to achieve the effective change, it is important to think precisely and clearly about the extent and nature of these flaws, and avoid generalised policy drawn from individual market failures. 2.29. If separate market failures are shown to have their own precipitate causes, they must be dealt with forensically, and separately. These issues are too important to be met by broad brush responses. 2.30. For example, some commentators see recent events as strengthening the argument for a return to Glass- Steagall style full separation of banking services, arguing that the structure of banks was responsible for many of the perceived failings in the sector. Indeed, Glass-Steagall did not protect US banks from a range of failures through the 20th Century and into the 21st. 2.31. In virtually every case, there is no apparent evidence to suggest that structure alone has had any, let alone any material, influence on the failings. Consequently, there is no evidence that splitting banks would have any beneficial impact on the probability of such events occurring again in the future. 2.32. It has also been argued that institutions that are combined are “too-big-to-manage”, however, a wide range of institution types have been involved in the various issues affecting industry trust. Building societies for example were also involved in issues connected with PPI. 2.33. Many have used recent events to reassert calls for reform related to “too-big-to-fail.” However, this issue has been extensively reviewed in the years since the financial crisis, not least by the Independent Commission on Banking. In fact, as has been well documented elsewhere, and was acknowledged by the Commission, universal banks were neither the cause of, nor were they disproportionately affected by, financial instability. 2.34. In fact, universal banking models were materially more likely to have survived the banking crisis than monoline peers. 2.35. However, as stated in paragraph 2.10 above, it is clear that business models must not prevent a bank from being resolvable. This is subject to considerable policy attention from the Banking Reform White Paper in the UK, to the Liikanen group and the Recovery and Resolution Directive in the EU, through to the international work of the Financial Stability Board on this issue. 2.36. There is no evidence that examples of mis-selling and other failings point to some kind of “infection” of retail culture by the presence and proximity of wholesale and investment banking. There have been regrettable issues that have arisen in all parts of banking. 2.37. Cultural differences can and do exist across business lines. Trying to achieve homogeneity is unwelcome, and likely to be unachievable. The outcome must be to create, within any particular organisation and across the industry, a minimum, consistent basis of expected behaviour across the relevant circumstances— be they geographic or business-specific. 2.38. Just as culture in different parts of banking can be different, so too can it evolve and change. Whilst recognising some inevitable differences, firms should ensure that appropriate values prevail and consistency of expected behaviour is achieved to the highest possible degree of frequency. It is partly to ensure this is the case that Barclays has commissioned Anthony Salz to lead an independent review. 2.39. It appears to us that the principal questions for the Commission in this regard relate to defining what that foundation standard should be comprised of, and how best to ensure that it is practiced day-in-and-day- out in particular organisations. 2.40. For both industry and individual institutions, leading by example plays an important part in ensuring a strong expectation of acceptable behaviour is prevalent. Having the right governance and reward structures to reinforce those expectations is equally crucial. Indeed, visibility of these standards may offer a competitive advantage. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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2.41. We believe it is fundamentally important that banks—as with all organisations—demonstrate through what they do and how they manage their operations the positive impact that they have on society. It is vital for employees to understand and feel proud of that contribution as part of reinforcing the principal purpose and objective of the organisation.

3. Reformingthe Industry: Maintaining Momentum on Change Underway

3.1. There are already signs of change in the way in which some banks operate: — For example, past mis-selling in PPI and Interest Rates Swaps is being dealt with through a comprehensive programme of redress. Barclays is committed to compensating customers, where mis-selling is proven to have occurred, and to identifying other instances where this may have taken place. — The vigour with which Barclays responded to and cooperated with the authorities when the problems with LIBOR emerged are a better signal of Barclays culture today than the, now historic, incidents that arose in the first place. In particular, Barclays has: — cooperated to an “extraordinary” degree with the investigating authorities and was the first institution to settle; — independently undertaken significant legal investigation, spending over £100 million and reviewing 22 million documents to ensure we rooted out the inappropriate conduct; — vigorously and thoroughly conducted a review of employee conduct including taking appropriate disciplinary action; — established strengthened systems and controls around rate submissions; and — established an independent review of our business practices led by Anthony Salz. — Changes in approach and incentives for our customer-facing retail staff: — We have been evolving our pay structures over recent years so that today, of our front line staff’s incentive pay, over half is based on customer satisfaction. — Our retail incentives are structured so that the value of any product has no impact on the level of reward received, so for example there is no incentive to turn a £5,000 loan into a £10,000 one. — There are strict rules in the incentives plans concerning sales practice and conduct. For example, if a colleague is found to have mis-sold a product, they will lose all incentive payments for the performance period. — We regularly review our incentive plans, which are subject to robust governance oversight to make sure they are operating appropriately. — Barclays has taken significant steps to re-focus on our customers. We have invested in branches and developed new, innovative products aimed at increasing customer convenience. We are ranked first in the UK for customer service amongst high street banks (JD Power UK Retail), and currently have record 80% customer satisfaction for Barclaycard in the UK and ranked 1st in the US (JD Power UK Retail). — The structure of Barclays remuneration policy, more generally, has undergone significant reform since the beginning of the credit crisis. This includes enhancements in the alignment between remuneration and risk. For senior roles, a significant proportion of variable remuneration is delivered in the form of deferred bonuses and long term incentive awards, which help ensure sustained performance over the longer term.

3.2. This action is the least that our stakeholders expect. Changes made so far, within individual banks and at an industry and regulatory level, have been signiﬁcant and wide-ranging. However, we believe that there remain areas where coordinated action by industry and policy makers would be welcome.

3.3. One way in which banks ensure that there is an outlet for employees to raise concerns, and where they do not feel able to do so via line management, is whistle blowing. Whistle blowing arrangements have operated for many years and are frequently subject to internal and external audit. Barclays policy on whistle blowing allows all employees to report concerns in good faith without fear of reprisal or any other detrimental or discriminatory action taken against them, and provides the means, including dedicated hotlines, for this to happen.

3.4. But there are always improvements that can be made to this type of process. Barclays is presently reviewing its whistle blowing arrangements, including whether outsourcing the operation of the Whistle blowing hotline would improve its effectiveness and the number and quality of concerns that employees raise. Evidence demonstrating that employees are deterred from raising concerns because the hotline is operated internally is hard to come by. What is more important is ensuring an environment and culture that is intolerant of unethical practices, so that any issues are escalated immediately. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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4. Specific Recommendations: an“Action Plan” for the Industry Regulatory reform: a final hurdle 4.1. Much change has been secured since the credit crisis and there are significant reforms underway. There are many within the industry, working alongside the authorities, that are focused on enabling this change, especially those changes required to eradicate “too big to fail.” The challenge will then be for industry to prove to supervisors and the markets that resolution is a reality and for sovereign states to communicate clearly that taxpayer finances will not be needed—and will not be provided—again.

Cultureand Behaviour: Professional Code of Conduct 4.2. Within any large organisation, there is a risk that individuals will take inappropriate decisions. Safeguards and structures must be put in place to minimise the risk of this happening whist at the same time maximising the likelihood of early detection, corrective action and deterrent. 4.3. We believe that a major step that could be taken to improve professional standards in banking would be to make it literally more “professional.” 4.4. In Appendix A we propose a signiﬁcant new approach—a professional code of conduct that could be set within the framework of a new Chartered Institute of Bankers and Register of Approved Bankers.

A code of conduct 4.5. We need to ensure that the high professional standards that the vast majority of bank employees adhere to are followed by all employees. This could be done through the development of a more rigorously enforced code of conduct for banks backed up by a register of banking professionals. 4.6. The “Code of Conduct” and the “Register” could be operated in full cooperation with the FCA and, where necessary, building on and broadening the FSA/FCA’s existing authorisation programmes which include the Approved Persons Regime, Significant Influence Function process, and requirements for front line staff to be appropriately trained and monitored. Where existing authorisation focuses on a particular specialism or senior executives, we see scope for the development of a far broader framework. We would welcome further consideration as to whether this could be achieved through the extension of current FSA schemes; the scope and scale of change required would probably be material and extensive. 4.7. Barclays staff who provide products to retail customers are currently required to be accredited through our Training and Competence Schemes, which are driven by regulatory requirements and our own standards of best practice. Our regulators require proper procedures for training, competence and monitoring to be in place for these staff, and ask to review the Scheme on a regular basis. 4.8. This principle of membership of an accredited Training and Competence Scheme could be developed to become an aspect of the proposed Register of Bankers. 4.9. We believe therefore that bank employees should be expected to train and qualify for accreditation and registration with a foundation of core banking skills and knowledge and that individuals should be subject to standards for continuing education over time, potentially including annual quota. 4.10. This would have to be supplemented significantly with further training—as is currently the case—so that specialists are appropriately able to carry out their particular functions.

Disciplinary procedures 4.11. The proposals would ensure that any serious misdemeanours by bank employees would be captured by the FCA/or another body and recorded on a register (potentially held by a Chartered Institute of Bankers). Future employers would be able to check the record. There would also need to be the possibility of being “struck off” the register altogether and, therefore, unable to be employed either in certain roles or the industry in general. 4.12. The process of continuous education and training would require individuals to maintain the requisite skills, knowledge, and (importantly) principles to be ofﬁcially accredited to work in the industry and in certain roles.

A new professional body for bankers 4.13. A newly established and independent professional body, with an enhanced foundation of training and accreditation, plus a robust system for detection and correction of misdemeanours would ensure that a high level of professional standards would be required right across the industry. 4.14. Customers would be able to conﬁrm that a person was a member of the Register, as with other professions, and would have recourse to make a complaint to the governing body in the event that they are concerned with the conduct of that person. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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4.15. We hope that this body could evolve into a centre for excellence, best practice and the further development of an informal expectation of conduct and behaviours to complement the new Code of Conduct.

Remuneration 4.16. The structure of remuneration for senior management and for front line staff has fundamentally changed post-crisis. This includes: — Enhancements in the alignment between remuneration and risk. — For senior roles, a significant proportion of variable remuneration is delivered in the form of deferred bonuses and long term incentive awards, including a significant proportion in the form of Barclays shares. — Clawback provisions apply to deferred bonuses and long term incentive awards, which help to ensure sustained performance over the longer term. 4.17. Whilst much has been achieved in the structure of the way banks pay, there is more to do to provide an appropriate balance in distributions between staff and other stakeholders, especially shareholders. We recognise the views of many commentators who believe further progress in bringing down the quantum of pay for banks in general, and for specific roles, is needed. 4.18. That journey will take time but Barclays took important steps in that direction in 2011: — Bonuses for our Executive Directors and eight highest paid senior executive officers were down 48% versus 2010 on a like-for-like basis and were deferred over three years. — Total incentive awards for 2011 were down 26% versus 2010, against 2% reduction in adjusted profit before tax. — Cash bonuses in the investment bank were capped at £65,000. — The proportion of the bonus pool that was deferred significantly exceeded the FSA Remuneration Code’s requirements and is expected to be one of the highest deferral levels globally. Some 75% of the bonus pool in the investment bank was deferred. 4.19. In 2011, as in every year, Barclays judgements on pay were designed to carefully balance overall commercial performance with the need to demonstrate responsibility to shareholders; to be sensitive to the environment; and to remain competitive by retaining the best talent to serve customers. 4.20. We believe those recent steps show a determination to achieve the right balance. However, this must receive an industry-wide focus. 4.21. It is also crucial that the nature of any incentives provided to staff accurately and materially reinforce the appropriate values, especially customer and client focus. 4.22. Staff can, should be, and are trained, encouraged, and incentivised to match the right products for customers’ needs responsibly, transparently, and at the right price. This should be maintained as the economy recovers.

Market Structure 4.23. Banks must focus on customers. The UK banking industry is the envy of the world in the eyes of competitors, but it is clear that many customers and much of the public do not share this view as a result of a fundamental breakdown in trust. 4.24. The industry must take responsibility for addressing this breakdown in trust, both by making sure it behaves in a way that puts the need of customers ﬁrst, within an appropriate risk framework. 4.25. It will take a long time to remediate that gap, but we believe that by demonstrating explicitly that it is focusing on delivering excellent services and products for customers, the industry can restore trust. 4.26. The Committee may wish to consider the implications of Lord Turner’s speech on the charging structure of UK current accounts. Free-if-in-credit banking is popular with customers, but banking is not free and banks must make a return for shareholders. The current model may not offer the best way to reconcile those differences and we would welcome a considered debate on the options for change.

Customer expectations 4.27. In the meantime, there must be sharp focus in the industry on regaining trust through excellent customer service with products that are innovative, respond to customer needs, and are transparently priced. At Barclays, we are focussed on understanding customers’ needs and matching those to the right products and services to make their lives much easier. 4.28. Over the past six months we have delivered a signiﬁcant number of measures designed to do exactly that. The industry leading Barclays Mobile Banking and Barclays Pingit “apps” have revolutionised the payments landscape allowing customers to send and receive money wherever they are; and our new Current Account Features Store also allows customers to choose the products and services they want easily and quickly. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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Almost 90% of Barclays customers are now within 10 miles or less of a branch equipped with a free and instant replacement debit card machine. Barclays will always continue to look for innovative solutions to enhance our customers’ experience. 4.29. Lasting relationships with customers are imperative to our success and so ensuring that all of our customers are presented with product choices that meet their needs and that they can easily understand is better for the customer and for our business in the long term. With this in mind, we are committed to the Government’s “Simple Financial Products” initiative and it is our intention now to lead the industry in reaching the right conclusions for all of our customers. There is still plenty of work to be done in defining, and reaching a consensus on, a consumer segment that simple products are targeted at. It will also be important to ensure that products are commercially viable and guided by industry-wide principles and consistent definitions that allow room to differentiate in the interests of the consumer and competition. Barclays looks forward to working closely both with the Sergeant Review team and Government over the coming months to turn the interim report into tangible outcomes for consumers. 4.30. Banks have a clear role in providing credit, particularly to individuals and small and medium sized businesses. However, financial markets have changed considerably in the last few decades. Financial innovation has allowed wider access to financial markets and diversification of funding sources. Investment banks have played a key role as intermediaries, channelling and allocating resources to support business growth. 4.31. Unlike in the US, where only 10% of US corporate borrowing is accessed via banks, access to funding through capital markets by European businesses is still in its infancy, with 70% of them financing themselves with debt. As the EU banking sector continues to deleverage, it remains important that alternative sources to funding are available for businesses. In this context it is important that the new regulatory regime provides an appropriate framework that does not hinder the ability of corporates to seek finance. 4.32. Whilst the needs are more complex than for retail customers and small businesses, banks must equally compete to provide an excellent service to corporate clients, providing the products, infrastructure and support network that clients need across all our business segments. As an example, the Barclays Investment Bank e- commerce platform, BARX, is a leading global provider of electronic transaction solutions for institutional investors, financial institutions and corporations. 4.33. Platforms such as BARX continually evolve to target client needs as we develop new services to ensure that clients are able to adapt to regulatory changes (eg, providing Central Clearing services). 4.34. However, the light that has recently been shed on past failings in the industry has illustrated the need for renewed efforts to ensure market integrity, in particular for end users. Barclays Investment Bank is undertaking a wide ranging internal review which will support the work being undertaken by Anthony Salz and will include a review of all business lines and our business conduct.

5. Conclusion 5.1. While important aspects of the changes highlighted here have already taken place, or are underway, we need to accelerate the pace of change and go further so that the UK can have an internationally recognised, robust and professional banking industry.

APPENDIX A: PROPOSAL FOR A CHARTERED INSTITUTE OF BANKERS AND A REGISTER OF APPROVED BANKERS A.1. Barclays would welcome serious consideration by the Commission of a single “Chartered Institute of Bankers” to promote and develop professional standards across the industry, and to administer a new professional register which all staff who work within certain functions are required to sign, and from which they can be “struck off” in the event that they fail to maintain the required standards. A.2. The current framework with the FSA, such as the Approved Persons Regime or the Training and Competence Regime, may well form a useful foundation, that could be strengthened and broadened. A.3 We believe that this approach would address four deeply significant areas: — First, it would provide a formal central UK register of bankers, providing certainty and confidence to customers that they are being served by qualified and trustworthy professionals who are bound by a code of conduct and are individually “licensed.” — Second, it would provide an enhanced process and means for the FCA, working with the Institute, to identify and discipline staff who fail to live up to the high standards customers expect. The combined efforts of the FCA and the register could ensure that staff guilty of serious malpractice could not continue to operate in the UK. — Third, the Institute could provide in parallel a forum for developing cultural renewal and the restoration of trust and confidence across the industry. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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— Fourth, the Institute could become the sole basis for the development of targeted professional qualifications for banking activities consolidating, or working with, the existing professional bodies (eg, CISI, CFA, Chartered Banker Institute) to develop industry wide technical qualifications as well as standards for ethics, behaviour and leadership. We would prefer a single—and more transparent— source for such standards and a broader framework than the current FSA Approved Persons Regime. A.4. In detail—the challenge Modern banking is characterised by considerable complexity, with highly qualified professionals undertaking specialised and diverse roles. This diversity and specialisation means that a single specific technical banking qualification could not offer banks’ stakeholders the necessary confidence—it would simply not be good enough. For example, being a highly qualified small business relationship manager would require a set of very different skills and expertise from an investment banker (and even within that broad base, a trader will require different skills and expertise than an advisor), or a trader in government bonds. The trend towards fragmenting technical specialism has been under way in both retail and wholesale banks for many decades, and is a prime driver in why traditional “banking exams” are no longer treated as a requisite in retail banking. As a result, a bewildering array of separate qualifications and associated professional bodies has evolved, each providing aspects of an individual “licence to operate” and in some cases with sophisticated codes of practice and the ability to suspend or discipline errant members. A.5. However, there are clearly fundamental standards of behaviour alongside some foundations of financial knowledge which underpin all aspects of banking—retail and wholesale—alongside the need to be properly skilled to undertake each specific role. Recent attempts to codify common standards across the industry (notably via the Chartered Banker: Professional Standards Board for the UK, of which Barclays is a founding member), are in their infancy, but it could form the basis for a new movement. Whether or not that is possible requires a much clearer articulation of the standards to which such a body must adhere. A.6. We believe, therefore, that the industry requires a code of conduct formalising these standards, with proper disciplinary procedures underpinning it, both within each bank and across banking as an industry. Similar professional safeguards exist in many other industries and professional fields, providing assurance and suitable barriers to entry for unqualified or unsuitable staff. A.7. In detail—proposal for the Commission Barclays asks the Commission to consider recommending the establishment of a new Chartered Institute of Bankers and the establishment of a register of approved bankers and roles. This could be housed within an existing body, but it must be clear what is required of that body to meet the expectations of the Commission. A.8. We believe that this body should take the following form: — It should be funded by industry subscription, but be governed with full charitable status to guarantee its independence and transparency. — Its role must not include advocacy on behalf of the industry. — It should propose and manage a set of Rules and Standards required of professionals generally and in specific roles within banks in conjunction with the FCA. The Rules and Standards should require professionals to meet serious criteria for knowledge, skills and conduct as well as demonstrating appropriate skill to undertake their specific role and to maintain those standards over time through continuous learning initiatives and quotas. — It should operate a Register of Approved Bankers and Roles, which is reinforced by a disciplinary process. If a professional is found by the FCA or any other regulatory body to have failed to meet the Rules and Standards, they should be subject to appropriate disciplinary procedures, which should include being removed from the list and therefore prevented from undertaking such a role in the future at any UK bank. The register should be made available to the public in a similar manner to other professions. — It should have a responsibility to make available to the Regulator at regular intervals data about complaints against individuals and vice versa. In the event that disciplinary action is taken against a professional, the Regulator should be informed and given the opportunity to comment. Where appropriate, processes should allow complaints and issues to be managed across multiple bodies simultaneously (eg, where a banker has transgressed rules of another professional body such as CISI). — It should take a lead in developing industry standards for learning and leadership development across the industry, working with the existing training providers and specialist professional accreditation bodies. — It should provide a forum with a view to further developing best practice, ideas and standards to improve the banking profession. By providing such a forum, Barclays hopes that an enhanced sense of professional pride in the ethical, professional and fiduciary responsibilities inherent in banking will be achieved. The body could also help drive the “right kinds of innovation” commensurate with the public interest. A.9. We invite the Commission to consider these suggestions. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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APPENDIX B:

REGULATORY DEVELOPMENTS SINCE THE CRISIS

B.1. Banks remain subject to unprecedented regulatory change following the ﬁnancial crisis and subsequent regulatory failings. Banks also continue to experience the effects of the new intensive and intrusive approach to supervision.

B.2. There are major changes in prospect in relation to business conduct that banks will be required to implement alongside the prudential reforms set out below. These include the revision of the MIFID and Market Abuse Directives, further consumer focused EU legislation and, within the UK, the implementation of product intervention, the Retail Distribution Review and the Mortgage Market Review.

B.3. Key prudential reforms include:

— International Regulatory Structure: the global regulatory infrastructure has been renewed and energised, with the Financial Stability Board given responsibility for delivering the G20 regulatory reform programme and acquiring an oversight role over global standards setters, over the quality of implementation of global standards through peer review. The FSB has notably developed Principles for sound practices in relation to remuneration, systemically signiﬁcant ﬁnancial institutions, and the recovery and resolution of failed institutions. The Basel Committee on Banking Supervision and the International Organisation of Securities Commissions and other global standard setters have also been reformed.

— European Regulatory Structure: the EU has established three sector focused supervisory authorities, including the European Banking Authority and the European Securities Markets Authority that will have responsibility for developing a common EU rulebook and for oversight and quality assurance of the activities of EU supervisory authorities. A European Systemic Risk Board has been established to maintain system-wide surveillance of ﬁnancial stability and threats to it.

— National Regulatory Structure: the UK—and other jurisdictions—are enhancing their approach to banking supervision. In the UK this has involved the development of a Twin Peaks approach, with prudential supervision being given to the Prudential Regulation Authority under the Bank of England, and market and conduct supervision being the responsibility of the FCA. A Financial Policy Committee is being established in the Bank of England to take a macro-prudential view of ﬁnancial stability. The overarching theme is that supervision should be more intensive, more intrusive, more judgement based and more driven by the big issues than by detailed rules. The new regime should be fully operational early in 2013. In advance of this, the FSA has implemented a more intrusive approach to supervision in relation both to business conduct and prudential issues, including the oversight of corporate governance, with greater scrutiny of candidates for governance positions including a formal assessment of their competence.

— Capital and liquidity: There have been substantial increases in these requirements under Basel III and CRR and CRD IV—with a minimum 4% Core Tier 1 requirement, supplemented by a 2.5% capital conservation buffer and, further surcharge on large and complex organisations (a “G-SIB” buffer described further below)—bringing expected minimum Core Tier 1 capital to c. 9.5% (before potential application of a countercyclical capital buffer of up to 2.5%). Basel III also introduces a non risk-adjusted leverage ratio and places greater emphasis on stress testing. For the ﬁrst time globally applicable quantitative liquidity standards are being introduced in the form of a Liquidity Coverage Ratio (LCR) and a Net Stable Funding Ratio (NSFR). Transition to the new regime is scheduled to begin on 1 January 2013, with full implementation on 1 January 2019 (although the UK has already implemented a more stringent version of the Basel LCR—see further below). More recently, the Basel Committee on Banking Stability (BCBS) has commenced a fundamental review of capital requirements for instruments held in the trading book, which will result in signiﬁcant further changes to the prudential bank capital framework.

— The UK is at the forefront of acting upon and indeed anticipating many of these changes, whether through an enhanced stress testing and an interim capital regime focused on Core Tier 1 or through the application of capital planning buffers on top of its basic requirements based on stress testing results. In addition, the Interim Financial Policy Committee has recommended that the FSA encourage UK banks to develop capital buffers if need be in excess of those implied by the need to transition to Basel III. The UK also anticipated the Basel liquidity requirements with a new UK liquidity regime that was implemented through 2010. It is therefore possible that the UK will seek to speed up the pace of transition for UK banks and/or set requirements that are higher than the globally agreed minimum. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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— Systemically Important Institutions: The FSB has developed a set of policy measures to address the risks from systemically important ﬁnancial institutions (SIFIs). These build on the methodology and additional capital buffer requirements developed by the Basel Committee for globally systemic banks—which envisage buffers of up to 3% of additional Tier 1 capital. The FSB published the names of an initial group of 29 global SIFIs, including Barclays, which will be updated annually. Basel has recently consulted on extending this sort of approach to domestic systemically important banks. Core supervisory colleges have been established for more than 30 large complex ﬁnancial institutions under the aegis of the FSB. Basel, IOSCO and the EU have each issued principles on cross-border supervisory co-operation with a particular emphasis on the role of colleges. EU banks also have EU supervisory colleges (which are separate from the global supervisory colleges operating under the aegis of the FSB) and which have responsibility for certain activities in relation to capital adequacy models recognition and overall capital requirements under the Capital Requirements Directive.

— Crisis management: As noted above, international regulators, led by the FSB are developing global standards for crisis management and resolution. The FSB has issued the Key Attributes of Effective Resolution Regimes for Financial Institutions. This sets out the responsibilities, instruments and powers that national resolution regimes should have to resolve a failing systemically important ﬁnancial institution (SIFI); it also sets out requirements for resolvability assessments and recovery and resolution planning for global SIFIs. This includes the preparation of Recovery and Resolution Plans by individual institutions and the planned introduction of measures aimed at further enhancing loss absorbing capacity, including through the introduction of a “bail-in” regime impacting certain bank creditors. Crisis Management Groups have been formed under the aegis of the FSB for all major international ﬁnancial groups. These will oversee the preparation of Recovery and Resolution Plans for these groups. A number of countries, including the UK, have put in place a statutory regime (under the UK Banking Act) with a set of tools to enable an orderly resolution of a failed institution to take place pre-insolvency. The EU has proposed a Recovery and Resolution Directive that will mandate both recovery and resolution planning and establish more effective resolution tools and procedures throughout the EU.

— Deposit guarantee schemes: The UK and EU have significantly reinforced levels of deposit protection, with the elimination of coinsurance and the raising of the level of cover from £35,000 to £85,000. Banks have also had to develop Single Customer View systems in order to allow the accelerated payment of compensation to depositors in failed banks. An EU Directive is likely to extend coverage to all non-financial corporates and will require the establishment of prefunded schemes financed by industry.

— Remuneration: the UK developed the Remuneration Code to implement FSB principles on Remuneration for the 2009 payround. This was subsequently reinforced following the implementation of CRD III in time for the 2010 payround.

— Conduct of business regulation: The FCA will build upon customer-focused initiatives undertaken in recent years. A key element of this will be a more interventionist approach with the regulator seeking to identify emerging threats of customer detriment at an earlier stage as opposed to simply ensuring customer redress after the event. The FSA has developed a strategy in relation to product intervention. The EU is in the process of revising its Market Abuse Directive and the Markets in Financial Instruments Directive. The latter, in addition to enhancing investor protection, introduces important changes to market structures and practices and will implement a number of the G20 requirements in relation to the trading of derivatives. The EU has also passed a European Market Infrastructure Regulation (EMIR) to cover “over the counter” (OTC) derivatives, central counterparties and trade repositories.

— Retail Distribution Review: the implementation of higher minimum qualiﬁcation standards for retail investment advisers, including bank advisers, by the end of 2012 will underpin greater professionalism across the investment advice sector. New adviser charging requirements will see a fundamental change in how remuneration is set for ﬁnancial advisers. The level of remuneration will, in future, be agreed between the customer and their adviser, rather than set by product providers by way of commission as is often the case now.

— Macroprudential regulation: the UK is establishing a Financial Policy Committee within the Bank of England with responsibility for deploying macroprudential limits on the banking system and monitoring risk within the ﬁnancial system as a whole. The Bank of England has made known the tools that it wishes to have. These mainly focus on increasing capital requirements and will be delivered through secondary legislation associated with the Financial Services Bill currently going through Parliament. At an EU level, the European Systemic Risk Board will also assess system- wide risk in a way which ties in with enhanced oversight envisaged under the EU’s reform of its supervisory structure. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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— Corporate Governance: In October 2010, Basel issued a set of principles for enhancing corporate governance in banks. These cover: the role of the board and its qualifications; the importance of a risk management function (including a chief risk officer for large and internationally active banks), a compliance function and an internal audit function, each with sufficient authority, stature, independence, resources and access to the board; the need to manage risks on a firm-wide and individual entity basis; and the board’s active oversight compensation. The EU issued a Green Paper on Corporate Governance, covering the role of the Board, the role of the risk management function, the role of external auditor, the role of the supervisor in relation to the Board, the role of shareholders and remuneration. The Walker Review covered similar territory in the UK. The FRC reviewed the Corporate Governance Code and developed the UK Stewardship Code. As noted, the FSA has reinforced its supervision of governance, and tightened its expectations of the risk management function, including expectations of Board-level risk committees and chief risk officers. It has also begun to assess formally the competency of candidates for senior management positions, as well as their probity and financial soundness. The FSA has also (jointly with the FRC) increased expectations of the auditor in the supervisory process in the light of its disappointment with some aspects of the performance of auditors during the financial crisis. — Other regulatory reforms: there are other significant changes which relate to credit rating agencies, hedge funds, securities markets and other aspects of governance, including accounting and auditing. B.4. These changes have changed, and will continue to affect substantially, the environment in which banks operate and the incentive structures implicit to their business and reward structures. The very substantial changes to the capital and liquidity regimes alter fundamentally the economics of different lines of business. The crisis management measures change substantially the paradigm in which banks operate and make it entirely clear to shareholders, senior creditors and management that no bank will be viewed as being too important to fail and in the process ensure that financial stability, regulatory compliance and fiduciary duty is central to the Board decision-making process. The need for more intrusive supervision is widely recognised and in the UK we are giving the regulators additional macroprudential tools and the means of ensuring that separate attention is given to prudential supervision and conduct of business considerations. This has been backed up by corporate governance and risk management changes and other market infrastructure and regulatory reforms intended to reduce the prospect of systemic risk. 28 August 2012

Written evidence from Barclays

In August, Barclays submitted evidence to the Parliamentary Commission on Banking Standards proposing the establishment of a “Chartered Institute of Bankers” and a Register of Approved Bankers. Since then, Barclays has undertaken extensive work—both on its own, including commissioning legal advice on the potential complexities of setting-up such a scheme, and alongside other banks via the British Bankers’ Association (BBA). Recognising that the Commission is now actively considering a similar set of issues in some detail, this note is intended to provide the Commission with some additional information that Barclays thought might aid those deliberations.

Barclays participated in the creation of and fully supports the BBA recommendations previously submitted to the Commission by Sir Nigel Wicks, Chairman of the BBA, on behalf of the largest UK bank chairmen. This information is explicitly intended to complement and build on the BBA submission by outlining the work that Barclays has done as a sole institution.

Barclays considers that the Commission should make a clear and explicit distinction between improvements in the standards that guide behaviour of “bankers” (however so defined) and the qualifications that different types of “bankers” need to do their jobs properly. The former can and should include a universal standard, while the latter must be tailored to specific role types. Barclays original submission to the Commission was not as clear on this demarcation as it could have been.

The focus of this note is on the subject of standards, not qualifications, as we believe that this is the pressing issue for the UK banking industry, in the context of cultural transformation, and relating to professional standards, not professional qualifications. The competitiveness of the UK financial services sector provides sufficient testament to the adequacy of the qualifications of the individuals employed here. However, if it would be of interest to the Commission, we would be happy to prepare a point of view on qualifications separately.

With respect to standards, Barclays believes that what is required is an industry-wide “code” of professional standards. At minimum, we envisage that this code would consist of a “foundation” level for all employees (whether working in retail or wholesale environments) of all banks26 (domestic and foreign) operating in the UK. For domestic banks, such a scheme could apply across their global operations; for foreign banks, it could only be required to apply to their UK operations. While this might appear to create an unhelpful gap between domestic and foreign institutions, we do not believe that would have any material practical implications given 26 For the purposes of this note, we do not deﬁne this term, but that would clearly be on the important early responsibilities of whatever body is established to set-up and administer this code. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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the code is intended to shape minimum standards in behaviour, and all of these institutions will presumably have some form of internal code of behaviour that they apply across their global staff. This “foundation” level of the “code” could then be tailored to suit particular role types. For instance, a further “leadership” level could be created for senior management, and certain “specialist” levels could be created for particular roles that merit specific standards because of the nature of the work required (eg, customer and client facing roles; trading roles etc). For the avoidance of doubt, none of these “codes” are intended to establish a specification of the technical qualifications required for whatever set of roles is covered by each. Those would be covered wholly separately, if at all. This “code” (and derivations from it) would set out clear principles for the behaviour expected of covered individuals. Those principles would need to set a higher standard than that set out by the Financial Conduct Authority as part of its Approved Persons Regime. Focusing the “code” on principles will ensure that they are not mistakenly regarded as a set of rules. They must be standards and need to apply across any eventuality that might arise in the course of relevant “bankers” (given the scope of the given “code”) completing the duties of their role. That cannot be achieved through a set of rules. Barclays considers that such a “code” would need to be created and maintained by an independent body, such as the Banking Standards Review Council (BSRC) outlined in the BBA’s evidence. The BSRC would need to be an independent regulatory body; have a board made up of a majority of representatives from outside the industry27; be underpinned by statute requiring it to serve the public interest; and be funded by the industry. The BSRC’s responsibilities would include: — Defining the scope of firms covered, including whether or not the application is voluntary or compelled; — Defining the specific scope of staff covered and any role types within that scope that required tailored versions of the “code”; — Engaging with a wide range of stakeholders to solicit input and feedback; — Defining and maintaining the “code”, including any derivations; and — Establishing standards for any training required to support the implementation of the “code” at covered firms. The BSRC would also have responsibility for ensuring covered firms comply with their responsibilities with respect to putting the “code” into practice through auditing and assessing practical application. This will be done at the firm level, not the individual, and include specifying how compliance with the “code” and its application requirements will be determined, monitored and audited. This will require careful design given the practical implementation of such a “code” will be subtly different in those firms where it has been successful and those where it has not, especially over short periods of time. However, we remain of the view that the success of such an arrangement will hinge on the ability of the BSRC to establish and enforce requirements for sanctions against breaches of the “code”. Given the various considerations involved, any sanctions system established would need to: — Protect appropriately the privacy and confidentiality of individuals; — Have a transparent and fair basis through which sanctions are determined; — Efficiently coordinate with existing personnel procedures inside institutions and the FSA/FCA ie, does not create a bureaucracy); — Ensure that any individual at risk of sanction has access to an effective appeal mechanism; and — Provide for any individual sanctioned to have access to independent arbitrage. To be effective, Barclays believes that individual covered firms would need to commit (or be compelled by statute) to communicate to the BSRC where a colleague is dismissed for a serious breach of the standards set out in the “code”. Those firms would also commit to checking with the BSRC before they hire any individual. These activities of the BSRC related to sanctions, in particular, may require it to have a statutory underpinning given their sensitive nature. A voluntary approach offers the advantage of being quicker to implement, although it also presents potential legal challenges to the authority of the BSRC. Underpinning the BSRC by statute, however, overcomes a number of the challenges of the voluntary model. (See appendix for a fuller explanation of the considerations involved). Finally, as part of serving its public service duty, the BSRC would need to conduct all of its affairs on a completely transparent basis. Barclays recognises that there are a number of existing bodies that could form the basis of such a BSRC or deliver a part of its remit—either as an outsourced delivery agent/partner or as one of several regulatory bodies established to achieve a similar overall objective. These range from the existing Chartered Institute of Bankers to the FCA (given their Approved Persons Regime). However, Barclays believes it is important, at this 27 The other members could include client and customer representative organisations; the Government; and industry representatives. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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particular juncture of the process, to remain agnostic as to whether or not any of these is fully fit for purpose until the requirements are fully specified and agreed. Barclays is fully committed to playing its part in restoring trust of the British public in the UK financial services industry. We believe the professionalisation of standards across the industry is vital to achieving that aim and stand ready to support the Commission in whatever way we can in pursuing this agenda. In particular, we would be happy to provide further information to the Commission on any of the points highlighted if that would be of use.

APPENDIX CONSIDERATION OF THE LEGAL AND PRACTICAL COMPLEXITIES OF ESTABLISHING A BANKING STANDARDS REVIEW COUNCIL This note considers how a Banking Standards Review Council as outlined in the main paper might operate either on a statutory or non-statutory basis, and the practical challenges to be addressed in order to ensure the body is an effective mechanism. Many of the challenges could be most simply addressed by placing the body on a statutory footing.

Executive Summary — There are two basic models that could be adopted; a voluntary scheme which participating banks agree to join or one created by statute. Other professions (the law, medicine etc) have governing bodies that are set up under statute. — In either case, there will be a number of significant challenges relating to the scope and powers of any body, for example: — Identifying who are “bankers” for these purposes and whether it would include back-office employees, contractors, and directors who are not also employed; — How to deal with overlap with the FSA (especially the FCA) and other regulators; and — What impact, if any, it would have on overseas bank employees. — A voluntary, non-statutory model would present practical and legal challenges which are potentially significant though not necessarily insurmountable. These challenges would be particularly acute under a structure where those whose ability to work in the banking industry in the UK may be limited in some specific way, as opposed to an advisory scheme of those who have been disciplined by a member bank whom another bank could choose to hire if they wish. — A model created by statute would overcome, by legislation, a number of the challenges of the non- statutory model. However, it would lead to greater external involvement and tighter process requirements.

Practical challenges under both a non-statutory and statutory model — The challenges below will need to be addressed in creating a scheme under either a non-statutory or statutory model: — Identifying staff within the scope of the code—who is a “banker” for these purposes? Will different aspects of the code apply depending on the nature of an individual’s role? Can this be applied consistently across banks? — How will the “code” apply to contractors? — How will it affect overseas employees of a bank, if at all? — How to achieve a consistent approach where a bank operates in multiple jurisdictions? — How to ensure consistency of approach by organisations in applying the “code” and reporting infringements? (For example, the possibility of participating banks agreeing as part of a compromise agreement exit that an individual will not be reported to the scheme?) — How to ensure it complements rather than conﬂicts with the FSA/FCA’s “ﬁt and proper” and Approved Persons regimes?

A non-statutory model—challenges and advantages — The principal advantage of non-statutory model would be that it could more closely reﬂect the shape of the industry. However, any powers and ability to impose sanctions would likely be constrained in comparison to a statutory body. — In the absence of any statutory authority over the employees, the scheme would have to derive its authority from a contractual agreement with the individual in question. — A bank could therefore make it a condition of employment that an incoming employee be subject to the scheme’s regulations and sanctions. Employee consent will be required if the scheme (as opposed to the employer bank) is to take any form of disciplinary action. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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— Existing employees’ contracts would have to be varied by consent. In the event of refusal, a company may opt to terminate and re-engage on a new contract with the relevant terms, which could give rise to a number of legal issues for example, unfair dismissal. — Consent would not be needed to compile and publish a register of approved individuals without the ability to impose separate sanctions. However, employees would need to be notified of the existence of the register and that their name is included on it. — There must be a risk that dismissal for refusing to be subject to the disciplinary sanctions of an unregulated body which could have the consequences of a lifelong exclusion from working in the banking sector would be regarded as unfair by a Tribunal. — If the scheme is not universally adopted, non-participant banks may be seen as more attractive employers by some people. Additionally, UK based branches of foreign owned banks may be reluctant/unable to “subscribe” to regulation by the scheme and its “code” if they are subject to local law regimes governing the “parent”. — The concept of being “struck off” (suspended from practice) under a voluntary scheme may have human rights implications. Article 6(1) of the European Convention on Human Rights (ECHR) provides that “...in the determination of his civil rights ... everyone is entitled to a fair and public hearing within a reasonable time by an independent and impartial tribunal established by law.” The right to carry on a profession is a civil right to which Article 6 applies28. — However, risk of a non-statutory register being challenged in this way can be reduced by avoiding any suggestion that the participant banks will not employ individuals on the register and specifically ensuring that this is not an express provision in the “code”, with employers making case-by-case judgements on hiring. — A similar register, operated by the fraud prevention service CIFAS, operates on this basis and includes a high evidential standard on information filed with it: — Information must be factual and accurate; — The criminal offence must be identifiable; — The Member must have sufficient clear evidence of wrongdoing to have reasonable grounds to press criminal charges; — the Member must be willing to make a full report to the police, although it is not mandatory to make such a report; and — suspicions and hearsay must NOT be filed to the database. — A non-statutory register might adopt this best practice. It might also indicate: — Whether an individual is challenging any disciplinary dismissal; — Has successfully challenged a dismissal (as unfair or discriminatory); and — Whether names should be withheld from the register until such time that the limitation period for bringing an employment tribunal claim has passed. — The provisions of the Data Protection Act 1998 would have to be strictly adhered to. — A right of appeal would be required. Failing to do so would place the bank in breach of the ACAS code of practice on disciplinary and grievance procedures and could lead to any dismissal or disciplinary sanction being found to be unfair.

A statutory model—challenges and advantages — Nearly all professional bodies derive their authority from statute. — A statutory approach to the scheme could address a number of the above concerns related to data protection, competition, human rights and public policy considerations. Statutory provisions could, for example, provide for the following: — Power to regulate specific groups of employees; — Power to impose separate sanctions (eg, fines; suspensions; “striking off”); — The ability to regulate who can be employed in specific fields/roles; — The “judicial” process (including levels of appeal) to be applied in respect of any sanctions imposed by it; and — Address concerns under Article 6 of the European Human Rights Act that a tribunal be “established by law”. — If the scheme is established by statute, then banks covered by the “code” would be able to require their employees to comply with the code as a condition of employment (as a minimum standard) in the same way that an employer can require its employees to comply with its policies and procedures whether or not those policies and procedures are contractual. 28 Le Compte and others v Belgium [1981] ECHR 3 This case concerned a decision by the Belgian equivalent of the General Medical Council, to strike the claimant medical practitioners off the register, with the result that they would be legally prohibited from practising that profession. It was held that the decision was "decisive" of their civil rights. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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Funding — Whether the scheme is a statutory or voluntary body, the issue of how it is to be funded must be addressed. — Levying a fee on individual employees might be problematic. Whilst the SRA levies registration fees on solicitors, those in private practice generally have those fees met by the law ﬁrms employing them. — If employees were required to pay the levy it should be noted that in order for it to be a tax deductible expense the scheme would likely have to be regarded as an approved body by HMRC; if the scheme is aimed at raising standards (via the “code”) and certain other criteria are satisﬁed then such approval may be forthcoming. 18 January 2013

Letter from Antony Jenkins, Group Chief Executive, Barclays I write further to Sir Hector Sants’ evidence to the Parliamentary Commission on Banking Standards on 10 January and your request that Barclays provide a letter clarifying the safeguards that exist to manage potential conflicts of interest around regulatory cases relating to Barclays, given Sir Hector’s previous role. As you are aware, the FSA has approved Barclays appointment of Sir Hector and the application for him to perform the role of Compliance Oversight. The FSA has indicated its full support of our desire to restructure Barclays compliance function. As Sir Hector explained when he gave evidence, there is a statutory contractual period determined by the FSA Board during which former senior directors of the FSA are prevented from working for regulated firms and Sir Hector is beyond that period. This period ensures that the individual does not have any up to date, current regulatory information which could benefit the firm they are joining. Barclays and Sir Hector are absolutely aware of the importance of, and are committed to, managing any potential conflicts of interest around regulatory cases relating to Barclays with which Sir Hector would have had visibility during his tenure as CEO of the FSA. We have agreed with the FSA that Sir Hector will not be party to discussions on settlement of formal action by the FSA (or FCA or PRA in due course). However, as you would expect, this will not preclude Sir Hector from being involved in broader discussions on lessons learned from such cases. I hope that this letter eases your concerns but please do not hesitate to contact me should you wish to discuss further. 22 January 2013

Letter from Sir David Walker, Chairman, Barclays Barclays have provided redacted copies of (1) Simmons & Simmons LLP’s Phase 1 Report dated 18 January 2013, and (2) the report prepared by Genesis Ventures, entitled “Barclays Wealth America Cultural Assessment”, dated March 2012. The materials referred to in the Mail on Sunday article dated 20 January 2013 were the Genesis Ventures Report and Simmons & Simmons’ Interim Report dated 21 December 2012. The Phase 1 Report sets out Simmons & Simmons’ ﬁndings in relation to the same matters covered by the Interim Report, but after further investigation. I have summarised below the background to the commissioning by Barclays Wealth of the Genesis Ventures Report, as well as some details relating to Simmons & Simmons’ investigation into the suppression of that written report. I have also explained the basis for the redactions to the reports. I hope that this information will assist the Commission’s understanding of the matters reported in the Mail on Sunday on 20 January 2013.

1. Genesis Ventures’Work for Barclays Wealth 1.1 Genesis Ventures is an independent consultancy that has worked for Barclays Wealth for two years, helping to improve culture and performance by facilitating workshops, offsites, providing management coaching, feedback and appraisals. In February and March 2012, senior management at Barclays Wealth commissioned Genesis Ventures and another consultancy to carry out a piece of work focusing on culture at Barclays Wealth Americas (“BWA”). Genesis Ventures were asked to conduct a series of interviews with senior management in BWA to highlight cultural problems affecting the development of the business. The need for this work was identified when, after a six month examination in 2011, the U.S. Securities and Exchange Commission (“SEC”) issued Deficiency Letters to BWA in early 2012. 1.2 Genesis Ventures were engaged on the basis that the outcome of their work (and that of other consultants) into culture at BWA would determine a programme of remediation amongst BWA’s leadership. Genesis Ventures reported their findings both verbally in a series of meetings in April and May 2012 (and in a written report, sent only to the Chief Operating Officer of Barclays Wealth). Since then they have worked with the business and with other consultants to develop a programme of activities to address their conclusions. 1.3 These activities have included a series of focus groups and workshops to create plans for cultural development, a comprehensive programme for employee communication and engagement, executive coaching cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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for senior leaders in BWA, re-alignment of individuals’ performance objectives and 3600 assessment of senior management. Within the last month Genesis Ventures and other consultants have conducted, and continue to conduct, a further series of interviews with senior and junior staff to monitor progress and senior management led an offsite event attended by business, ofﬁce, control function and infrastructure heads, aimed at addressing the cultural issues within the BWA business. As this programme of activities makes clear, progress has been made, and continues to be made, towards improving culture within BWA. 1.4 As you will know, Antony Jenkins acknowledged very recently that there is a need to change culture across all areas of Barclays business. We have set out a plan for how we are going to do this. We see BWA’s ongoing programme of activities as an integral part of Barclays wider plan.

2. Simmons& Simmons’Investigation andReports 2.1 Simmons & Simmons LLP was instructed in November 2012 by the Group Litigation and Investigations unit of Barclays to undertake an internal investigation into matters relating to culture within Barclays Wealth, in light of issues raised in whistle blow emails and by staff within the business. 2.2 Phase 1 of their investigation focused on the allegation that a “Wealth cultural audit report” had been commissioned and suppressed. This allegation was made in two whistle blow emails received in September and October 2012. 2.3 Simmons & Simmons reported the findings of Phase 1 of the investigation to the regulators, first in its Interim Report dated 21 December 2012 and then more fully in its Phase 1 Report dated 18 January 2013. The conclusions are that: (A) the Genesis Ventures Report had been commissioned by Andrew Tinney, the former Chief Operating Officer of Barclays Wealth; (B) he had actively suppressed the existence of that Report; (C) no other individuals within Barclays Wealth ever received the Report; (D) there is no evidence that any other individuals participated actively or knowingly in the suppression of the Report; and (E) although the existence of the Genesis Ventures Report itself was suppressed, the contents of the Report were, and continue to be, acted upon as part of BWA’s ongoing programme to improve culture, as I have described above.

3. Integrity ofContinuingInvestigations 3.1 It is extremely important to Barclays that the continuing activities within BWA and Barclays to improve culture, and particularly Simmons & Simmons’ ongoing investigations into matters relating to Barclays culture, are not undermined by the disclosure of information to the Commission. Simmons & Simmons have advised that, without appropriate safeguards, disclosure could potentially affect the integrity of the ongoing investigation, including the willingness of Barclays staff to co-operate with the investigation. It may also harm Barclays ongoing relations with those employees if these matters were subjected to scrutiny by the Commission. In addition, Barclays has a responsibility both to protect the privacy of its members of staff and to maintain the relationship of trust between Barclays and its staff which is central to our efforts to change culture. 3.2 With those matters in mind, we have redacted from the Phase 1 Report: (A) matters which are the subject of ongoing investigation and of continuing reporting obligations to the FSA and other regulators; and (B) various of the detailed ﬁndings in the Phase 1 Report which relate to existing employees of Barclays and which remain the subject of further enquiries. 3.3 For the same, and additional, reasons we have also redacted from the Genesis Ventures Report all direct quotations provided by BWA employees during interview with Genesis Ventures, the names of all individuals, and passages which may enable those familiar with BWA to determine the identities of those individuals. The direct quotations record comments made by individuals during conﬁdential interviews with Genesis Ventures. Many of the interviewees and subjects of the comments remain employees of BWA and many will be unaware they have been named or criticised in the Genesis Ventures Report. It would be unfair to the interviewees or to the individuals referred to in the Genesis Ventures Report to quote them directly, or to reveal their identities. As the Genesis Ventures Report addresses exclusively matters relating to BWA, and not Barclays Wealth’s UK business, we do not consider that this will hinder the Commission’s investigation of matters within its remit.

4. Confidentiality 4.1 We request that you do not publish the Phase 1 Report, for the reason that the report is confidential, is not in the public domain and has been prepared for the benefit of regulators, including US regulators, in the context of an ongoing investigation. 4.2 We have provided a redacted version of the Genesis Ventures Report so that the Commission is able to appreciate the nature of the report which was suppressed. However, as is clear from section 1 of this letter, the cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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content relates exclusively to Barclays Wealth America and contains direct quotes from members of staff provided during the course of strictly conﬁdential interviews. Publication of this report would compromise ongoing investigations internally and by the authorities and would undermine Barclays ability to conduct further exercises of this nature in the future. For these reasons, we again request that the Genesis Ventures Report not be made public in any way. Please do not hesitate to contact me if you have any queries about the reports in the information in this letter. 1 February 2013

Written evidence from Nicolas J Bellord 1. My name is Nicolas Bellord and I practised as a solicitor until my retirement in 2000. During my professional career I advised many charities and amongst other matters I introduced many of them to investment on the Stock Exchange after the passing of the Trustee Investment Act 1961 which allowed investment in equities for many of them for the first time. Thus over a period of some forty years I had regular contact with stockbrokers and others in the City of London and inevitably with deregulation this meant dealing with stockbrokers who were owned or controlled by banks. 2. On my retirement, having unfortunately invested my pension fund in the Equitable Life Assurance Society I spent some ten years fighting for compensation for the members of that Society. Until early 2011 I was deputy chairman of EMAG (the Equitable Members Action Group) from which I retired for personal reasons. I am submitting this memorandum on a personal basis. 3. However during my time on the board of EMAG I was closely involved with the production of the Parliamentary Ombudsman’s report “Equitable Life: a decade of regulatory failure”. I wrote the 100 page submission of evidence to the Parliamentary Ombudsman on behalf of EMAG at the start of her inquiry and I was a member of the confidential committee of EMAG which liaised with the Parliamentary Ombudsman’s office during the course of the inquiry. My particular concern was to concentrate on the Chronology, in its various drafts, which detailed the failure of regulation, and I therefore acquired a detailed knowledge of regulation and its failures and in particular the fraudulent aspects of that regulation.

4. Summary In respect of the Commission’s present inquiries it has been alleged that the regulators or others in positions of authority may have connived at the activities of Barclays Bank in respect of the setting of LIBOR. I have no comment or evidence in respect of this allegation but I would like to draw the Commission’s attention to: A. Some general comments on the Financial Services Industry. and B. Profoundly improper behaviour by the FSA and others in respect of allegations of criminal fraud not only by Equitable Life itself but by the FSA. My submission is that there has been a culture of impunity at the highest level in the regulation of financial services in that criminal fraud has been alleged but no action taken by either the FSA or the Serious Fraud Office (SFO). It would seem that above a certain level individuals are exempt from the ordinary processes of the criminal law. This is unacceptable. In this response I propose to cover the following points: — The relevance of the Equitable Life saga to the Banking saga. — Morality, Regulation and the Culture of the Financial Services Industry. — Financial Innovation—Conflicts of interest, gambling, usury and regulatory arbitrage. — The Regulators: their failures and impunity in Criminal Law. — Concluding Remarks.

5. TheRelevance of the Equitable LifeSaga to the BankingSaga. The Equitable Life saga relates to the regulation of the insurance industry and it might be thought this is therefore not relevant to the banking industry. However both industries have come under the same regulators namely the Financial Services Authority (often acting as an agent of the Treasury) and eventually the Tripartite Committee. Consumers have had to have recourse to the Financial Ombudman’s Service (FOS) which is the subject of control by the Financial Services Authority (FSA). Further there are general principles of morality and regulation which apply to both industries.

6. Morality, Regulation and the Culture of the Financial Services Industry. 6.1.In the ﬁnal analysis we are dealing with the behaviour of individual human beings. It has been an observable fact throughout history that human beings have a tendency to behave badly and there is a need for a moral code backed up (to a limited extent) by legislation in order for this behaviour to be corrected in the interests of the common good. Traditionally this country followed the Judaeo-Christian ethical system (based cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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upon but not limited to the Ten Commandments) accompanied by a certain amount of legislation. I will refer to this Judaeo-Christian ethical system as Traditional Ethics. However over the course of the last century there has been a gradual rejection of those Traditional Ethics and they have been often replaced by utilitarian or consequentialist theories of ethics which themselves evolved and have been taught particularly in the UK from Bentham onwards. The idea behind these theories is that no action is intrinsically wrong but one has to calculate the consequences of one’s actions as to which consequences give rise to the greater good. The problem with this is that a person’s perception of the greater good will sometimes be dictated by selfishness or greed and, whilst at other times people may act altruistically, they will be faced with calculating the incalculable particularly in the field of economics. 6.2.To give a simple example. The regulators may have a duty imposed upon them to “support the market” at the same time as “protecting consumers”. These duties, as I will explain further in the case of Equitable Life, can conflict. The regulators will be faced with the problem of calculating where the greater good lies if they are to be good utilitarians and have abandoned Traditional Ethics. Thus deceiving the consumers and using fraudulent instruments can become justifiable in the interests of “supporting the market”. Disaster usually follows. 6.3.The response of the legislature to this situation has been ever more legislation and regulation. The gap created by the abandonment of Traditional Ethics is supposedly filled by this impenetrable mass of legislation. Whereas Traditional Ethics are ascertainable by practical reason and are conceptually simple—tell the Truth, do not steal, be honest, do not deceive, act in good faith, usury is wrong, gambling is a vice etc—regulation by legislation becomes evermore complex and obscure. Just try and make head or tail of the Financial Services and Marketing Act. The legislation comes to be seen as the only guide and provided one can get round it or find a loophole then that is okay. Indeed in view of the obscurity and complexity of the legislation one can always take the chance that a particular breach will go undetected. It is a particular problem with the “black letter” approach of English law as opposed to following the spirit of the law. Regulation, like Patriotism, is not enough. 6.4.Most importantly it is not just the regulated who can misbehave but the regulators themselves as is clear from the Equitable Life saga. There is a real problem of “Quis custodiet ipsos custodes”.

7. Financial Innovation—Conflicts ofInterest,Gambling,Usury andRegulatoryArbitrage. 7.1 Conflicts of interest. Prior to 1986 the stockbrokers with whom I dealt were independent. However from then on they were increasingly owned by non-stockbrokers particularly banks. It seems that a rather rosy view of human nature was adopted and inherent frailty in the face of temptation to wrong-doing was ignored. It became common to believe that everyone could handle conflicts of interest and that “Chinese walls” would prevent any undue influence being exerted on individual stockbrokers. On several occasions I had stockbrokers informing me that they were moving to a different firm because they were unable to give independent advice and were being leant upon. It was obvious that “Chinese walls” were not working. 7.2 In written agreements with stockbrokers it now seems to be the case that they think that declaring that on occasions they might have some unspecified conflict of interest is sufficient to deal with the matter. But what do you do when you have a conflict of interest? Choose the side that advantages you most and risk opprobrium when and if you are found out or lean over backwards in the other direction to avoid being accused of being biased? Either way you are not in a position to give unbiased advice or more seriously to make a proper judgement. In the case concerning Equitable Life in the House of Lords, Lord Steyn declared an interest in the outcome of the case but went on to make a judgement. He may have felt that he had excluded his interest from influencing his judgement but the world at large took a different view. It brought the legal system into disrepute.

7.3 Gambling. If you look at the historical records of gambling bets placed at Brooks’s Club you will see bets relating to the future price of Government Bonds etc. Historically such contracts were regarded as gambling and therefore made unenforceable. Section 86 of the Financial Services Act 1986 (re-enacted as s.412 FSMA 2000) suddenly made any kind of gambling enforceable subject to certain impenetrable restrictions. Gambling on such intangibles as the future level of a stock exchange index has become commonplace. 7.4. The relevant part of Traditional Ethics lies in the interpretation of the commandment “Thou shalt not steal”. The Catechism of the Catholic Church states “2413 Games of chance (card games, etc.) or wagers are not in themselves contrary to justice. They become morally unacceptable when they deprive someone of what is necessary to provide for his needs and those of others. The passion for gambling risks becoming an enslavement”. 7.5. The ﬁrst point is that such gambling now permitted by the said legislation is almost invariably with other people’s money when it is carried out within a bank or other ﬁnancial institution. It can become a form of stealing contrary to the Commandment in that it can deprive others “of what is necessary to provide for his needs and those of others”. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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7.6. The second point concerns gambling as a vice involving enslavement. Studies of ordinary gambling in casinos emphasise the illusion, entertained by addictive gamblers, that they are in control and this is a major factor in their addiction which persuades them to continue gambling usually to chase losses. They believe that they have some skill when in fact the casino has stacked the odds against them and the house always wins. In the case of gambling in the ﬁnancial sector that illusion may have some basis in fact; the gambler’s skill and knowledge of the market serve to reinforce the illusion making the compulsion even stronger. The only escape from this enslavement is to lose everything so that he can gamble no more. Whilst he may believe that in continuing to gamble he may win, he is in fact gambling to lose as that way lies catharsis and escape for him but possibly ruin for the ﬁnancial institution as was the case for Barings. 7.7. I am not saying that all derivative trading is wrong. Obviously future trading where there is a tangible asset involved, such as a crop, is legitimate. The subject is complicated but it does need to be looked at much more closely with much more restrictions and closer monitoring. Recent experience mandates that there is a need for research and much greater caution in what is allowed.

7.8 Usury. Traditional Ethics have seen usury as contrary to the Commandment “Thou shalt not steal”. It can be seen as even worse: “Those whose usurious and avaricious dealings lead to the hunger and death of their brethren in the human family indirectly commit homicide, which is imputable to them”.29 The prophet Amos warns: “Here is word for you, oppressors of the poor, that bring ruin on your fellow-citizens in their need; you that long for new moon and sabbath to be at an end, for trading to begin and granary to be opened, so that you may be at your shifts again, the scant measure, the high price, the false weights! You that for a debt, though it were but the price of a pair of shoes, will make slaves of poor, honest folk”.30 7.9 That last sentence of Amos reminds one of the pay-day loans: “borrow £100 and repay £125 in 14 days”31; surely that is usury with rates of interest into the tens of thousands per annum regarded as licit because the lenders are licensed. It is perhaps curious that whilst there is a call to relax further shopping restrictions on the sabbath I have not heard of a call to keep financial trading going seven days a week! But it will probably come. However the question is “What is usury?” To say that all lending of money at interest is usury and therefore wrong is simplistic. The subject is complicated and eventually boils down to oppressive and/or irresponsible lending. On the one hand there is an interesting essay “On Usury” by Hilaire Belloc written after the 1929 crash. On the other hand there is Ayn Rand who says all lending is legitimate and eschews any moral dimension. There is a middle way if one considers “Interest is the difference in the valuation of present goods and future goods; it is the discount in the valuation of future goods as against that of present goods.” That definition surely implies that there exist “future goods” and that they have a certain value. That is to say one should not lend money to enable someone to buy something that will be consumed and that the valuation of the future goods should be reasonably correct ie interest rates should be realistic but not excessive. 7.10 There has been an enormous change in retail banking in my lifetime. Previously when one wanted to borrow money one would have an interview with the Bank Manager when he would examine what you wanted the money for and either grant you the necessary bank overdraft or not in the light of his assessment. Generally the rate of interest on the overdraft would be two or three% over bank rate. To-day however the local Bank Manager no longer exists and all one can obtain is a “product”. No interview is required—I can just ask for an overdraft facility over the phone or online. However the interest rate is 19.9% ie over 19% above base rate. The bank is saving money by not having the traditional local bank manager who knows his patch, it can close branches and it covers the fact that it is lending in a irresponsible manner by charging a usurious rate of interest that has no relation to the value of any “future goods” even if such exist. Credit cards and store cards are another symptom where people pay for their groceries and then pay similar rates of interest. This is just one example of how bank lending has become usurious and irresponsible, leading to the excessive levels of household debt in the UK. Hilaire Belloc finished his essay by saying the “A day will come”. It may well have done. 7.11 The disappearance of the traditional bank manager who knew his patch and his customers is probably one of the principal reasons that Banks have failed to respond to the Government’s pleas to lend to small businesses in a responsible and sensible manner. They simply lack the structures to do this.

7.12 Regulatory Arbitrage. This rather fancy expression refers to the practice where in order to escape regulation in your own country you perform some action in another country where there is less regulation. This is what happened in the Equitable Life saga. As explained below the FSA advised Equitable Life to take out a reinsurance contract which they duly did in Dublin—a transaction that was indorsed by the FSA. The Irish Government did not regulate such transactions at all. In the USA you get sent to prison for this kind of activity; in the UK you probably get a CBE. 29 Catechism of the Catholic Church para 2269. 30 Amos Chap 8 verses 4–10. 31 Seen in the window of a loan shop in a main street of Brighton. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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8. The Regulators:TheirFailures andImpunity in Criminal Law. This part of my response relates to the Equitable Life saga. By regulators I mean all those responsible for regulation and the enforcement thereof. So it includes the Financial Services Authority, the Financial Ombudsman Service, the Treasury and the Tripartite Committee. 8.1 Lord Penrose in his report of 8 March 2004 to the House of Commons of the Equitable Life Inquiry stated in his covering letter addressed to the Financial Secretary to the Treasury “I have informed the appropriate public prosecution authorities of aspects of the evidence and my emerging findings”. 8.2 Nothing more was heard from the prosecution authorities. 8.3 In the last eighteen months a “Vetting Note” was obtained under the Freedom of Information Act from the Serious Fraud Office (SFO). This was an opinion given to the SFO by a Mr Hacking Q.C. Generally this note advised against any prosecution of anyone in Equitable Life on several grounds but notably on the grounds that the regulators knew of the alleged criminal activity viz: 15.1 There was close oversight by the regulators, who had access to large amounts of data from Equitable and throughout the material period were aware of what the Society was doing and on some occasions condoned it. and 94. The Penrose report is very critical of the regulators. The relevance to SFO is that in very many cases transactions, activities and representations which might be considered to be criminal offences were known to the regulators. It is, therefore, likely that potential defendants would raise many defences based on having disclosed what they were doing to the regulators and having received their approval, or at least not received their disapproval. So it would seem that where regulators are aware of criminal activity and do nothing or actually condone it then no action will be taken. Effectively there was a cover-up of the regulators’ misdoings. 8.4 The Parliamentary Ombudsman’s Report “Equitable Life: a decade of regulatory failure” was published in July 2008. It revealed a criminal fraud instigated at the behest of the FSA. In brief at the end of 1998 it was found that Equitable Life was short of assets by £1.5 billion. They were advised by the FSA to take out a reassurance treaty to cover the deficit. On being presented with a draft the Government Actuary’s Department (GAD) advised that it did not do the job. However someone in the FSA or possibly in the Tripartite Committee or the Treasury told the GAD to continue revising it. However nothing substantive changed and a completely worthless instrument, negotiated with a company in Dublin, was used to cover this £1.5 billion shortfall. This was a criminal fraud to misrepresent the financial position of Equitable Life at the suggestion and full approval of the FSA. It is costing the British taxpayer some £1.5 billion to compensate the victims but no individual has been brought to account for this criminal activity. 8.5 After the failure to sell Equitable Life in 2001 a compromise under the Companies Act was proposed. A balance sheet and accounts were drawn up to 30 June 2001 taking credit for the reinsurance treaty. However by that time the FSA and Equitable Life had been advised by Leading Counsel that the reassurance treaty was worthless and that there were enormous potential claims by certain classes of policyholders which indicated that Equitable Life was insolvent. Nevertheless the FSA and Equitable Life allowed the compromise to proceed on the basis of the June 2001 accounts thereby deliberately deceiving the policyholders and the Court as to the true financial state of Equitable Life. 8.6 In December 2008 I wrote a short and a long report, concerning this matter, for the Public Administration Committee. The short report is available at:

The long report was not printed. I attach as an Appendix my full examination of the reassurance treat saga upon which these reports were based. I commented at the time: “My expectation of the regulators is that they should not connive at the dishonest behaviour of those being regulated nor should they indulge in a cover up. The regulators helped Equitable to arrange a reinsurance treaty which was entirely worthless. If they had not suggested this bogus treaty, Equitable would have been ﬁnished in early 1999. Instead, we have continued with dishonest regulators leading to a whole host of other chickens coming home to roost. If anyone doubts this, read the chronology (Part 3 of the PO’s report) from December 1998 onwards.” (see ) 8.7 In March 2010 I wrote to the Serious Fraud Ofﬁce drawing their attention to this. They sent me a stock reply saying they could only investigate those cases “where there are reasonable grounds to suspect serious or complex fraud”. Over a million policyholders and losses estimated in the billions? But perhaps it was not complex enough for them. They went on to say that they usually only dealt with matters referred to them by the police or other “law enforcement agencies”. I had been told earlier that they would only act on a reference from the FSA. Do bank robbers only get prosecuted if they refer their crimes to the police themselves? cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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8.8 In a subsequent meeting with Mark Hoban at the Treasury I raised the question of why had there not been a prosecution to which he responded in the sense of “What would be the point?” I found that breathtaking. 8.9 My purpose in submitting this response is to draw the Commission’s attention to the lamentable behaviour of the regulators where those in very senior positions can seemingly act with impunity. The rot in the Financial Services Industry goes to the very top. It is a question of “Quis custodiet ipsos custodes”. I was disappointed that the Public Administration Committee took no notice of my memorandum other than to print the shorter version. I would hope that the Commission will be able to take steps to restore public conﬁdence in regulation and not allow the perception that those at the top are too close to the Financial Services Industry, in a manner akin to the matters being examined in the Leveson Inquiry, so that nothing effective is done and we move to even greater disasters.

8.10. The Financial Ombudsman Service. The problem for any ordinary member of the public attempting to obtain justice when faced with wrongdoing by a large ﬁnancial institution is the costs indemnity rule whereby a loser has to pay not only his own costs but those of the winner. Our legal system favours the rich. Suppose an individual has a claim for £20,000 and a 90% chance of winning. If he wins he gets £20,000. If he loses he may get a bill for £500,000 as he pays for the top lawyers employed by the ﬁnancial institution. Logically he should not sue. Do not imagine that “No win, no cost” is any solution particularly when you are suing an insurance company. The only hope is in the Financial Ombudsman Service (FOS) where no such rule applies and it is free. 8.11 However in the Equitable Life saga the FOS showed itself to be thoroughly venial. The experience of claimants was that it stonewalled every claim at every opportunity. In particular when Lord Penrose’s report was published, which revealed the misdoings of Equitable Life and some of the shortcomings of the regulators, the FOS issued a blanket ruling that it would not consider any claim based on anything in the Penrose report despite a Treasury Minister having informed the House of Commons, at the time of publication, that the FOS was the avenue of complaint for the policyholders and that she would ensure that the FOS had adequate resources to handle those complaints. 8.12 EMAG (Equitable Members Action Group) became so disgusted with the behaviour of the FOS that it commissioned a report from Lord Neill of Bladen Q.C.—a former Chairman of the Committee on Standards in Public Life. His report is available at: Lord Neill’s overall conclusion was that the FOS fell short of the standards which it had itself proclaimed. The report was rejected by the Financial Ombudsman who in due course received a CBE.

8.13 The Criminal Law. There is an obvious discrepancy in the application of Criminal Law in the UK. It is blatantly illustrated in the case of the Equitable Life reassurance treaty where not even a criminal investigation has taken place despite what Lord Penrose and the Parliamentary Ombudsman revealed. In an almost identical case with another provider in Dublin involving a similar reassurance treaty, designed to fraudulently boost the balance sheet of AIG, the United States authorities successfully prosecuted the perpetrators: Why were the perpetrators of the Equitable Life treaty not even investigated? Too high up in the ﬁnancial system? There is a disgraceful impunity for the regulators.

9. Concluding Remarks. 9.1 I have advocated that regulation is not enough. There needs to be an overriding moral code. I have proposed Traditional Ethics. In the present climate there is a certain hostility to Christianity but all I can say is that if you do not like Traditional Ethics please let me know of a better proven system—utilitarianism is not the answer. Regulators may be faced with dilemmas of choosing between supporting the market and protecting consumers but they must regard Traditional Ethics as being supreme—in whatever they choose to do they must not lie, deceive or act fraudulently. The end does not justify the means. 9.2 It should be a requirement of all those working in management in the financial services industry that they should be of good moral character and should be required to have a knowledge of Traditional Ethics to be taught in conjunction with any required knowledge of regulation. We must get away from the idea that just following the regulations is sufficient. 9.3 The Criminal Law must be used to ensure proper behaviour. At present it is not. Wrong-doers must be seen being sent to prison. There was the ridiculous spectacle of three bankers pleading to be prosecuted in this country rather than being extradited to a Texas gaol. The recent PPI scandal where policies were sold fraudulently has cost Lloyds Bank over £3 billion pounds but has anyone been disciplined let alone prosecuted for that fraud? Why has there been no criminal investigation into the Equitable Life reassurance treaty fraud? Is it because somebody on the Tripartite Committee said “Fix it and I don’t care how it is done.”? 9.4 The myth of being able to handle conflicts of interest needs to be dropped. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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9.5 There needs to be much greater restriction and surveillance in the derivatives market; research needs to be conducted to see what is proper and what should be disallowed. The present blanket permission to gamble on anything needs to be reviewed. 9.6 Usury is a complicated subject but present consumer credit legislation is far too liberal. We need to return to sensible and responsible lending for proper purposes. 9.7 Regulatory arbitrage needs to be controlled so that such can only taken place in countries where regulation actually works. 9.8 As I have said this raises questions of “Quis custodiet ipsos custodes”. The Parliamentary Ombudsman’s report “Equitable Life: a decade of regulatory failure” was a remarkable inquiry into and revelation of how the Regulators operated. It has been ﬁrm Government policy that no such inquiry should ever happen again. That is unacceptable. The regulators need to be accountable and Parliament needs to make sure that they are effectively accountable. That means that they must be accountable to a body such as the Parliamentary Ombudsman who have the resources to conduct inquiries. 23 August 2012

Written evidence from Professor Julia Black and Professor David Kershaw, London School of Economics and Political Science32 Summary The key points of our response are the following: — Whilst we agree that the imposition of criminal liability for directors of financial institutions would have an important signalling effect, we doubt whether it would have much impact on behaviour in practice over the long term for reasons which we specify. — If criminal liability were to be introduced, we think that the standard should be one of reckless or wilful breach and that it should apply to both directors and non-executive directors. — The introduction of a rebuttable presumption would not materially alter the current regulatory position. — The apparent reluctance of the FSA to take enforcement action against either firms or individuals for conduct related to the financial crisis is likely to be due to factors other than lack of enforcement powers or inadequately specified regulatory rules. — The scope of APER should only be extended on a case by case basis, but that some clarifications could be beneficial; however we support the proposal that those exercising significant influence functions should be subject to APER in the conduct of all their regulatory activities. — There should be greater dissemination of the standards of behaviour expected, for example by respected bodies such as the Institute of Directors, but that the introduction of a separate transnational, but mandatory, professional body is unlikely to be feasible or bring practical benefits. — The Commission should consider whether the burden of proof should be reversed in demonstrating compliance with APER, in an analogy to the situation under health and safety legislation (where it is for the firm and individual directors to demonstrate that there is a safe system of work). — The Commission should consider three further sets of reforms — Reforms to the duties of directors of ring fenced banks or those enjoying a “too big to fail” subsidy to require them to owe their duties to all their constituents, not just to shareholders, or alternatively to specify a hierarchy of interests—that they owe their duties primarily to deposit-holders, and secondarily to shareholders; — To bar directors of ring fenced banks or those enjoying a “too big to fail” subsidy to from being paid bonuses, or for the bonus policy to be akin to that in the public sector; and — The promotion of an ethical culture across the financial services industry through the development of targeted supervisory strategies, notably encouraging regulators to extend the FSA’s “treating customers fairly” approach to ethics and developing strategies of “ethical scenario analysis” and “ethical stress testing” throughout the firm in conjuction with senior management.

Responses to the Questionnaire The Parliamentary Commission on Banking Standards was established to consider and report on professional standards and culture of the UK banking sector. One element of the Commission’s work is to consider the 32 The authors are Professors of Law at the London School of Economics and Political Science, and are writing in their personal capacity. Note that the original text and questions posed by the Commission are in bold font throughout cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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sanctions (criminal, civil and regulatory) that can be imposed on directors and make recommendations for any legislative or regulatory changes that may be required. In order to aide evidence gathering, the Commission would welcome responses to the following questions by 11 January 2013.

Criminal Sanctions On 3 July 2013, HM Treasury published a proposal to create a new criminal offence of serious misconduct in the management of a bank. The proposal considered four main possibilities for the kind of managerial misconduct by bank directors and senior management that might be subject to new criminal sanctions: (i) Strict liability—being a director at the relevant time of a failed bank. (ii) Negligence—failure in a duty of care which leads to a reasonably foreseeable outcome. (iii) Incompetence—failure to act in accordance with professional standards or practices. (iv) Recklessness—failure to have sufﬁcient regard for the dangers posed to the safety and soundness of the ﬁrm concerned or for the possibility that there were such dangers.

1. What are your views on extending criminal sanctions to cover managerial misconduct by bank directors? 1.1 Some commentators (eg, P Ramsay, “The Responsible Subject As Citizen: Criminal Law, Democracy And The Welfare State” (2006) 69(1) Modern Law Review 29) argue that one of the primary reasons why we criminalise certain activity is because the state has a broader interest in deterring that activity which is distinct from providing justice or recompense to the persons who are directly injured. In this regard a case can be made that there is a role for the criminal law in regulating bank activity as when banks fails the costs imposed on society are enormous. The State’s interest in having a banking system that effectively intermediates savings and provides a payments systems provides such a distinctive “state interest”. Note however, that the extent of such a “state interest” varies with the nature of the financial institution: the more systemically important the financial institution the more apposite this justification. 1.2 A criminal offence for managerial failings would also amount to a strong signal of society’s disapproval of bank conduct that led us into the financial crisis. It would also, in the opinion of many citizens, address the view (whether or not this view is correct) that the scope of criminal law is in some sense unjust because it criminalises smaller scale misconduct but does not hold powerful businessmen responsible for the economic destruction wrought by the financial crisis. 1.3 The above considerations provide good reasons for introducing such a criminal offence but in our view one should not expect such an offence to have a notable impact on bank conduct and culture over the longer term. That does not, for the reasons given above, mean that such an offence should not be introduced, but it does mean that it should not be mistaken for an effective remedy for recent examples of bank misconduct and bank cultures that have fostered such behaviour. Although there are multiple corporate criminal offences that apply to companies more generally they are very rarely enforced. In our view more effective remedies are to be found in altering the still skewed incentive structure to which directors and senior managers are subject (generated by corporate law, not merely by methods of remuneration). We discuss this more fully in our answer to question 28 below. 1.4 Although some commentators argue that an effective enforcement deterrent (including using criminal law and significant periods of incarceration) is central to disciplining and improving bank behaviour there are several theoretical and practical reasons to doubt that this is the case. In this regard we make the following observations. 1.4.1 The extent to which any liability rule deters the targeted activity depends on: (i) the probability of being caught; (ii) the probability that an action will be brought if caught; (iii) the probability of being found liable in any suit or prosecution given the nature of the offence and the applicable burden of proof; and (iv) the consequences of being found liable. 1.4.2 Although this leads us into the territory of the next question, the standard that is adopted will have very significant effects on the probability that misconduct will be sanctioned and the effectiveness of a criminal offence as a deterrent. 1.4.3 Strict liability standard If a strict liability standard is adopted the deterrent effect is likely to be significant. But a strict liability standard for an individual director or senior manager that results in the significant criminal fines or incarceration would be draconian, and are unlikely to be imposed. In other areas of regulation where there are strict liability offences, for example in health and safety or environmental regulation, the result has been that the sanctions imposed have often been negligible. This weakens the deterrent effect and diminishing the stigma attached to the criminal liability standard. Indeed, the practice of imposing low fines for breaches of regulatory offences was criticised in the Hampton Review (Reducing Administrative Burdens; Effective Inspection and Enforcement 2005), and led to the BRE/Macrory Review of cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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regulatory sanctions (Regulatory Justice: Making Sanctions Effective, 2006), and in turn to the Regulatory Enforcement and Sanctions Act 2008, which expanded civil sanctions to compensate for the effective failure of criminal sanctions. 1.4.4 Negligence standard We also think it inappropriate to adopt a negligence standard for a criminal offence (note that the negligence and incompetence standard in the above list are, from a legal standpoint, aspects of the negligence standard). While negligence standards for corporate individual crimes are clearly not unheard of they are problematic for a number of reasons. (i) First, criminal offences are typically associated with very serious failings—ideas of recklessness or gross negligence resonate with such failings. Many might ask whether mere negligence is sufficiently culpable to warrant criminalisation. In a major study on the role of criminal law in regulatory regimes, the Law Commission recommended that criminal liability should only be imposed where there was a “harm related moral failure” and not simply to act as a deterrent. Individuals should not be subject to criminal liability unless their wrongdoing was knowing or reckless (Criminal Liability in Regulatory Contexts, CP 195, 2010, chapter 4 and para 8.11). (ii) Second—which goes to question 3 below—adopting a negligence standard could have a chilling effect. As bank failings are judged with hindsight, many managers would fear that their competent and reasonable risk taking activity may, with the benefit of the knowledge of failure, be judged more harshly after the fact. If that is the case it could result in extreme risk aversion by managers and directors, or their refusal to serve. In systemically important banks such aversion may be a good thing, however it would not be beneficial across the financial sector as a whole. More importantly, it is reasonable to think that such a standard enforced by the FCA would lead many managers to refuse to serve. Importantly, it will be the more risk-averse managers and directors who are more likely to refuse to serve which means that such a standard could paradoxically lead to only those who are risk- takers self-selecting to become members of bank boards, and thus a have negative effect on bank conduct from society’s perspective. (iii) Third, not all of the activities that created the financial crisis would contravene a negligence standard, indeed many may not. The reason for this is that a negligence standard judges a manager’s behaviour by the benchmark of the hypothetical reasonable average bank manager’s behaviour. If the managers’ peers are behaving in the same way, then although as a group of citizens we may view this behaviour as negligent, the court may not agree when applying the standard to the individual. (iv) Fourth, there is little reason to think that enforcement will be any higher if the standard is lower. Consider, for example, the criminal offence associated with financial assistance in section 156(7) Companies Act 1985 for which there is no reported criminal prosecution. It seems likely that one of the reasons for this is the difficulty of obtaining a conviction even though on the face of the statute the standard is a negligence standard. Of course, resource constraints of the prosecution authorities may be a relevant consideration as well (discussed below). 1.4.5 Recklessness standard Accordingly, if a criminal offence were to be introduced the preferable standard would be akin to one of recklessness (although one that is articulated differently to that above, which sounds rather similar to a negligence standard). In the US, for example, (Delaware Corporate Law) the civil care standard for directors is a gross negligence standard that deploys the idea of recklessness: “reckless indifference to or deliberate disregard to the whole body of shareholders”. The problem with a recklessness standard is that it is very difficult to prove, especially with a criminal burden of proof. This is particularly the case where risk management systems are in place and where the risk strategy adopted by the bank is a rational one for the bank and its shareholders (if not for society). Furthermore, even where the activity in question is clearly unlawful—such as with LIBOR rigging—managers can communicate preferences which result in misconduct without referring to or directing subordinate employees to engage in such misconduct. In such instances the possibility that managers will be found to fall foul of a recklessness standard are very low. 1.4.6 US experience Certain US commentators argue that there significant advantages in deterring wrongdoing by a strong public civil and criminal enforcement policy. In this regard it is clear that: (i) US authorities have long been more aggressive and have devoted more resources to their enforcement policy than UK authorities; (ii) US authorities aggressively deploy procedural means such as plea bargaining to obtain enforcement without trial which have either not been available or more difficult to deploy in the UK; and (iii) US criminal sanctions have been much more onerous than comparable UK sanctions—Jeffrey Skilling was sentenced to 24 years, Kenneth Lay 45 years, Bernie Madoff to 150 years. It is correct that by providing more resources to enforcement, by being more willing to deploy such enforcement tools, and by increasing the costs of being sanctioned (financially and long term loss of liberty) that the deterrent effect of a criminal offence is increased. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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1.4.7 However, it is also clear that even with such an enforcement outlook and sanctions the deterrent effect may remain weak when one factors in the probability of being caught and successfully prosecuted. One only has to consider many of the actions brought to light by the financial crisis and the Madoff scandal—which all occurred within the salient presence of the Enron, WorldCom and Martha Stewart criminal sentences—to see this. One view of the deterrent effect of criminal sanctions is that although the probability of being caught and sanctioned may in fact be very low that when a high profile person is successfully prosecuted this results in other market players overweighting the actual possibility that they too could be prosecuted. That is we have an irrational response to the fear of ending up like Jeffrey Skilling and therefore we are deterred. Empirically it is very difficult to assess whether there was such an effect on US managers post-Enron and WorldCom. We know only that in multiple instances this was not the case. 1.4.8 Costs In the UK the costs of enforcement actions are very high. One only has to look at the list of lawyers in the Pottage v FSA (which exonerated MR Pottage in relation to a £100,000 fine) to realise that the legal costs far exceeded the value of the fine in that case and that, more generally, market participants have very strong incentives to deploy their deep pockets to resist enforcement action. For a regulator to compete effectively with such deep pockets and to increase the probability of successful suit would require very significant increase in resource. Note also, as the Madoff scandal highlights even comparatively resource rich US regulators are subject to clear resource constraints that put them a significant disadvantage in identifying and understanding financial crime. 1.4.9 In summary, given (i) that a significant increase in enforcement resources is improbable, (ii) even if it occurred its effectiveness is limited, and (iii) that the harsh US-type sanctions are not likely to be deployed in the UK, we see that the behavioural effect of a criminal offence based on a recklessness-type standard will be modest at best.

2. What are your views on the possible formulations of a criminal offence based on options (i) to (iv)? 2.1 See 1.4.3–1.4.5 above.

3. Do you think that an offence based on one of those options would be likely to discourage those considering positions of leadership within banks? 3.1 It depends on the selected standard (see 1.4.3–1.4.5 above). If a negligence standard was selected then yes, it could discourage risk-averse individuals from considering leadership positions in banks, with paradoxical effects as noted above. A more onerous standard—such as a recklessness standard—could have a more limited effect in this regard. These effects could be muted if the offences were combined with a due diligence defence, as recommended by the Law Commission for offences relating to managerial conduct which do not involve fault on the part of the wrongdoer (Criminal Liability in Regulatory Contexts, para 8.14).

4. Will the possibility of criminalising behaviour which can already be sanctioned under Financial Services and Markets Act 2000 (FSMA) act as a greater deterrent? 4.1 As criminalising behaviour may result in harsher sentences—both ﬁnes and incarceration—and as a criminal record carries with it signiﬁcant and distinct social stigma, then the effect of criminalisation could increase the deterrent effect of an identical civil or regulatory sanction, but only if prosecution is likely to be successful and the sanctions are not negligible in practice, as noted above in the response to question 1.

5. Do you think that it is likely that the threat of criminal action will stiﬂe perfectly legitimate activity and ultimately deter growth in the banking sector? 5.1 See the response to question 3.

6. What are your views on the statement that there appears to be significant reluctance from regulators to take criminal prosecution against banks or individuals responsible for compliance functions? To the extent you agree with the statement, what, in your opinion, are the reasons for this reluctance? 6.1 We agree that this assessment is correct. Many of the reasons are discussed more fully in the answer to question 1. The reasons include: (i) significant asymmetries of skill and knowledge in understanding whether financial activity has broken the applicable rules; (ii) resource constraints and a pragmatic recognition that using resources on enforcement, although may generate media profile, may have a limited behavioural impact; (iii) the more demanding behavioural standards and the criminal burden of proof; (iv) a recognition that whatever the behavioural standard courts are unlikely to make a finding of criminal wrongdoing unless there is clear evidence of serious misconduct; cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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(v) limited and more problematic availability of procedural negotiating tools such as plea bargaining; (vi) possibly, a view that financial crime is not as morally culpable as other types of crime; (vii) a longstanding fear—which is being partially corrected—that aggressive regulatory action will damage the attractiveness of the UK’s financial industry; and, relatedly (viii) a political climate which was perceived as unsupportive of tough regulation of international financial institutions or their senior managers.

Civil and Regulatory Sanctions Rebuttable Presumption On 3 July 2012, HM Treasury published proposals to amend FSMA in order to put in place a rebuttable presumption that a director of a failed bank is not suitable to be approved by the regulator as someone who could hold a position as a senior executive in a bank. The Government also proposed two groups of “supporting measures”, which could be taken forward by the regulators under existing FSMA powers: (a) Introducing clearer regulatory requirements on individual responsibilities and the standards required of people performing certain key roles; or, in the alternative, a “firm-led approach” (with the onus on the firm and individual to set out a detailed written statement of the responsibilities and duties of each role); and (b) Requiring banks explicitly to run their affairs in a prudent manner, and requiring bank boards to notify the regulator where they become aware that there is a significant risk of the bank being unable to meet the threshold conditions for authorisation.

7. What are your views on the proposal to introduce a rebuttable presumption that the directors of failed banks are not suitable to hold senior executive positions in other financial institutions? 7.1 It is a reasonable proposal that would not exclude such an executive working again in the industry if s/ he could demonstrate that s/he was not culpable. However, as with the possible criminal offence discussed above one should not overstate the likely disciplinary effect of such a presumption. As the crisis has demonstrated, the leaders of failed banks will suffer significant reputational damage which means that even in the absence of a regulatory ban it is highly unlikely that they could ever work at any level in a bank again, and indeed for some to find work in any industry. From the perspective of the bank manager (prior to failure) the projected financial costs of failure for her/him personally are likely to be close to the same with or without such a rebuttable presumption. Accordingly, the behavioural impact of the presumption is neutral.

8. Does the rebuttable presumption go any further than the current regulatory regime? 8.1 It is formally different but substantively neutral given the current powers set forth in the Financial Services Act 2010.

9. Do you think that the introduction of the “rebuttable presumption” could discourage skilled individuals from accepting key management positions? 9.1 For the reasons set forth the answer to question 7 above we think the effect in this regard would be neutral. However, any introduction of a rebuttable presumption could be accompanied by a requirement for the regulators to review its operation after a period of time, such as ﬁve years.

10. Do you think introducing the presumption would send a clear message that bank senior executives and boards have a responsibility to ensure there is a strong focus on downside risks? 10.1 No more than currently exists.

11. What are your views on the possible supporting measures aimed at clarifying management responsibilities and changing the regulatory duties of bank directors? 11.1 This is currently possible under the existing arrangements for SYSC and APER and so arguably does not require new legislation. Moreover the FSA has indicated that both the FCA and PRA will be elaborating further on the responsibilities that approved persons holding significant influence functions will have in their respective rulebooks (CP 12/26). There is no clear need for further specification of these responsibilities in legislation, indeed given the significant disparities in size and management structures of firms regulated by each of the FCA and PRA, such specification is not recommended. However the Commission could encourage the regulators to specify these responsibilities further, and we address the question of whether APER should be amended or clarified in question 17 below. 11.2 The Commission could also encourage the regulators to engage with others bodies to help clarify and communicate their personal regulatory obligations more clearly and directly to senior managers. The practice of the UK Corporate Governance Code (eg, the Financial Reporting Council’s Guidance on Board Effectiveness) shows how useful it can be to provide directors with clear guidance as to what exactly they are cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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expected to do. Anecdotal evidence suggests that boards have largely welcomed this guidance. Such supporting measures may operate as a personal benchmark for directors and senior managers when performing the role as well as a benchmark for the periodic assessment of overall bank board effectiveness. Similarly, in the area of health and safety, where directors can be held criminally liable for breaches of health and safety legislation by their companies, the Health and Safety Executive has worked with the Institute of Directors to produce a clear set of guidance to directors and senior officers as to their responsibilities (IOD and HSE, Leading Health and Safety at Work, 2007). 11.3 The supporting measures which go beyond simply elaborating more rules should, therefore, be strongly supported. A hybrid approach would be best whereby the general guidance is set forth by the regulator, potentially in conjunction with leading representative organisations, but it is expected that the financial institution will engage directly with these supporting measures and tailor them to the nature of the financial institution’s business. 11.4 In addition imposing obligations on directors and senior managers to have to run the company in a prudent manner is something that should be considered. This could be addressed through APER (see below, para 17.6), and/or through the corporate objective applicable to banks according to UK corporate law. We address this point further in our answer to question 28.

Existing Regulatory Sanctions The Financial Services Act 2010 provided the FSA with greater enforcement powers. The FSA has the power to fine authorised persons and approved individuals for misconduct. The 2010 Act extended these powers to enable the FSA to suspend or limit an authorised person’s permission or an approved person’s approval. It also enabled the FSA to impose a fine on an individual performing a controlled function without approval in addition to being able to prohibit the individual from working in the financial services industry. It also included provisions in respect of the disclosure by the FSA of decision notices.

12. Despite the range of enforcement powers currently available to the FSA, are additional powers necessary? If so, what would those powers be? 12.1 As the Commission notes, the FSA already has powers to impose a range of sanctions on individuals, including public censure, imposition of ﬁnancial penalties and prohibiting that person from as acting as an approved person in the future, or for a period of time. It is not clear that any additional sanctions would act as a signiﬁcant deterrent to misconduct or otherwise encourage compliance. Other strategies have to be found. We address this more fully in question 28 below.

13. What are your views on amending FSMA to include a power to prohibit an individual from performing a controlled function on an interim basis? 13.1 The FSA has suggested that the FCA should also be able to suspend a person from acting as an approved person whilst it conducts investigation into approved persons. Whilst this would no doubt be useful to the regulators, and give them a more complete set of powers, it is difﬁcult to see that it would transform their ability to bring enforcement actions against individuals.

14. Considering the current powers and measures, do you think the perceived shortcomings in being able to hold individual directors personally culpable are as a result of statutory or regulatory deficits or as a result of regulators and law enforcement agencies not utilising the powers already available to them as fully as they could? 14.1 The FSA has brought cases against individuals for breach of APER provisions in the past, but it is clear that enforcement under APER has not proved to be a robust regulatory tool in the wake of the crisis. Just why so few enforcement actions against individuals for crisis-related failings have been brought is a question to which only the FSA can provide the answer. However a number of factors could be at play, many of which echo the arguments expressed in response to question 1 above. 14.2 First, the current provisions do provide considerable scope for regulators to take enforcement action for breach of APER, but each case is always going to turn on its facts. The selection of cases for enforcement brought by both the FSA and that of the Australian securities regulator, ASIC, suggests that certain types of breaches are easier to prove than others. Notably, misconduct which involves misleading statements, for example, is easier to demonstrate than misconduct which involves failures of oversight. In cases involving failures of the overall management system, and in a context of collective decision making, pinpointing individual culpability can be difficult, though not impossible, as the Cummings case illustrates. However, it is clear from the Pottage case that it is difficult to prove that there has been personal culpability for failure to supervise effectively where the individual is responsible for the oversight of complex operations being performed by numerous individuals often operating in a number of divisions, in a matrix management structure in which the functional requirements of managers based overseas can conflict with the regulatory requirements to which local operations are subject. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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14.3 Second, taking enforcement action is a risk. Any decision to take enforcement action has to involve an estimation of likely chances of success. As with any decision involving risk (and cost), decision makers can be risk-preferring or risk-avoiding. The benefits for the regulator of bringing a successful action have to be weighed against both the financial cost and reputational damage of bringing an action, but losing. 14.4 Third, taking enforcement action is costly. Again, it would be for the FSA to confirm the costs of an investigation such as that which led to the actions against Pottage or Cummings, but the costs both of investigation and of taking proceedings can be substantial. For example, as noted above, in the Pottage case, the FSA sought to impose a fine of £100,000 on the individual concerned. The level of the fine was dwarfed by the legal costs involved: in the Upper Tribunal the parties (including UBS) were represented by at total of two QCs, three counsel and two solicitors from leading City firms. Though the parties’ costs were not disclosed, they are likely to have exceeded the level of the fine sought by a considerable margin. 14.5 Fourth, given the risks and costs involved, there is a real question of how should resources be best allocated, and what the opportunity costs are in taking one enforcement action rather than another. During the period when it would have been pursuing those actions against individuals under APER the FSA has been bringing a number of other criminal prosecutions against individuals for insider dealing which have been successful. It has also been pursuing a significant number of PPI misselling cases against firms. It is impossible to say without knowing further details whether the FSA would have had sufficient financial and personnel resources to pursue these actions as well as pursue extensive actions against individuals under APER, and whether if it had brought more actions under APER that these would have been successful. It is also an open question as to why the FSA did not take enforcement actions against more firms for breaches of the Principles for Business, in particular Principles 2 and 3 (due skill and care, and adequate systems of management and controls). 14.6 In the likely event that real choices had to be made as to how to allocate limited enforcement resources, it could be that the FSA decided that risk-benefit calculation pointed more clearly in favour of pursuing cases which has done on the basis that these had a higher chance of success. Whilst the decision may have been rational narrow risk-benefit terms, politically it was probably a miscalculation. The reputational damage for the FSA in not bringing actions against individuals in RBS, for example, or indeed against financial institutions for breach of the Principles, has arguably been far greater than if it had brought enforcement actions which then failed on appeal.

15. What are your views on extending the limitation period for taking action against approved persons? 15.1 Under s.66(4) and (5) of FSMA, as amended by Financial Services Act 2010, the FSA cannot bring an action against an approved person after three years of the date that it “knew” the misconduct under the approved persons regime occurred. It is deemed to “know” of the misconduct if it “has information from which the misconduct may reasonably be inferred”. In contrast, there is no limitation period for bringing actions against firms for breaches of the rules. 15.2 Whilst the limitation period for individuals could be justified on the basis that individuals should be able to have certainty as to their potential exposure to regulatory liability, in other areas of law where liabilities are imposed on individuals, limitation periods are longer, particularly for criminal liability.33 In a review of limitation periods conducted in 2001, the Law Commission concluded that the law was unsatisfactory (Limitation of Actions, Law Com 270, HC 23, 2001). It recommended the introduction of a “core limitation period” which would apply to the majority of legal actions (with some adjustments for personal injury cases). This would consist of a primary three year limitation period, starting from the date that the claimant knew or ought reasonably to have known (i) that the cause of action had accrued, (ii) the identity of the relevant individual, and (iii) the scale of the loss or damage, and a long stop limitation period of 10 years, which would run from the action or omission which gave rise to the cause of action, unless the individual had dishonestly concealed the relevant facts. The Law Commission’s proposals were confined to actions in private law and have not been adopted, but its reasoning is still cogent. 15.3 There is clearly a balance to be struck between the interests of the individual in not being exposed to an extensive period of potential liability, and the public interest in ensuring that those who are subject to regulatory provisions, which are imposed to further public objectives, can be brought to account if they have breached those provisions. In the regulatory context, given the complexity of management structures and organisational decision making, particularly within large organisations, the delay that there can be in ascertaining that an individual may have been at fault, and the potential social cost that could be associated with compliance failures by individuals, there are good arguments for not curtailing the limitation period unduly. 15.4 However, there is no clear public evidence that the limitation period has operated as a bar to bringing actions. There is also no obvious indication from the FSA that the limitation period has hindered its ability to 33 Under the Limitation Act 1980, for example, the limitation period for claims in contract and for simple negligence cases is six years. For contracts agreed as a formal deed, it is 12 years. Under the Latent Damage Act 1986, the period is extended with respect to certain negligence claims where the damage is not evident at the time the negligence occurred (other than for personal injury claims), to six years from the date of accrual of the cause of action being raised; and three years from the earliest date on which the potential claimant knew, or reasonably ought to have known, material facts necessary to bring an action alleging negligence, subject to an overall limit of fifteen years from the accrual of damage. In addition, there are a number of other limitation periods relating to other causes of action, including those based on breach of statute. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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bring cases against approved persons for suspected misconduct. In particular, in its recent consultation paper on amendments to APER to be introduced by the FCA and PRA, the FSA did not raise the issue (FSA, Regulatory Reform: the PRA and FCA regimes for Approved Persons, CP 12/26, 2012). If, however, it has been the case that actions that could otherwise have been brought have been barred because of the provisions on limitation, then either the period could be extended, or the deﬁnition of the point at which the limitation period is set to run could be speciﬁed more closely in line with the Law Commission’s recommendation. For instance, it could specify that the period of three years starts to run from the time at which the relevant regulator (FCA or PRA) had information from which it could reasonably infer (i) that misconduct had occurred, through action or omission, by the relevant individual and (ii) the scale of the misconduct.34

Legislation versus Regulation 16. In order to make bank directors more accountable (due to the adverse impact a large failed bank can have on the wider economy), what are your views on amending the approved persons’ regime under FSMA rather than the Companies Act 2006 and the Insolvency Act 1986. To the extent you consider changes should be made to the legal framework, please articulate how you think this could be achieved given the legislation would apply to all company directors 16.1 It is recommended that any changes should be confined to the regulated sector. Any changes to the general law applicable to companies would run the risk of significant unintended consequences, and a separate inquiry would therefore be needed. Such an inquiry would have to encompass both the legal definition of the relevant duties, and the question of who should be empowered to bring action for their breach. One of the critical differences between the regime for financial regulation and that of company law in general is that there is a public agency responsible for the approval of appointments and enforcement of duties of directors and senior managers in financial services firms; there is no parallel public agency responsible for the enforcement of directors’ duties in general company law. Australia provides an example of where such an agency exists, the Australian Securities and Investments Commission (ASIC) acts as a regulator of companies and brings civil actions against company directors for failing to comply with their statutory duties of skill and care, for example. Any extension of APER-like provisions to directors and senior managers of companies more generally would have to consider whether a statutory agency such as ASIC would be needed to enforce those duties. Given the scale of the changes this would involve, it is recommended that the current inquiry confine itself to the regulated sector, ie firms which are to be authorised and regulated by FCA and PRA under the forthcoming legislation.

The Approved Persons’ Regime (APER) 17. The Upper Tribunal ruling in John Pottage v The FSA (FS/2010/0033) highlighted that enforcement action against senior managers is only likely to be successful where there is evidence of actual wrongdoing by the executive concerned. In your opinion, what changes could be made to some of the statements in APER about the standard of conduct expected of directors in order to make it easier to bring enforcement? 17.1 Both SYSC and APER both contain provisions requiring firms to detail the responsibilities of approved persons, particularly those occupying significant influence functions, and APER contains quite extensive guidance as to what the Statements of Principle require. Given the significant variety of firms to which APER applies, it is always going to be difficult to specify the standards of conduct expected with any great precision.

Reforms to the APER regime 17.2 There are nevertheless some enhancements to the APER regime which could be beneficial. Some are already proposed in the Bill; others could be achieved through changes to the APER provisions themselves by the incoming regulators (FCA and PRA). 17.3 First, the Bill provides for an extension of the scope of the APER regime to cover regulated activities performed by a SIF outside the functions for which they are approved. This is a sensible measure which avoids complicated and impractical distinctions having to be made as to what aspects of a person’s role fall within or outside their controlled activities. 17.4 Secondly, the guidance relating to the threshold conditions for approval and the APER regime could make it clearer that the fact that a person had been a SIF in a failed financial institution would be a material factor in determining whether or not to grant approval. 17.5 Thirdly, the Statements of Principle require all approved persons to deal with the FSA in an open and cooperative way. The evidential provisions accompanying the Principle require those with responsibility reporting to the FSA to disclose any information which could reasonably be supposed to be of “material significance” to the regulator (APER 4.4). These could be amended to make it clear that all SIFS, whether reporting to the regulators is within the scope of their controlled function or not, are under an obligation to report if there is a significant risk that the firm is or is likely to soon be unable to meet its threshold conditions. 34 The requirement (as at present) that the regulator actually has the information addresses the issue of concealment, dishonest or otherwise, for if it the information had been concealed, the regulator would not be in possession of it. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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17.6 Fourth, the Statements of Principle could be amended to include a requirement for prudent management of the firm’s business, as well as a requirement to exercise due skill, care and diligence. This would bring them in line with the Principles for Business which apply to firms as a whole (and which it is recommended should be kept by both FCA and PRA, albeit with amendments to reflect their new remits and objectives). Whilst this duty could be inferred from the current Statements of Principle, stating it explicitly would serve to emphasise its importance and raise awareness.

17.7 Fifth, the obligations of SIFs (those occupying significant influence functions) within ring-fenced banks could be separately defined under the PRA (and where relevant, FCA) APER regime. Given that SIFs of ring fenced banks (RFBs) will be a clearly defined sub-set of the regulated population, it should be possible to craft more specific rules or guidance as to what standards of conduct are required from those holding these positions. We develop this point further in the response to question 28.

Changes to the burden of proof

17.8 The burden of proof could be reversed, both in cases relating to breaches of the Principles for Business and for breaches of the APER regime. An important precedent provided by the Health and Safety at Work Act 1974, s.40. This provides: “In any proceedings for an offence under any of the relevant statutory provisions consisting of a failure to comply with a duty or requirement to do something so far as is practicable or so far as is reasonably practicable, or to use the best practicable means to do something, it shall be for the accused to prove (as the case may be) that it was not practicable or not reasonably practicable to do more than was in fact done to satisfy the duty or requirement, or that there was no better practicable means than was in fact used to satisfy the duty or requirement.”

Under this proposal, it would be for individuals or ﬁrms to demonstrate that the actions they took were reasonable, rather than for the regulator to prove that they were not. Such a change would have to be made by legislation.

Consciousness-raising

17.9 The third reform relates not to the specification and definition of senior management responsibilities but to their communication and promotion. We referred above to the HSE’s collaboration with the Institute of Directors (IoD) to produce guidance leaflets setting out the responsibilities of senior managers in clear and intelligible language, using practical examples (para 11.2). The engagement of organisations such as the IoD in helping to communicate the nature of senior management obligations and their importance could play an important role in raising awareness.

18.1 Both SYSC and APER already require firms to document clearly the different responsibilities and remits of each approved person. In particular, SYSC 2.1 already requires firms to: “take reasonable care to maintain a clear and appropriate apportionment of significant responsibilities among its directors and senior managers in such a way that: (1) it is clear who has which of those responsibilities; and (2) the business and affairs of the firm can be adequately monitored and controlled by the directors, relevant senior managershttp://fsahandbook.info/FSA/glossary-html/handbook/Glossary/ S?definition=G1065 and governing body of the firm”.

18.2 SYSC 2.2 requires these arrangements to be documented and for those documents to be kept up to date. In addition, APER 4.5 requires a SIF to ensure that the business of the ﬁrm for which he or she is responsible can be controlled effectively. This includes a provision to take reasonable steps to apportion responsibilites effectively. It is difﬁcult to see how the rules could be clearer in this regard.

19.1 The FSA has adopted a more intrusive approach for the last 2–3 years, when it started interviewing those who were to be appointed to SIF positions, and in a number of cases refusing to accept appointments which the ﬁrm wanted to make. Given the importance of effective internal governance in ensuring that the public policy objectives of the legislation are met, such an intrusive approach is justiﬁable. However, it is a matter for supervisory practice rather than legislation. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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20. Do you see merit in requiring the regulator to re-appraise SIF individuals at set intervals and on other occasions if it believes that circumstances justify it. 20.1 Whilst this should be good supervisory practice, it is difﬁcult to see what enshrining this requirement in legislation would add to the current supervisory framework.

21. What are your views on extending APER so that it applies to all bank employees in order to enable the regulator to take disciplinary action against employees who are currently outside the scope of APER? 21.1 The argument in favour of extending APER to all employees, including traders for example, could be that each employee is under a personal obligation to uphold certain regulatory principles and responsibilities. To this extent, it would be akin to the individual obligations held by members of professional bodies, such as lawyers or accountants. 21.2 There is clearly a significant need to raise standards of conduct across the industry, and extending personal liability could at first sight appear to be a potential way to achieve that. However, it is unlikely that the regulator will have the resources to bring actions for breaches by individuals, and indeed the most appropriate actor to impose disciplinary measures should be the firm itself. Further, it is not clear that it would be appropriate for the APER regime to apply indiscriminately to all employees—should it include those working in the office canteen, for example? If the main concern is that APER should be extended so as to catch certain groups of employees, such as traders, then a better approach would be to extend the categories of approved persons on a case by case basis.

22. Do you see merit in the establishment of an independent professional body with mandatory membership which has the power to impose civil and possibly criminal sanctions? In your view, could such a body provide a solution for the issue of global matrix management structures that can exist within universal banks? 22.1 The argument for creating such a body would presumably be that it would be an attempt to create and infuse a sense of professional responsibility into senior managers, comprising both high standards of competence and a strong sense of ethics. 22.2 Whilst high standards of professionalism are clearly desirable aims to have, it is far from clear how the creation of such a body could achieve them. At the very least, there are a number of practical and legal difficulties which would have to be overcome. 22.3 If such a body were to address the difficulties of extra-territoriality and global matrix management structures, it could not be based in the laws of any one national jurisdiction. It would have to be either based in treaty (which is highly unlikely), or an international organisation akin to the current global regulatory committees, or a self-regulatory body which operates transnationally. In either of the latter two cases it would be operating on the basis of soft law. It could be the case that one of the international committees requires its members to enact a legal obligation to require all senior managers in all authorised firms in their jurisdiction to be a member of such a body, but the difficulty is that there is no single international regulatory committee which covers all jurisdictions and all financial sectors. It is therefore very difficult to see how membership of any such body could be made legally mandatory on a global basis. 22.4 Even if such a body were to be created within the UK, where membership could be made mandatory, it is difficult to see what the creation of such a body would add to the existing regulatory regime. Particularly for those individuals in firms which are dual-regulated by both PRA and FCA, the introduction of a third regulatory body which would be imposing the same duties would add an unnecessary level of complexity. There would also be the risk of double jeopardy if each were to bring enforcement actions under similar rules with respect to the same acts or omissions. Further, if there were a difference between the rules of the professional body and those of the jurisdiction in which the individual member were operating, then the individual would necessarily find themselves in the situation in which compliance with one set of rules would put them in breach of another. It is difficult to see how this would be an improvement on the current situation.

Cost 23. Understandably, there is considerable cost in pursuing individual actions. What changes do you think could be made in order to ensure that cost does not act as a deterrent in pursuing all but the largest cases? 23.1 Unless a cap were imposed on the fees that lawyers representing both regulators and defendants could charge, it is difficult to see how overall costs can be constrained. As noted above (para 1.4.8), in the Pottage case, seven senior lawyers acted as representatives for parties in the Upper Tribunal alone: one QC and counsel for the FSA, one QC and counsel for Pottage, and three counsel and two solicitors for UBS. The costs are likely to have exceeded by significant measure the £100,000 sought in fines. 23.2 Whilst overall costs are difficult to contain, there are different options for how those costs are allocated. (i) Defendant pays—requiring the defendant to pay the regulators’ costs regardless of the outcome of the case has the advantage of ensuring that the regulators’ costs are always covered, but could have perverse incentive effects if left to operate untrammelled: regulators could be cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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incentivised to pursue weaker cases, secure in the knowledge that their costs will always be covered by the other side. It would also be regressive, with the costs burden having a greater impact on smaller firms. (ii) Loser pays—this is broadly the position at common law and has the advantage of ensuring that the regulator only takes cases which have a good chance of success, though it may act as a deterrent to taking more marginal cases, particularly against large firms who are likely to run up significant legal costs which the regulator risks bearing should it lose. (iii) Each bears their own—requiring each side to bear their own costs regardless of the outcome has the advantage of helping each side to have greater control over the costs it will ultimately bear, even if it will not limit costs overall, and is likely to have the least adverse incentive effects on regulators to bring enforcement actions. As noted, these options as to allocation of cost would not of themselves address the overall level of cost of taking enforcement actions, however.

International 24. Do you think introducing additional criminal, civil or regulatory sanctions would have an impact on the international competitiveness of UK banks? Only if such standards resulted in the hiring of sub-standard managers. For the reasons outlined in the response to question 1 above it would depend on the selected standard as well as on any efforts to improve the level of resources provided to the UK regulators for effective enforcement.

25. In your opinion, are there other legal or regulatory regimes that the Commission should be considering? Please provide your reasons for suggesting the applicable regime. 25.1 The Australian Securities and Investments Commission (ASIC) mentioned above (para 16.1), provides an example of a public agency which is responsible for taking actions against directors and ofﬁcers for breaches of duty. An analysis of their experience in bringing such actions, and on any effect it may have had on the incentives for individuals to become directors, could provide a useful comparison.

Other 26. The regulator has an extensive range of enforcement powers but is arguably hesitant in using those powers. What are your views on the introduction of sanction(s) that could be imposed against the regulator to the extent they do not deploy their powers appropriately? 26.1 There are three key questions to be addressed: (i) who would have the power to bring an action to impose the sanctions, (ii) what those sanctions should be, and (iii) which body should determine whether or not they should be imposed. 26.2 In constitutional terms, in order to preserve the independence of the regulator, any determination of whether or not a sanction should be imposed should lie with the courts, not with the executive or with Parliament. Giving the executive or legislature powers to sanction regulators would be a signiﬁcant compromise of the principle of independent regulation, which has become so embedded that the House of Lords Committee on Regulators has described it a “quasi-constitutional principle” (Report on UK Economic Regulators, HL 189- I, para 6.44). 26.3 Regulators are already subject to accountability through the courts. Enforcement decisions against individuals or ﬁrms by the FSA (and incoming regulators) are appealable to the Upper Tribunal and then to the Court of Appeal. Statutory regulators are also public bodies and as such subject to public law. There is already the possibility of bringing an action in public law against public authorities for failure to perform their statutory duties. However the courts have been understandably reluctant in to hold that public authorities should have taken certain actions, such as arrest suspects sooner, but failed to do so. As for who can bring such actions, the rules of standing to bring actions in public law are wide, and so it is open to any interested party to bring such an action within the relevant time-limits. 26.4 In addition, regulators are already subject to a wide array of non-judicial accountability arrangements, including to Parliament, and if legislation so permits, are subject to scrutiny by the NAO. Moreover, the executive and legislature together have the ultimate sanction—they can abolish the organisation altogether, as they have with the FSA. Therefore we do not agree that regulators should be subject to any additional sanctions, and would argue strongly against any sanctions which contravened the principle of independent regulation.

27. What are your views on applying different sanctions for different types of directors—for example, non- executive directors? 27.1 Sanctions necessarily take account of the role and function of a director and therefore will vary in application as between executive and non-executive directors. If the question is concerned with whether cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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criminal liability should only be applicable to some types of director—say executive rather than non-executive, then there are reasons both for and against this. It may be justiﬁable to exclude part time non-executives from such a criminal regime as they are not likely to be responsible directly for the actual misconduct in question and, because of the limited remuneration for these positions, may be more likely to be deterred from service. On the other hand, egregious failures to monitor and discipline executive directors or to respond to red ﬂags or to ensure that control systems are in place may be just as blameworthy as operational misconduct and clearly have grave social implications. Whether it is appropriate to exclude non-executive directors is a function of the selected standard. If the standard is a demanding negligence standard of criminal liability then on balance we would argue that they should be excluded. If the standard is a recklessness or higher fault-based standard the arguments may be tipped in favour of not making any distinction between executive and non-executive directors.

28. Are there any other measures or legal/regulatory changes that the Commission should consider? 28.1 We consider that there are three key sets of measures that the Commission should consider. These relate to: — Redeﬁnition of corporate objectives and identiﬁcation of to whom directors own their duties, with particular recommendations for ring fenced banks. — Remuneration for managers, particularly in ring fenced banks. — Culture and ethics.

Structural Incentives and Risk Taking: objectives and duties 28.2 In our view there is much scope to improve bank conduct and culture by more effectively addressing the ex-ante incentives of banks and their managers and directors rather than by focusing on less effective ex- post liability rules—whether criminal or civil. By incentives we refer to much more than the remuneration arrangements of managers and bank employees, though we would include these. Note also that when we think about these incentive arrangements we need to ask whether we need different incentive structures for banks that are deemed to be systemically important. The imposition of additional corporate governance arrangements for regulated financial institutions under SYSC and APER recognises that financial institutions are in many ways “special” and so require additional regulation beyond the corporate governance requirements that apply to companies in general. We would argue that systemically important institutions, and in particular ring fenced banks, are even more “special”. 28.3 We would argue that the structural incentives generated by UK corporate law are worthy of further consideration by the Commission, at least within the context of the regulated financial sector. UK company law is often described by as shareholder friendly as compared to other corporate law regimes, such as those found in the United States or in Germany. This view is correct. For example, in the United Kingdom in all companies, including banks and financial institutions, the directors must exercise corporate powers to promote the interest of shareholders. When the company is solvent, the interests of other groups such as those of creditors, employees and society at large should be considered and taken into account by directors but only to the extent that they further the interests of shareholders. The corporate objective in the UK is correctly described as a shareholder primacy objective, sometimes referred to the UK as enlightened shareholder value objective. In many other jurisdictions, both continental European and American, the corporate objective which directors should pursue is better described as a pluralistic or multiple interest objective, where the interests of shareholders, creditors and employees are to be balanced with no one constituency is given overall priority. When it comes to shareholder rights the UK is firmly situated at the shareholder primacy end of the spectrum. For example, shareholders have mandatory rights to remove directors without cause by simple majority vote and 5% of the shareholder body may instruct the board to call a meeting. Again in the US and the Germany the rights given to shareholders are less powerful. 28.4 One response to the crisis has been to call for greater shareholder involvement (see, eg., the UK Stewardship Code and in some instances for more shareholder rights (see, for example, US “say on pay” rights). However, there is good reason to doubt the appropriateness of this strategy in relation to banks and some empirical evidence to support these doubts. Shareholders in banks that benefit from the States “too-big- to-fail” (TBTF) subsidy have the wrong risk taking incentives. It is well known that shareholders who benefit from limited liability have an incentive to increase the risk profile of the company in which they hold shares. In non-financial companies this is not thought to be problematic as the debt providers discipline any attempt to increase the risk profile of the company. But in banks that benefit from the TBTF subsidy creditors do not discipline the banks because they assume they will get repaid even if the banks fail—because the State provides formal (deposit insurance) and uncosted informal guarantees. Importantly, this means that for a diversified shareholders it may be rational to encourage managers to “bet the bank”. For managers whose are required to promote the success of the company for the benefit of the shareholders they comply with their duties if they increase the banks risk profile at the expense of the ultimate non-adjusting creditor—the state. 28.5 This means that within systemically important banks that benefit from the TBTF subsidy the focus on shareholder value and rights in UK company law is not appropriate. Accordingly, there is concern that UK company law gives legitimacy to the very activity that we want to discourage and provides legal support for cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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the culture which needs to be changed. If diversified shareholders have the wrong incentives in TBTF banks we must ask what sense it makes to priortize the interests of bank shareholders over the interests of other constituencies—most importantly depositors and the State. 28.6 We should also consider whether it would make sense not to strengthen shareholder rights in such banks but to weaken them. There is some empirical support for the view that strong shareholder rights increase bank risk taking and the probability of bank failure. Ferriera, Kershaw, Kirchmaier and Schuster (“Shareholder Empowerment and Bank Bail Outs” available at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2170392) show that in the United States banks with stronger shareholder rights were more likely to be bailed out that those with weaker shareholder rights and more likely to engage in riskier banking activities. In the United States core corporate law rights—such as rights of removal and the right to call a shareholder meeting are optional. This means that it is possible to identify banks with weaker shareholder rights that are very different to UK banks and banks with stronger shareholder rights more similar to the UK position. This paper codes the weaker and stronger banks and then analyses the comparative probability that these different banks will be bailed out. This finding may be subject to different interpretations discussed in the paper, but an important possible explanation is that direct or indirect shareholder pressure supported by strong shareholder rights results in more risk taking than in banks with weaker shareholder rights where managers could resist that pressure. 28.7 There is therefore a case to revisit the effect of corporate law on bank conduct. In particular, we suggest that there is a need to consider whether directors of regulated financial institutions, or a sub-sector of them, should be required to give equal weighting to the interests of all corporate constituencies when they act and to correspondingly consider whether it would be appropriate to weaken shareholder rights in financial institutions that have such a corporate objective (D. Awrey, M. Blair and D. Kershaw, “Between Law and Markets: Is there a Role for Culture and Ethics in Financial Regulation, available at: http://papers.ssrn.com/sol3/ papers.cfm?abstract_id=2157588). For example, the shareholders right to remove directors in the middle of their term could require a simple majority of the outstanding shares rather than a majority of the votes cast at the meeting. 28.8 It may be that if such changes are deemed worthy of exploration further consideration should be given to whether they should only be applicable to ring-fenced banks or to financial institutions that benefit from a TBTF subsidy as it is only in those banks where the shareholder focus generates these incentive problems. 28.9 It could be argued that by requiring directors to owe their duties to everyone, they will in effect hold them to no one, as those interests are often likely to conflict. Whilst we do not agree that this argument is fatal to the proposal, an alternative option could be to specify the hierarchy of interests to whom directors of banks, or at least ring-fence banks, own their duties. The crisis made a number of features of the financial system clear, one of which was that the interests of shareholders in banks are diametrically opposed to those of deposit- holders. Shareholders have a limited amount to lose and everything to gain from the risk-taking of mangers. Deposit-holders have everything to lose and very little to gain. 28.10 It could therefore be specified in legislation that directors of ring-fenced banks owe their duties primarily to deposit-holders, and only secondarily to shareholders. It is recommended that this amendment apply to the directors of ring-fenced banks, as they are a clearly definable set of institutions, and it is those banks which are in effect underwritten by the tax-payer. Requiring directors to owe their duties to deposit holders would make it clear that they were not to engage in conduct which, although profitable, could ultimately harm deposit-holders. It would also give leverage to regulators who through their supervisory interventions require the bank to act or to refrain from acting in certain ways, as banks would not be able to argue that their behaviour was justified in the interests of shareholders. 28.11 There are examples from other jurisdictions where companies themselves have, in agreement with regulators, amended their hierarchy of duties. In Australia, the legal services regulators have required Australia’s two publicly listed legal practices to state in their prospectuses, constituent documents and shareholder agreements that their primary duty is to the court; their secondary duty is to the client; their tertiary duty is to the shareholder; and that where there is a clash between the Legal Profession Act 2004 (under which lawyers owe their primary duty to the court) and the Corporations Act 2001 (under which directors owe their duties to their shareholders), the former will prevail. 28.12 The Australian position is not completely satisfactory, as their remains a tension between two sets of legislative provisions. However it does provide an illustration of how legislation could be used to realign the duties of directors, at least in ring-fenced banks, so as to bring them closer in line with the public policy objectives that the regulatory regime is seeking to pursue.

Remuneration in Systemically Important Banks 28.13 Regulating remuneration has clearly been at the forefront of regulatory responses to the crisis. The primary regulatory response has been to ensure that bank remuneration is aligned with long term economic interests of bank and bank shareholders. For example, to limit cash bonus payments and other performance related pay and to ensure that bonuses and other performance based remuneration vests or is paid over a longer period of time. However, there is still a case to revisit remuneration regulation in relation to the most systemically important banks, which for these purposes we assume are the ring fenced banks. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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28.14 Any performance-based pay arrangements that are linked to financial or equity based targets generate incentives to exploit the TBTF subsidy and incentives to engage in socially excessive risk taking. This is the case in a ring fenced retail bank as it is in any current universal bank. As HBOS but also Lehman show, socially excessive risk taking can take place through commercial lending activity. 28.15 If a primary goal of regulation is to ensure that a core set of retail banks can perform basic financial intermediation and provide a reliable payments system, then the Commission should consider whether in these ring fenced banks senior management should only be paid by salary with no bonus or performance related pay at all or at most the sort of bonus structure that would be payable in the public sector. It would also need to provide that any pension provision could not vest prior to retirement age or unexpected ill health. Such banks would be less innovative, daring and creative. But they are likely to be safe. Their managers would have incentives to keep shareholders happy but not to take unwarranted risk that could jeopardize what for them would be the most important asset: keeping their job in a solvent bank. Such managers would not be interested in exploiting any gaps in the ring fence or allowing a connected investment bank to influence the ring fenced retail bank’s activities. Indeed it is likely to drive separation—but internally by the individuals who know the banks rather than by regulators who are inevitably at a significant informational disadvantage. See generally: D. Kershaw, T Kirchmaier and E Schuster, “Its About the Incentives, Stupid” available at: http://www2.lse.ac.uk/ newsAndMedia/commentAndOpinion/2012/07/ItsAboutTheIncentivesStupid.aspx

Culture and Ethics 28.16 There is an increasing acceptance by senior bankers, at the level of rhetoric at least, that the industry needs to build a more ethical culture. However, building ethical cultures is not easy, and is hard to reconcile with the “eat what you kill” or even “devour your own young” culture of the financial industry. Ethical behaviour is “other regarding” behaviour, eg behaviour which marked by integrity and fair dealing, acting in the best interests of clients and being aware that your actions may have consequences for non-contracting parties. 28.17 Obligations to uphold such standards of behaviour have been in place in the regulatory realm for nearly 25 years- they were first articulated in regulatory rules in 1988, and have been present in equitable duties for far longer. Nonetheless, what it means to behave “ethically” to investors is contested. In the retail markets, for every claim by the regulator that firms have failed in their suitability obligations, for example, there is a counter-claim by firms that regulators are imposing retrospective regulation. In the wholesale markets, any deviation from “caveat emptor” is closely contested. One person’s misselling is another’s fair market transaction. 28.18 So to build an ethical culture two things are needed: to build an agreement on just what “ethical behaviour” requires in any particular instance, and to develop organisational cultures in which those principles are upheld. As to how regulation can help to build an ethical culture, from decades of research into organisational behaviour, including regulatory compliance, we know the following: (i) that for both individuals and organisations, behaviour is shaped by the interaction of internal and external factors. For individuals those internal factors are their own ethical sense; for organisations it is its own structures, systems and culture. External factors in both cases arise from the social and market context in which those individuals and organisations interact with one another; (ii) that as a result of this interaction, an individuals’ personal ethical sense is socially derived—it is shaped by immediate interpersonal interactions and by broader social factors—in particular those of the organisations in which they work; (iii) with respect to organisations’ ethical culture—the “ethical whole” is not the sum of the parts, ie, it is not the sum of the ethical cultures of those individuals within the organisation. Organisations are comprised of individuals, but individuals alone cannot necessarily withstand the structures, processes and ethos of the organisation. As a result, those who may be quite ethical in their lives outside work may behave unethically in their professional lives. We have seen how organisational structures and processes reinforce self-interested norms rather than those which are “other-interested”—notably remuneration structures. After decades of misselling banks are finally realising that paying salespeople by volume can be counter- productive for the firm, not just contrary to the interests of investors; (iv) that for cultural change to occur, it has to come from the top, and it has to be “mainstreamed” throughout the organisation, not siloed off into “compliance” or “risk” divisions, but even if senior management do attempt to introduce change, organisations are difficult things to manage and to run—the leaders of large organisations face the same problem as regulators do in attempting to “manage at a distance”—problems of scale and scope, complexity and delegation. Further, what it means to be “ethical” is not always clear; and (vii) as a result, organisations send contradictory signals about what behaviour is expected; those lower down may not trust senior management to behave ethically themselves either to clients or internally, and their HR practices can reinforce this lack of trust—for example, employees at UBS recently found out they had been sacked because their passes did not work in the morning—not an HR strategy which obviously demonstrates a “caring” culture which builds loyalty. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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28.19 Thus whilst the primary driver of ethical culture has to be the ﬁrm itself, regulators have a role in promoting that culture in a number of ways.

28.20 First, there needs to be far closer supervisory attention to internal processes, systems and structures. Admirably the FSA has been an innovator in using regulatory techniques to improve culture in retail investment firms. The FSA’s “Treating Customers Fairly’ initiative is designed to use firm knowledge and resources to design systems and processes which ensure compliance with the general objectives specified by the FSA (See J Black, “The Rise (and Fall?) of Principles Based Regulation” in K Alexander and N Moloney (eds) Law Reform and Financial Markets (Cheltenham: Edward Elgar, 2011); J Black “Outcomes Focused Regulation— The Historical Context” in A Hopper QC and G Treverton-Jones QC, Outcomes-Focused Regulation (The Law Society, London, 2011). Through a combination of management by-in, FSA enforcement action and the conversations and engagement by employees with process design it is thought (hoped) that cultural norms consistent with the specified objectives will form and become embedded with the firm. We think that there is clear scope to extend this project into other areas of financial services, including wholesale activities (see D Awrey, M Blair and D Kershaw, “Between Law and Markets: Is there a Role for Culture and Ethics in Financial Regulation, available at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2157588).

28.21 Second, there needs to be greater supervisory attention to building a common set of expectations as to what ethical behaviour consists of in different situations. Ethical scenario analysis and ethical stress-testing within organisations could be a way for regulators and firms to examine and address ethical weaknesses, in much the same way as it is used in other areas of risk management. The results could have implications for regulatory strategy and serve to increase awareness within organisations. In order to ensure consistency across the industry, there would need to be agreement on the most ethical conduct and outcomes in the scenarios to be tested—a likely difficulty given how difficult it is to define ethics but the approach could at least raise the profile of ethics within firms and across the industry as a whole, and form part of its dialogue with regulators. 11 January 2013

Written evidence from Board Intelligence — Board Intelligence provides services to boards and executive committees to drive board effectiveness and improve the quality of decision making. We specialise in improving the scope and quality of the information that board directors receive and with which they formulate their judgement and challenge. — We have reviewed over 80 board packs in the past year alone from a range of sectors (including, but not limited to ﬁnancial services). We observe board meetings to help us tailor our solutions to the speciﬁc needs of each client and as such we have considerable exposure to current practice within the boardroom. — We welcome the opportunity to participate in the Parliamentary Commission on Banking Standards Inquiry.

Response Summary

We have limited our consultation response to those issues about which we feel qualiﬁed to comment. Our response is therefore limited to elements of questions 4 and 5 as set out by the Commission.

1. Question 4: What caused any problems in banking standards and the weaknesses in corporate governance?

And question 5: What can and should be done about it?

Since the financial crisis, the governance of banks has rightly been in the spotlight but we believe this spotlight has been too narrowly cast, being focused almost exclusively on board composition. In our view, there are four other factors that have inhibited board effectiveness and that warrant a greater profile in the debate: (a) Firstly, most boards are blindfolded as they do not receive adequate information. (b) Secondly, the challenge of “seeing what matters” is compounded by the complexity of many large banks. Expectations on any board are arguably superhuman, but the scale and complexity of the financial service conglomerates creates an additional strain. (c) Thirdly, we believe that the way boards spend their time is inefficient: by habit and convention, too much of it is spent in board meetings and the time that is spent in board meetings is rarely used to great effect. (d) And finally, we observe a number of weaknesses in the unitary board structure, including the challenge it presents for the non-executive, given the very people they are there to supervise are peers of equal status. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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2. Question 4: What caused any problems in banking standards and weaknesses in whistle blowing? And question 5: What can and should be done about it? We propose two ideas as food for thought, in addressing the weaknesses in the arrangements for whistleblowing: (a) The establishment of an Ombudsman Program by Pfizer provides an independent and neutral channel through which employees can raise issues in confidence, similar to the role that is performed by the Partners’ Counsellor within the John Lewis Partnership. (b) The roll-out of a programme of continuous employee insight sourcing (with a cross section of the workforce polled every month and all employees polled at least twice a year) creates a culture of openness and, in line with Richard Thaler’s “nudge” theory, it makes it easier for employees to raise matters of concern. We do not propose that legislation or regulation should mandate such practices, but we wish to raise the profile of best practice and its benefits.

Full Response 1. What caused any problems in banking standards and the weaknesses in corporate governance? What can and should be done about it? 1.1. The sheer number of near-death experiences and compliance scandals that have afflicted the banking sector in recent years suggests systemic failure amongst boards as company supervisors and stewards. Following each scandal, the conclusion has been drawn that the people on the board were the wrong people. By extension, appointing the right people (with the right skills, experience, commitment and diversity) has widely been proclaimed as the answer to an effective board. 1.2. It is our belief that this is an incomplete analysis and that the focus of attention has been cast too narrowly on board composition. We would like to raise the profile of four additional factors that we believe impede the effectiveness of banking boards and that should feature more prominently in the debate: (a) The inadequacy of the information boards receive (b) The scale and complexity of many financial institutions (c) The way boards allocate and manage their time (d) The pitfalls of the unitary board structure These four challenges are shared by the boards of companies in every sector, however, many are particularly acute in banks, and still more so in large banks. (a) The inadequacy of the information boards receive 1.3. No matter how knowledgeable, experienced and diverse a board of directors may be, they are effectively blindfolded until they are provided with the information around which they formulate their judgment and challenge. 1.4. “Information risk” is arguably one of the biggest risks faced by the board: our banks have not been plunged into crisis because of a lack of problem-solving prowess—but because, for far too long, they didn’t know they had a problem. The principal source of information for most non-executives (outside of the board meeting) is the board pack and in our experience, the state of most company board packs does little to mitigate this risk. To highlight a few of the most widespread failings of company board packs: 1.4.1. Size: They are too big to read: A FTSE 100 board pack averages 288 pages (excluding committee papers) which would take over nine hours to read35—and yet directors admit that they allocate just three hours. The problem is even more acute amongst FSA regulated firms, as management strives to disclose every possible detail that (in hindsight) the regulator may have deemed relevant to the board. Banking boards are drowning in paperwork and it is a monumental challenge for any director to digest their briefing papers, let alone discern what really matters at any point in time. 1.4.2. Scope: The content is too narrow in focus: Board packs are heavily weighted towards backward- looking financials and operational detail, providing little (if any) stimulus for a more strategic discussion in the boardroom. 1.4.3. Style: The reports are impenetrable: One director aptly described their board pack as “an obstacle to clear thinking”. 1.5. We work with the boards of some of the UK’s largest companies (usually at the behest of an executive team wanting to empower their board), where the quality of the boardroom conversation has been transformed by equipping the directors with the information they need. With the right scope and quality of information, presented in a concise and readable fashion, the board is demonstrably more effective. The directors are then better placed to supervise and ask the pertinent questions about the things that really matter. And when it comes to strategy, they have the requisite stimulus around which to add their judgment and experience. 35 Board Intelligence/ University of Cambridge Judge Business School research, 2011. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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1.6. A survey published by Korn/Ferry Whitehead Mann & KPMG earlier this year revealed that one in ﬁve non-executives felt out of depth in boardroom discussions because of the inadequate brieﬁng materials. We have spent the past four years focused on nothing but how to equip the board with effective board packs; having witnessed the impact this can have, we would like to see board information given greater prominence in the governance debate.

(b) The scale and complexity of many ﬁnancial institutions

1.7. The expectations placed on boards can appear superhuman:

1.7.1. An army of many thousands of external auditors are not expected to overturn every stone within a major multinational but the regulator, shareholders and the public express astonishment when a handful of non-executives with a 30-day mandate, are taken by surprise.

1.8. However, the challenge facing the board is aggravated by complexity, which characterises many of our largest ﬁnancial service ﬁrms. It is especially hard to provide effective oversight of anything one doesn’t understand or cannot see clearly. The more complex an organisation the harder it is to understand—even for the “experts” whose expertise will usually reside within one or other specialism. Add to this the sheer scale of many of these organisations and the challenge of “seeing what matters” is compounded further.

1.9. Over-reliance on board meetings: Given the board’s duty to supervise and steward, we believe too much emphasis is placed on board meetings which, although necessary, are insufficient for the job at hand. From the confines of the boardroom a director cannot hope to gain a firm grasp on the culture of a business, the calibre of its management or the opportunities and threats it is facing. And yet most boards seek to fulfill their role principally through attending a series of board meetings (notwithstanding the occasional away day and office or branch tour). We would advocate the board draw on a wider set of tools beyond the board meeting and re- weight the time directors spend in board meetings vs the time spent in the business, speaking to external stakeholders and participating in more board away days.

1.10. Use of time in board meetings: It is not uncommon for the board of a FTSE 350 to regularly endure over 20 items on their board meeting agenda, turning the board into a highly administrative forum with no time for substantive discussion. In our experience, most boards have an appetite to reduce the burden on their agenda but they feel constrained (rightly or wrongly) by what they believe are the expectations of the regulator. We would encourage this Commission (together with the FSA and the FRC) to initiate a conversation around which items do and do not need to be dealt with at a board meeting and those that may be dealt via alternative channels (eg secure digital forums, conference calls or sub-committees). This would help the board meeting to be reserved for serious, in-depth discussion on the future of the organisation, free from other distractions.

(d) The pitfalls of the unitary board

1.11. The unitary board is considered one of the great strengths of UK governance. However, in our opinion there are ﬂaws to the unitary board structure (as set out below):

1.11.1. Taking ﬁrst the board’s role as “supervisor”: We wonder whether the unitary structure may be an obstacle to the board’s fulﬁllment of its role as “supervisor”. The board seeks to supervise the executive who number among them—as such, the non-executives are supervising their peers. In most other walks of life (and for good reason), supervision is embedded within a clear hierarchy to empower the supervisor. The challenge of supervising a peer in the unitary board structure is aggravated by the asymmetry of information between executives and non- executives: with knowledge comes power and given the time they spend in the business, the executive holds the balance. Regardless of the ideals of the unitary board, power amongst directors is far from evenly spread, making supervision still harder.

1.11.2. Taking next the board’s role as “steward”: The unitary principles would make good sense for the purpose of formulating the strategy—were it actually the case that this was what boards do. In reality, board meetings allow little time for a meaningful discussion of strategy, and away days tend to occur only once a year (and often address more than just strategy). A series of snatched conversations at board meetings and one-day immersion in the topic is inadequate for the development of a robust strategy, especially for a major multinational. When the board engages with strategy it does so to challenge and ratify rather than originate and develop. In effect, the board engages with strategy as a “supervisor” rather than a “steward”. And in this regard, non-executives face the same challenges as those described above. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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2. What caused any problems in banking standards and weaknesses in the arrangements for whistle blowing? What can and should be done about it? 2.1. We would like to propose two ideas as food for thought, in addressing the weaknesses in the arrangements for whistle-blowing: (a) The office of the Ombudsman 2.2. As part of the settlement to a derivative action in the US brought against the Directors of Pfizer in 2010, Pfizer has created the position of an Ombudsman whose role is to provide an alternative channel for employees to express work-related concerns and, amongst other things, to facilitate whistle-blowing: 2.3. “The capacity of the board or a committee to monitor is dependent on the quality of the information that it receives… employees may feel disempowered or be concerned about exposure and retaliation should they report on wrong-doing. An Ombudsman Program can mitigate such anxieties by providing a protected channel for employees to express work-related concerns.” Affidavit for Final Approval of Derivative Action Settlement, February 2011 “The Office of the Ombudsman provides an informal place where all Pfizer colleagues can talk confidentially and off-the-record. The Ombudsman is independent and neutral.” The Blue Book, Pfizer Closer to home, the role of the Ombudsman is similar to that of Partners’ Counsellor at the John Lewis Partnership: “He [the Partners’ Counsellor] will encourage confidence on the part of any Partner to come to him and talk freely and confidentially without fear of repercussion…. The Partners’ Counsellor may be dismissed only with the specific agreement of the Trustees of the Constitution.” The Constitution of the John Lewis Partnership, April 2012 (b) Continuous employee insight sourcing 2.4. Most large organisations poll their employees once a year to track engagement. Thanks to the ease with which web-based surveys can be administered, we advocate a far more frequent programme, polling a cross section of the workforce every month (and all employees polled at least twice a year). We advocate asking no more than 10 questions (to achieve high response rates) but covering a broader scope than just engagement, to include questions about the governance and reporting culture, as well as other risks and opportunities. 2.5. A system of monthly surveys creates a culture of openness and proactive reporting. An independent source of insight removes a monopoly on information and information no longer flows only through the single tracks of line management, reducing the inclination to conceal critical developments in the first place. 2.6. As well as fostering a healthy and open culture, a programme of monthly employee insight sourcing benefits from Richard Thaler’s principles of “nudge”, making it easy for all employees to communicate with senior management—whether the matter relates to misconduct or any other risk or opportunity that is visible to the workforce, but not visible to senior management and the board. 2.7. We do not propose that legislation or regulation should mandate such practices but we wish to raise the profile of best practice and its benefits. 24 August 2012

Written evidence from Donald T Brash, former Governor of the Reserve Bank of New Zealand Some background comments on the New Zealand approach to banking supervision You have asked for some comments on the background to New Zealand’s having “strict liability” attaching to the directors of registered banks, and I’m happy to elaborate on that to the best of my recollection. I must confess that I’m not entirely sure what “strict liability” means in this context, but I’m assuming it refers to the obligations which bank directors assume when they personally sign off bank disclosure statements each quarter. Historically, prior to the election of the reforming Labour Government in 1984, New Zealand had only four registered banks—one of them owned by the government (the Bank of New Zealand), one owned by Lloyds Bank (the National Bank of New Zealand), and two owned by large Australian banks (the ANZ Bank and Westpac Bank). Supervision of the banks was rudimentary or non-existent, although all of them were subject to a range of controls related more to the implementation of monetary policy than to prudential policy as normally understood. The Government opened the door to new banks in the mid-eighties and as a result a signiﬁcant number of foreign banks opened either subsidiaries or branches in New Zealand, and some non-bank ﬁnancial institutions sought and received banking licences. The Reserve Bank of New Zealand was given the task of registering new banks and supervising their activities. (The four existing banks were “deemed” registered.) cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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Initially, the Reserve Bank’s supervision was at the “light-handed” end of the spectrum. Following the share- market crash of October 1987, New Zealand saw the collapse of the commercial property market and the failure of a number of highly-geared companies. As a result, several banks and other financial institutions found themselves in severe financial difficulties, including the Bank of New Zealand (still owned by government). The instinctive reaction of the Reserve Bank’s banking supervisors was to call for much more detailed reporting from the banks than we had been receiving previously. (I became Governor of the Reserve Bank on 1 September 1988.) If we had not been able to avoid the crisis getting information quarterly, then surely we should be getting it monthly or even more frequently. The supervisors also wanted more stringent prudential rules, including a limit on the maximum credit exposure which a bank could have to any single counter-party, expressed as a percentage of the bank’s equity. (Surprisingly to me—I had been appointed Governor after being for two years the CEO of a relatively small retail bank—the Reserve Bank had had no limit on maximum credit exposure previously.) By contrast, the Reserve Bank’s economists argued that better public disclosure of banks’ activities would be a more effective sanction against imprudent behaviour than more stringent rules laid down by the Reserve Bank. There followed an internal debate lasting several years, with the banking supervisors arguing for steadily more intensive supervision and the Reserve Bank’s economists arguing for better public disclosure as an alternative to more intensive supervision. There were several memorable events along the way. One was a chance meeting I had with somebody who had been a very senior official in H.M. Treasury, and who had just become a director of one of the largest UK clearing banks. I had not met this person previously but found myself sitting beside him at a dinner in Washington at the time of the World Bank/IMF annual meetings in September 1992. I asked him how he found being a director of a major bank after a life-time in the Treasury. “Funny you should ask that,” he said. “I’d always thought that banking was all about measuring and pricing risk, and of course I’ve had no involvement in that in the Treasury. So I was greatly relieved to find that all I had to worry about as a director was whether we were complying with the Bank of England’s rules.” (This was, of course, before the establishment of the FSA.) At around the same time, we in the Reserve Bank were worrying about how to ensure that banks had appropriate risk control systems in place. There was an assumption in the Reserve Bank that we should specify those risk control systems, and monitor that they were being properly operated. But it was clear that no single risk control system would be appropriate for all our banks: some banks were very simple operations, taking money on deposit and making loans on residential mortgages, with virtually no treasury operations; other banks were extremely sophisticated operations, with elaborate treasury operations and complex loan books. So we decided that instead of the Reserve Bank stipulating what risk control systems each bank should have, we would require bank directors to attest personally to the fact that, in their opinion, their bank had risk control systems appropriate to the nature of their banking operations, and that those systems were being appropriately operated. In the event, at the conclusion of the internal debate we decided to rely heavily on public disclosure and director attestations rather than on complex rules. So while we did adopt the minimum 8% of risk-weighted capital (as specified in Basel I), mainly because we felt that to have ignored that minimum capital rule would have made New Zealand-based banks international pariahs, we had very few other rules. We did have a rule limiting exposure to related parties but we did not, for example, have any limit on other credit exposures, any limit on open foreign exchange positions, or any requirement for minimum liquidity. Instead, we required banks to disclosure to the public every quarter detailed financial information in two formats—one was to be highly detailed and was likely to be of interest only to financial analysts (and competitors!); the other was what we referred to as the KIS statement (KIS for Key Information Summary)— a very brief statement of key facts which could be readily understood by the interested layman. The KIS statement had to be available in hard-copy form in every bank branch, whereas the more detailed information had to be provided online and in hard-copy form within four or five days (to minimise needless printing costs). The disclosure had to include information on such issues as credit risk concentration (how many credit exposures exceed 10% of equity, how many exceed 20% of equity, etc.), liquidity, open foreign exchange positions, etc. We also required banks to disclose a credit rating from a reputable rating agency—if they had a rating—and to disclose the fact that they did not have a rating if they didn’t have one. (Later all banks were required to have a rating.) The statements were designed to cover both end of quarter and intra-quarter information. The quarterly disclosure statements were to be accompanied by a statement signed by each bank director, personally attesting to the accuracy of the information and the adequacy of the risk control systems. When we first announced our intention to adopt such a system in the mid-nineties, the banks were not terribly pleased. The CEO of one of the big Australian banks, a bank which had a very big operation in New Zealand, flew to New Zealand to remonstrate with me. He argued that we simply could not adopt a system of the kind we proposed, involving having all bank directors attest to the accuracy and appropriateness of the information being disclosed, and to the adequacy of their bank’s risk control systems, because, he said, “most cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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bank directors know absolutely nothing about banking”. He argued that it was therefore quite unreasonable for us to impose these obligations on bank directors. I made it very clear to him that, if he didn’t have bank directors who understood banking, he should get some who did—but that in any event I was not going to be responsible for making all the key decisions for the prudent operation of his bank. In the years since this system was introduced, no registered bank in New Zealand has got into financial difficulties and it would therefore be tempting to believe that the New Zealand approach to banking supervision is a very good one. But unfortunately, although I remain strongly supportive of the New Zealand approach, no such conclusion would be warranted at this stage. First, that is because the four biggest banks in New Zealand are now wholly-owned by large Australian banks, all of which are supervised by APRA, the Australian regulatory authority, in ways which are more closely similar to the international orthodoxy. And of course many of the smaller banks are subsidiaries or branches of international banks, such as HSBC and Rabobank. Secondly, the largest single part of the asset base of the large Australian-owned banks consists of mortgages over residential property, and while there was a modest fall in the real price of residential property in New Zealand following the onset of the Global Financial Crisis, that fall was quite small by international standards and, at least in Auckland, currently seems to have been largely reversed. Third, at the height of the Global Financial Crisis, in October 2008, even the largest banks were able to access special Reserve Bank liquidity facilities when international capital markets essentially “froze”. Moreover, since I resigned as Governor in April 2002, the Reserve Bank has moved somewhat closer to the international orthodoxy, while retaining the emphasis on public disclosure and quarterly director attestation. Banks now have an obligation to fund a minimum proportion of their asset base from retail deposits and longer-term wholesale funding, reducing their reliance on short-term capital market funding. The Reserve Bank now reserves the right to approve the appointment of all bank directors, bank CEOs, and “first reports” to the CEO. Nevertheless, I believe the New Zealand emphasis on public disclosure and director attestation has had a beneficial impact on bank behaviour. I well recall an event which happened not long after the introduction of this approach in the mid-nineties. The New Zealand subsidiary of Bankers Trust disclosed in their quarterly statement that they had had more on deposit with their parent company in New York than they had shareholders’ funds in New Zealand. The National Bank of New Zealand (wholly owned by Lloyds Bank at that time) protested vigorously to Bankers Trust New Zealand because they (the National Bank) had had very substantial funds on deposit with Bankers Trust New Zealand at that time. Despite Bankers Trust New Zealand being fully guaranteed by its New York parent, the National Bank was angry about the situation and to the best of my recollection Bankers Trust New Zealand never again had such a large exposure to its parent bank. (I can mention Bankers Trust New Zealand by name because of course their quarterly statement was public knowledge.) Similarly, although the Reserve Bank still has no limit on individual credit exposures, banks keep their individual credit exposures low relative to their equity in New Zealand because they recognise that to disclose high levels of credit concentration is damaging to their reputation. After almost five years in the New Zealand Parliament, I myself because a director of the ANZ National Bank, by far the largest single bank in New Zealand (formed after the acquisition of the National Bank by the ANZ Bank). When it came time to sign the quarterly disclosure statements, I can confirm that each director took the matter very seriously! Of course, it is not feasible for any bank director to personally check every number in the disclosure statement of a major bank, and we did not attempt to do so. But we had an elaborate process whereby the head of every division in the bank, as well as the Internal Auditor, the CFO and the CEO, were required to attest to the accuracy of the numbers, and the adequacy of the risk control systems, before we individually signed those quarterly statements. Will this system guarantee that New Zealand will have no bank failures? Of course not, but I have no doubt that the system reduces the risk of bank failure in a useful way by making bank directors very much aware of their responsibilities. I should add in conclusion that when we were discussing the introduction of this system in the early nineties, one of the previous Governors of the Reserve Bank, Mr Ray White, strongly encouraged me to shed responsibility for bank supervision if possible. He argued that when the banking system was stable, the Reserve Bank would get none of the credit. When a bank failure occurred, as it inevitably would at some stage, the Reserve Bank would shoulder much of the blame. He further argued that almost every bank failure which had occurred in the developed world since 1945 had been a result of either fraud or an abrupt fall in asset prices, typically property prices. He pointed out that bank supervisors are not well placed to detect fraud, especially where there is collusion between bank insiders and their customers (for example, BCCI); and rarely anticipate accurately the problems created by an abrupt fall in asset prices. When asset prices are going up, optimism prevails—bank balance sheets look strong and loss provisions robust. Even “stress-testing” often fails to anticipate just how badly damaged banks would be in the event of a sharp fall in asset prices. It is vitally important therefore that the bank regulator makes it abundantly clear that he cannot be expected to prevent all cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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bank failures, and that bank customers therefore have some responsibility to make their own assessments in dealing with a bank. 8 October 2012

Written evidence from the British Bankers’ Association

Introduction

1. The British Bankers’ Association (BBA) welcomes the opportunity to make this written submission in response to the initial call for evidence issued on 26 July by the Parliamentary Commission on Banking Standards. The BBA represents 220 banks from 50 countries on UK and international banking issues.

2. The remit of the Commission is to consider and report upon: the professional standards and culture of the UK banking sector, taking account of regulatory and competition investigations into the LIBOR rate-setting process; the lessons to be learnt about corporate governance, transparency and conﬂicts of interest, and their implications for regulation and Government policy; and to make recommendations for legislative and other action.

3. The initial call for evidence identiﬁed a broad range of issues within this remit. We have aimed to provide a clear initial response to these issues and, in the limited time given to respond to the 26 July notice, to identify a number of additional steps that could be taken to reinforce professional standards within banks. We look forward to contributing further to the Commission’s review as its deliberations progress.

4. A separate review of the framework for the setting of LIBOR is also in process under the chairmanship of Martin Wheatley, managing director of the FSA and Chief Executive-designate of the Financial Conduct Authority. The BBA has undertaken to engage fully on the review and plans to reply formally to the consultation fully within the four week deadline. We will also reﬂect on the observations and recommendations of the Treasury Committee.

OpeningSummary

5. Based on the questions set in the preliminary call for evidence we have adopted a broad perspective in this response. The points made in response to the individual questions can be summarised as follows: — The Parliamentary Commission’s review takes place against an already substantial reform programme. Bank capital and liquidity standards have been vastly increased, reliance on wholesale funding reduced, and UK banks have been at the forefront of meeting these new standards; the FSA is being divided into a prudential regulator and a conduct regulator; the Bank of England is being given a better defined responsibility for financial stability and new macroprudential tools; banks are being required to reorganise their retail activities into a separately capitalised and run entity overseen by an independent Board; and changes are being made in corporate governance, risk management, remuneration and recovery and resolution planning. — Banks recognise that the incidence of product mis-selling and other compliance failures in recent years have significantly damaged the reputation of the industry and must be definitively addressed. Their long-term interests are aligned to ensuring products are fit for purpose in the first instance and that that all employees act with integrity in the normal course of business and in their dealings with customers and regulators, which the vast majority already do. The reorganisation implied by the advent of dual regulation by the PRA and FCA and the introduction of retail ring-fencing as required by the Independent Commission on Banking will of themselves require a reappraisal of culture, values, governance processes, incentives and expectations. — Since the financial crisis the FSA has stepped up its Significant Influence Function (SIF) process and has adopted a far more intrusive approach to senior appointments; it would seem natural with the move to ‘twin peaks’ regulation for the Financial Conduct Authority to apply a more rigorous approach than previously to roles most relevant to business conduct. — Training and competence falls within regulatory scope and of itself is the subject of considerable change. Under the Retail Distribution Review (RDR), for instance, the implementation of higher minimum qualification standards for retail investment advisers, including bank advisers, by the end of 2012 will underpin a step change in the promotion of professionalism across the investment advice sector. — We would see it as a natural step for thought to be given to whether there is, more generally, a sufficiently strong compliance and risk management ethos and expectation of ethical standards espoused as part of relevant Board practices, internal corporate statements, training and codes of conduct, and the FSA’s high level principles; also whether compliance and risk management ethos and ethical standards can be linked in more tangible terms to daily responsibilities and duties. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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— The enforcement of sanctions in the event of fraudulent or unprofessional behaviour is integral to the maintenance of professional standards. The FSA already has extensive regulatory enforcement powers and the Serious Fraud Office (SFO) and Crown Prosecution Service (CPS) have responsibility for prosecution of criminal fraud offences. The new National Crime Agency will also provide more effective operational coordination for economic crime. We are keen to build on this and would support a firmer approach to enforcement. — In determining what further steps are necessary we would see merit in the Parliamentary Commission considering whether current powers and measures already in train will fill the gap; also whether shortcomings are a result of statutory or regulatory deficits or a result of regulators and law enforcement agencies not utilising the powers already available to them as fully as they could. — Our response to the questions set by the Commission builds upon these themes and identifies a number of areas where professional standards could be reinforced through additional steps in these areas. These initial thoughts are drawn together in our response to question six and illustrated in Appendix 1. The measures identified draw upon broader changes being made to the legal and regulatory environment in which banks operate and include suggestions specifically relating to the promotion of professional and ethical standards.

Question 1: To what extent are professional standards in UK banking absent or defective? How does this compare to (a) other leading markets (b) other professions and (c) the historic experience of the UK and its place in global markets? 6. Professional standards in the UK banking industry are defined by a combination of: — Statutory provision, eg in the form of directors’ responsibilities and duties as set out in the Companies Act 2006; — Listing Rules ‘comply or explain’ requirement in respect of the Corporate Governance Code; — The FSA’s SIF process and the Approved Persons Regime for senior executives and non-executives; — The FSA’s Training and Competence regime for employees carrying out specified activities with retail customers and other FSA Handbook requirements including COND, PRIN and SYSC; — Relevant provisions within professional qualifications; and — Further industry-based guidance and training. 7. The FSA’s SIF regime exists to enable the regulator to exercise material influence over the running of a financial services firm in relation to the regulator’s objectives, including or even particularly in relation to a firm’s safety and soundness and its fair treatment of customers. The FSA assesses whether individuals are suitable for senior roles and oversees the appointment process by the firm. Pre-financial crisis, the authorisation process operated more as a register and judgements about individuals were based solely on probity; the aim since has been for the SIF process to become more intrusive and for the regulator to play a more active part in assessing suitability for holding a key oversight function and technical competence. 8. In revising the SIF process, the FSA determined that it would focus on the Chair, the senior independent director, the chair(s) of the Audit and Risk Committee(s) and on the principal executive functions—the CEO, finance director and chief risk officer—with the need to interview other individuals judged on a firm-specific basis. Under the regulatory regime being introduced under the Financial Services Bill currently before Parliament, the Prudential Regulation Authority (PRA) will have responsibility for running the process in respect of these roles, for those firms subject to dual regulation, with the involvement of the Financial Conduct Authority (FCA), which will also have a veto; and the FCA will lead the process for all other authorised roles, including those most relevant to business conduct and treating customers fairly, both retail or wholesale. 9. The role of the regulator however is to create boundaries within which banks and other regulated entities take responsibility for their own decisions. This includes the mix of skills and qualifications which they expect to see around their Board table and amongst their staff. Bodies such as the CFA Institute, the Chartered Institute of Bankers in Scotland, the Chartered Institute for Securities and Investment, the Chartered Insurance Institute and the Institute of Financial Services include ethical standards within their professional codes as do other professional bodies whose members have a significant representation in banking and financial services—the six UK accounting institutes, the Law Society and the Institute of Directors. Where the individual’s expertise is not based on professional qualification, then it is incumbent upon the firm to ensure that they receive an appropriate induction which should include grounding in the firm’s and the regulator’s ethical, prudential regulation and conduct of business requirements. Ensuring staff competency across a bank or other financial services firm is also a matter of regulation and the FSA sets the standards of training and competence that firms are required to reach. Further work on key aspects of this is currently being undertaken and as of 31/12/ 12 the increased regulatory focus given to staff competency will be backed up by the introduction of closer monitoring of professional standards based on quantified data. 10. But it needs also to be appreciated that diversity is also important. Technical expertise alone, for instance, is not the sole characteristic of a good non-executive and other skills and backgrounds offer an important counterbalance to ‘group think’. The imperative therefore is to have the right mix of skills, experience and technical expertise not only in banking and financial services, but law, accounting, risk management and other, cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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unrelated disciplines if the individual has other attributes from which the firm would benefit. A modern bank or financial services firm therefore has a need to draw upon a broad range of skills and expertise and a further factor to bear in mind is the global nature of the financial services sector hosted in the UK and its international workforce. 11. There are however clearly roles in which the clear achievement of a professional standard or some other form of training and competency is likely to be appropriate at a management level. Under the RDR, for instance, the implementation of higher minimum qualification standards for retail investment advisers, including bank advisers, by the end of 2012 will underpin a step change in professionalism across the investment advice sector. Retail investment advisers will need to attain a Statement of Professional Standing from an FSA accredited body and undertake a mix of structured and unstructured continuous professional development under new FSA rules. 12. We would see it as a natural step for thought to be given to whether there is a sufficiently strong compliance and risk management ethos and expectation of ethical standards espoused as part of: (a) Board composition, competences and practices; (b) The foundation courses of most professional qualifications and internal corporate statements, training and codes of conduct; and (c) The FSA’s high level principles which require integrity, skill, care and diligence, building relationships of trust with both customers and regulators, and so on. 13. There would also be benefit from a more tangible linking of compliance and risk management ethos and ethical standards to governance processes and the daily responsibilities and duties of all employees— particularly line management. Given London’s role as a host to a large international banking sector we believe that whilst it might be difficult for regulators to mandate a detailed syllabus it should be possible for regulators to set a clear expectation of the behaviours that would be expected in key staff. 14. In regard to paragraph 12a) above, the Financial Skills Partnership has commenced a project intended to produce a resource which would aim to provide a sector-wide benchmark for standards around Board composition, competence and cultural lead and which we believe has the potential to provide at least a useful sector-wide reference point for reviewing Board practices to see whether they are conducive to setting the right strategy, culture and focus on compliance requirements and customer needs. This project has been in planning for over 12 months and formally got underway in May. Whether from the perspective of the training and professional standards requirements under the RDR, the move to dual regulation or preparing for ring-fencing it could not have been better timed in terms of the changing environment in which banks find themselves. 15. Professional standards, and where they sit within the training and competence of the 1.4 million people working in banking and financial services in the UK need to be aligned to the broad nature of financial services in question and the more integrated way in which financial services are provided. Households and businesses have access to a far broader range of financial services than was the case in past decades and the skills involved in delivering modern banking services are much broader than may have been the case in the past. We also work in an environment in which 97% of the population hold a bank account. Customer needs therefore are very different to the days in which a local branch manager provided simple deposit, safe keeping and basic lending services mostly to the middle classes. While we fully accept that a return to core values and a renewed customer-focus lies at the heart of several legislative and regulatory initiatives we need to make sure that all aspects of such initiatives are tailored to the modern environment and the demands placed on banking by households and businesses including SMEs not necessarily as prevalent in previous decades. 16. The enforcement of sanctions in the event of fraudulent or unprofessional behaviour is integral to the maintenance of professional standards. It should further be recalled that the Financial Services Act 2010 provided the FSA with greater enforcement powers. The FSA has the power to fine authorised persons and approved individuals for misconduct. The 2010 Act extended these powers to enable the FSA to suspend or limit an authorised person’s permission or an approved person’s approval. It also enabled the FSA to impose a fine on an individual performing a controlled function without approval in addition to being able to prohibit the individual from working in the financial services industry. It also included provisions in respect of the disclosure by the FSA of decision notices. 17. It is further relevant to note that the Serious Fraud Office has responsibility for prosecuting in the case of fraud and on 30th July confirmed that it considered existing criminal offences to be capable of covering conduct in relation to the alleged manipulation of LIBOR and related interest rates. The Government also outlined plans to improve the investigation and prosecution of fraud cases through the “Fighting Fraud Together” strategy. As a signatory to the strategy, the banking sector is working closely with Government to support its delivery. In addition to the Fraud Act, the enforcement agencies have powers available to them under the Proceeds of Crime Act, the Bribery Act or the Competition Act. It may be therefore that a strategic assessment is needed of the uses of these powers. 18. It is also the case that the Companies Act was updated in 2006 to provide that directors (including directors of banks) must act in a way most likely to promote the success of the company for the benefit of its members as a whole and in doing so must have regard to: — the likely consequences of any decision in the long term; cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 843

— the interests of the company’s employees; — the need to foster the company’s business relationships with suppliers, customers and others; — the impact of the company’s operations on the community and the environment; — the desirability of the company maintaining a reputation for high standards of business conduct; and — the need to act fairly as between members of the company. 19. This enshrined common law procedure and enables Court action where the directors are viewed as having been negligent or in breach of duty. The Government is currently consulting upon whether, for banks, there should be a rebuttable presumption that directors of failed banks should not be viewed as ﬁt and proper for a senior management position in another bank and whether criminal proceedings should be possible for a new offence of recklessness. 20. We are ﬁrmly of the view that notwithstanding the less intrusive approach to regulation which characterised the FSA’s initial approach, the legislative and regulatory standards applying to UK banks—and the reputation that we have built for acting upon both international agreed principles and EU legislative requirement—mean that the UK regulatory requirements are seen as matching those in existence in other developed economies. Further additional reforms are being undertaken at a UK level which we do not expect to be replicated elsewhere—not least the introduction of a ring-fence division between retail and investment banking—and we therefore believe that the starting point for the adoption of new measures should be an appraisal of the application of existing mechanisms. Effective supervision, with supervisors willing and able to challenge, and regulatory enforcement and the application of existing criminal sanctions are important components of the regulatory regime. 21. There has been a substantial increase in the FSA’s Enforcement outcomes and penalties over the last two or three years and its general effectiveness, which had previously been lacking. The FSA has now become internationally acclaimed for being able to successfully investigate and prosecute highly challenging and large scale cases such as sophisticated criminal insider dealing rings, complex market manipulation cases and boiler room frauds. This success has in part been due to the joint partnership approach adopted by the FSA with the industry.

Question 2: What have been the consequences of the above for 9a) consumers, both retail and wholesale, and (b) the economy as a whole? 22. It needs to be appreciated that in some cases the conduct failures currently being reported took place before measures intended to improve compliance, the supervision of compliance and the renewal of focus on professional standards. That said, there have in recent years been too many instances of mis-selling and other compliance failures. We would very much endorse the observations made recently by Lord Turner in 24th July speech ‘Banking at the Crossroads: Where do we go from here’ that much greater emphasis must be given to ensuring that banking products are fit for purpose from the outset. Consumer redress is not a substitute for this. While the primary responsibility for this must rest with banks themselves, we also believe that the introduction of product intervention powers within the Financial Services Bill currently before Parliament provides an opportunity for the regulator to work with firms on a more constructive basis than has previously been the case. The Sergeant Review of Simple Financial Products also bears much promise and merits a collective participation to carry it forward from Government, regulators, the industry and consumer groups. 23. The result of recent market failures has been hostility towards banks on the part of many and the potential for damage to the UK economy since a modern economy is founded upon a depth in financial services. The uncertain environment which regulatory enforcement action creates can only have a detrimental effect on the attractiveness of the UK as a place from which to conduct financial services. Financial crimes against banks and their customers also have a bearing on confidence and while significant investment has been made in strengthening defences there is more that can be done including through partnership between industry and government. 24. The exuberance in banking and some other financial services in the lead up to the financial crisis also contributed substantially to the economic downturn which followed, though we would maintain that it is inappropriate for NIESR and others to assign exclusive responsibility for all of the economic downturn to the financial crisis as opposed to building in an element in respect of the economic cycle.

Question 3: What have been the consequences of any problems identiﬁed in question 1 for public trust in, and expectations of, the banking sector? 25. The public loss of conﬁdence in banking is palpable. This results from actions within the industry and the industry needs to take decisive action—and be seen to be taking decisive action—to achieve higher standards not only of regulatory compliance but good and reliable customer service. We agree with Lord Turner when, in the speech referenced above, he observed that much of the responsibility for restoring public trust in banking must lie not with the regulators but with the leadership of banks—a point which must be undeniable. But we also agree that regulators, politicians, consumer groups and society at large have a part to play and would recognise as a matter for public debate what he described as the constraints under which banks operate and the need to ‘honestly debate a crucial trade off’. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 844 Parliamentary Commission on Banking Standards: Evidence

Question 4: What caused any problems in banking standards identified in question 1? The Commission requests that respondents consider (a) the following general themes: — the culture of banking, including the incentivisation of risk-taking; — the impact of globalisation on standards and culture; — global regulatory arbitrage; — the impact of financial innovation on standards and culture; — corporate structure, including the relationship between retail and investment banking; — the level and effectiveness of competition in both retail and wholesale markets, domestically and internationally, and its effects; — taxation, including the differences in treatment of debt and equity; and — other themes not included above. 26. If there is a common theme running through the items listed here, it is that many factors unwittingly combined to incentivise outcomes which can be seen to have contributed to firm and system-wide financial instability. — While there is little doubt that remuneration policies and practices pre-crisis failed to keep pace with innovative banking activities and as a result failed to reflect risk—and arguably have incentivised it—there are also grounds for saying that the EU, and the UK in particular, has not only acted upon but gone further than internationally agreed measures. For the example, the remuneration aspects of the RDR, through the implementation of adviser charging for retail investment advisers, designed to remove negative incentives, go much further than the anticipated MIFID 2 reforms. — The failure to develop and implement a consistent regulatory framework for an increasingly internationally active industry led to numerous instances of regulatory arbitrage which can be seen as drivers and amplifiers of the conditions which led to the financial crisis and should serve as a warning as we contemplate the implementation of the new regulatory structure. To limit such incentives in the future the UK should continue to act as a strong proponent for equivalent implementation around the world of internationally agreed rules and standards. — The question implies that financial innovation should in some way be viewed negatively. While it is undoubtedly the case that innovation complicates the control process and its regulation, it has also provided the means of bringing financial products to market that have removed substantial risks from business and households—ranging from foreign exchange and interest rate risk management, to the hedging of commodities prices, fixed rate mortgages and specialised insurances. There is however a need to find a means within the new regulatory framework to achieve a more stable platform for both service providers and consumers, while permitting the benefits of well-grounded financial innovation to be realised. This requires further work on the development of a suite of highly transparent, simplified products but also the agreement of a process around product intervention. — We believe that the problems caused through the inter-relationship between retail and investment banking can be overstated since an evidenced-based view of the financial crisis shows that financial losses arose across the entire banking spectrum, from more traditional retail and commercial banks, big and small, through to building societies, universal banks and pure investment banks. This said, the Government’s proposals for ring-fencing include provisions for the ring-fenced entity to have its own independent Board charged with establishing a culture appropriate to the retail-orientation of the business. It is incumbent therefore upon banks with significant retail and SME business to review their cultures, values and service provision in light of the financial stability objectives which sit behind the introduction of ring-fencing. This is in addition to the more general reassessment of risk and risk management taking place under the banking reform programme more generally. — With the RBS sale of 318 branches and regional SME centres to Santander, the Lloyds Banking Group ‘Verde’ sale of 632 branches and key brands including TSB, and the advent of new entrants into the market place—Tesco, Metrobank, Virgin Finance, M&S, Asda—plus the prospect of other non-traditional service providers, we can expect to see a healthy injection of competition into UK retail banking. On the investment banking side, the UK already benefits from a market presence of more firms than most other countries. — Taxation is a major driver of incentives and therefore of outcomes which are often at odds to the stated regulatory or supervisory objectives. The most obvious example relates to the differences in the treatment of debt and equity for tax purposes. Whilst a continued objective of prudential regulation has been to encourage greater holdings of equity the tax code continues to incentivise firms to fund themselves with debt. and (b) weaknesses in the following somewhat more specific areas: — the role of shareholders, and particularly institutional shareholders; — creditor discipline and incentives; — corporate governance including — the role of non-executive directors cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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— the compliance function

— internal audit and controls

— remuneration incentives at all levels

— recruitment and retention;

— arrangements for whistle-blowing;

— external audit and accounting standards;

— the regulatory and supervisory approach, culture and accountability;

— the corporate legal framework and general criminal law; and

— other areas not included above

27. We would comment as follows on the speciﬁc areas identiﬁed in the initial call for evidence:

— The Stewardship Code was introduced by the Financial Reporting Council (FRC) in 2010 with the aim of using transparency to encourage institutional investors to engage actively in the corporate governance and due process of the companies in which they invest other people’s money. We see the Kay Review of UK Equity Markets and Long-Term Decision Making, published this July, as a natural extension of this and believe that relevant aspects for investors (and also firms themselves) should be acted upon. The issues raised of course are not specific to banks and financial services.

— A perceived benefit of the ‘bail-in’ regime is that the potential loss in the event of resolution of a failing institution is that it will result in significant senior creditors, such as fixed income bond holders, taking a more active interest in the financial stability of the banks in which they invest.

— The Walker Review, reporting in November 2009, made 38 specific recommendations aimed at strengthening the corporate governance of UK banks and other financial industry entities. These required implementation by either the FRC, through review of the Corporate Governance Code or other FRC guidance, or the FSA through its supervisory approach, handbook rules or guidance. Walker was substantially about improvements to corporate governance in the areas identified in the question including Board effectiveness and qualification, the governance of risk, enhancing the disciplines around remuneration and, additionally, improving engagement on the part of institutional investors and fund managers. The FSA has also taken a closer interest in Board governance.

— The EU, and the UK in particular, has moved further than internationally agreed principles of remuneration and measures so far embedded in the Capital Requirements Directive have been built upon by the FSA’s remuneration framework which aims to promote sound and effective risk management and greater symmetry between the economic incentives of individuals and shareholders (and backed up by measures enabling remuneration and dividend restrictions in the event of financial difficulty). In his final speech as FSA CEO, on 24th April, Hector Sants observed that ‘too often reward structures continue to encourage short term-gain and excessive risk-taking’, that senior executives’ annual remuneration in the past had tended to be heavily influenced by operating profit, earnings per share growth and return on equity as distinct from return on assets and prudent management of leverage and that he wished to see firms place greater weight on non-financial performance measures, particularly the fair treatment of customers, in determining an individual’s compensation

— The Public Interest Disclosure Act 1998, supported by relevant employment law, provides a framework of legal protection for individuals disclosing information in order to expose malpractice and matters of similar concern. It is based upon information being of the right type in order to be viewed as a ‘qualifying disclosure’ and being made to the right person and in the right way in order to make it a ‘protected disclosure’. Qualifying disclosures include information concerning criminal offences, financial malpractice, impropriety or fraud, the failure to comply with a legal obligation, miscarriages of justice, professional malpractice, improper conduct or unethical behaviour, conflicts of interest without disclosure, health and safety, environmental damage and deliberate attempts to cover up any of these. Employment contacts and employee manuals or handbooks set out the procedure for making a protected disclosure and it is in the interest of firms to ensure that the arrangements are robust and work in practice. Our assessment is that the legal protections in respect of whistle blowing are sufficient and that banks have put in place procedures to reflect the intention of the legislation. There may, however, be a case for policies to be reviewed with the aim of ensuring that they are as operational as they need be, whether in terms of being communicated in clear terms, offer suitable reassurance and provide necessary details of who to contact outside of line management if necessary. FSA guidance and contact details would appear suitably accessible. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 846 Parliamentary Commission on Banking Standards: Evidence

— While we would agree that the International Accounting Standards Board needs to complete its revision of IAS 39 on financial instruments, in respect of recognition and measurement, including own credit, expected loss provisioning and hedging, we do not believe that an evidence based comparison of IFRS and UK GAAP preceding the adoption of IFRS in 2005 supports the view that the international standards adopted are inherently inferior to IFRS. Similarly, while we support certain measures to strengthen auditing, such as the strengthening of the role of the Audit Committee, requiring periodic competitive tendering under the Corporate Governance Code and the re- establishment of the auditor-banking supervisor dialogue, we are of the view that other measures proposed eg by the European Commission in its 2010 audit green paper may potentially result in a weakening of the audit process, a lower level of assurance in respect of risk management processes and a loss of accountability. — The approach to banking regulation and supervision is already the subject of radical change, nowhere more so than in the UK, where the FSA’s move towards a more intrusive, judgement-led approach to supervision is being built upon through the introduction of ‘twin peaks’ regulation in which a designated focus will be given to both prudential regulation and financial conduct regulation. This will involve a further change in the responsibility assigned to both regulators and it is essential that they step up to the plate. As expressed in connection with the Financial Services Bill, however, we share the concerns of others about whether the accountability and due process arrangements being built into the regime match the responsibilities being assigned. — As explained above, the Companies Act 2006 was updated to give a clearer set of responsibilities to directors in respect of a broad range of stakeholders; HM Treasury is currently conducting a consultation ‘Sanctions for the directors of failed banks’ which asks the question of whether the directors of failed banks should be presumed not to be fit and proper to undertake a similar role, underpinned by a clarification of their management responsibilities and relevant regulatory duties, and whether there should be a criminal offence in respect of ‘recklessness’ or other forms of underperformance, though the consultation also draws attention to the practical difficulties involved.

28. As outlined in our response to the preceding (and following) question, the banking industry and financial system generally has been the subject of a wide variety of reform initiatives since the outset of the financial crisis, some of which have now been adopted, but are still bedding in, some of which are still in the final stages of development and some of which are still subject to final decision-making. Our preliminary suggestions in terms of what can and should be done to address weaknesses in respect of the specific areas outlined in question four would include: — While ostensibly not within the scope of a Commission on Banking Standards, we see an imperative need for the completion of the ‘bail-in’ regime and see this, and the special resolution regime, as one of the cornerstones of the banking reform programme. Establishing the means by which we can be said to have reached the point at which no bank need be viewed as ‘too important to fail’ constitutes a fundamental shift in the relationship between banking and society. The Commission therefore should lend its influence to ensuring that maximum priority is given to the completion of an appropriate bail-in regime across the European Union. While the prospect for this looks good, the draft Recovery and Resolution Directive is still at a relatively early stage in terms of it legislative passage. — The Commission may care to consider in particular the overlapping relationship between companies legislation, the FRC’s Corporate Governance Code, the FSA’s Approved Persons Regime and principles as embodied in professional standards and industry-based guidance and training and whether there are fundamental gaps in these arrangements and/or there are specific changes in provision or execution which may improve their effectiveness. — It will soon be three years since Sir David Walker published his final report. Given its clear relevance to the Commission’s remit, there would seem merit in calling for a post-event evaluation of the recommendations made, the extent to which they have been acted upon and their expected effectiveness.

Question 6: Are the changes already proposed by (a) the Government, (b) regulators and (c) industry sufﬁcient? Respondents may wish to refer to the Financial Services Bill and the Government’s proposals for the Banking Reform Bill. They may also wish to refer to proposals by the Bank of England and the Financial Services Authority on how the Financial Policy Committee, Prudential Regulation Authority and Financial Conduct Authority will operate in practice.

29. As the question implies, there are very signiﬁcant changes already being made to the UK regulatory framework, the structure of ﬁrms within the industry and the way in which the regulatory authorities go about their work. An appreciation of the extent of these changes, many of which are being taken forward under an international or EU umbrella, is a prerequisite to the question of whether further measures are necessary. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 847

30. Key reforms include: — Capital and liquidity: strengthening the quantity and quality of capital. Substantial increases under Basel III -and CRR and CRD IV—with minimum requirements to be supplemented by a capital conservation buffer, a further surcharge on large and complex organisations—bringing minimum Tier 1 capital to 9.5%—and a countercyclical buffer of up to 2.5%; also the introduction of a Leverage Ratio as a backstop and a greater emphasis on stress testing. For the first time globally applicable quantitative liquidity standards are being introduced in the form of a Liquidity Coverage Ratio (LCR) and a Net Stable Funding Ratio (NSFR). A review of capital requirements for instruments held in the trading book is currently underway. These changes are fundamental in scale and when taken together with the prospective addition of bail-in debt place banks on a substantially different footing to where they stood pre-financial crisis. The UK—whether in terms of the regulatory authorities or the banks themselves—is at the forefront of acting upon these changes. Reliance upon wholesale funding has also been reduced (a process encouraged by the structure of the UK bank levy which draws a distinction between long and short term funding). — Crisis management: a number of regimes, including the UK, have put in place a statutory regime enabling the exercise of a number of tools to enable an orderly resolution of a failed institution to take place pre-insolvency; in the UK this intertwines with the FSA’s Proactive Intervention Framework (PIF), the preparation of Recovery and Resolution Plans by individual institutions and the planned introduction of measures aimed at further enhancing primary loss absorbing capacity, including through the introduction of a ‘bail-in’ regime for bondholders and senior creditors. UK plans to introduce retail ring-fencing take this a considerable step further through requiring a substantial restructuring on a ‘business as normal’ basis. — Deposit guarantee schemes: many jurisdictions, including the EU, have raised substantially their deposit guarantee limits, additionally removing co-insurance on the part of the depositor, and have improved the efficiency with which their deposit guarantee schemes could make compensation payments. The scheme remains industry funded and discussions are advanced in the EU on the introduction of an element of pre-funding so that there is a pool of working capital available in the event of need. — Banking supervision: Many jurisdictions have taken the view that banking supervision needs to be more intensive than had been the case in the period directly preceding the financial crisis. In the UK, this includes the adoption of a more judgement-led, strategic approach under the FSA’s enhanced supervision programme and a strengthening of cross-border cooperation. At an EU level this has been supported by the formation of the European system of supervisors and will be underpinned by the adoption of a single rulebook to be drawn up by the European Banking Authority. — Conduct of business regulation: it is also the case that the UK is moving towards a ‘twin peaks’ form of regulation in which the Financial Conduct Authority will be given designated responsibility for conduct of business regulation across retail and wholesale markets. This will build upon customer-focused initiatives undertaken in recent years and give more bite to regulatory activity in respect of conduct. A key facet of this will be a more interventionist approach with the regulator seeking to identify emerging threats of customer detriment at an earlier stage as opposed to simply ensuring customer redress after the event. — Retail Distribution Review: the implementation of higher minimum qualification standards for retail investment advisers, including bank advisers, by the end of 2012 will underpin a step change in professionalism across the investment advice sector. Retail investment advisers will need to attain a Statement of Professional Standing from an FSA accredited body and undertake a mix of structured and unstructured continuous professional development under new FSA rules. The new adviser charging requirements will see a fundamental change in how remuneration is set for financial advisers. The level of remuneration will, in future, be agreed between the customer and their adviser, rather than set by product providers by way of commission as is often the case now. — Macroprudential regulation: the UK is in the process of establishing a Financial Policy Committee within the Bank of England with responsibility for deploying macroprudential limits on the banking system and monitoring risk within the financial system as a whole. At an EU level, the European Systemic Risk Board has been given a more limited mandate but will have responsibility for assessing system-wide risk in a way which ties in with enhanced oversight envisaged under the EU’s Shadow Banking initiative. A consultation on the macroprudential tools to be made available to the FPC is due shortly. — Corporate governance and risk management: banks are substantially strengthening their corporate governance arrangements and in some jurisdictions, including the UK, greater emphasis has been placed on risk management through measures such as the establishment of a Board-level risk committee and the appointment of a senior, independent Chief Risk Officer (CRO). Changes were made to both the FRC Corporate Governance Code and the FSA Approved Persons Regime following the Walker Review. EU reforms on remuneration under CRD III have been fully implemented. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 848 Parliamentary Commission on Banking Standards: Evidence

— Market infrastructure: There have been substantial improvements in market infrastructure and transparency through encouraging derivative trades to be centrally reported and/or cleared through central counterparties. These measures will reduce counterparty risk and interconnectedness between ﬁnancial institutions. — Other regulatory reforms: there are other signiﬁcant changes which relate to credit rating agencies, hedge funds, securities markets and other aspects of governance, including accounting and auditing.

26. These changes will change substantially the environment in which banks operate and the incentive structures implicit to their business and reward structures. The very substantial changes to the capital and liquidity regimes alter fundamentally the economics of different lines of business and align cost much more closely to risk. The crisis management measures change substantially the paradigm in which banks operate and make it entirely clear to shareholders, senior creditors and management that no bank will be viewed as being too important to fail and in the process ensure that ﬁnancial stability, regulatory compliance and ﬁduciary duty is central to the Board decision-making process. The need for more intrusive supervision is widely recognised and in the UK we are giving the regulators additional macroprudential tools and the means of ensuring that separate attention is given to prudential supervision and conduct of business considerations. This has been backed up by corporate governance and risk management changes and other market infrastructure and regulatory reforms intended to reduce the prospect of systemic risk.

27. We believe that it would be entirely consistent with the strategic objectives of these reforms to ask whether more can be done to ensure that firms internalise the shift in priorities implied and put in place processes intended to ensure the maintenance of professional standards at all times. This would have several aspects and could imply the following additional specific steps beyond those already being acted upon or in the final stages of development: (1) Completing the final elements of the changes to capital and liquidity standards and implement further remuneration changes in hand. (2) Ensuring that a review of culture, values, responsibilities and incentives lies at the heart of the reorganisation required through the introduction of retail ring-fencing and the dual regulatory focus on prudential supervision and conduct of business in the UK including support for the Financial Skills Partnership in its initiative to create a sector resource on Board composition, competence and practices. (3) Building upon the FSA’s renewed emphasis on the SIF process and Approved Persons Regime with a more broadly scoped approach to regulatory vetting for key roles, including by the FCA, and also to the regulators satisfying themselves that directors and key staff are assigned the right roles and responsibilities. (4) Building upon the increased emphasis placed on ethics within professional qualifications for retail investment advisors through an increased emphasis upon Board oversight of the competence and training programmes in place for all staff and review on the part of the regulatory authorities. (5) Entering into dialogue with the Government and the regulatory and law enforcement agencies on strategy in support of the utilisation of enforcement powers in instances of professional misconduct including the use of existing powers within existing legislation, whether the Fraud Act, the Proceeds of Crime Act, the Bribery Act or the Competition Act. (6) Completing work on the proposed presumption that the directors of a failed bank are not viewed as suitable for similar positions in other financial institutions and, subject to overcoming the practical difficulties, the introduction of a new criminal sanction for recklessness. Of course, care must be taken not to discourage candidates from taking on directorships in challenging circumstances. (7) Ensuring that the advent of the FCA—and the Sergeant Review of Simple Financial Products—puts in place a regime in which there are more checks and balances within the system so as to ensure products are fit for purpose in the first instance than to rely upon post-event customer redress. Simple outcomes, however, can require complex structuring under the surface. (8) Conducting a three-year evaluation of the Walker Review, changes then made to the Corporate Governance Code and Approved Persons Regime, and company practice to see whether a further initiative is need to redouble compliance. (9) Reviewing whistle blowing procedures to ensure that they are not only legally compliant but operational in practice.

28. It is further relevant to note that, although not specific to banks, the Kay Review of UK Equity Markets and Long-term Decision Making published on 23rd July proposes the development of the Stewardship Code with the aim of incorporating a more expansive form of stewardship which would include a focus on strategic issues, corporate governance and long-term decision taking; the report also reinforces the view that fiduciary standards should be applied to all relationships in the investment chain independent of the classification of the client and looks to apply more generally the expectation that directors’ remuneration should relate incentives to sustainable long-term business performance. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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Question 7: What other matters should the Commission take into account? 27. As outlined above, banking reform measures currently underway, whether in terms of capital and liquidity standards, the new macro-prudential capability invested in the FPC, the configuration of UK banks, other financial stability measures, or the way in which the new UK financial authorities plan to conduct themselves, will significantly alter the way in which banking is organised, regulated and supervised in the UK. This programme commenced shortly after the onset of the financial crisis—at international, European and national level—and taken together the measures will result in a very substantial shift in primary obligations, values and incentives. But many of the reforms have been in place for only a short period of time or are still in the process of finalisation. 28. The task for the Parliamentary Commission therefore must be to sift through these measures and to ask which should be viewed as largely having completed the job—but need more time for implementation or bedding down—and which can be said to fall short or otherwise require reaffirmation or strengthening. The question therefore is whether the answer lies in additional statutory powers or responsibilities on behalf of the various authorities (and enforcement agencies involved) or in the provision of a strong Parliamentary steer towards a greater utilisation of powers and responsibilities which may already exist. 29. The raising of professional standards is integral to the change process currently being conducted within the banking industry. We have therefore sought to look at the reforms being undertaken with this in mind and to draw together further actions which could be taken to bring about a step change consistent with ensuring that as banks emerge from this period of change there can be greater confidence in their having the right value structure and the practical tools of ensuring that this is upheld by all staff. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 850 Parliamentary Commission on Banking Standards: Evidence Standards Professional Legal obligations on directors including fiduciary duties Firm responsible for ensuring directors and employees have right attributes and competencies for role FSA vetting for SIFs and Approved Persons Professional standards through external qualification relevant to role and responsibilities or internal training Minimum standards for retail investment advisers and the monitoring of standards by the regulator under the Retail Distribution Review; further emphasis placed on ethics by chartered institutes Regulatory oversight of the prevalence of professional qualification and/or competency Regulators Persons Regime Greater emphasis on checks and balances to ensure that financial products are market compliant than Responsible for ensuring firms have the right systems and controls in place toable be handle issues. Enhanced supervision, twin peaks regulation and changes to SIF process Approved Audit Compliance and Internal Compliance has a roleplay to in ensuring compliance with legislation and internal policies and procedures. Internal audit is lastof line defence and keyensuring for that internal policies and procedures are adhered to. [Is one of the international bodies currently undertaking a review.?] APPENDIX 1 Compliance Culture Staff understand the importance of a compliance culture and importantly this forms an element ofremuneration. their Staff have accessing towhistle a blowing regime which is taken seriouslysenior by management. Remuneration changes Remuneration changes Whistle blowing procedures GOVERNANCE AND PROFESSIONAL STANDARDS IN BANKS Board and Risk Functions the whole of thethrough company risk appetite. Board level committees consider key reputational risks through Committee structure. Partnership Board Boards set the tone for Walker Review Post-Walker evaluation Financial Skills Risk functions set risk policies and authorise risk limits on different parts of the business. The FSA has recently undertaken reviews of Board governance at banks. composition, competency and behaviour initiative Shareholders actively with banks. Itenvisaged is that the bail-in arrangements for senior creditors will increase the active involvement of debt holders. Decision Making Large shareholders engage Stewardship Code Kay Review of UKMarkets Equity and Long-term Current position Recent changes Scope for development cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 851 Standards Professional Tie-in between individual ethics and responsibilities, company values, regulatory principles and shareholder expectations Regulators redress Greater emphasis on conduct roles in the SIF regime and the approved persons regime post event consumer Audit Compliance and Internal Compliance Culture Board and Risk Functions Shareholders 22 August 2012 cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 852 Parliamentary Commission on Banking Standards: Evidence

Written evidence from the British Bankers’ Association Executive Summary Introduction There are a number of potential mechanisms to strengthen standards and restore trust in the banking industry in the UK. This submission sets out at a high level the existing regulatory and legal framework around conduct and standards. It then seeks to outline the options for what else could be done, and sets out some of the issues and questions that would need to be addressed. The options can broadly be divided into three approaches: — Strengthening the existing framework. — Adopting a top-down approach, focusing on the ﬁrms. — Adopting a bottom-up approach, focusing on the individuals. The likelihood is that none of these approaches on their own would be sufﬁcient to restore trust. Therefore, they should be considered as ingredients that could be part of a range of measures or that could be used in conjunction with each other to amplify their effect.

Strengthening the ExistingRegime Consideration is already being given to how to strengthen or extend the existing legal and regulatory framework. There are, however, further steps that could potentially be taken. These include being clearer upon the expectations placed upon senior management and extending the number of roles covered under the existing Approved Persons Regime where gaps can be identified. This could include extending the regime to include more individuals involved in customer facing roles and those involved in significant wholesale market transactions or dealing. An alternative approach could be to apply the Approved Persons Principles to a broader set of employees, but stop short of expanding the Approved Persons Regime. The BBA also sees scope for making improvements in the way that individuals are treated when they leave an institution and a withdrawal notice from the Approved Persons Regime is submitted to the regulatory authorities. For example, if an individual resigns before disciplinary proceedings are completed, even in circumstances falling short of a breach of a regulatory requirement of the type which usually requires reporting, banks could be required to include this fact in any withdrawal form. Another potential option, which relates to the concept of a “bottom-up” approach, is for the FCA to be more explicit on its views on training and competency, including professional development. This could include the new regulator making an assessment of whether there are other activities which would benefit from requirements similar to those applying from 1 January 2013 for those covered under the Retail Distribution Review.

ATop-downApproach A “top-down approach” would be aligned with the traditional model of governance. This would involve the development of a Code of Conduct which could be applied universally across all bank employees. The Code would not necessarily be prescriptive but instead provide a standard form that could be drawn upon and developed in light of business mix and character. Banks would then be required to implement the Code and report on its implementation. The Code would cover the organisation as a whole and include expectations on: — the Board and senior management, recognising that the culture and ethics are set at the top of the organisation, since this ultimately is where responsibility lies; — systems, controls and incentives, recognising that these are key checks and drivers on behaviour; and — individuals, recognising that the individuals themselves are the “ﬁrst line of defence” in terms of ensuring high standards of conduct and protecting reputation. Responsibility for the Code of Conduct could rest with one of the new regulatory authorities—most likely the FCA—possibly in conjunction with an advisory panel drawing together what the Consumer and Practitioner Panels of the FSA do today together with FCA and industry representation to create a forum to agree high level principles of conduct and monitor market trends that suggest areas where fresh thinking or interpretative guidance is required. Alternatively, an independent Banking Standards Review Council could be established to monitor and uphold ethical standards. This would need to be independent of the industry—by which we mean an independent non- banking chairman and a majority of non-banking members, including customers of banking services and the public interest, but with industry support and input. Consideration would need to be given to questions such as whether any independent Banking Standards Review Council would need a statutory footing, its relationship with the existing regulatory framework and the scope of its application. In order to be credible and effective, it is likely to need to have some statutory or regulatory support, be independent of the industry and be universally applicable to all sectors of the banking industry. Under this approach, there would be an expectation upon banks to report on how the Code was cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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implemented and enforced, including disciplinary action taken in respect of breaches of the Code. It is also likely that some form of assurance mechanism would be required.

The inter-relationship between the approach and the existing regulatory framework would need careful consideration, as a move to a “three peaks” regulatory system would seem to cause unnecessary and confusing complexity. It is for instance difﬁcult to see how the Banking Standards Review Council could have a role in individual cases of misconduct without duplicating the existing Approved Persons Regime and encountering difﬁculties with employment law and Human Rights legislation. There may also be scope for building in some of the activity of the current FSA Practitioner and Consumer Panels.

ABottom-upApproach

A bottom-up approach is one that focuses primarily on the individuals employed in the banking industry. In some respects, it can be seen an analogous to the approach adopted in professions such as legal, accounting and medicine.

There are a variety of potential options and it should be recognised that there are already a number of initiatives in this area.

One approach would be to focus on the training and development of employees, and for this to identify professional standards expected in speciﬁc areas of business. Banks are already making efforts in this area; and therefore the question is what else could be done. An option would be for the industry to work collectively on standards and promoting awareness of these efforts. However, such an industry-led initiative may lack the necessary credibility. Another option would be to increase the independent oversight of training and development or for the FCA to take the lead in producing guidance or setting standards.

In any event, we would see beneﬁt in greater coordination in the area of training and education. This could involve a Professional Standards Board. Consideration would need to be given to its remit, independence and governance, to ensure its credibility. The Professional Standards Board could have a role in recognising and promoting the various existing standards, professional bodies and institutes operating in this area. It could be separate to the potential Banking Standards Review Council envisaged under the “top-down” approach, or be one and the same.

One question is whether there should be a broader register of bankers in some form. Such an approach would focus on the individual rather than the ﬁrm, but would still raise signiﬁcant issues, such as the need for statutory support, its relationship with the existing regulatory regime, the scope of any register, what its disciplinary powers would be and how it would operate in a way that would not damage the UK’s international position or cause “restraint of trade” or “free movement of labour” issues.

There are no prima facia insurmountable obstacles to an approach focusing on the individual, and a greater focus on the “professionalisation” of employees within the banking industry is clearly desirable. However, a regime focused on the individual, based on their observing certain standards of behaviour and conduct, would not be effective if the organisations that employ them operate a culture that works against these standards. Careful consideration would therefore need to be given to how this would be overcome and what could be done, either to strengthen the existing regulatory framework or adopt a top-down approach, as discussed above. In effect, raising standards using a “bottom-up” approach is likely to be a necessary, but not sufﬁcient step to raise standards and restore trust.

Banking and theInternationalContext

Any proposal would need to take account of the international nature of banking in the UK. This is not just in respect of ensuring the UK’s attractiveness as a place to do business, but also in ensuring a level playing ﬁeld for both UK and overseas banks operating here.

It is vital that the UK remains an attractive place to do business. And, although some may view any initiative in this area as potentially adversely affecting this attractiveness, this need not be the case. A well-formulated, proportionate approach should, in fact, enhance the attractiveness of the UK as a place to do business. If the initiative made clear standards of professional conduct and enhanced trust, it should attract banks, capital and clients to the market. Of course, any initiative would need to be cognisant of the need to protect freedom of trade and free movement of capital, and these issues would need further consideration.

Ensuring a level playing ﬁeld between UK and overseas banks must also be an important consideration. However, it is not an insurmountable obstacle, as UK and subsidiaries of overseas banks are already regulated by the UK authorities and subject to UK law. There are further questions regarding how the Code would apply to branches of overseas banks operating here; and how it would apply to the overseas operations of the UK banks and how it may interact with local requirements. These points also would require further careful consideration. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 854 Parliamentary Commission on Banking Standards: Evidence

Raising Banking Standards—Context and Options for change 1. Introduction: Context and options for change The Commission on Banking Standards has been appointed by both Houses of Parliament with a Terms of Reference to consider and report on: (1) Professional standards and culture of the UK banking sector, taking account of the regulatory and competition investigations into the LIBOR rate-setting process. (2) Lessons to be learnt about corporate governance, transparency and conﬂicts of interest, and their implications for regulation and for Government policy.

In addition, during the hearings of the Parliamentary Commission, issues surrounding the standards and trust in banking have been raised frequently by members of the Commission and those giving evidence.

Banking is an industry that must be based on trust and high standards of professional conduct. Trust and standards within banking must be supported and sustained by a culture that is well entrenched in everyone who works for the bank. There is a general recognition that this has not been the case in parts of the banking industry in recent years and steps must now be taken to remedy the situation.

There are a number of potential approaches to raising standards in banking, and within each there are a number of further elements that need to be considered. One option is to look at the existing regime and consider ways in which it could be strengthened. It needs to be recognised that in addition to the many ﬁnancial stability measures devised since the outset of the ﬁnancial crisis, the UK Coalition Government has also put in place a new regulatory architecture and that this includes the establishment of a conduct-focused regulator in the form of the Financial Conduct Authority. This will only obtain its formal powers later this year and is in the process of developing its approach to conduct regulation. It therefore may be that the answer to strengthening ethical and professional standards lies in large part with the new regulator.

Working in conjunction with the new regulatory authorities we see two possible means by which ethical and professional standards can be strengthened: — A top-down approach, for example, one focused on a Code—this focuses on organisations as a whole and seeks to raise standards by requiring them to take steps to improve the oversight, monitoring and control of employees. This approach could also be characterised as one focused on “tone from the top” and is aligned with traditional method of corporate governance in limited liability companies. It is premised upon external oversight which could be provided by an independent Banking Standards Review Council. — A bottom-up approach, for example, one focused on Professional Standards—this focuses on the individuals operating within the industry and seeks to raise their technical competencies and ethical standards. This approach is a feature of other professions, including the medical, legal and accounting sectors.

These approaches and the various elements within them can be combined, or used in conjunction with each other and the existing regimes. They could involve the introduction of reinforcement or disciplinary mechanisms; that is, the tools and sanctions available to a party to promote, monitor and enforce any initiatives to raise standards.

Set out below is an account of the potential approaches and a summary of some of the issues.

2. Existing Regulatory and Legal Framework

Regulatory Framework

The banking industry is already subject to a broad-ranging regulatory regime. This regime is evolving, particularly with the separation of the Financial Services Authority (FSA) into the Prudential Regulatory Authority (PRA) and the Financial Conduct Authority (FCA), and any steps to raise standards will need to take account of and be conducted within this context.

The regulatory authorities already make substantial demands of firms in the context of professional standards. These requirements focus on both the regulatory entities and the individuals operating within them. The primary mechanism the FSA currently utilises in relation to the behaviour of individuals is the Approved Persons Regime (“APER”). This requires individuals with significant management roles and/or responsibilities (a “Significant Influence Function” or “SIFs”) to be approved and registered with the FSA.36 In addition to the SIF regime, there is also the concept of Customer Functions, which covers those interacting 36 List of SIFs—CF 1 Director function; CF 2 Non-executive director function; CF 3 Chief executive function; CF 4 Partner function; CF 5 directors of an unincorporated association; CF 6 Small friendly society function; CF 8 Apportionment and oversight function (Non-MiFID business only); CF 10 Compliance oversight function; CF10a CASS operational oversight function; CF 11 Money laundering reporting function; CF 12 Actuarial function; CF 12A With-profits actuary function; CF 12B Lloyd's Actuary function; CF 28 System and controls function; CF 29 Significant management function. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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or providing advice to customers.37 These functions are considered to be Controlled Functions (“CFs”)38 and those holding them must be registered and approved by the FSA. The approval process for those holding Controlled Functions already includes a “fit and proper test” and, dependent on the role performed, a consideration of the individual’s experience, competency and skills.39 Those discharging a Controlled Function are required under Section 64 of FSMA to observe the seven Principles; these include: that they must act with integrity; show due care and diligence; and observe proper standards of market conduct. (The Principles are listed in Appendix 1.) As at 31 March 2012 there around 156,000 registered Approved Persons. It is recognised, however, that there are significant gaps in the current regime in terms of who is covered; and consideration is being given to how and in what respects it could be extended. For example, a number of individuals involved in alleged manipulation of LIBOR would not have been covered. Approved Persons may have their authorisations withdrawn and be banned from holding a Controlled Function by the regulatory authorities. The authorities further set principles and rules around the structure and conduct of individual regulated entities as part of their High-Level Principles that apply to a firm as a whole. These require, inter alia, that the firm must conduct business with integrity, with due care and diligence and treat customers fairly. (The High-Level Principles are provided at Appendix 2.) The High-Level principles are supplemented by the rules on Senior Management Arrangements, Systems and Controls (often referred to as “SYSC”). These rules cover, inter alia: Senior Management Arrangements; Compliance, Internal Audit, and Financial Crime; Risk Control; Conflicts of Interest; and whistleblowing. In addition to the Approved Persons Regime, the High-Level Standards, the SYSC rules, and detailed Handbook, the regulatory authorities have a range of powers relating to the supervision and conduct of regulated entities, including the ability to commission an Independent Review by a Skilled Person of a regulated entity (or individual within that entity). These reviews are commonly referred to as Section 166 Reviews.40 These reviews may seek to address, report on and suggest remedial actions on wide range of topics, including concerns on the adequacy of systems and controls, anti-money laundering, client assets and to assess whether there have been or may be likely to be any breaches of regulatory requirements. The FSA may also conduct its own investigation, require remedial actions, impose fines and ultimately withdraw a firm’s authorisation to engage in a regulated activity. In addition to the above powers, the FSA has also introduced in recent years its Remuneration Code. The Code sets out the standards that banks, building societies and some investment firms have to meet when setting pay and bonus awards for their staff and aims to ensure that firms’ remuneration practices are consistent with effective risk management.41 The Code is contained in and applied through SYSC 19A of the FSA’s Handbook. The Remuneration Code is primarily focused at those employees who hold significant management positions or are considered to be significant risk takers (these operating primarily in the wholesale market). In the retail market, the FSA has completed its Retail Distribution Review which looks at the sales processes and incentives surrounding the sale of retail products and bans the use of commission-based selling. It has also recently conducted a review of sales incentive programmes in financial institutions and will be introducing the requirement for these institutions to make significant changes. The FSA and its successor organisations have committed to developing the use of the existing framework, and have identified early intervention and the enforcement of credible deterrents as key to this. The FCA’s stated objectives include: — Protecting and enhancing the integrity of the UK market. — Securing an appropriate degree of protection for the consumer. Both of these objectives address directly the issues of raising standards and restoring trust. The FCA will also have new powers in product intervention; to direct firms to withdraw or amend misleading financial promotions; and to publish warning notices. The new regime will focus more on ensuring the suitability of 37 The customer function is the function CF30 and includes those: (1) advising on investments other than a non-investment insurance contract (but not where this is advising on investments in the course of carrying on the activity of, giving basic advice on a stakeholder product) and performing other functions related to this such as dealing and arranging; (2) giving advice to clients solely in connection with corporate finance business and performing other functions related to this; (3) giving advice or performing related activities in connection with pension transfers or opt-outs for retail clients; (4) giving advice to a person to become, or continue or cease to be, a member of a particular Lloyd's syndicate; (5) dealing, as principal or as agent, and arranging (bringing about) deals in investments other than a non-investment insurance contract with or for, or in connection with customers where the dealing or arranging deals is governed by COBS 11 (Dealing and managing); (6) acting in the capacity of an investment manager and carrying on functions connected to this; (7) in relation to bidding in emissions auctions, acting as a 'bidder's representative' within the meaning of subparagraph 3 of article 6(3) of the auction regulation. 38 Under Section 59 (Approval of Particular Arrangements) of the Financial Services and Markets Act 2000 (“FSMA”) 39 FSA Handbook, FIT 1.3.1, The FSA will have regard to a number of factors when assessing the fitness and propriety of a person to perform a particular controlled function. The most important considerations will be the person's: (1) honesty, integrity and reputation; (2) competence and capability; and (3) financial soundness. Detailed guidance on these factors is provided in FIT 2.1–2.3. 40 Section 166, the appointment of a skilled person, FSMA 2000 41 The Code is part of the FSA Handbook cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 856 Parliamentary Commission on Banking Standards: Evidence

products. It will also focus more on wholesale market conduct than has previously been the case, and intervene and bring enforcement actions where necessary.

Consumer Protection In addition to the above regulatory framework, which will be reinforced by the FCA’s proposed approach, retail customers also have a variety of rights and protections. Bodies such as the Ofﬁce of Fair Trading, the Financial Ombudsman Service and the Lending Standards Board already provide retail consumers with a high degree of protection and avenues for redress. Such protection and redress, however, is clearly not sufﬁcient to address directly the main issue, namely reducing the instances where consumers need to complain. That requires action to raise professional standards and improve culture in the UK banking sector.

Legal Framework In addition to the regulatory regime, those operating in banking are subject to the overarching criminal and civil legal framework. Indeed, many of the high profiles cases of misconduct in the financial services industry result in sanctions being applied through both the legal and regulatory regimes. The Fraud Act 2006 considers there to be three core definitions of fraud: false representation; failing to disclose information; and fraud by abuse of position. These definitions are clearly relevant, and are frequently applied to cases of misconduct in the financial services industry and have substantial sanctions associated with successful prosecutions.42 In addition, activities such as Market Abuse, commonly termed “insider-trading”, are covered in the Criminal Justice Act 1993 and FSMA and are in the process of being extensively revised under the EU’s Market Abuse Directive to include a broader range of potential market manipulations. In addition to the criminal legal framework, those serving as directors of a regulated entity that is incorporated under the Companies Act 2006 are subject to its Directors’ Duties.43 These duties include a requirement to act in good faith, in a way that would be most likely to promote the success of the company (Directors’ Duties under Section 172 of the Companies Act 2006 are set out in Appendix 3). Directors are also required to exercise independent judgement, act with reasonable care, skill and diligence, and avoid conflicts of interest. Individuals may be disqualified from serving as a director on a mandatory or discretionary basis under the Company Directors Disqualification Act 1986. Individuals may be disqualified for a variety of reasons, including evidence of any misfeasance or breach of any fiduciary or other duty by the director in relation to the company. The primary purpose of the disqualification sanction is to protect the public against the future conduct of companies by persons whose past records as directors of insolvent companies showed them to be a danger to creditors and others. In addition, HM Treasury is currently consulting on the possible extension of the sanction regime for directors of failed banks, including the introduction of a rebuttal presumption that the director of a failed bank should not hold in future hold a similar position, the extension of criminal sanctions to cover managerial misconduct, and the application of tests associated to strict liability, negligence or incompetence, or recklessness. A number of high-profile cases provide some evidence that the current regulatory regime, consumer protections and legal framework, working together, can be effective in prosecuting those engaged in misconduct and imposing substantial sanctions. More can be done, however, to raise standards further and to restore trust, whether through strengthening the existing regime or by the introduction of new additional or complementary initiatives.

3. Strengthening the existing regime Consideration is already being given to how the existing regulatory regime could be strengthened. This could include broadening the Approved Persons Regime so that it captures more individuals. For example, more Controlled Functions could be introduced, so that they were more granular in terms of roles performed and covered more individuals. The concept of the Customer Function (CF30) could be extended to include individuals involved in the sale/distribution of ﬁnancial products to retail customers akin to the new Retail Distribution Review requirements. Another approach could be for the existing regime to be supplemented by a more overarching framework that captures more people through a general requirement to observe the APER Principles. These approaches would require further consideration of who would be subject to the extended regime. Another area of improvement could be around the process for withdrawal of approval when an individual leaves an institution. For example, where an Approved Person is subject to disciplinary proceedings, they may resign before the process is completed and this is not necessarily reported on the withdrawal form to the FSA. This resignation before completion of process would be useful information for the regulatory authorities to consider if the individual sought another approved persons role and was subject to the Fit and Proper Test. Reporting could also include circumstances falling short of a breach of regulatory requirements. We would envisage that the withdrawal form would report only that proceedings had been initiated, not completed, and 42 Including recommended jail sentences of seven to 10 years 43 Companies Act 2006, Sections 171–177. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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that no outcome had been determined and as such the individual would be free to explain their reasoning and would not be “banned” as a result. A further possibility is for the regulatory authorities to be more explicit in their view on training and competency requirements, including a requirement for continuous professional development. For example, as part of the changes applying from 1 January 2013 under Retail Distribution Review, individuals are required to have a higher level of professional competency (including passing a “Level 4 exam”), are required to hold a Statement of Professional Standard from an accredited body, undergo a minimum number of annual training (a Continuous Professional Development requirement) and sign a declaration annually that they have complied with the APER Principles. This approach—or something similar to it—could potentially be adopted for other sections of the banking industry. It can also be questioned whether, historically, the regulatory authorities and law enforcement agencies have given sufﬁcient priority to enforcement action. This is a matter upon which we commented in our response to the Parliamentary Commission’s initial call for evidence last summer (see for instance paragraphs 16 to 21).

4. Other potential approaches Although there may be some beneﬁt in extending or strengthening the existing regime, it remains open to question whether this would be sufﬁcient to achieve the aims of both raising standards and restoring trust. Therefore, it merits further consideration of what other mechanisms or approaches could be adopted. These can be characterised as “top down” and “bottom up”.

4(A) A top-down approach The “top-down approach” is one that is most closely aligned with the traditional model of governance. This approach focuses upon the system by which companies are directed and controlled, where the Boards of Directors are responsible for the governance responsibilities of the Board including deﬁning its culture and approach, providing the leadership to put it into effect, supervising the management of the business and reporting on conduct. Under this approach, the standards would be set and upheld externally, potentially through a new independent body. Responsibility for the Code of Conduct could rest with one of the new regulatory authorities—most likely the FCA—possibly in conjunction with an advisory panel drawing together what the Consumer and Practitioner Panels of the FSA do today together with FCA and industry representation to create a forum to agree high level principles of conduct and monitor market trends that suggest areas where fresh thinking or interpretative guidance is required. Alternatively, it could rest with an independent body; we explore this further below.

Code of Conduct for banks and a Banking Standards Review Council Under this approach, an independent body could be established with responsibility for drawing up general conduct principles, monitoring how these are being applied in practice and how practitioner firms are enforcing their own codes of conduct. This could take the form of a “Banking Standards Review Council”. In addition to preparing a Code of Conduct, and monitoring its application, the Council could receive and address application reports thereby ensuring that banks and their employees live up to the standards set out in the Code. Such a body would need to be independent of the industry—by which we mean an independent non-banking chairman and a majority of non-banking members, including customers of banking services and the public interest, but with industry support and input. This would require consideration of a number of questions and options. The first question that would need to be addressed would be the content of such a Code, and who it would cover, both in terms of the types of business and the individuals. As noted previously, recent years have seen examples of misconduct in both the retail and wholesale areas of banking, the loss of trust in the banking industry is general in nature rather than relating to one aspect of it, and the concept of high professional standards is a universal one. Therefore, it would be difficult to argue that the Code should only apply to one area of banking; account, however, may need to be taken of how it should apply in each area. The content of any Code is something that would need careful consideration, both in terms of making any initiative effective but also in terms of ensuring that it is complementary to existing regulatory or legal requirements. The Code would be ascribed to at an organisational level and would set out the types of ethical standard and principle that banks should expect of the employee. One possible model would be the Lord George Principles of Business Conduct which read:44 1. To act honestly and fairly at all times when dealing with clients, customers and counterparties and to be a good steward of their interests, taking into account the nature of the business relationship with each of them, the nature of the service to be provided to them and the individual mandates given by them. 44 Lord George Principles of Business Conduct, as promulgated by the Worshipful Company of International Bankers. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 858 Parliamentary Commission on Banking Standards: Evidence

2. To act with integrity in fulfilling the responsibilities of your appointment and seek to avoid any acts or omissions or business practices which damage the reputation of your organization and the financial services industry. 3. To observe applicable law, regulations and professional conduct standards when carrying out financial service activities and to interpret and apply them according to principles rooted in trust, honesty and integrity. 4. To observe the standards of market integrity, good practice and conduct required by or expected of participants in markets when engaged in any form of market dealings. 5. To be alert to, and manage fairly and effectively—and to the best of your ability—any relevant conflict of interest. 6. To attain and actively manage a level of professional competence appropriate to your responsibilities, to commit to continued learning to ensure the currency of your knowledge, skills and expertise and to promote the development of others. 7. To decline any engagement for which you are not competent unless you have access to such advice and assistance as will enable you to carry out the work competently. 8. To strive to uphold the highest personal and professional standards. Whilst a standard approach would benefit from the transparency it would bring, there is arguably a balance of advantage to be had in individual banks being able to adapt a model approach to reflect their business mix and character. There is for instance a distinction between retail banking on the one hand and wholesale and investment banking on the other and other specialist activities which banks may undertake; other factors such as the nationality of the parent company may also have a bearing on the best way in which to give expression to a core set of Code principles. It is recognised that the simple presence of a Code of Conduct is unlikely to be sufficient to ensure that standards are raised and trust is rebuilt. The Banking Standards Review Council is therefore likely to need responsibility and processes for oversight and assurance.45 The Code would also need to contain details, not just on the expected conduct of individuals, but also on: — The expectation on company Boards and senior management in terms of on overseeing the implementation and receiving assurance. Given the important and complex role that the Board already plays in the governance of financial institutions, it would be necessary for any change in their role in this respect to involve a reorientation of duties rather than an addition. — The expectations of the systems, controls and remuneration structures. These would need to be aligned with the Code and have a role in making sure it was promulgated across the organisation, any necessary training steps had been completed by employees, information upon compliance and breaches collected and that this information is reported to appropriate levels of senior management and ultimately the Board. — The expectations on the individuals, both in terms of understanding the Code, including any required training or development initiatives, and abiding by it. This is aligned with the expectation that the individuals are the frontline and have a primary responsibility for reputation and conduct. These expectations may also include ensuring that employees understand any associated disciplinary proceedings and potential sanctions. The content and status of the Code of Conduct also raises questions regarding the role of any Banking Standards Review Council that would develop, monitor and enforce the Code. It could be given statutory underpinning or be established on a non-statutory basis where banks would publicly commit to adhere to its requirements—with or without a regulatory expectation that they so do. A key question is the basis upon which any such Council operate? There are a number of options in this area, although it is clear that in order to be credible and effective any such body would need to be independent of the industry. This issue of independence also relates to its composition. In order to be credible and effective, the Council should have a majority of members from a non-banking background, including the chairman. There are also questions regarding how its members would be appointed and how it could be ensured that there was suitable representation of the broad constituency of customers of banking services and the public interest.

Relationship with existing regulatory framework While it is envisaged that the Banking Standards Review Council should most likely be separate from the regulatory authorities, it will nevertheless be necessary to ensure that their responsibilities align and that unnecessary duplication and conﬂict is avoided. This is particularly the case in respect of the Approved Persons 45 An example of this concept working successfully is the UK Code of Corporate Governance, a model of corporate governance and control based on the now 20 year old recommendations of Cadbury Committee which has been copied across the globe. The Code is often mistakenly referred to as self-regulation. However, companies listed on the Main Market of the London Stock Exchange are required to make disclosures against the Code’s Principles and Provisions in their Annual Report and a number of these disclosures are subject to veriﬁcation by the appointed statutory auditors. Finally, the decisions take by the Board of Directors under the “comply or explain” regime are judged by the shareholders who through their ability to remove directors, block capital raising, approve remuneration schemes and approve the auditors, retain the ultimate sanctions within the corporate governance regime of listed companies. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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Regime. There may, however, be scope for building in some of the activity of the current FSA Practitioner and Consumer Panels. There may be a case for some form of statutory underpinning or Royal Charter, though we assume its powers would be civil and not involve criminal sanction. Other questions include what would its powers of investigation and discovery be, and how would its sanctions regime differ from the existing processes and sanctions under the Approved Persons Regime? Thought needs to be given to the circumstances in which an individual could be disciplined under any Code where their actions did not involve a reportable regulatory breach. It is also arguable that the creation of a third regulatory body would introduce increased complexity for both the supervisors and the institutions without any corresponding beneﬁt that could not be achieved more efﬁciently through other means.

Scope of application The Code of Conduct, and its Council, would require a clearly deﬁned scope in terms what types of institutions it would apply to (effectively addressing the core question, “what is a bank?”), what account would need to be taken of the international nature of banking, and how it would apply to organisations and individuals. As noted above, a universal Code, applying to all banks, would seem to be the best way forward. Consideration, however, would still need to be given to how a Code would work in the context of overseas banks operating in the UK, and how it would apply to organisations as a whole and the individuals who operate in them.

Banking and the International context Any proposal in this area would need to take account of the international nature of banking in the UK. This is not just in respect of ensuring the UK’s attractiveness as a place to do business, but also in ensuring a level playing field for both UK and overseas banks operating here. The UK remaining an attractive place to conduct business is vitally important and, although some may view any Code of Conduct and its Council as potentially adversely affecting the attractiveness, this need not be the case. A well-formulated proportionate approach to any Code and Council should, in fact, enhance the attractiveness of the UK as a place to do business. If the application of the Code raised standards of professional conduct and enhanced trust it should attract companies, capital and clients to the market. In this respect, parallels can be drawn with the UK law and judicial system, which draws people to London by virtue of the confidence in which it is held. Similarly, the UK approach to, and high standards of, corporate governance actively attract foreign companies and investors to the UK market. Ensuring a level playing field between UK and overseas banks must also be an important consideration. However, it is not an insurmountable obstacle, as UK and subsidiaries of overseas banks are already regulated by the FSA and subject to UK law. Consideration may have to be given to how the Boards of such subsidiaries approach their duties but there is no prima facie reason why the Code could not operate effectively. There are further questions regarding how the Code would apply to branches of overseas banks operating here, how it would apply to the overseas operations of the UK banks and how it may interact with local requirements. These points would require further careful consideration.

Organisations and Individuals There are various options as to what the scope of the Code of Conduct and the Banking Standards Review Council should be, in terms of which individuals it would apply to. As noted above, adhering to proper standards of business conduct should apply to all working in the banking industry. However, not all employees within the banking industry are engaged in banking activity; for example, banks employ large numbers of individuals in Human Resources and Information Technology. One option therefore is for the individuals within scope to be those undertaking defined activities, for example traders or those selling financial products to retail customers. However, this would likely develop into something very similar to and perhaps ultimately indistinct from the Approved Persons Regime. It would also require detailed rules and guidance as to who exactly was covered, and this could create gaps and risk missing key individuals, particularly as banking activities and practices develop over time. Another approach would be for the Code to apply to all individuals working in banking. This would recognise that how individuals and firms conduct themselves is a universal responsibility. There is a risk, however, a standard Code applied universally may end up being based on the lowest denominator of commonality and give no recognition of individual roles and responsibilities, or may be a disproportionate burden on individuals who have, for example, no customer interaction or who take no risks. A means of overcoming this would be for a universal code to apply to all firms, but for firms to be entitled to adapt the standard model to their circumstances. Firms would implement according to their individual business activities and staff profiles. The Code would also be placed within the context of employment contract. Firms should also be required to report on how they have implemented the Code and the Council would be able to make judgements on how it is being implemented, hold firms to account for their decisions and, dependent on powers, require firms to make changes. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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Monitoring and reporting As noted above, any Code of Conduct would need to include details on the expectations of the bank Board and senior management, the systems, controls and incentive structures, and the individuals. Any Code and associated governance arrangement would be unlikely to successfully raise standards and restore trust if there was no monitoring or reporting. Monitoring and reporting naturally divides into two aspects, the internal and external. To be effective, the internal aspect would require the Board and senior management to receive relevant high quality information of the implementation and operation of the Code. The provision of such management information focusing on conduct would enable the Board and senior management to monitor performance and make any necessary operational changes to ensure that standards are maintained. This is clearly in line with their existing governance responsibilities. The external aspects of monitoring and reporting would be key in terms of rebuilding trust. There are therefore a number of options in this area which are worth considering. One option is that the reporting could be to the Review Council. This reporting could be used in assessing the overall conduct of business and the potential areas of improvement. In the event of regulatory involvement, it could also be used to inform the overall approach to a firm’s supervision by helping the regulatory authorities identify any areas of weakness and helping them assess the overall culture of the firm. Another option reflects the truism that transparency is key to creating trust. Given this, there is perhaps merit in considering a wider, more transparent reporting requirement. For example, firms could be required to publish some form of report on how the Code is implemented, monitored and reported on. This would allow both the regulators and other stakeholders to take a view on how the Code has been implemented and the overall culture of the firm. An added advantage of this approach is that it may create a momentum around raising performance to meet the market leaders and best practice levels. It would have to be decided what would have to be reported above and beyond a simple compliance statement. This could include it setting out the key performance metrics that would have to be reported. The reporting could further include, for example: — A description of the company Board and senior management’s role in relation to the Code. — To whom the Code applies to and how this application varies according to role, including how these variations are decided. — How the Code is promulgated and monitored. — The systems for reporting. — How the controls and incentives framework support the Code. — How training and development programmes support the Code, including quantified metrics on training and continuous professional development. — How the Company uses professional qualifications and bodies to support the Code. — The levels of compliance with the Code and/or breaches of it — The disciplinary procedures around the Code and how they were used throughout the reporting period.

Whistleblowing A further aspect to the upholding of ethical and professional standards is whistleblowing. Many banks already operate a whistleblowing system, in some cases operated independently of the bank by a third party. A Banking Standards Review Council could offer guidance on effective whistleblowing systems, and could provide a route for those who felt that standards of conduct were not being upheld to report these concerns by, for example, operating its own whistleblowing system.

The role of assurance and investigation Although transparency and reporting may engender a degree of confidence, they may not be sufficient on their own to rebuild trust. This therefore raises questions regarding what level of assurance and potentially investigatory powers would be necessary. There are a number of options in this area beyond simple self-assessment. These include: — Self-assessment combined with some sort of self-certification (for example, by the internal audit), or attestation to the Review Council. — A regime of voluntary assurance, whereby individual banks would not be required but encouraged to obtain external assurance at regular intervals, or explain why not. This approach is already used for example in relation to board effectiveness reviews, which under the Financial Reporting Council’s Corporate Governance Code should be externally facilitated at least every three years. — Assurance or verification could be mandatory, but with banks permitted to select who would supply this service. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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— Assurance or veriﬁcation could be part of the external audit process. This would require discussion with the accounting industry and the audit standard setter to understand what is expected and achievable in this context. All of the above options would need careful consideration of the practical issues and how the process would work, the level of burden and cost it would impose on organisations and the nature of the beneﬁts arising. One possibility would be that the Banking Standards Review Council would allow each bank to choose the relevant mechanism but be entitled to request a change. This power to request change might be key to the credibility of any Review Council. There are also questions regarding what powers of investigation are necessary. Ultimately, these powers or lack thereof would form part of its statutory underpinning and its relation with the existing regulatory bodies. However, the FSA already conducts thematic reviews and has the power to request a “Section 166” review and therefore there may be existing tools available in this area.

Enforcement and disciplinary procedures The FCA has explicitly stated that in the future it will focus more on the concept of “a credible deterrent” and with any additional Code of Conduct and Review Council there are questions regarding what disciplinary powers, if any, there should be; and who would fall within its remit. If the Code’s role was to raise standards primarily through reporting, transparency and assurance, it may be sufficient for the Council to have only limited direct enforcement powers. For example, it could require greater assurance from a firm if it felt that the level of reporting was inadequate or the content of the report caused concern. This would leave the primary disciplinary mechanisms of firms and individuals with the regulatory authorities through the High-Level Principles, APER Regime and SYSC Rules. At the same time, the regulatory regime and approach could be strengthened or extended as discussed above, including potentially a requirement in some way to take account of the Code of Conduct or the Review Council’s view on individual banks or behaviours. During the course of the Parliamentary Commission’s work, however, a number of people have commented that any new approach to ethical and professional standards would need the facility to “strike people off” or “blacklist” individuals to prevent them working in the industry. As noted above, the existing APER regime already has the ability to withdraw permissions and make judgements on the fitness and propriety of individuals carrying out the relevant specified function covered by the regime. Within this existing regime, it is hard to conceive of a situation where an individual would have their authorisation withdrawn following proven misconduct but subsequently be approved to hold another significant influence or customer function. In addition, as noted above, the individual banks and the regulatory authorities could work together more effectively to ensure that if an individual resigns before an internal misconduct enquiry is completed by a bank that this is recorded in the withdrawal form and subsequent references. However, this may be regarded as being insufficient or ineffective and it may be considered that more needs to be done in terms of setting up a “register of bankers” that individuals could be removed from or some sort of “blacklisting” be possible with the aim of preventing an individual from working in the banking sector (and perhaps all of financial services). The setting-up of such a register would need careful consideration of a range of factors. Firstly, there would need to be consideration of which individuals should be on such a register, and how it would differ substantively from the existing, or potentially extended, Approved Persons list. There would also have to be consideration about how such a list, if separate, would relate to the Approved Persons list to avoid duplication or contradiction. The next question would be the fundamental one of on what grounds an individual would be struck-off or blacklisted and how this would differ from breaches of the existing regulatory or legal requirements. If they had breached more than one, there would be a further question of precedence, particularly between any Banking Standards Register and the Approved Persons list. One potential extension of an existing concept would be that the withdrawal form or references could be lodged with the Review Council and that they may use this to develop some form of list that could be checked against. If these questions were addressed, the disciplinary procedure would also require careful consideration of the need to preserve the concept of natural justice, due process, burden and standard of proof and the right of appeal. There are also clearly significant issues around how any regime would interact with employment law and Human Rights legislation, which need thorough investigation and consideration.

4(B) A Bottom-up approach The “bottom-up approach” is one that focuses primarily on the individuals employed in the banking industry. In some respects, this approach can be seen as analogous to that seen in accounting, legal and medical professions. The focus on the individual recognises that they are the “ﬁrst line of defence” and that by raising cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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their professional standards the industry as a whole would beneﬁt and this would contribute to the restoring of trust. There are a variety of potential options in how a bottom-up approach could work, and in how these could work in conjunction with both a strengthening of the existing regime and a “top-down approach”. It should also be recognised that there are already a number of initiatives in this area, such as the work by the Chartered Bankers Institute and the Professional Standards Board (“CB:PSB”). The work already done in this area would need to be taken into account to avoid unnecessary duplication of activity.46 There are also a number of Institute and Educational organisations looking at the area of professional education and training, such as the ifs School of Finance and the Chartered Institute of Securities and Investments. They have initiatives and programmes in progress and these should be taken into account. There are a number of options in this area that could contribute to the raising of standards and the rebuilding of trust. The bottom-up approach is one that could be used particularly effectively to support both the strengthening of the existing framework and the top-down approach discussed above.

Training and Development Banks already devote significant resources to the training and development of employees and they are already looking at how this could be developed further in relation to professional standards. For example, one UK bank has already committed to 50,000 of its staff obtaining the Foundation level qualification of CB:PSB. Effective training and development focuses not just on the passing exams and the attainment of qualifications, but also on continuous professional development and reinforcement through behaviours and culture. This is also something that many banks are actively developing and implementing. There may be value in considering what further work could be done in this area by the banks and whether there was scope for them to develop collectively an agreed approach to training and development that would seek to raise standards across the industry. While the on-going work should be viewed as a positive development, there remain questions regarding whether such industry-led initiatives would be credible. An option could therefore be for the regulatory authorities to consider whether they should set out guidance or requirements around professional development and training. This is something FSA already does in certain areas, for example in relation to the requirements, discussed above, relating to providing financial advice under the RDR initiative. Any extension of this role would naturally raise questions around what would be the scope of such a regime (including how it would apply to different activities in banking), what the new authorities would expect in monitoring and reporting, and how any enforcement or sanctions regime would apply. Such a regime would have to be complementary to the existing FSA requirements around ensuring the skill and diligence is applied and that Approved Persons have the necessary skills and experience to discharge the role.

A Professional Standards Body Consideration may need to be given as to the development of a board whose remit extended further than training and development. As noted above, the Chartered Bankers Institute and a number of banks have already developed a Professional Standards Board and a professional code of conduct for individuals (see Appendix 4). This Code is currently supported by a Foundation Standard Course for individuals. This focuses upon professional knowledge and skills, professional values, attributes and behaviours. The current focus of this work is on the retail and commercial banking sector. Another potential option may lie in developing more coherence to the professional standards and training industry through the broadening out of the Professional Standards Board. Currently, while there are a number of different bodies doing positive work in this area, there is no overarching body that recognises them all.47 Its relationship with the FSA and any reporting requirements would need further consideration. A further option would be that if some form of Banking Standards Review Council was formed, as described above, its remit could include the oversight and development of professional standards and the various training providers. In either event, the focus should be on ensuring that the level of training and qualiﬁcations are appropriate to the role performed. A more “catch-all” approach would risk being disproportionate, not take proper accounts of the different areas and roles in banking, and potentially ultimately counter-productive, as it likely not focus enough attention on those roles and individuals where the needs where greatest. In order to elevate the Professional Standards Board various issues would have to be addressed. It is likely that in order to be credible, the body’s governance would have to demonstrate a high-degree of independence from the industry. This would mean, for example, that its governing Board would have to be at a minimum chaired by someone independent of the banking sector and would have include a number of similarly independent Board members. This is already the case with the Lending Standards Board,48 whose Board 46 http://www.cbpsb.org/ 47 Different bodies have different status. For example the ifs School of Finance has the ability to award degrees by virtue of its recognition by the Privy Council, whilst the Chartered Institute of Securities and Investment, whilst also holding a Royal Charter, does not have degree awarding powers. 48 http://www.lendingstandardsboard.org.uk/staffdirectors.htm cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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includes public interest members. There are also questions around its exact role and status within the regulatory framework, many of these are similar in nature to the issues discussed under the “top-down” approach. A further issue, as discussed above, is the question of whether there should be a register or blacklist.

A holistic approach An increased focus on training and development will be a necessary part of any effort to raise standards. However, a regime focused on the individual, requiring them to observe certain standards of behaviour and conduct, would not be effective if the organisations that employ them operate a culture that works against these standards. Therefore, careful consideration would need to be given to how this would be overcome and what could be done either to strengthen the existing regulatory framework or adopt a top down approach, as discussed above. In effect, the raising standards using a “bottom-up” approach is likely to be a necessary but not sufﬁcient step to raise standards and restore trust. If it is considered by the Parliamentary Commission that both a “top-down” and a “bottom-up” approach is needed, then a further question is whether the two initiatives should be progressed separately, with the establishment of a Banking Standards Review Council and a Professional Standards Board, or combined and a single body given responsibility for upholding both ethical and professional standards.

APPENDICES APPENDIX 1 APPROVED PERSONS PRINCIPLES — Statement of Principle 1—An approved person must act with integrity in carrying out his controlled function. — Statement of Principle 2—An approved person must act with due skill, care and diligence in carrying out his controlled function. — Statement of Principle 3—An approved person must observe proper standards of market conduct in carrying out his controlled function. — Statement of Principle 4—An approved person must deal with the FSA and with other regulators in an open and cooperative way and must disclose appropriately any information of which the FSA would reasonably expect notice. — Statement of Principle 5—An approved person performing a significant influence function must take reasonable steps to ensure that the business of the firm for which he is responsible in his controlled function is organised so that it can be controlled effectively. — Statement of Principle 6—An approved person performing a significant influence function must exercise due skill, care and diligence in managing the business of the firm for which he is responsible in his controlled function — Statement of Principle 7—An approved person performing a significant influence function must take reasonable steps to ensure that the business of the firm for which he is responsible in his controlled function complies with the relevant requirements and standards of the regulatory system.

APPENDIX 2 FSA HIGH-LEVEL PRINCIPLES (1) Conduct its business with integrity. (2) Conduct its business with due skill, care and diligence. (3) Take reasonable care to organise and control its affairs responsibly and effectively, with adequate risk management systems. (4) Maintain adequate ﬁnancial resources. (5) Observe proper standards of market conduct. (6) Pay due regard to the interests of its customers and treat them fairly. (7) Pay due regard to the information needs of its clients, and communicate information to them in a way which is clear, fair and not misleading. (8) Manage conﬂicts of interest fairly, both between itself and its customers and between a customer and another client. (9) Take reasonable care to ensure the suitability of its advice and discretionary decisions for any customer who is entitled to rely upon its judgment. (10) Arrange adequate protection for clients’ assets when it is responsible for them. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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(11) Deal with its regulators in an open and cooperative way, and must disclose to the FSA appropriately anything relating to the ﬁrm of which the FSA would reasonably expect notice.

APPENDIX 3 SECTION 172, COMPANIES ACT 2006—DIRECTORS’ DUTIES Directors to act in good faith, in a way that would be most likely to promote the success of the company (Directors’ Duties under Section 172 of the Companies Act 2006 set out in Appendix [X]), for the beneﬁt of its members as a whole, and in doing so have regard (amongst other matters) to: (a) the likely consequences of any decision in the long term; (b) the interests of the company’s employees; (c) the need to foster the company’s business relationships with suppliers, customers and others; (d) the impact of the company’s operations on the community and the environment; (e) the desirability of the company maintaining a reputation for high standards of business conduct; and (f) the need to act fairly as between members of the company.

APPENDIX 4 CHARTERED BANKER CODE OF PROFESSIONAL CONDUCT I will demonstrate my personal commitment to professionalism in banking by: 1. Treating all customers, colleagues and counterparties with respect and integrity; 2. Considering the risks and implications of my actions and advice, and holding myself accountable for them and for the impact these may have on others; 3. Complying with all current regulatory and legal requirements and following best industry practice; 4. Treating information with appropriate conﬁdentiality and sensitivity; 5. Being alert to and managing potential conﬂicts of interest which may arise whilst performing my role; 6. Developing and maintaining my professional knowledge and skills; and 7. Acting, at all times, in a fair, honest, trustworthy and diligent manner. 9 January 2012

Written evidence from the British Bankers’ Association Background This submission provides information around the following written requests from the Commission: The BBA’s annual income and, more speciﬁcally, what proportion of the BBA’s income comes from membership fees and what proportion comes from other sources. How individual membership fees are determined and what proportion of membership income comes from top 5 payers and what proportion from top 10 payers. — Per the last audited statutory accounts for the year to 31 December 2011, BBA income totalled £10.0 million and fee income from full and associate members accounted for £6.6 million of this total. Therefore 66% of income came from membership fees and 34% from other sources. — In the same period, approximately 59% of member income came from the top 5 payers and 65% from the top 10 payers. The British Bankers’ Association (“BBA”) is the leading association for UK banking and ﬁnancial services representing members on the full range of UK and international banking issues. It represents over 150 banking members active in the UK, which are headquartered in 50 countries and have operations in 180 countries worldwide. All the major banking groups in the UK are members of our association as are large international EU banks, US and Canadian banks operating in the UK as well as a range of other banks from Asia, including China, the Middle East, Africa and South America. A full list of BBA banking members and associate members is provided. In our draft strategy, we commit to serving the entire cross-section of banks operating in the UK. Much of the information in this document is available online: http://www.bba.org.uk/about-us. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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SubscriptionCalculation The methodology for calculating member subscriptions was agreed by the BBA Council in March 1997 and re-confirmed in 2005. — For members within banking groups, subscriptions are calculated on aggregated data relating to all banking entities within the group. — Subscriptions are paid on a stand-alone or banking group basis as appropriate. — Subscriptions are subject to a minimum — Subscriptions are based on three measures of ‘institutional size’: — No. of full-time equivalent staff in the UK — (reported by members to the BBA annually, as at June) — Sterling eligible liabilities held on the balance sheet of the member’s operational offices in the UK — (a measure of sterling resources as reported to the Bank of England monthly/quarterly and the basis of cash ratio deposits placed with the BoE) — Total foreign currency assets held on the balance sheet of the member’s operational offices in the UK — (as reported to the Bank of England monthly/quarterly) — Subscription amounts are calculated by multiplying each of the ‘size’ measures by variable weighting factors, subject to: — The contribution of the currency assets component not exceeding the sum of the staff and eligible liabilities components. — Minimum subscriptions level. — Weighting factors are determined in the proportions of 45% : 45% : 10% (staff : eligible liabilities : foreign currency assets) — New members are charged a pro-rata subscription relating to their joining date Subscriptions charging in proportion to member size, according to recognised metrics (reported in part to an independent source), is equitable and transparent to our membership and produces a smooth spectrum of subscriptions. The calculation methodology forms part of the BBA’s annual financial review by external Auditors. The BBA will be reviewing its membership subscription methodology during 2013 to come in for 2014.

BBAMemberList 49 ABC International Bank plc ABN AMRO Bank NV Adam & Company Investment Management Adam & Company plc Ahli United Bank (UK) Plc Aldermore Allied Irish Bank (GB)/First Trust Bank (AIB Group (UK) plc) Allied Irish Bank plc Alpha Bank AE {Part of the Alpha Bank London Group} Alpha Bank London Ltd {Part of the Alpha Bank London Group} AMC Bank Ltd {Part of the Lloyds Banking Group} ANZ Investment Bank Arab National Bank Arbuthnot Latham & Co Ltd Arbuthnot Securities Ltd Australia & New Zealand Banking Group Ltd Banca Monte Dei Paschi di Siena SpA Banco Bilbao Vizcaya Argentaria SA Banco de Sabadell SA Banco Santander Group Bangkok Bank Public Company Ltd Bank J. Safra (Gibraltar) Ltd Bank Leumi (UK) plc Bank of America NA Bank of Baroda Bank of Ceylon (UK) Ltd Bank of China 49 As at 14/1/13 cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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Bank of Cyprus UK Bank of India Bank of Ireland Bank of London and the Middle East Bank of Montreal Bank of Scotland plc {Part of the Lloyds Banking Group} Barclays Bank Group Blom Bank France (Formely Banque Banorabe) BNP Paribas Group Britannia British Arab Commercial Bank Plc Brown Shipley & Co Ltd Butterﬁeld Private Bank C Hoare & Co CAF Bank Ltd Cambridge & Counties Bank Canadian Imperial Bank of Commerce Canara Bank Cater Allen Ltd {Part of the Banco Santander Group} China Construction Bank (London) Limited Citibank NA Close Brothers Ltd Clydesdale Bank plc Commerzbank AG Commonwealth Bank of Australia Coutts & Co Credit Agricole Corporate and Investment Bank (formerly Calyon) Credit Industriel et Commercial Credit Suisse Group Crown Agents Bank Ltd Cyprus Popular Bank Public Co Ltd Danske Bank A/S DB UK Bank Limited Deutsche Bank AG Duncan Lawrie Limited EFG Private Bank Ltd Europe Arab Bank plc FBN Bank (UK) Ltd FCE Bank Plc FIBI Bank (UK) Ltd Fortis Bank SA/NV Ghana International Bank plc Gulf International Bank (UK) Ltd Gulf International Bank BSC Habib Allied International Bank plc Habib Bank AG Zurich Habibsons Bank Ltd Hampshire Trust plc Harrods Bank Ltd Havin Bank HSBC Bank Group ICICI Bank ING Bank NV Investec Bank Plc Irish Bank Resolution Corporation Limited Jordan International Bank plc JP Morgan Chase Bank Group Julian Hodge Bank Ltd KBC Bank NV Kingdom Bank Ltd Kleinwort Benson Bank Ltd Lloyds Banking Group Mashreqbank PSC Metro Bank Plc Mitsubishi UFJ Trust and Banking Corporation Mizuho Corporate Bank Ltd Mizuho International plc cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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Morgan Stanley Bank International Limited N M Rothschild & Sons Ltd Nacional Financiera SNC National Australia Bank Limited National Bank of Canada National Bank of Egypt (UK) Ltd National Bank of Greece SA National Bank of Kuwait (International) plc Nationwide Building Society Natixis Nedbank Ltd Nomura Bank International plc Northern Trust Company Punjab National Bank Qatar National Bank SAQ QIB (UK) plc R Raphael & Sons plc Rabobank International Rathbone Investment Management Ltd Reliance Bank Ltd Royal Bank of Canada Royal Bank of Canada Europe Ltd Sainsbury’s Bank plc Santander UK Group Santander Cards UK Ltd Schroder & Co Ltd Scotiabank Europe plc {Part of The Bank of Nova Scotia Group} Secure Trust Bank plc Shawbrook Bank Limited Smith & Williamson Investment Management Ltd Société Générale Standard Bank plc (formerly Standard Bank London Ltd) Standard Chartered Bank State Bank of India State Street Bank and Trust Company Sumitomo Mitsui Banking Corporation Europe Ltd Sumitomo Mitsui Trust Bank Limited Svenska Handelsbanken AB (publ) Syndicate Bank TD Bank NV Tesco Personal Finance PLC The Bank of New York Mellon Group The Bank of Nova Scotia The Bank of Tokyo Mitsubishi UFJ Limited The Charity Bank Ltd The Co-operative Bank Group The Norinchukin Bank The Royal Bank of Scotland Group Triodos Bank NV UBS AG Union Bancaire Privee UBP Union Bank UK plc United National Bank Ltd United Trust Bank Ltd Unity Trust Bank plc Virgin Money VTB Capital Plc Weatherbys Bank Ltd Wells Fargo Bank NA Wesleyan Bank Limited Westdeutsche ImmobilienBank AG Westpac Banking Corporation

BBA AssociateMemberList Accenture ADT Fire and Security plc Allen & Overy cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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Allied Bank Philippines (UK) Plc avantage (UK) Ltd Bank Monarch Ltd Bank of England Bankersalmanac.com BDO LLP Brown Brothers Harriman & Co Business Control Solutions plc Callcredit Limited Capital One (Europe) plc Clifford Chance CLS Bank International Cognizant DBRS Deloitte DLA Piper UK LLP Equifax plc Ernst & Young Eversheds LLP Exasoft Plc Experian Farrer & Co Freshﬁelds Bruckhaus Deringer G4S Genpact Government Banking Service Herbert Smith Freehills LLP Hinduja Bank (Switzerland) Ltd Hogan Lovells Huntswood IBM ING Direct NV Innovative Systems, Inc. Isle of Man Bankers’ Association Jersey Bankers Association Kinetic Partners KnowCo Limited KPMG Linklaters LLP Logica Mayer Brown Morton Fraser LLP National Savings & Investments Norton Rose Oracle Ordnance Survey Pannone LLP Premier European Capital Ltd Protiviti PwC Qivox ReD Riyad Bank Selftrade Shearman & Sterling LLP Sidley Austin LLP SJ Berwin LLP Slaughter and May Speechly Bircham SunGard Tata Consultancy Services Ltd The Post Ofﬁce Ltd thinkmoney VocaLink Wolters Kluwer Financial Services Wragge & Co LLP cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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Letter from BBA Chairman toMembers—New Year Message This is available on the BBA’s website: http://www.bba.org.uk/media/article/bba-chairman-new-years- message I have now been Chairman of the Association for some three months and I want to use this New Year’s Message to give you my first impressions. I am the first Chairman who has not been associated with one of the major UK banks and so am, to that extent, independent and it is in this independent capacity that I write this letter. I intend to use that independence to seek to lead the Association in a way that is in the interest of the banking community as a whole and is in the wider public interest. Those two objectives are not in conflict: indeed, as with any responsible business, they must be mutually supportive. It follows from these objectives that the guiding theme of all the Association’s work in 2013, and indeed for many years thereafter, has to be the restoration of trust and confidence in British banking. From my discussions with leading bankers, it is clear this is their agenda too. There is a growing appreciation that while the sustainable success of the bank is the key business objective, that success has to be coincident with what is generally perceived as working in the wider public interest. Many of you will tell me that this is much easier to write about than to achieve; and you would be right. It will require changes in culture within banks and better training for staff. It will require better communication about what banks do and why they do it. To those ends, work is already in progress, but there is much more to do. Let me draw attention in this context to some work which we do already—the successful programme to support finance for business. This is one aspect of the approach set out in our in our draft strategy, where we commit ourselves to helping customers, promoting growth and raising standards. An example of this was in the Association’s submission to the Autumn statement, where we proposed measures our members believed would help growth across the whole economy some of which were reflected in the Chancellor’s Autumn Statement. On the issue of raising standards, there is a debate now in progress about the possible establishment of “a Banking Standards Board” to oversee ethical standards in the banking industry. I put the phrase in inverted commas because the precise form and objectives of the initiative are as yet unclear. Your Association is participating in this debate and will early in January come up with options. But one thing is already clear. Whatever is decided—and I believe some form oversight of will be decided—that oversight will have to operate independent of bankers. The Association itself cannot remain immune from the public criticism of banks and bankers. I judge that many perceive the Association as “a club where bankers talk to bankers”. We need to act to counter that impression. The Chief Executive, Anthony Browne, has taken a valuable initiative to establish a BBA Consumer Panel, to enable us to better listen to customers in our policy making. I believe that we should go further and I will ask the Association’s Board to consider the establishment of an Advisory Council for the Association. As a preparatory step the Board’s staff is carrying out a review of trade associations and other bodies who have Advisory Councils so that if the Board does decide to move in that direction, our decisions will represent best practice. The objective would be for the Board to have a source of independent, but informed, advice about public concerns relating to the conduct of banking and how we should react to those concerns. It would, I hope, be a concrete demonstration that the Association is ready to listen to advice from outside banking and so help guide the Association in our future work. An excellent example of this approach—establishing a source of independent but informed advice—is our existing Business Finance Round Table. This brings together the banks, the statutory authorities and government together with business organisations such as the CBI and Federation of Small Businesses to support and guide policy to help small businesses. The UK’s banks have built a nationwide network to help small businesses get in touch with mentors, an independently-monitored appeals process for businesses initially declined a loan, and a referral system to put businesses in touch with alternative sources of finance. Three final points. Chairmanship of the Association provides a good vantage point to appreciate the scale and breadth of banking activity in the UK, much of which has not been touched by the scandals that grab the headlines. Much of the business of banking and its support activities is carried outside the City of London and Canary Wharf and is a source of good jobs. Financial services employs 1.06 million people in the UK (454,200 in banking) and related professional services employ another million. London employs 641,000 people in banking and financial services; Edinburgh 50,500; Manchester 48,300; Birmingham 44,800; Leeds 40,500; Glasgow 37,500; Bristol 37,300. That needs to be better recognised. Banking’s contribution to British exports needs to be better recognised too. In 2010, financial and professional services contributed £175 billion to the UK economy—some 14% of UK GDP. One third of financial services’ GDP contribution comes from exports (services provided to overseas clients). That contribution would not exist without the work of the foreign banks in London and elsewhere in the UK. It will be a priority of the Association to remind the relevant public authorities that London’s place as the pre-eminent international financial centre cannot be taken for granted. The banking community is, for obvious and good reason, facing an avalanche of legislation. Much of it emanates from the European Union, though some of it comes from wider international initiatives, such as the G20. It is vital for the health of the banking sector and for its ability to serve its customers that there is a body, cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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like the Association, which can offer informed advice to legislators in this country and abroad on the consequences, intended and otherwise, of legislative decisions. I am glad to say that the Association’s staff carries out this function with great dedication and expertise. I regard this as a core a function of the Association. 14 January 2012

Written evidence from Anthony Browne, Chief Executive, British Bankers’ Association 14 January Evidence Session By my reckoning there were two points which arose during my 14th January evidence session upon which I undertook to follow-up in writing: the BBA’s position on the Commission’s ﬁrst report following its pre- legislative scrutiny of the draft Banking Reform Bill and a speciﬁc issue on LIBOR.

Draft Banking Reform Bill The first concerned the BBA’s response to the Commission’s report following its pre-legislative scrutiny of the draft Banking Reform Bill. This resulted from confusion between an article written prior to the release of the report expressing concern within the banking industry over the prospect of a full Glass-Steagall division of retail and investment banking of a type rejected by both the US and the European Union, since neither the Volcker rule nor the Liikanen report involve this. While the Volcker rule prohibits proprietary trading, this is clearly much more limited than a complete separation of investment banking; Liikanen, on the other hand, adopts an approach more akin to Vickers, though proposes the ring-fencing of activity to be excluded from the retail banking part of a banking group. We issued the attached Press Release on the day of the report outlining that we broadly viewed its publication as a step forward. As you can see, it starts by saying in unambiguous terms that: “We welcome this report which broadly endorses the Government’s approach to banking reform. The industry is strongly committed to taking the necessary steps to ensure that taxpayers are never again asked to bail out failing banks.” We also said that the report: “…shows that the Commission has thought very fully about many of the key issues arising out of the ICB’s recommendations and not just the immediate ones arising from the from the draft primary legislation”. Within this context we then listed what we saw as some of the key issues, including the potential effect of imposing a more constraining leverage ratio than that set out by the Basel Committee and the importance of the limitations and safeguards relating to the ‘electrification’ of the ring-fence. More generally, and we can send you copies, it can be seen from submissions to the Treasury Committee back in 2011 and our responses to the Government consultations—and indeed your pre-legislative scrutiny exercise—that, from the time that the Government announced that it supported the Vickers’ recommendations, we have focused our efforts on trying to help get the technical detail right. This is about ensuring that there is minimum disruption to customers and ensuring that the statutory provisions work. To give two examples: we have explained in various submissions that the position on ring-fenced banks being able to provide trade finance in support of exporters appears in conflict with the geographical limitations; and we have set out concerns relating to the proposed reliance upon Part VII FSMA transfer powers to reassign bank accounts and contracts to the new legal entities. This is purely about making sure that the legislation works as well as it can.

LIBOR Turning to LIBOR, Lord McFall asked whether the BBA had placed any legal impediment upon my predecessor, Angela Knight, from commenting publicly. The position here is that the BBA places all employees under a confidentiality obligation. This is common in commercial organisations and is not unlike the obligation placed upon civil servants and other public sector employees. It does not preclude commenting publicly, but involves ensuring that the right director is fielded and that the BBA has an overview of what is being said on industry issues on behalf of its members. The circumstances in which ex-employees would be expected to comment on issues from the perspective of their time at the BBA is quite limited and may even be said to be non-existent other than in the case of the current Parliamentary inquiry. I would say that the BBA’s general expectations on confidentiality would not usually place limitations on what can be said to Parliament. LIBOR is however an exception since there are criminal and regulatory enforcement actions taking place not only in the UK but in other jurisdictions around the World. This does not prevent any information being provided in support of Parliamentary interest, but it did mean that the BBA, for instance, in providing evidence to the Treasury Committee (and this is available to the Parliamentary Commission) took great care to ensure that the information put into the public domain did not unknowingly prejudice any of these on-going actions. This is a point that was underlined for the handful of BBA employees with access to information concerning LIBOR upon the public announcement of regulatory investigation, which preceded my joining the BBA. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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APPENDIX

BBA response to PCBS report 21/12/2012

Tighter leverage ratios could increase mortgage costs for British families

Commenting on the Parliamentary Commission on Banking Standards’ First report, British Bankers’ Association Chief Executive, Anthony Browne said:

“We welcome this report which broadly endorses the Government’s approach to banking reform. The industry is strongly committed to taking the necessary steps to ensure that taxpayers are never again asked to bail out failing banks.

“We welcome the Commission’s recognition that the banking industry needs time to prepare for the huge structural changes that creating a ring fence would require. While it is clearly important to retain a degree of ﬂexibility around the scope of the ring fence it is equally critical that any new system creates regulatory certainty for banks and their investors. Too much uncertainty will deter investment and could hurt London’s position as the world’s leading ﬁnancial centre. We will work with parliamentarians to try and achieve the right balance.

“We continue to believe the Government is correct to seek to align the leverage ratio requirements with international standards. The Commission’s support for a tighter leverage ratio that would come into force several years earlier than the rest of the world could cause real problems. Increasing the leverage ratio would restrict the number of mortgages banks could agree to and ultimately lead to more expensive mortgages for British families.”

Notes to Editors

PCBS First Report: 21st December 2012–12–20

General — Report shows Commission has thought very fully about many of the key issues arising from the ICB’s recommendations and not just the immediate ones arising from the draft primary legislation. — Overall they support the Government’s proposed approach but wish to see disciplines built in to ensure the integrity of the ring-fencing arrangements. — They also rightly wish to see greater assurance about Parliamentary scrutiny of both the primary legislation and the accompanying secondary legislation which will to a large degree give deﬁnition to the ring fence and recommend eg that a small ad hoc committee of both Houses be established in support of the afﬁrmative procedure for the secondary legislation. — They recommend the inclusion is FSMA of a legal duty on directors to preserve the integrity of the ring fence. (Paragraph 222) — The de minimis exemption is supported. (Paragraph 200) — They do not question the 2019 deadline for full implementation of the ring-fence but consider the extended timeline to necessitate a high degree of transparency during the implementation phase. (Paragraph 125)

Held over until next year

They have related that they plan to give further thought on some key issues: — Whether ring-fencing should be augmented by an equivalent to the Volcker rule. (Paragraph 96) — Whether further measures are needed in respect of large systemic banks and investment banks. (para 104) — Whether the ‘continuity’ objective is sufficiently defined. (Paragraph 130) — The provision of ‘simple’ derivative products by the ring-fenced bank is supported on the proviso that these are defined in the primary legislation. (Paragraph 194) — They recognise concerns expressed about trade finance and the ability to support exporters and therefore recommend that the Treasury undertakes a full separate consultation exercise on this next year. (Paragraph 209) [This has been a key concern for the industry] cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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Headline issues — The Commission proposes that the ring-fence be ‘electriﬁed’ by which they mean that there should be reserve powers to enable the regulator to demand full separation of an individual banking groups if there was a risk that the objectives for the ring-fence would not be met and that there be a general reserve power enabling full separation across the sector if need be. (paragraph 165); it is recognised however that a recommendation of this signiﬁcance ‘will require a number of limitations and safeguards including an independent review of ring-fencing effectiveness (paragraph 171) [This process will be critical and if such powers are to exist it will be important that such reviews are technical and not political in nature] — They recommend that regulators be given power to require a holding company structure and expect this power to be exercised. (Paragraph 228) — They recommend that the Treasury and the Bank of England establish a joint group to prepare and publish a full report on the implications for resolution of depositor preference and the scope and extent of deposit insurance including the feasibility of a voluntary scheme for deposits over £85,000. (Paragraph 279) — They recommend that the leverage ratio be set substantially higher than the minimum 3% required under Basel III but acknowledge that this would pose particular problems for some building societies. (Paragraph 259) [A concern the BBA would have would be if this constrained prime mortgage lending] 23 January 2013

Written evidence from the British Bankers’ Association Sanctions for Bank Directors We welcome the opportunity to provide input to the Parliamentary Commission’s consideration of criminal, civil and regulatory sanctions. Our response below is based principally on the response that we made on behalf of members to the 2012 HM Treasury consultation ‘sanctions for the directors of failed banks’. In this we aimed to give considered thought to the options set out, to highlight existing provision and to set out what we saw as some of the very real practical considerations involved in some of the options. We also commented in our response to the initial call for evidence by the Parliamentary Commission that we view the enforcement of sanctions in the event of fraudulent or unprofessional behaviour as integral to the maintenance of professional standards. In writing to the Commission, we suggested that it should be borne in mind that the Financial Services Act 2010 enhanced the FSA’s enforcement powers. The FSA already had the power to fine authorised persons and approved individuals for misconduct. The 2010 Act extended these powers to enable the FSA to suspend or limit an authorised person’s permission or an approved person’s approval. It also enabled the FSA to impose a fine on an individual performing a controlled function without approval in addition to being able to prohibit the individual from working in the financial services industry. It also included provisions in respect of the disclosure by the FSA of decision notices. We also commented upon the responsibilities of the Serious Fraud Office that the Government had outlined plans to improve the investigation and prosecution of fraud cases through the “Fighting Fraud Together” strategy. As a signatory to the strategy the banking sector is working closely with Government to support its delivery. In addition to the Fraud Act, the relevant enforcement agencies have powers available to them under the Proceeds of Crime Act, the Bribery Act or the Competition Act. It is also the case that the Companies Act was updated in 2006 to provide that directors, including directors of banks, must act in a way most likely to promote the success of the company for the benefit of its members as a whole and in doing so must have regard to: — the likely consequences of any decision in the long term; — the interests of the company’s employees; — the need to foster the company’s business relationships with suppliers, customers and others; — the impact of the company’s operations on the community and the environment; — the desirability of the company maintaining a reputation for high standards of business conduct; and — the need to act fairly as between members of the company. These changes are enshrined common law procedure and enables Court action to be taken where the directors are viewed as having been negligent or in breach of these Companies Act duties. There has also been an increase in the FSA’s enforcement outcomes and penalties in recent years. The FSA has now become internationally acclaimed for being able to successfully investigate and prosecute highly challenging and large scale cases such as sophisticated criminal insider dealing rings, complex market manipulation cases and boiler room frauds. This success has in part been facilitated by the joint partnership approach adopted by the FSA with the industry. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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Criminal Sanctions On 3 July 2013, HM Treasury published a proposal to create a new criminal offence of serious misconduct in the management of a bank. The proposal considered four main possibilities for the kind of managerial misconduct by bank directors and senior management that might be subject to new criminal sanctions: (i) Strict liability—being a director at the relevant time of a failed bank (ii) Negligence—failure in a duty of care which leads to a reasonably foreseeable outcome (iii) Incompetence—failure to act in accordance with professional standards or practices (iv) Recklessness—failure to have sufﬁcient regard for the dangers posed to the safety and soundness of the ﬁrm concerned or for the possibility that there were such dangers.

1. What are your views on extending criminal sanctions to cover managerial misconduct by bank directors? 2. What are your views on the possible formulations of a criminal offence based on options (i) to (iv)? We commented as follows in response to the HMT consultation:

“Strict liability The consultation explains that the introduction of a strict liability offence would incentivise bank boards to avoid bank failure but also recognises that there could be company boards which were well-intentioned and conscientious and took a wrong decision or happened to be in charge when the company was a victim of a combination of unfortunate decisions and outside events. It also recognises that imposing severe criminal penalties on individuals who “were plainly not at fault would be controversial”. The consultation also sees further signiﬁcant difﬁculties with strict liability in that the sanction could capture directors brought on board to try and rescue a failing bank, fail to capture directors who had ran the bank badly but been dismissed or resigned, and apart from questions of fairness, could deter people from taking up board appointments in rescue or recovery situations. For all these reasons the Government considers that it would be more appropriate to focus on other types of criminal offence and not proceed with strict liability. Such offences would require the prosecutor to prove that the individual had failed to meet a required standard of conduct in some way -ie had engaged in managerial misconduct which could involve negligence, incompetence or recklessness. We agree that strict liability would appear the least appropriate for the reasons set out in the consultation.

Negligence or incompetence The consultation explains that the introduction of a criminal offence covering negligence or incompetence would send a clear signal that society is not prepared to tolerate conduct of this kind but also acknowledges that it is already possible for the regulator to take action against individuals for negligence or incompetence and to take action against the firm if negligence or incompetence of an individual means that the firm failed to comply with regulatory rules or to satisfy the threshold conditions for authorisation. Negligence and incompetence can already give rise to civil law actions for tort (delict in Scotland) or breach of contract which could be pursued against individuals by the company itself, its liquidator and possibly by shareholders by means of derivative action in company law. The consultation observes, however, that it is usually more difficult to mount a successful criminal prosecution than for the regulator to take action under the Financial Services and Markets Act 2000. For these reasons, it is not clear there would be any advantage in introducing a new offence which would enable the regulator or a criminal prosecutor to pursue an individual bank director or senior manager in a criminal court for conduct which could be subject to regulatory sanction.

Recklessness The consultation next considers whether a criminal offence based on excessive risk taking or recklessness should be introduced. While it is already possible for regulatory action to be taken against individuals for recklessness in the same way as for negligence or incompetence it is nevertheless considered that the more egregious character of recklessness may make it more suitable for criminal sanction. Apart from sending out the clear signal that society will not accept such conduct, it is believed that it would make directors think twice about taking certain decisions and possibly take legal advice on whether a decision could be viewed as reckless. The consultation recognises that it can be difficult to decide whether someone was aware of a risk but wrongly decided that it was not significant, or to judge whether it was reasonable or not to take a particular risk. The Government nevertheless considers that recklessness would be the appropriate basis for a new criminal offence for misconduct in bank management. While it is hard to suggest that a course of action or decision that could be described as ‘reckless’ should not be subject to sanction, the practical considerations outlined still apply to a considerable degree. Should the Government decide to proceed, then there would be a need to develop a clear and understandable definition of what constituted ‘normal or non-excessive risk taking’ and the factors that would deem an action or decision ‘reckless’. Similarly, the defences that would be available to directors should also be clearly set out in the cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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legislation—one example might be that it would be a defence for the director to show they acted reasonably in all the circumstances. It must be recognised that banks are in business of taking risk—as with recent banking crisis, collective lack of appreciation of possible sub prime mortgage risks (by banks, sophisticated investors, regulators and politicians)—and it is important not to stiﬂe competition within the banking sector. As the paper observes, this test would involve opining on business and investment decisions which by their nature are forward looking and judgement-based and as a result are more subjective than decisions made relating to natural sciences or engineering. The paper also rightly points out the need to determine the relevance to be placed upon a lack of risk awareness, on the one hand, and risk awareness on the other combined with underestimation or misjudgement.”

3. Do you think that an offence based on one of those options would be likely to discourage those considering positions of leadership within banks? Our response would more be that we would consider the downside of any of the options other than a well thought through offence of recklessness to outweigh any perceived beneﬁts.

4. Will the possibility of criminalising behaviour which can already be sanctioned under Financial Services and Markets Act 2000 (FSMA) act as a greater deterrent? While there are both criminal and civil offences in FSMA, criminalising behaviour that is currently only a civil offence may in the case of recklessness act as a greater deterrence by focussing the minds of directors before a certain course of action is undertaken (as stated above)

5. Do you think that it is likely that the threat of criminal action will stiﬂe perfectly legitimate activity and ultimately deter growth in the banking sector? The threat of an unduly broad and poorly deﬁned criminal action most likely would.

Civil and Regulatory Sanctions Rebuttable Presumption On 3 July 2012, HM Treasury published proposals to amend FSMA in order to put in place a rebuttable presumption that a director of a failed bank is not suitable to be approved by the regulator as someone who could hold a position as a senior executive in a bank. The Government also proposed two groups of ‘supporting measures’, which could be taken forward by the regulators under existing FSMA powers: (a) Introducing clearer regulatory requirements on individual responsibilities and the standards required of people performing certain key roles; or, in the alternative, a ‘firm-led approach’ (with the onus on the firm and individual to set out a detailed written statement of the responsibilities and duties of each role); and (b) Requiring banks explicitly to run their affairs in a prudent manner, and requiring bank boards to notify the regulator where they become aware that there is a significant risk of the bank being unable to meet the threshold conditions for authorisation.

7. What are your views on the proposal to introduce a rebuttable presumption that the directors of failed banks are not suitable to hold senior executive positions in other financial institutions? We commented as follows in response to the HMT consultation: The regulator already has the ability to remove an individual’s approval to perform controlled functions and to prohibit an individual from performing functions in the financial services sector. BIS has powers to disqualify individuals as company directors and the UK has fully implemented EU remuneration standards with exceed international principles issued by the Financial Stability Board and endorsed by G20 governments. Underpinning these measures with a rebuttable presumption that the director of a failed bank will not be viewed as suitable to be approved by the regulator as someone who could hold a position as a senior executive in a bank would be in keeping with other measures being introduced to ensure that bank executives and Boards place greater weight on avoiding downside risks. It is nevertheless right that, as suggested in paragraph 3.12, the provision should not be automatic since there may be circumstances in which a director can credibly show that their reputation remains intact and that they should not be viewed as having been culpable for the failure. In fact it may be that the alternative of more detailed regulatory guidance on regulatory assessment of suitability and competence, as suggested in paragraph 3.13, may suffice. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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The measure will also need to be based on a suitable definition of both what constitutes failure—which we would say should be the triggering of the special resolution regime; also an understanding of the time period for which a rebuttable presumption would exist, in terms of both the extent to which past directors should be included and the extent to which current directors may be excluded on the grounds that they were more recently engaged with the aim of turning an ailing institution around (discussed further below). Clarity would also be required as to what roles are covered by the rebuttable presumption. The consultation states it will apply to directors of failed banks, when those directors apply for a ‘senior executive’ position in another bank. Sufficient flexibility over the term ‘directors’ will be required to take account of different management models within banks, for example where the bank has executives, who are not directors, who play a significant role in decision making. Likewise, clarity would be welcome as to what senior executive roles will trigger the presumption when a ‘director’ of a failed bank applies for a new role. When setting up the type of regime being proposed, it would be important to take into account issues that can significantly alter culpability such as: — The allocation of responsibilities to directors—some directors will be specifically responsible for certain areas of bank operations — Non-executive directors and the difference in nature of their responsibilities when contrasted with executive directors — The nature of the information that was available to the Board—if insufficient information was available to the Board, why that was the case — Whether events leading up to a failure were outside the control of the Board — If some directors have challenged the decision but have been overruled — There will be multiple Boards within each banking group—so if a subsidiary fails, culpability becomes more complicated. — There are also a number of practical matters that will need to be addressed, including the following: — If the presumption were to apply only to directors who were in post when the bank failed, directors who had left before then, and who may have been responsible for the decisions which led to the bank’s failure, would not be subject to the rebuttable presumption which would undermine the effectiveness of the proposed measures. It could also dis-incentivise directors of banks in distress from staying and trying to turn the bank around (contrary to the drive towards long term incentivisation)—similarly it could dis-incentivise directors from joining a bank in distress for the purpose of helping to turn it round. — On the other hand, for the directors who remain with the bank through the point of failure, it is unclear how the presumption would apply. In any event, this could be very disruptive for those directors and the bank at an important time. — If the presumption extends back in time that also raises a number of practical difficulties such as what would happen to a director who has since started a job at another bank—for example, would they then have to re-apply for approved person status which could be very disruptive for their new bank? — Directors could also face difficulties obtaining evidence demonstrating that they did not contribute to the failure when applying for a new post given they will likely no longer have access to the records of their former bank. The rebuttable presumption therefore risks distracting directors, particularly during periods of difficulty for their banks. Of even greater concern is the risk that, in light of the rebuttable presumption applying automatically, directors of banks decide to leave the sector altogether (or potential directors don’t join the sector) which could be detrimental to the quality of directors, including non-executive directors in the banking sector.

8. Does the rebuttable presumption go any further than the current regulatory regime? Yes, the nature of a rebuttable presumption will make it easier for the regulator to keep a director of a failed bank out of the industry as the regulator’s decision would be less open to legal challenge. It probably also increases transparency over the consequence of presiding over a failed bank.

9. Do you think that the introduction of the ‘rebuttable presumption’ could discourage skilled individuals from accepting key management positions? Possibly. In our response to the HMT consultation we commented that the rebuttable presumption “risks distracting directors, particularly during periods of difﬁculty for their banks. Of even greater concern is the risk that, in light of the rebuttable presumption applying automatically, directors of banks decide to leave the sector altogether (or potential directors don’t join the sector) which could be detrimental to the quality of directors, including non-executive directors in the banking sector.” cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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10. Do you think introducing the presumption would send a clear message that bank senior executives and boards have a responsibility to ensure there is a strong focus on downside risks?

Yes; and as such we would consider a well thought through presumption that addresses the risks and issues we raise above to be a reasonable measure.

11. What are your views on the possible supporting measures aimed at clarifying management responsibilities and changing the regulatory duties of bank directors?

We believe that there is a great deal to be gained from clarity about management responsibilities and the emphasis to be placed upon changing regulatory duties.

12. Despite the range of enforcement powers currently available to the FSA, are additional powers necessary? If so, what would those powers be?

We consider the range of enforcement powers to be wider than often is appreciated.

13. What are your views on amending FSMA to include a power to prohibit an individual from performing a controlled function on an interim basis?

We can see that there would be logic in enabling interim prohibition in support of the regulatory authorities being able to act more swiftly and decisively than previously may have been the case. We see a case though for the circumstances in which such a facility could be utilised being well deﬁned and the application of suitable safeguards including a high expectation that full prohibition will be the outcome once due process has been completed. We also see grounds for compensation in the event that the regulatory action subsequently proves unjustiﬁed.

We believe that, while historically insufﬁcient emphasis may have been placed on enforcement action, this most likely is no longer the case.

15. What are your views on extending the limitation period for taking action against approved persons?

We would consider that providing three years for a case to be brought from the time of discovery should be viewed as providing suitable discipline upon the regulatory authorities to progress an action reasonably and would argue that if anything the timeframe should be shortened. While on the one hand it means that the regulators have less time, on the other there must be beneﬁt to accrue from any enforcement action being concluded more closely to the time that any regulatory requirements were breached. There should also be consideration given to the signiﬁcant impact such action can have over the livelihood of approved persons and their families, in circumstances where some will not be found to have been ultimately culpable.

LegislationVersus Regulation 16. In order to make bank directors more accountable (due to the adverse impact a large failed bank can have on the wider economy), what are your views on amending the approved persons’ regime under FSMA rather than the Companies Act 2006 and the Insolvency Act 1986. To the extent you consider changes should be made to the legal framework, please articulate how you think this could be achieved given the legislation would apply to all company directors.

FSMA is an appropriate vehicle if the Parliamentary Commission is convinced that it wishes the additional criminal sanction to apply only to banks. It should consider, however, that if eg a charge of ‘recklessness’ is deemed appropriate for banking, might there not also be circumstances in which it could apply in other sectors? cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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The Approved Persons’ Regime (APER) 17. The Upper Tribunal ruling in John Pottage v The FSA (FS/2010/0033) highlighted that enforcement action against senior managers is only likely to be successful where there is evidence of actual wrongdoing by the executive concerned. In your opinion, what changes could be made to some of the statements in APER about the standard of conduct expected of directors in order to make it easier to bring enforcement? We would not consider a requirement for evidence to be an unreasonable test for finding someone guilty of wrongdoing providing that ‘evidence’ can include objectively showing that an individual materially failed in fulfilling the duties compatible with their specific Approved Persons registration.

18. In your opinion, has a lack of direct senior management accountability inside firms for specific areas of conduct contributed to the shortcomings in holding individuals personally culpable? Do you think APER should be revised to remedy this? We have no difficulty with an expectation that job descriptions should be suitably clear about the nature of senior management responsibilities providing the expectations are based on a good professional standard and are capable of being met.

19. Would it be beneficial for the regulator to adopt a more intrusive approach to senior appointments as part of the Significant Influence Function (SIF) process? How could such an approach be adopted? We would support this providing disproportionate bureaucracy was avoided and the regulators applied the right amount of resource in order to process appointments without undue delay. It needs to be borne in mind that there are risks to control systems from not being able make appointments in a timely and efficient manner.

20. Do you see merit in requiring the regulator to re-appraise SIF individuals at set intervals and on other occasions if it believes that circumstances justify it. There may be a case for this. The alternative is to address the need to maintain professional standards through CPD requirements.

21. What are your views on extending APER so that it applies to all bank employees in order to enable the regulator to take disciplinary action against employees who are currently outside the scope of APER? In supplementary evidence on professional standards provided to the Parliamentary Commission on 9th January, we acknowledge the possible case for extending APER principles to all employees; we did not however contemplate whether this should mean that the regulator would be able to take disciplinary action against these employees and instead proposed, as outlined in response to the following question, a Code of Conduct that would be enforced through employment contract.

22. Do you see merit in the establishment of an independent professional body with mandatory membership which has the power to impose civil and possibly criminal sanctions? In your view, could such a body provide a solution for the issue of global matrix management structures that can exist within universal banks? The proposed approach set out by the BBA envisages a tiered approach in which: — The Approved Persons Regime is reviewed to ensure that all appropriate categories of staff are covered ie those with relevant customer-facing roles and responsibility for risk (and we have recommended a new approach to withdrawal notices where employees leave before the completion of a disciplinary process, not only for alleged regulatory breach but other ethical and professional shortcomings); — That all bank employees governed by UK regulation be subject to a Code of Conduct for which the Board and senior management of a bank would commit to embed in the bank’s systems, controls and incentives (and, again, breaches could be notiﬁable to what we have termed a ‘top-down’ ‘Banking Standards Review Council’); and — That the professional institutes uphold high standards for their members. Under this model, the regulatory authorities would be primarily responsible for enforcement action against Approved Persons and the banks themselves, through employment contract, would be responsible for the disciplining of employees found to have not maintained appropriate standards of conduct. All employees would remain subject to criminal prosecution where they had committed criminal acts, whether in terms of fraud, proceeds of crime, bribery or competition legislation. Together with other elements explored in our supplementary evidence, this adds a greater degree of assurance without creating a third regulator and undue overlap between the ethical and professional standards oversight mechanism which we have proposed and existing regulatory responsibilities, including for the policing of the Approved Persons Regime. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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Cost

23. Understandably, there is considerable cost in pursuing individual actions. What changes do you think could be made in order to ensure that cost does not act as a deterrent in pursuing all but the largest cases?

Complex fraud trials are known to be extremely lengthy and thus expensive. Thought perhaps should be given to how Government can make prosecutions more effective and cost-effective. In our view more efﬁcient processes and better coordination between the different agencies with responsibilities in this area may be needed. A review of the disclosure requirements on the prosecuting agencies under the Criminal Procedures and Investigations Act 1996 may also be needed for complex criminal trials such as fraud and insider dealing— we understand that this is one of the key reasons such cases take so long to investigate and prosecute.

The banking sector has worked closely with Government in recent years on such matters, including as a member of the committee for the Fraud Review in 2006 and more recently as a signatory to this Government’s strategy for tackling fraud. We will of course be prepared to provide any further input on these matters as requested.

International

24. Do you think introducing additional criminal, civil or regulatory sanctions would have an impact on the international competitiveness of UK banks?

If they are proportionate then they will raise the reputation of the UK as a place from which to conduct banking and ﬁnancial services; if they are disproportionate then they will add to the belief that the UK is becoming an unattractive place in which an individual would choose to spend part of their career.

25. In your opinion, are there other legal or regulatory regimes that the Commission should be considering? Please provide your reasons for suggesting the applicable regime.

Though applicable to organisations rather than individuals, the planned introduction of Deferred Prosecution Agreements is an example of the UK authorities adopting an approach that appears to have worked elsewhere.

Other

26. The regulator has an extensive range of enforcement powers but is arguably hesitant in using those powers. What are your views on the introduction of sanction(s) that could be imposed against the regulator to the extent they do not deploy their powers appropriately?

Enforcement actions should be seen as a positive duty on the Regulator. The Regulator should be encouraged to act proportionately, fairly and impartially. The introduction of sanctions against the Regulator could pose risks in these respects.

Parliamentary accountability over the regulator’s enforcement activity has grown in recent years as a number of reviews into past cases were conducted. Provided this enhanced scrutiny is not excessive, it can have beneﬁcial effects on a regulator’s enforcement activity. However, excessive scrutiny can have a high cost in terms of signiﬁcant essential resources being diverted away from front line activity, or encouraging the regulatory authorities to act disproportionately, unfairly or partially.

27. What are your views on applying different sanctions for different types of directors—for example, non- executive directors?

Sanctions should be relevant to the duties and responsibilities that can be reasonably expected in instances of people fulﬁlling their tasks to a professional standard. This necessarily varies from role to role and we would consider there to be a distinction in expectation placed upon executives and non-executives.

28. Are there any other measures or legal/regulatory changes that the Commission should consider?

We are aware that the introduction of Deferred Prosecution Agreements (DPAs) is now at an advanced stage. These have long been used in the United States. They allow courts to agree that prosecution of an organisation will be deferred generally in exchange for the payment of monetary penalties and compliance with the terms and conditions of the DPA. As a sanctioning tool DPAs are limited to ﬁnancial crime breaches and are only applied to the corporate body, nonetheless it is conceivable that the use of a DPA may be undertaken in parallel to sanctions applied on individuals. 23 January 2013 cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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Letter from Anthony Browne, Chief Executive, British Bankers’ Association OFT Review of Personal Current Accounts: Switching Given your interest in current account switching and account number portability, I thought I should bring to your attention the results of the independent consumer research commissioned by the OFT into personal current accounts, particularly with respect to customers’ views on switching accounts. We support making account switching easier and increased competition between providers. But it is essential to take account of the evidence on why switching rates are as low as they are when considering the appropriate policies. The OFT asked consumers who have never moved their current account why they had not done so. The research confirmed that the majority of consumers have not moved their current account because they like their current account/bank, have never wanted to switch, have never thought about it, or perceived no significant benefits in changing provider. Contrary to numerous reports, the overwhelming majority of customers are not deterred from changing banks because of perceived difficulties with switching—only 8% of consumers have not switched because they believe it is too complicated and only 3% have not switched because they perceive that too much could go wrong. In full, the OFT research found that consumers gave the following reasons for not switching their current account: — I like my current account/bank—58%; — have never wanted to—16%; — never thought about it—10%; — too complicated—8%; — no significant benefits to be gained—7%; — too time consuming—6%; — too much could go wrong—3%; — I would have to rearrange other services—3%; and — too lazy—4%. The data is contained in table 89/1 in Annex C, on page 328 of the OFT report, and can be found at http://www.oft.gov.uk/shared_oft/reports/financial_products/annex-c.pdf. Consumers were also asked how familiar they would say they were with the services offered by banks to help customers switch their current account. The research confirmed that 80% of consumers are aware of these services (recorded at table 83/3 on page 311 of Annex C). I hope this information is of use and am happy to discuss with you further these findings and any other aspects of the OFT report. 28 January 2013

Letter from Anthony Browne, Chief Executive, British Bankers’ Association ProfessionalStandards inBanking In responding to the Parliamentary Commission’s initial call for evidence in summer last year the BBA indicated that it believed that more could be done to strengthen professional standards in banking. In the intervening months we have given further thought to these issues and, in consultation with members and the assistance of KPMG, would like to submit the enclosed supplementary submission in preparation for the evidence session scheduled for next week. The enclosed submission sets out the wide range of opportunities for raising standards. It is clear this is not a simple problem with a simple solution, but rather there are a number of reforms that need to be made. Care should be taken, however, to ensure that any new arrangements align to the regulatory architecture about to be put in place with the advent of the Prudential Regulation Authority and the Financial Conduct Authority and plans that they may have under their new approaches. The options for reform identified in the submission fall into three categories: strengthening the existing framework; adopting a top-down approach focusing on firms and their responsibility for ethos and culture; and a bottom-up approach focusing upon the training and qualification of individuals. Reform measures could include: Strengthening the existing framework — Extending the number of specifically defined roles covered by the existing Approved Persons Regime, including more of those involved in consumer facing roles and wholesale dealing. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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— Supplementing the existing Approved Persons Regime with an overarching requirement for bank employees to observe its principles. — Requiring banks to report if disciplinary proceedings against an Approved Person have been initiated where an individual resigns before they are completed. — The regulatory authorities being more explicit in its views on training and competency, including professional development. — More resources being used to enforce existing laws on fraud, conspiracy to defraud, theft and proceeds of crime. A top-down approach — The establishment of a Banking Standards Review Council (BSRC), independent of the industry, to monitor and uphold ethical and/or professional standards in banks operating in the UK. The BSRC would have a non-banking chair, and a majority of non-banking members, with others representing the users of banking services and the wider public interest. — An industry-wide Code of Conduct, which would be upheld by the BSRC, and could include expectations of the bank boards, systems of control and incentives, and individual employees. — The Code of Conduct either covering everyone who works in banks (including, for example, HR people and caterers), or just those actually offering banking services. — The BSRC monitoring whistleblowing regimes in banks, to ensure they are effective. A bottom- up approach — The FSA taking the lead in producing guidance or setting standards in the training and development of bank employees. — An overarching Professional Standards Body (PSB) to recognise and promote various existing standards, professional bodies and institutes. This board could be separate from the Banking Standards Review Council, or the same (if it was separate, then the BSRC would oversee ethical standards, while the PSB would oversee professional standards). — The PSB also overseeing a register of individuals accredited to the professional bodies that it monitors. The details of these (and some other) options are included in the appended report, with discussion of the various beneﬁts, drawbacks and implications. In considering the optimal solution, it is vital that the UK remains an attractive place to do business. A well-formulated, proportionate approach should enhance the attractiveness of the UK as a place to do business, rather than reduce it. The BBA—and the industry as a whole—is determined to play a constructive role in raising standards. I hope you ﬁnd this contribution helpful. 9 January 2013

Letter from Anthony Browne, Chief Executive, and Sir Nigel Wicks, Chairman, British Bankers’ Association We are writing to you as chairman and chief executive of the British Bankers Association, with the support of the chairmen of the six main UK banks. The most important priority for the banking sector is to earn back the trust and confidence of the British public and the business community, particularly smaller businesses, and to reinforce the reputation of the UK as the leading international global financial centre. All UK banks have been making reforms to earn back trust, but there is still clearly much more to do. One of the most fundamental challenges is ensuring that banks can demonstrate the professional and ethical standards that the public—and bank employees—have the right to expect. Lapses in, and breaches of, existing standards have been evident in many of the recent scandals, reinforcing the need to add rigour to the definition and enforcement of required conduct. The BBA submission to the Parliamentary Commission on Banking Standards (sent separately) sets out a wide range of opportunities for raising standards, illustrating that this is not a simple problem with a simple solution, but rather that there are a range of actions that could be contemplated. There is already a strong regulatory and legal regime, which through ongoing reform and restructuring is necessarily being more rigorously—and visibly—enforced. As banks, we also recognise the need to reinforce our own efforts to raise professional standards, including building on the work of the various professional institutes. We strongly believe that any incremental reforms must be considered against the existing backdrop of the upgrading of the regulatory regime in the UK, with the separation of the FSA into the FCA and PRA, which cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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are being given new powers. In particular, we understand the FCA will be expanding the Approved Persons Regime, to make it more effective. However, should the PCBS conclude these reforms are not sufficient and that a broader initiative than that governed by the FCA’s general principles of conduct and its Approved Persons Regime is required, we recommend that consideration is given to the establishment of an independent body with responsibility for establishing general conduct principles, monitoring how these are being applied in practice and how practitioner firms are enforcing their own codes of conduct; this might take the form of a “Banking Standards Review Council” (hereafter referred to as BSRC for convenience). The BSRC could set the framework for an industry- wide code of conduct, monitor how it is being applied, receive and address reports of alleged breaches and thereby ensure that banks and their employees live up to the standards set out in the code. Clearly the BSRC would have to be independent of the industry, and should have a governance structure that reflects all stakeholders, including those who represent the users of financial services as well as the wider public interest. There would also be the possibility of combining some of what is currently done through the FSA’s Practitioner and Consumer Panels, thereby contributing to both simplifying and enhancing the governance framework. There are many issues that would need to be resolved, most critically the relationship of any new body with the existing regulatory regime. But if the PCBS decides that a BSRC should be established, then the major British banks are ready to pledge co-operation. We hope you find this commitment, and the BBA evidence, a useful contribution to your vitally important work at the Parliamentary Commission on Banking Standards. We too are committed to raising standards in the industry, and keenly await your findings and recommendations. 9 January 2013

Written evidence from British Chambers of Commerce Introduction 1. The British Chambers of Commerce (BCC) represents 104,000 companies, who are members of 51 accredited Chambers of Commerce in every region and nation of the UK. Many of these companies are small- and medium-sized businesses. In turn, many of these companies have reported serious concerns regarding access to ﬁnance issues—concerns which the BCC has raised with various government departments and Parliamentary inquiries in recent years. 2. The comments below are a synthesis of business views on the wide range of issues covered by the Commission’s remit. If members of the Commission would like further detail on any of the points raised below, we will be happy to elaborate.

SME Concerns Regarding the Standards and Culture of British Banking 3. The access to finance issues faced by small- and medium-sized businesses across the globe over the past five years are well-known. Yet, as the Breedon Review, Eurostat and others have noted, the situation in the UK is unique. No other country has seen a bank deleveraging on the same scale as the UK. SME loan rejection rates in the UK are higher than in other European countries. And UK small- and medium-sized companies, are overwhelmingly reliant on debt when they seek external financing. Breedon suggests that UK SMEs alone face a finance gap of up to £59bn within five years.50 4. These constraints are borne out by the BCC’s own research. In a recent survey, fully 42% of businesses said that access to finance issues would have either “a strong influence” or “a significant influence” on their business during 2012 —this is an astonishingly high number during a period when many businesses have de- leveraged.51 And as BCC research and the independent SME Finance Monitor show, many of the remaining companies are “happy non-seekers” of external finance, funding their business principally using their own resources. 5. Chamber of Commerce members seeking business finance have reported a number of increasingly-acute problems since 2008. 6. It is more difficult for businesses to access external finance now than it was before the financial crisis. Banks require more information before approving credit facilities, and are more likely to use imperfect information as a justification for rejection rather than incur the cost of assessing risk more fully; certain sectors (such as construction and hospitality) seem to suffer from a negative bias, tending toward swift rejection; and there are greater security requirements when facilities are offered. Many businesses are realistic about the cost 50 Tim Breedon, Boosting Finance Options for Business, March 2012. 51 British Chambers of Commerce snap poll, June 2012 cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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of finance, and understand that it will be more expensive than the years leading up to 2008, but still report increased obstacles to securing finance in the first place. 7. Failure to address business concerns around access to finance is undermining the transition to a “new model economy” driven by exports. The continued difficulties faced by business act as a drag-anchor on the UK’s export performance by hindering those looking to trade internationally for the first time.52 Seeking out and growing new markets involves upfront costs and additional risks: over a third of potential exporters say that resource levels and access to finance are “highly influential” in deciding if, when, and where to export. 8. There is a lack of trust between lenders and businesses, damaged when the original credit crunch occurred, and not repaired since. The BCC has summarised this as a gap in relationships, transparency, and trust—which has been further exacerbated by the LIBOR and mis-selling scandals. This has led to the phenomenon of “discouraged demand”, which translates as businesses that want finance, but will not approach banks to try and get it because of the assumption that they will either be rejected or that they will have other facilities re- evaluated. Fully 12% of companies—one in every eight—surveyed in the largest independent survey of SME finance conditions, represent “discouraged demand”.53 9. There is a fundamental lack of competition within the highly concentrated UK banking sector. This was discussed extensively by the Independent Commission on Banking, which noted that fully 85% of SME accounts sat with the “big four” high street banks.54 The ICB’s recommendations for increased competition are moving ahead, but businesses in the real economy still often view banks as being “all the same”, both in terms of their attitudes toward business and their internal cultures. This viewpoint, combined with the perceptions that switching between finance providers is difficult and that some banks will only lend to certain sectors, leads to a lack of choice for businesses attempting to obtain external finance. 10. Smaller, younger, and higher-growth businesses find it much more difficult to access finance than more established firms. Statistical evidence backs this up—with the SME Finance Monitor’s results showing renewals more likely to be approved than new applications, and that businesses trading for less than five years were more likely to face declines.55 Many of the oft-mentioned “gazelle” firms, who create a significant proportion of all employment growth, have noted access to finance as a key barrier to further expansion as far back as 2008.56 Some firms also report that they are discouraged from accessing finance due to a lack of clarity, knowledge, or skills. 11. Regulatory changes, including the Basel III rules and the Independent Commission on Banking’s recommendations, will affect both the cost and the availability of SME debt financing. Higher bank capital ratios and liquidity requirements, the separation of investment banking and high street banking, and other shifts in the regulatory environment will have a further effect on banks’ willingness to lend to SMEs over the long term. 12. The introduction of state-backed support schemes has been impeded by lack of coherence, poor roll-out, poor communication, and over-dependence on existing bank infrastructure. While the Government has made a number of attempts to increase the availability of finance to SMEs, including the Enterprise Finance Guarantee, the introduction of welcome new short-term export finance products, through to the most recent Funding for Lending scheme, these have been bedevilled by a capability-expectations gap.57 This has been commented on extensively by the BCC, and by independent commentators.58 Businesses expected swift availability, clear information, and efficient processes—but the reality on the ground has been far different, with coal-face bank personnel often unable or unwilling to facilitate access to what is a bewildering array of products. Inexperienced relationship managers and credit officers are still often incapable of explaining how state-backed products work, or how local businesses can access them. It is an open question whether this is down to incomplete information, difficulties in rolling out training, or the fact that banks’ incentive structures are geared to the sale of their own products, rather than helping companies to access government support.

Recommendations for Action 13. Chamber of Commerce members have three priorities for the financial system: — Immediate action by financial institutions to address the gap in relationships, transparency, and trust that arose in the wake of the credit crunch and deleveraging. — Action to increase competition in the banking system, to ensure real choice and to widen access to commercial lending. — The creation of mechanisms by government and the Bank of England to prevent future credit crises on the scale seen in recent years. 52 British Chambers of Commerce, Exporting is Good for Britain: Finance and Costs, June 2012. 53 BDRC, SME Finance Monitor, Q1 2012, p 10. 54 Sir John Vickers, Independent Commission on Banking Final Report, September 2011 55 BDRC, SME Finance Monitor, Q1 2012, http://www.bdrc-continental.com/business-sectors/financial-and-business/sme-finance- monitor/ 56 BERR, High Growth Firms in the UK: lessons from an analysis of comparative UK performance, 2008. 57 The BCC’s 2012 International Trade Survey, for example, found that only 3% of over 2,500 exporters had used UK Export Finance assistance, many of whom were large companies. 58 See, for example, Breedon (op cit). cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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14. For the BCC, the first of these priorities is the principal responsibility of the banks. Some steps are already being taken through the Business Finance Taskforce to increase transparency, facilitate SME appeals, and widen access to information.59 The banks have a long road to travel to restore relationships with their existing customers, however, as the current situation is the result of long-term over-centralisation of decision- making and poor relationship management, in addition to the serious failings of the LIBOR scandal and the mis-selling of structured derivatives to SMEs. Given that these trends stretch back several decades, their reversal will take some time. While we are not in favour of “bashing” the banks, and work closely with lenders wherever possible to resolve individual companies’ concerns around decisions, trust, and transparency, we believe that the Commission is well-placed to recommend more permanent and systematic monitoring of relationship management in business banking for the future, perhaps by regulators. 15. Increasing competition, the second priority, is being addressed in part, through the implementation of the recommendations of the Independent Commission on Banking. The recent expansion of activity by SME lenders such as Handelsbanken and Aldermore is welcome news, as is the development of new peer-to-peer and alternative funding models, such as Funding Circle, Market Invoice, and Platform Black. But these are niche players. Regulators, including the successor to the Financial Services Authority and the further- empowered Bank of England, must ensure that mainstream competition continues to expand. For competition to have an impact on confidence in the “real economy”, businesses must see lower barriers to account-switching and more variety in the type and cost of facilities available. What’s more, business account holders should not be forced to cross-subsidise so-called “free” banking services for individual consumers through higher fees and charges. 16. The achievement of business’s third demand, however, will require legislative and policy action by government. Additional Quantitative Easing, which played a crucial role in stabilising the financial system early in the crisis, will not be enough as it does not reach the “real economy”. It is the BCC’s firm belief that only a state-backed business bank can play both a pro-cyclical and counter-cyclical role to encourage access to finance. As work by a wide range of commentators—including independent reviewers acting on behalf of government60 and think-tanks61—has shown, the UK is virtually unique in lacking a state-backed business finance institution of the sort of institution we would propose. The BCC’s paper on The Case for a British Business Bank—which would lend to viable new and growing businesses un-served by a risk-averse commercial banking sector—is enclosed alongside this submission.

Conclusion 17. To summarise, the BCC believes that concerted action to restore small- and medium-sized companies’ conﬁdence and trust in the commercial banking system is required. This must sit alongside a concerted drive to expand competition, and the creation of a British Business Bank. 7 September 2012

Written evidence from the British Standards Institution Summary 1. BSI is of the view that voluntary, consensus-based standards could play a signiﬁcant role in rebuilding trust and stimulating a culture of responsible behaviour within the banking sector. Such standards could be used in addition to the proposed legislation providing a practical means to reduce risk.

BSI Response 2. BSI has closely followed the publication of the government White Paper “Banking reform: delivering stability and supporting a sustainable economy” and the subsequent Banking Reform Bill in response to the recommendations of the Independent Commission on Banking. We have seen the call for evidence on the Banking Reform Bill and would like to submit a response with regard to issues of the management of risk, both internally and for banks’ customers. Our response relates in general terms to the 3rd objective of curbing incentives for excessive risk taking and to questions 1, 7 and 32 of the call for evidence. 3. We note as signiﬁcant the submissions in response to the Banking Standards White Paper from City organizations, including the City of London Corporation, that appear to highlight a need for a fundamental shift in values and ethics in the City in addition to regulatory reform. 4. Much discussion to date has taken place around the merits of introducing professional standards for the banking sector, with a focus on assessing knowledge and experience as a method for dealing with conduct. However, even where professional standards and regulation are prevalent we feel there is also an opportunity to tackle values and culture at the organizational level through benchmarking of good practice and risk 59 The 17 Taskforce commitments, which the BCC is actively working to implement and monitor, can be viewed at www.betterbusinessﬁnance.co.uk 60 See, for example, ongoing work by AFME and the working group on an “aggregation agency”, following on from the Breedon Review. 61 See, for example, work by NESTA, Civitas, and the Institute for Public Policy Research. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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management. Unlike professional standards or qualiﬁcations, the self-regulatory approach of formal standardization is used to embed processes, systems and behaviours as well as competencies, applying to the business and its personnel.

5. Standards also provide a means for an organization to demonstrate to its shareholders, customers, investors not just that processes and values are in place but that operational, regulatory and market risks are being managed. We would suggest the potential impact of formal standards differs from the European and International standards for banking regulators, such as Basel III, by providing this conﬁdence and assurance to external customers in retail markets.

6. As the UK’s National Standards Body, BSI believes that voluntary standards could provide a mechanism for the delivery of Government policy with regard to the improvement of trust and promotion of ethical behaviour in the banking sector.

7. BSI’s standards embody best practice through an open and transparent process of consensus-building among all relevant experts. Organizations outside of the banking sector routinely use standards to help reduce risks related to business critical functions and the impact on customers. BSI has developed a number of standards used within the ﬁnancial institutions and ﬁrms for this very purpose and also to help organizations provide assurance internally and externally to customers.

8. An example of a standard that performs this function is BS 8453:2011 Compliance Framework for Regulated Financial Services Firms that was developed with City trade associations, professional institutes and practitioners from across the banking industry.

9. This standard provides a framework for managing compliance risk in financial services firms. It aims to help embed good practice in terms of processes, behaviours and to foster a culture of compliance within the firm’s governing body. Other retail-focussed standards have been developed with the Chartered Insurance Institute and consumer bodies such as Which? in order to help organizations meet changing business models and to provide transparent and fair personal financial advice and planning services.

10. BSI’s facilitation of the development of European and international standards offers an opportunity to harmonize good practices across Europe and globally.

11. BSI is currently exploring potential partnerships with City organizations and industry to determine the feasibility for formal standards to play such a role. Our aim is to do this by building upon our existing work and by developing a new strand of engagement with the City.

12. We would welcome the views of the Commission on the possibility of using voluntary standards to help rebuild trust and stimulate a culture of responsible behaviour within the banking sector and on any potential role for BSI in this regard.

Background on BSI

13. BSI is the UK’s National Standards Body, incorporated by Royal Charter and responsible independently for preparing British Standards and related publications. BSI has 111 years of experience in serving the interest of a wide range of stakeholders including government, business and society.

14. BSI presents the UK view on standards in Europe (to CEN and CENELEC) and internationally (to ISO and IEC). BSI has a globally recognized reputation for independence, integrity and innovation ensuring standards are useful, relevant and authoritative.

15. A BSI (as well as CEN/CENELEC, ISO/IEC) standard is a document deﬁning best practice, established by consensus. Each standard is kept current through a process of maintenance and reviewed whereby it is updated, revised or withdrawn as necessary.

16. Standards are designed to set out clear and unambiguous provisions and objectives. Although standards are voluntary and separate from legal and regulatory systems, they can be used to support or complement legislation.

17. Standards are developed when there is a deﬁned market need through consultation with stakeholders and a rigorous development process. National committee members represent their communities in order to develop standards and related documents by consensus. They include representatives from a range of bodies, including government, business, consumers, academic institutions, social interests, regulators and trade unions. 31 October 2012 cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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Written evidence from Sir Alan Budd 1. The comments in this memorandum are mainly partly based on my experience as Group Economic Adviser to Barclays Bank from 1988 to 1991. This was after Big Bang and some of the challenges of amalgamating two different sorts of financial institution were still evident. 2. I set out my thoughts under three headings. The first is the conduct of what were then known as the clearing banks before Big Bang. The second, which is related to the first, concerns the culture of those who worked for the clearing banks. The third concerns the culture of those who worked in investment banking and the ways in which it differed from those in the clearing bank. I end with some conclusions.

TheClearingBanks—“aCosyCartel”. 3. The clearing bank system in the UK, prior to Big Bang, was commonly described as a “cosy cartel”. The phrase was not used in a technical (or even necessarily pejorative) sense but applied to arrangements under which a small number of banks shared the retail and commercial banking business between them. It was slightly odd that economic conditions in the UK, which were not greatly different from those in other industrial countries, resulted in a market with such a small number of institutions and others have offered explanations. It may be worth recalling that in my lifetime, and before Big Bang, clearing banks had continued to merge— the National Provincial, Martins and Williams and Glyn’s, for example, had disappeared as separate entities. Whatever the explanation, it can be said that mergers were permitted because the authorities believed that the surviving banks would not take undue advantage of their market position. In fact an implicit gentleman’s agreement operated between the banks themselves and between the banks and the Bank of England. 4. The implicit agreement between banks limited the intensity of competition between them in terms of lending and deposit rates. (They also operated an informal no-poaching agreement under which they would not attempt to recruit staff from their competitors.) I can describe three aspects of the implicit agreement between the clearing banks as a whole and the Bank of England. The first, as I have already mentioned, is that the clearing banks would not seek fully to exploit their oligopoly position and to make excessive profits. There were also gains to be made from the considerable inertia in relation to the normal business of banks for households and businesses. In the days before credit-scoring, detailed knowledge and long experience of clients’ financial affairs were key to decisions about lending. The acquisition of this knowledge was time- consuming and costly but it could be seen as an investment by both parties. Clients were reluctant to move because they were unwilling to go through the whole process again, and banks did not have a strong incentive to attract customers from other banks because they would have to pay the costs of acquiring the information. It can be said that the extent of competition between the banks was a matter for the competition authorities rather than for the Bank of England but it is reasonable to conclude that the Bank of England’s attitude to the clearing banks was coloured by the extent to which they were believed to be exploiting their favoured market position. The second aspect of the implicit agreement concerned banking regulation. To over-simplify, rules were regarded as a boundary to be kept well clear of rather than limits to be tested. “Light-touch regulation” was appropriate because the banks themselves kept a margin of safety around themselves. They had no wish to disturb their comfortable relationship with the Bank of England and were also quick to recognise informal signals about their actions—the Governor’s mythical eyebrows. 5. The third aspect of the agreement concerned the use of controls on banks as an instrument of economic policy. They could be formal, as in the case of limits on the growth of bank advances, or informal—the eyebrows again. Such formal and informal controls are more powerful when good relations with the Bank of England are important. 6. What were the banks getting in exchange? They will have been confident that, in extremis, they would be helped out if they got into difficulties. But they also got a quiet life in which they could make comfortable profits without too much competition. We hear a great deal about “regulatory capture” in which regulators attach too much importance to the interests of those whom they are supposed to be regulating. But it works both ways. The regulators can learn to live comfortably with regulation, particularly if it raises the costs of entry to the industry.

ClearingBankCulture 7. A bridge between the previous section and this one can be provided by the following story. De-regulation of the clearing banks, before Big Bang, allowed them to enter the housing loan market which had previously been limited to the building societies. By the early 1990s, problems were emerging as borrowers found themselves with negative equity and repossessions were rising. A senior colleague at Barclays said to me, “They never should have let us do this”. 8. The culture at the clearing banks reﬂected the environment in which they were operating. Loyalty and long experience were the essential qualities. The bankers were responding to familiar, repetitive problems. The organisation was hierarchical with a careful and detailed grading system to establish status. Two members of a bank meeting each other would soon discover (by asking questions about cars etc) what their relative status was. At Barclays and, I assume, the other clearing banks, operations were run by the general managers, most of whom would have left school at 16 and worked their way to the top. At the higher levels, bankers would be respected members of their local community. At the highest level they were part of a club playing a role, cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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through their links to the Bank of England, in the management of the economy. They were part of the Establishment. All employees could see how loyalty and experience were rewarded. The ethos was at least as important as regulations in controlling behaviour. Risk-taking was not a signiﬁcant part of the culture. 9. I am not suggesting that this was some kind of paradise lost. It was not obvious, for example, that the careful and rather comfortable way of doing business was in the best interests of the customers. The lack of competition made it fairly easy for customers, to be exploited. I can still recall an excellent paper given by a visiting academic at the London Business School, explaining how UK banks could proﬁt from the funds that were, in effect, locked in to their deposits at close to zero interest rates (he also explained why you had to queue in UK banks but not American ones). The exploitation could extend to the terms on which overdrafts were granted. 10. Nor did the cosy cartel prevent the clearing banks from making major lending errors.

InvestmentBankCulture 11. The culture of the clearing banks fitted the tasks that they faced. Investment banking, which is concerned with transactions rather than relationships, needed different skills and a different organisation (there are obvious analogies with the organisation of military units). Transactions required an immense concentration of time and effort over a relatively short term. The relevant unit was a team, able to operate flexibly and intensively, often for very long hours. The leaders of the teams would choose the members on the basis of their relevant skills. Each transaction could involve unique challenges and precedents were not necessarily relevant. 12. In my time at Barclays most of my dealings were with the “old” bank rather than the investment banking side and I was aware of the tensions between them. A crude and slightly unfair way of distinguishing between the two cultures is to say that those at the old bank thought of themselves as working for Barclays whereas those on the investment banking side thought of themselves as working at Barclays. The investment bankers needed the infrastructure and the capital. The question was how the profits from a transaction were to be shared between those who had worked on it and the bank. If the investment bankers did not like the split they could move elsewhere and would not hesitate to do so. (This characterisation is crude and unfair, since it certainly did not apply to all those who worked on the investment banking side, but it does, I think, describe the difference between the average behaviour in the two parts of the bank.) I heard complaints from both sides. The clearing bankers regarded the investment bankers as overpaid, reckless and not loyal to the bank. The investment bankers regarded the clearing bankers (who provided the capital) as timid, unimaginative and slow. 13. In such an environment it is difficult to see how a corporate ethos could have prevailed and it certainly could not have mirrored the ethos of the clearing banks. It is also worth noting that constraints that would have applied before the big bang mergers had been weakened or removed. The first refers to the financial risks. Stockbroking and jobbing firms, for example, were partnerships and the partners had their own capital at risk. In fact the main motive for the mergers following Big Bang was to increase the capital available to them so that they could operate on a global scale. Partners as providers of capital were replaced by shareholders (and eventually by taxpayers). The second constraint was the opportunity to become a partner, a position granting recognition and respect within the City community. After Big Bang the rewards and the measurement of success were provided by money. It should also be noted that the weakness of employee loyalty was matched by the terms and practices of employment. People could lose their jobs at a moment’s notice if market conditions were believed to require it. Loyalty works both ways. 14. I have described the cultures of clearing banking and investment banking separately and commented on the difficulty of combining the two. It is reasonable to ask whether the culture of clearing banking was already changing and, if so, whether this was due to “contamination” from investment banking or whether there were other factors. I believe that changes were already in process; the story does not begin in 1986. The de-regulation of the financial sector from the early 1980s (with some changes dating from the early 1970s) was changing opportunities and incentives. I have already quoted the comment on the effect of allowing banks to provide mortgages. Prior to that, building societies were often operating what was in effect a rationing system, just as banks had at times been operating a rationing system for overdrafts. That is a very different world from one in which institutions are competing with each other for deposits and borrowers. Barclays itself was engaged in a campaign to regain the leading place as a commercial bank that it had lost to the National Westminster Bank. I can remember bank managers saying how odd they found it to be trying to increase loans rather than deposits. 15. I have also mentioned the move to credit-scoring, which was replacing the knowledge gained through a long-term relationship with a personal or business customer. Branch closures were another aspect of the same development. 16. Banks were also increasing the recruitment of graduates in response to the changes in banking and the greatly increased supply of graduates. 17. I have always assumed that the main motive for the changes in regulation which permitted Big Bang was the wish to allow London to maintain or expand its role as a major centre for international financial transactions. There was no attempt to keep this as a domestic activity. Overseas banks were welcome. The result was never going to be cosy and the Governor’s eyebrows could not be seen in all the bustle. It is true that retail banking has remained largely a domestically owned business but it operates in a much more open cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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environment and the culture that suited the old style of clearing bank was bound to change, though I believe that it can still be distinguished from the culture that suits investment banking.

ConcludingComments 18. The comments in this note are anecdotal rather than scientific, and my direct experience of Barclays ended over 20 years ago. At the time I thought that the clash of cultures meant that the attempt to create a universal bank could not succeed. I may have been too pessimistic. I did not anticipate any of the kinds of action that have given rise to the current inquiry but my experiences may help to explain why they have occurred. 19. All this is by way of diagnosis rather than cure and I am conscious that it is difficult for me to say what could be done to alleviate the sorts of problems that have led to the establishment of the Independent Commission. I have considered how much overlap there is between the work of the Vickers Commission and this Commission. The former was concerned with the questions of financial stability and competitiveness. The latter is concerned with the extent to which professional standards in UK banking are absent or defective. The Vickers Commission believes that a change in structure can reduce the risk of financial structure while other changes, including the divestiture of branches from Lloyds, the introduction of a switching system for current accounts and the actions of the Financial Conduct Authority can enhance competition. This Commission is considering the extent to which professional standards, or their absence, contributed to the actions which caused the financial crisis, but members will be aware that the inappropriate selling of payment protection insurance, on the retail side, or the misreporting of LIBOR, on the wholesale side, for example, can hardly themselves be thought of as contributory factors. They are both symptoms of the same sort of forces which also produced the crisis. My pessimism about Barclays in 1988 arose from what I saw as the great difficulty of combining two cultures, particularly when the constraints on conduct in the investment banking side were already being weakened, for the reasons I have given. 20. I do not know to what extent the universal banks distinguish in their recruitment between the different parts of the organisation. I assume that they do, and those that apply for jobs will be aware both of differences of culture, and of financial rewards, so it continues to be the case that banks combine different cultures and that people will apply for the side that best suits their temperament, though no doubt there has been some convergence. I can argue the case for or against breaking up the universal banks. The clearing bank side may exercise constraints on the investment banking side or the investment bank may contaminate the clearing bank side. Breaking up the universal banks may make the clearing/retail side better (and increase the confidence of its customers) but make the investment banking side worse. If problems are more likely to arise on the investment banking side, that is where the solutions have to be found. 21. Finally, I am sure that the Commission recognises the distinction, between culture and ethos on the one hand and regulations on the other. I have mentioned that the culture of the clearing banks was to operate comfortably within the regulations (and not to chafe at their presence). The Treasury Committee’s Report on Fixing LIBOR shows that there can also be a culture, in some parts of a universal bank, of breaking regulations. Severity of penalties and success in enforcement can help discourage such a culture but both the regulations and the culture may need to change. 8 October 2012

Written evidence from Jennifer D. Budden 1. Introduction and Synopsis 1.1 I have felt the need to make this very late submission to the Commission; because of the experience I am currently going through regarding some banking issues relating to an elderly relative. I consider that my experience is a good illustration of a fundamental problem with the current impersonal banking model, the result of which is to make ordinary customers spend a lot of time fitting in with opaque bank systems rather than the bank systems providing a customer friendly service that can deal efficiently with individual issues. 1.2 These problems are exacerbated by the banks’ approach, which concentrates on short-term relationships, so savers for example are expected to constantly monitor their savings accounts and continually shop around for a better offer. One of the effects of this approach is that people constantly have to go through the same bureaucratic process over and over again which has costs for the individual in both time and effort. 1.3 The system is predicated on the fact that this gives competition. It may give some competition in terms of return on savings but there is no competition in terms of the approach used by banks and building societies. Their processes are all essentially the same: it is the customer who is required to take all the initiatives and do all the work to fit in with the banks’ systems. The number of people who end up with low interest bearing accounts as they have failed to take action to move their money is an obvious outcome. 1.4 The ensuing frustration experienced by people trying to work their way through the bureaucracy contributes to the lack of confidence and negative attitude that the public tends to have about the banks, their competence and customer care. A new model is needed which starts from the question of what customers really need, not only in terms of products, but bank processes that really give customer care. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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2. Anexample 2.1 A nice example of this is to consider the problem of an elderly person who has just gone into residential care and is looking, (especially because of the need to meet care home fees) to maximise savings returns. Most savings products offer short-term rates or for a fixed period. Many of the savings accounts offering the best rates are on line. 2.2 However when opening a new account with a different bank or building society it is necessary to prove identity and also one’s address. I appreciate that for legal reasons, money laundering and to prevent fraud this proof of identity and address is important. However while the guidance lists of what is acceptable include notification of entitlements to other governmental/local authority grants or a coding from HMRC, these latter documents are much more difficult to standardise or access than having a current passport or driving licence. Routine coding from HMRC or updates on pension amounts are sent out at a specific time of year. Change of address acknowledgements from such bodies are not sufficient to prove identity. This leads to all sorts of Kafkaesque problems for people in trying to prove who they are and is likely to be of particular problem to a very elderly person. 2.3 Take the example of someone who is elderly and infirm who moves into a residential home because they are no longer able to look after themselves but who has more assets than the amount at which the state will provide any assistance. Such elderly people are unlikely to have a valid passport and if they do have a driving licence it will have their old address on it. It is unlikely that they will want or be considered well enough to continue to drive so will not change the address on the driving licence. 2.4 Also such a move into residential care is unlikely to be planned. It may result from a sudden crisis such as an illness or a hospital stay. But the need to meet the fees of the home is urgent. Good homes are sympathetic but they do need fees to continue to run. So the need to access funds, close or transfer savings accounts and open accounts to maximise the interest on available funds becomes very significant. But if the account to be closed has not been actively used for some years, perhaps because it was seen as a rainy day account, trying to get the account closed with a new address raises all the concerns of the banks about fraud or money laundering and proving identity then becomes a bureaucratic nightmare. Photocopies of official documents may have to be certified. Information may be held to be incomplete even when properly provided by the official organisation because for various reasons it does not include precisely the information specified by the bank concerned. There is a lot of discussion in the press about the number of people who are currently living into their 90s or over a 100. It seems to me ironic that someone can be on this earth for 90+ years but not be able to easily prove who they are to the bank’s satisfaction. 2.5 Proving an address may be equally challenging. Once in residential care the elderly person won’t have utility bills. They may not have a BT telephone. They may not be online savvy. Phoning up distant call centres to check up what to do is stressful particularly if you need pass words and to use the phone keypad to put in pin numbers, assuming you can remember them. When you finally do get through—assuming you can hear them—the call centre staff may have to transfer you to another department—more cost on your phone bill and you may get information that is then not accepted when acted upon. 2.6 Relatives cannot help because activating power of attorney takes time for the banks to confirm and also seems a waste of time if the account is to be closed. Even having power of attorney does not make the bank systems any more transparent. You have to pick up understanding by trial and error. There is no one to guide you through.

3. Failures of a Centralised System 3.1 Many banks, especially for on line accounts, deal with proof of identity centrally. Such central departments have by definition no local knowledge—they won’t know even if a residential home actually exists for example. The decision made to accept or reject proof of identity and address is purely on the basis of written information which, when it is not a standard passport or driving licence, may be open to interpretation. For example a letter from the Pension Service may be rejected because it only contains initials rather than the person’s full name. So what can ensue is a series of apparently standard letters from the banks demanding more detailed information to prove identity. For an elderly person, even assuming they understand what is required; it may be difficult to work out how they might obtain the information demanded. The whole process is time consuming, stressful and probably beyond may elderly people and even for their relatives trying to support them. 3.2 Banks obviously need to prevent fraud and meet legislative standards. However my contention is that the systems banks put in place to do this often make it incredibly difficult for genuine people to meet the requirements. In this as in many other aspects of current banking, the systems in place may keep both administrative and training costs down for the banks but do not provide a service that meets what an individual customer needs or wants, especially if the person concerned is not articulate, IT savvy, able easily to understand complex detail or has the time to devote to working their way through websites or hanging on for telephone call centres or know precisely what information they are seeking. 3.3 The whole basis of a call centre for example is that it is impersonal. You never speak to the same person twice. Different calls may elicit different information in answer to the same problem. The cost in time and cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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money is born by the customer: for example many banks’ call centres frequently seem to be “experiencing high volumes of calls” where a wait at a cost to the customer’s phone bill can be lengthy. Such call centres deal with general enquiries but may not able to deal with particular aspects which have to be transferred to other departments with even more waiting time. Websites may be difﬁcult to navigate or not give the answers to the questions you have. Most people will shudder when required to phone many bank’s call centres or use their website for all but routine matters—how much more difﬁcult and stressful is it for a very elderly person?

3.4 Even where a local branch exists, local staff have limited authority to sort out issues. They do not know their customers personally even if the person has been banking with their bank all their adult life. They are not allowed to interpret the rules with common sense. They are not trained to act as gatekeepers or to anticipate what the person concerned will need to do and give them the appropriate guidance. This may be bad enough for a person in good health, for someone who is elderly, fatigued and inﬁrm—the sort of person who is likely to go into residential care for example, it can add to the distress of losing one’s independence, feeling unwell and generally out of control. Relatives have limited power to help.

4. Need toConsult Age UK

I don’t know if the Banking Commission has received a submission from Age UK or other organisations that support the elderly or those who are more vulnerable about the shortcomings of bank systems for their use. However anecdotally I know that this is a common problem.

5. BanksNeed toFundamentallyChangeTheirApproach

5.1 The processes the banks have put in place to meet customer need are essentially clerical in nature not professional: the staff that their customers come into contact with either in person or remotely are often only allowed to follow procedures rather than to exercise judgments on how the policies should be applied in that particular case. While all the banks pay lip service to good customer service in practice their systems mean that are unable to treat customers as individuals: their systems do not allow them to differentiate between those whose simple standard questions can be answered automatically from those who really need individual help to sort out the problems they are grappling with.

5.2 Banks will no doubt argue that with the volume of their business they cannot provide a personal service and that such a model harks back to an earlier era when life was simpler. However I would contend that companies such as John Lewis do manage to provide a personal service, which also deals with volume and this may be one of the reasons why the public holds them in more regard. It is a question of corporate culture and attitude and the systems put in place to meet that culture.

5.3 While banks and building societies claim there is competition between them, they mostly all operate in the same way so there is little to chose between them. In effect they are mostly as bad as each other. If they really put customer service ﬁrst they could not have set up the business systems that they have.

5.4 If the banks are really to find favour with the public, they need a total change in culture. They need to put their customers needs really at the heart of what they do rather than expecting customers to fit with what works for the bank. This would include: 5.4.1 if they are going to use call centres, these should be free for the user so that the costs of insufficient staffing are born by the banks not their customers. 5.4.2 Training their local branch staff so that they have the authority to understand and interpret the rules with professionalism and common sense. 5.4.3 Rather than offering short term savings products they should seek to create a long term relationship with their clients where the bank or building society continuously seeks to provide the best savings rates, for example, without the customer having to continuously shop around and go through the same bureaucratic process again and again.

6. Conclusion

6.1 In the 21st century it is vital that banks and building societies work for all sections of society and are inclusive. Everyone needs banking services and everyone needs to maximise the amounts they earn on their savings. If banks are to be inclusive they must fundamentally change their approach so that they really do put customers at the heart of what they are doing, not only in their advertisements.

6.2 If this happened then the public might over time develop more trust for their banks and feel that they were genuinely working to meet their customer needs rather than as now feeling either exploited or totally frustrated. 5 October 2012 cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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Written evidence from the Building Societies Association Introduction and Summary 1. The Building Societies Association (BSA) represents mutual lenders and deposit takers in the UK including all 47 UK building societies. Mutual lenders and deposit takers have total assets of over £375 billion and, together with their subsidiaries, hold residential mortgages of £245 billion, 20% of the total outstanding in the UK. They hold more than £250 billion of retail deposits, accounting for 22% of all such deposits in the UK. Mutual deposit takers account for 31% of cash ISA balances. They employ approximately 50,000 full and part-time staff and operate through approximately 2,000 branches. 2. A well functioning financial system supports economic growth, efficiently allocating resources to benefit society by intermediating between savers and long-term borrowers. However, a financial system that does not operate well can lead to benefits being appropriated by those in powerful positions, to the detriment of society more widely. It seems clear that some of the largest, most complex banks benefitted from too much power and influence in the run up to, and through, the financial crisis. This has been shown by the extensive state support given to the largest banking groups in the crisis, as well as by the scandalous events that have emerged in recent months, many of which occurred prior to or through the financial crisis. However, this does not mean that there is a universal problem afflicting all organisations or individuals working in the financial services or banking sectors. The incentives and culture that developed from the organisational structures at some of these institutions led to opportunities and motives such that in some instances individuals worked to the long-run detriment of society and the organisations themselves. 3. Mutuals are owned collectively by their customers, so have very different incentives and a very different culture to shareholder-owned banks. No mutual lender or deposit taker is involved in the LIBOR setting process, they did not sell swaps to SMEs, and mutuals were not responsible for the widespread mis-selling of Payment Protection Insurance (PPI). However, mutuality does not guarantee good governance and a socially responsible culture, and there have been instances where problems have arisen at some mutuals. Even so, the primacy of the customer in mutually owned firms does mean that conflicts of interest are less prevalent than in other organisational forms, and that their organisational cultures do tend to place more importance on serving customers. Mutuals continue to work on improving their corporate governance to ensure that the businesses deliver even more benefit to members. 4. It will be extremely difficult to correct failings in corporate culture by directly regulating professional standards at firms. This is because organisational culture and ethics emerge from the deeply held values of those people working within and responding to a firm’s structure, leadership and its external environment. It is by changing the structure of firms or the operating environment that the ethics might be shaped. 5. If the retail financial services sector required by society in the years ahead is characterised by lower risk, lower return operations that are focussed of the needs of households and businesses, then structural reforms that promote competition and break the power of banks that are too big and complex to fail are likely to be beneficial. Necessary changes include: (i) Support for a diverse range of business models. This will help to make the system more robust, and also enable firms to operate to different incentives, enhancing competition. (ii) Reforms, including to governance structures, that encourage ring-fenced retail banks to operate in ways that mean that they are more easily resolved, so that they do not benefit from implicit State guarantees.

MitigatingPrincipal-Agent Problems:Governance at Mutuals 6. An important aspect of how the financial system responded to its operating environment was because of the approach to governance in banks due to the separation of ownership and control. How the owners try to influence the behaviour of the agents they employ to run the business has a direct effect on the incentives they operate to. It has been noted that a surprising lack of attention has been given to bank governance given the considerable work on principal-agent problems that suggests that ownership structure influences risk taking (Laeven 2011). 7. Much of the theoretical work looks at the agency problems at quoted institutions, and the incentives for equity shareholders to increase short-term risks, particularly as they enjoy limited liability. They therefore would benefit from higher returns to risk taking, but their potential losses are limited. And to incentivise managers to act in accordance with shareholders’ interests, managers of shareholder-owned banks have been increasingly remunerated in line with shareholder returns. However, shareholders’ interests may conflict with those of a bank’s customers (or indeed, those of society more widely). At publicly quoted companies, the number of votes corresponds to the number of shares a body or an individual holds. Therefore a small number of large equity holders can seek greater risk and returns at the potential expense of creditors, including depositors. Accordingly, the interests of external shareholders and customers need not be aligned. 8. Building societies and other mutual lenders and deposit takers are owned collectively by their customers. They therefore do not face the same conflict of interests between customers and owners, as these groups are one and the same. For this reason Andy Haldane, Executive Director for Financial Stability at the Bank of England has said that “mutuality may do a better job of aligning stakeholder incentives than some alternative cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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forms of corporate governance” and cites as evidence that no demutualised building society survived the financial crisis as an independent entity due to the change in incentives at those organisations (Haldane, 2009). 9. Mutuals’ governance is based on the principle of one member, one vote, irrespective of the size of investment or borrowing. Building society members have the right to vote at the Annual General Meeting to appoint directors and approve the annual report and accounts. All building societies now also voluntarily hold an advisory vote on directors’ remuneration. Members also have the right to nominate candidates and to stand for election as directors themselves. Therefore, building society members have a much greater degree of influence and control over the institution than do customers of banks. It is sometimes argued that the wide dispersion of building society ownership means that control of management is weak as it is difficult for members to build a consensus, but the failures of many quoted banks shows that active engagement of owners is a universal challenge. 10. Mutuals try to engage their members to reduce the principal-agent problems they face. They have developed various methods to enable more of their members to participate in how the institution is run, and for those that do, an opportunity to do so in a deeper and more meaningful way. A study by the BSA found examples of actions building societies are taking to engage their members in more effective relationships and to garner their feedback, including: — Meet the director sessions—where non-executive and executive directors go to meet members around the society’s operating area to answer questions and inform members of how their society is performing. These are separate to the AGM. — Member panels—where members can apply to be appointed to a panel or committee. Panels discuss topics including product development and marketing but also operations and giving their opinions on strategic decisions. Some also have access to some society board papers, and direct access to members of senior management within the society. — Member questionnaires and surveys—on levels of customer service and satisfaction, but also other feedback. Many societies have procedures so that member feedback is brought to the attention of the board and senior management. — Encouraging voting at the Annual General Meeting—via online voting, a “quick vote” option, charitable donations for each vote cast. (BSA 2010) 11. Recognition has increased among mutuals that they benefit from having engaged members, with the Chief Executive or Chairman ultimately responsible for engaging members at most societies. 12. The UK Corporate Governance Code, including the recommendations from the Walker Review, applies to publicly quoted firms. However, with the help of the BSA, building societies have voluntarily taken on the provisions in the Code, insofar as these do not conflict with mutual ownership. 13. Corporate governance at building societies and other mutuals is not perfect, and all continue to work on improving their corporate governance processes, supported by the BSA. For example, many building societies have instigated reviews of board effectiveness to help them improve the skills and processes the board uses to oversee the business.

The Effect ofMutual Ownership on Culture 14. Being owned by customers rather than external shareholders affects not just the potential agency problems an institution faces. It has a fundamental affect on the culture and ethics of the firm, which emerge from the ongoing interaction between the operating environment and the people within the business; how they communicate and behave, the values they hold and how they identify with the organisation and its heritage. 15. As a consequence of their ownership structure, the culture at mutual organisations is very different to that at shareholder-owned banks. Employees at mutuals know that when they serve a customer they are serving one of the owners of the business. And though mutuals do have to operate efficiently and make sufficient profits to build capital and to invest in future operations, they do not have to maximise profits to increase returns to shareholders. The economist John Kay has previously noted that “the special value of mutuality rests in its capacity to establish and sustain relational contract structures. These are exemplified in the most successful mutual organisations which have built a culture and an ethos among their employees and their customers, which even the best of plc structures find difficult to emulate.” (Kay, 1991). Such long-term customer relationships are well suited to mortgage lending, where bespoke, customer specific information is helpful to ensure loans are made on a prudent basis, and to savers seeking low-risk savings options. 16. And many mutuals have a long heritage, often with a deep-rooted social perspective, as they were originally established to open up opportunities for home ownership to previously excluded groups in their communities. This need has changed somewhat, but this prestige still bears on the ethics and culture at mutual institutions. Many mutuals retain a relatively simple focus of helping their customers to save and to buy their home, and some have explicit ethical charters linked to the purposes for which they were originally established. 17. Another factor that feeds into the organisational culture at mutuals is one of a long-term focus. This flows from the ownership structure as it is more difficult for mutuals to raise external capital than it is for cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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publicly quoted firms. Mutuals rely on retained profits, as options such as rights issues are not available to them. Mutually owned firms tend to hold more capital (the average Core Tier 1 ratio across the largest mutuals was 12.2% in 2011/12, far above the 7% under Basel III requirements). In addition, members who have savings accounts with mutuals (outnumbering borrowing members by approximately eight to one) would not benefit from any upside to greater risk-taking, but would suffer the downside consequences. They therefore tend to have a very risk-averse outlook. Mutuals therefore follow more prudent strategies than banks, as indicated by the lower level of arrears on their mortgage books, which run at approximately two thirds of the level across the market as a whole. Accordingly, mutuals’ low risk, low return approach, focused on the needs of savers and borrowers means they are well placed to deliver the retail financial services society requires. This has been recognised recently by the Government: “The Government believes that building societies have an important role to play in the future of UK financial services. They have been successful in delivering a range of services to a large proportion of the UK population, to a high degree of customer satisfaction. They have stayed faithful to a relatively low risk model, and have generally come through the financial crisis in good shape. Finally, they have offered a mutually-owned alternative to UK consumers, and contributed to diversity in the financial services sector.” HM Treasury 2012

18. An example from a demutualised society is instructive in how the culture differs between a business owned by customers and one owned by shareholders. In 1997 when The Woolwich converted from a building society to a publicly quoted bank, it emphasised the corporate culture as one of its distinguishing features: “We believe very strongly that retaining the Woolwich’s culture and values is important for ensuring that the Woolwich’s high standards of customer service are maintained and for safeguarding the future of its management and employees.” Woolwich Building Society, Transfer Document, 1997

19. However, the following year John Stewart, Woolwich Group Chief Executive, noted that the future of many senior Woolwich employees had not been safeguarded and that the culture—previously a valuable asset at the Woolwich—was no longer suitable for the quoted bank: “Commenting on the departure of 25% of the group’s senior managers during and since the conversion process, John Stewart, Group Chief Executive, said, “Culture has been the biggest change at the Woolwich over the last year to 18 months. A building society culture is wonderful in terms of customer care, but it isn’t particularly good at identifying where the value is in the business. We need a different type of person in the future.”” Financial Times, 19 February 1998

20. The BSA would question Mr. Stewart’s assertion that listening to customers is not a good way of identifying where value is in a business—his comments perhaps indicate for whom the shareholder-owned bank was trying to create value following its demutualisation.

21. The difference in culture at mutuals means that they are less likely to get involved in widespread consumer abuses. For example, Payment Protection Insurance (PPI) was not a major product for many BSA members—this is evidenced by the fact that the big banks have so far set aside around £7 billion in redress for consumers who were mis-sold PPI. Between them, BSA members have set aside around £200 million (a substantial proportion of which is to cover the administration of dealing with claims from Claims Management Companies for instances where there are no grounds as no product was ever sold). In other markets where there have been recent scandals, such as the selling of swaps to small businesses, mutuals are not active, and no BSA members were involved in the setting of LIBOR.

22. There have been isolated incidents of mis-selling by mutuals in the past, demonstrating that mutuals are still required to put controls in place to ensure that badly formed incentives do not arise that put the customer, and ultimately the institution, at risk. Mutuals’ organisational form, and the long-term focus on members that it engenders, may help to reduce these incentive problems, but they do not remove them entirely. Regulatory compliance is a responsibility of mutuals’ boards and senior management, part of whose role is to lead and to communicate the desired behaviours and culture. Mutuals’ focus on their members’ interests helps to enforce this compliance culture.

The Effect of Mutual Ownership onConsumerTrust

23. Trust is imperative to banking. A breakdown in trust can stop the financial system operating effectively (Haldane 2009). Trust is a broad concept that can cover a range of different things, from whether the individual has confidence in an institution’s competence (to look after their money, to deal with their transactions effectively, and so on) to whether they can rely on the institution to treat them fairly and not to take advantage of them. These are value judgements that develop gradually over time. As such, trust and confidence are generated slowly by building relationships, though they can be undermined in an instant. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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24. Consumer research has consistently shown that building societies are more trusted than banks and other providers. Recent research commissioned by the BSA has shown that a greater proportion of customers of mutuals agree that they can trust their provider to look after their best interests than do customers of banks.62 25. Because the research was run prior to the recent spate of scandals, some questions were re-run to see how these events have changed opinion. There is now a greater gap between mutuals and banks on many aspects of service, including in terms of what proportion of their customers consider them to be open and honest. 26. Overall, the research shows that customers of mutuals consider that their provider delivers on various aspects of service to a greater extent than do customers at banks. This includes — being more trusted to act in their best interests (mutuals outscore banks by 17%pts in July 2012); — being open and honest (mutuals outscore banks by 11%pts in July 2012, up from 3%pts in May 2012); — feels their provider has high ethical standards (mutuals outscore banks by 24%pts in July 2012); — treating customers fairly (mutuals outscore banks by 10%pts in July 2012); — feeling valued as a customer (mutuals outscore banks by 22%pts in July 2012, up from 15%pts in May); and — feeling their money is safe (mutuals outscore banks by 16%pts in July, up from 7% in May 2012). 27. Other research commissioned by the BSA asked consumers how their trust had changed in the few weeks in late June/early July 2012 when news of the scandals broke. 66% of consumers said their trust in banks had fallen, while 79% of consumers said their trust in building societies had stayed the same or increased63. 28. Other research backs up these findings. For example, the Financial Services Research Forum at the Nottingham University Business School has run a Trust Index for several years. This finds that of financial service providers only building societies and brokers have a positive net trust score. Banks and credit card companies have persistent negative trust scores. 29. The same institution also conducts research into how fairly different types of institutions are deemed to treat their customers. The Fairness Index shows that in 2012 consumers gave building societies a score of 53.9, while banks scored just 42.9 (a score over 50 is “fair”, a score under 50 is “unfair”).

MUTUALS VERSUS BANKS: DIFFERENCES IN NET AGREEMENT, % POINTS July 2012 May 2012 Mutuals outscore banks across various aspects of service, and by more in July than May 2012 May 24% only 22% May 17% only

16% 14% 13% 21% 19% 11% May 16% 10% 15% May only 10% only 7% 8% July 7% 6% 4% 3% only

The BSA commissioned consumer research in May, prior to the scandals in the banking industry. The research was conducted by GfK NOP, who asked 2,005 UK adults between how they rated various aspects of service at their ﬁnancial service provider. We then ran some of the questions again in July to see how the widely reported events had changed opinions (1,972 UK adults between 19 and 24 July 2012). The results are summarised in the chart below. Questions on some aspects were run in May only. 63 Survey conducted by Canadean Consumer for the BSA between 6–8 July 2012. The total sample size was 2,000 adults. The survey was carried out online. The ﬁgures have been weighted and are representative of all UK adults. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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30. These results are consistent with those in previous years, so are not merely a reaction to recent events. Mutuals have been shown to satisfy a much greater proportion of their saving, borrowing and current account customers than other providers for several years, including prior to the ﬁnancial crisis (BSA 2012). It is likely that the higher levels of trust and customer service are a result of mutuals’ ownership structure and leadership which mean they are focused on operating in the interests of members, rather than those of external shareholders.

Directors’Remuneration 31. All building societies hold an advisory vote at their Annual General Meeting on directors’ remuneration, though they are not required to do so by law. Since 2006, when comparable data was first collated by the BSA, on average 89% to 95% of voting members have approved building society directors’ remuneration. Over this period, all remuneration packages have been approved by at least 80% of voting members. 32. Further, analysis of the remuneration packages of building society Chief Executives suggests that they have not seen pay growth far in excess of that seen for all employees across the whole of the financial services sector, and well below that seen by FTSE 100 Chief Executives. 33. Earlier this year the Secretary of State for Business, Vince Cable MP, was reported to have noted that FTSE 100 Chief Executive remuneration increased on average by over 13.6% per year from 1999 to 2010 (FT Adviser 2012). Looking at building societies that operated over this period, the average annual growth rate in Chief Executives’ total pay (basic salary, pension contributions, benefits and performance related pay) from 1999 to 2010 was 5.4% (Source: BSA analysis of annual reports and accounts). Analysis of ONS figures for average pay in the sector “Financial & Insurance Activities” from 2000 to 2010 (data not available for 1999) indicates that average annual pay growth across the sector as a whole was 5.2%, just below the figure for building society chief executives’ pay growth. In financial years ending in 2011, executive remuneration at building societies was 80% salary and 20% performance related bonuses, where performance is often assessed on range of factors, including non-financial ones such as customer satisfaction. This is testimony to the mutual ethos and robust corporate governance that have meant that excessive distributions to Chief Executives of building societies have not been widespread.

Changing Culture 34. The Commission has been asked to report on proposals for legislative action before the end of the year, and on other matters as soon as possible after that. However, the BSA would recommend that the Commission guards against knee-jerk reactions to the unsavoury incidents that have been uncovered recently, as such reactions, though well intentioned, could do more damage than good. Government needs to ensure that reforms are focussed on improving the functioning of the financial system, freeing up competition, rather than increasing compliance costs that would ultimately be passed on to the users of financial services. 35. An organisation’s culture emerges from the deeply held values of those people working within and responding to a firm’s structure and strategy in relation to its external environment. These factors will be interdependent. It is therefore very difficult to precisely control or direct changes in culture. This is not to say that organisational culture cannot be changed, and a factor shaping this will be leadership from senior management, with a firm’s leaders a strong influence on the values and beliefs within it. At mutuals, this is informed by the primary focus on creating value for saving and borrowing members. 36. A wide range of regulators and informed commentators have recognised that specific regulatory requirements are likely to enjoy limited success at changing culture64. As well as increasing compliance costs, regulatory rules may not alter the underlying incentives, and may be ineffective or even counterproductive. John Kay, in his review of UK equity markets and long-term decision making, noted the risks of using regulation to impose an ethos of trust: “There is a real danger that such a system will stimulate the very behaviour it seeks to constrain, as people come to believe that appropriate standards of behaviour are defined by rules rather than by the integrity of the participants. … When regulation imposes requirements which are directly contrary to the business interests of those who are regulated, the likely result is formal rather than substantive compliance, and a regime which will be undermined by avoidance through regulatory arbitrage. Frustration and the resulting ineffectiveness of policy then leads to further complexity. Regulation of market structure is generally preferable to regulation of market behaviour. This lesson has been learned and applied in the regulation of other industries, such as transport and utilities, but has not been sufficiently recognised in financial services. Regulation based on behavioural prescription tends to be at once extensive and intrusive, yet limited in effectiveness and vulnerable 64 In his final speech before departing as Chief Executive of the FSA, Hector Sants said, “Central to good governance is a firm’s culture. I have spoken a number of times on culture explaining that I do not believe a regulator should prescribe what the “right” culture is. Rather a regulator should ensure that the right enablers are present to incentivise a culture that delivers the right outcomes.” (FSA 2012) Similarly, the Bank of England’s Andrew Haldane has suggested that regulation might be insufficient to restore public trust in the financial system if financial institutions themselves are not seen to engage in “root and branch” reform to create “a self- generated sea-change in the structure and strategy of banking,” concluding that “thrift, mutuality and relationship-building… offer a tried and tested—indeed, trusted—roadmap for the period ahead.” (Haldane 2009). cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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to problems of regulatory capture—a tendency to see issues through the eyes of the industry rather than its customers. All these outcomes are characteristic of the regulation of ﬁnancial services and have developed in recent years.” (Kay 2012) To affect culture more fundamentally is therefore likely to need changes to the structure of organisations and markets, for example those being implemented in the Banking Reform White Paper, based on the ICB recommendations. Changing the operating environment will then change the values that result in successful performance.

Influencing Corporate Cultures through a more Diverse and Competitive Market 37. The BSA believes that the Parliamentary Commission’s proposals should focus on enhancing the environment and structures within which the financial system operates. This can be achieved by breaking the power of the largest banking institutions that are too large and complex to be disciplined effectively by market forces, and enabling effective competition by supporting a diverse range of financial service providers. 38. Having organisations that are too complex to be allowed to fail distorts the incentives in these firms, affecting their corporate cultures, particularly regarding their approach to risk. The subsidy that large, complex banks enjoyed as a result of the implicit Government guarantee also distorts competition. Analysis by the Bank of England found that the largest banks benefitted from subsidies of £102 billion in 2009, while building societies received benefits of about £2 billion (Bank of England 2010). 39. It is to be hoped that the implementation of the ICB’s recommendations on structural reform will go some way to reducing these guarantees and correcting these distortions. Requiring ring-fenced banks to hold more capital and making them (and their parent groups) easier to resolve will also improve the discipline on management. 40. Indeed, the introduction of these reforms provides an opportunity to require governance structures in ring-fenced retail banks that support the development of cultures and incentives in these parts of banks that fit with the needs of society. Ensuring that appropriate controls are in place for ring-fenced banks, and that a strong enough internal separation between the board and operations of the ring-fenced bank and the investment bank will be essential to reforming the behaviour of the largest banking groups. Risk management at building societies was specifically highlighted by the Independent Commission on Banking in its Final Report as providing “a particularly good basis for the risk management functions of ring-fenced banks” (ICB 2011). 41. The Building Societies Act (1986, and the 1997 amendments) imposes restrictions that shape the appetite for risk in building societies, and therefore have a profound impact on their corporate cultures. These include so-called “nature” limits which restrict the proportion of non-member funding to a maximum of 50% and a requirement that at least 75% of loans be secured on residential property. Restrictions on the powers of building societies’ treasury functions prevent them from acting as a market-maker in securities, commodities or currencies. And building societies may not trade commodities or currencies. A society may use derivatives to limit its exposure to a specified list of risks only, including interest rate (and basis) risk, inflation risk and house price inflation risk. The use of such derivatives, such as interest rate swaps which underlie the provision of fixed rate loan and deposit products, helps a society to manage and hedge its own risks. 42. While the BSA supports the proposal in the Treasury discussion document The Future of Building Societies that building societies be allowed to offer an expanded range of simple derivative products, subject to the same safeguards as ring-fenced banks, this would not represent a change in the fundamental purpose of building societies. This would merely enable building societies to compete on an equal basis to ring-fenced banks, including any potential expansion into SME lending any mutuals may wish to make, enhancing competition in these markets. 43. No organisational or governance structure is perfect. There is therefore value in having a diverse range of firms providing financial services. With different models, firms face different incentives and therefore react to the external environment in different ways. This has benefits for financial stability as it makes the system as a whole more robust to shocks, but it also leads to more effective competition as the different business models provide competition of a qualitatively different type than is provided by just adding an additional firm with the same business model (Michie 2010). In an uncertain world, a diverse range of firms operating to varied incentives will be most able to cope and to evolve to changes, and will offer wider choice and more innovative products to consumers, to the benefit society more widely. Similarly, the Ownership Commission recently found that effective ownership across an economy stemmed from a plurality of ownership types, as well as good stewardship and engagement (Ownership Commission 2012). 44. Diversity of provision should therefore be supported, with a range of firms in terms of size, structure and geographical focus. The commitment in the Coalition’s Partnership Agreement to “bring forward detailed proposals to foster diversity in financial services, to promote mutuals and to create a more competitive banking industry” remains an important objective. The Treasury discussion document The Future of Building Societies should be the springboard to modernise the Building Societies Act to free building societies to compete on an equal basis with ring-fenced banks, as well as each other. Other regulatory reforms should be proportionate to cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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the risk posed by an institution, and the varying effects of regulations on different structures should be recognised (Laeven 2011). 45. A thriving mutual sector that is able to compete on an equal basis with banks that no longer enjoy implicit Government guarantees will provide a constraint on the banking sector. This competition will be based on incentives and corporate cultures that derive from an organisational structure where consumers and their communities are the main focus. As such, increased competition from diverse providers can prevent incentives that have results detrimental to society becoming prevalent.

Conclusion 46. The financial crisis, and the recent scandals that have come to light, show that the behaviour of the largest banks in the UK needs to change. Reducing the power of too complex to fail institutions by making them easier to resolve, and opening them up to more effective competition from a diverse range of providers will shape the incentives within these organisations so that they act in a more socially appropriate way. While mutual ownership is not without governance problems, mutuals’ low risk, low return approach is likely to fit better with what society demands from retail financial service providers in the future. Together with their focus on members rather than external shareholders, a focus which runs through their corporate cultures and how they serve their customers, they will provide a valuable competitive challenge to large banks. 30 August 2012

References: Bank of England, Financial Stability Report December 2010, Chart 5.9 BSA, 2010, Conversations with members http://www.bsa.org.uk/docs/publications/conversations_with_members.pdf Coalition Partnership Agreement, 2010 Financial Times, 19 February 1998 FT Adviser, 23 January 2012 http://www.ftadviser.com/2012/01/23/investments/uk/government-details-new- powers-for-investors-on-executive-pay-w48Gy38yVPHtuu07OrINHI/article.html Financial Services Research Forum, Nottingham Business School Trust Index 2012 http://www.nottingham.ac.uk/business/forum/documents/researchreports/paper93.pdf Fairness Index 2012: http://www.nottingham.ac.uk/business/forum/documents/researchreports/paper91.pdf FSA 2012, http://www.fsa.gov.uk/library/communication/speeches/2012/0424-hs.shtml Haldane, A, 2009, Credit is trust Haldane, A, 2011, Control rights (and wrongs) HM Treasury, 2012, The Future of Building Societies Independent Commission on Banking, 2011, Final Report Kay, J, 1991, The Economics of Mutuality. Kay, J, 2012, The Kay Review of UK equity markets and long-term decision making Laeven, L, 2011, The Future of Banking, Vox.eu Michie, J, 2010, Promoting Corporate Diversity in the Financial Services Sector http://www.kellogg.ox.ac.uk/sites/kellogg/ﬁles/documents/Corporate_Diversity_Report.pdf Ownership Commission, 2012, Final Report http://ownershipcomm.org/ﬁles/ownership_commission_2012.pdf

Written evidence from Burnley Savings and Loans This submission to the Parliamentary Commission on Banking Standards is made on behalf of David Fishwick, CEO of Burnley Savings and Loans.

Summary — Moves to create more competition in banking by hiving off chunks of the big banks to other smaller banks is laudable but it doesn’t go far enough. — More effective competition will not simply evolve within the present regulatory framework. The regime is so tightly enforced and the bar to entry set so high that, in Britain, only one brand new high street bank licence (Metro) has been granted in the last 100 years.65 — Budding mini-banks are effectively priced out of the market and the FSA’s present interpretation of European legislation means any new banks are likely to be as “corporate” as the others with proﬁts for the shareholders being the main driving force. — We need proper competition and innovation that gives customers genuine choice and a better deal— not more of the same. 65 From Metro publicity, at the time of their launch. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 897

— Now, while the big banks are being tamed, we should also be sowing the seeds for a new generation of banks—small, relatively easy to set up, community banks—potentially thousands of them. If successful, they could become the modest, safe, good value banks of the future, without excessive bonuses, without risk to the tax-payer and with customers’ savings guaranteed. — David has seen how small community banks in countries like the US and Germany are successful and even encouraged, which is in stark contrast to the situation in Britain. Yet Britain once had a vibrant and diverse banking landscape. If community banks with limited scope and risk were allowed and encouraged once again, we could have safer, simpler, better and more varied banking. — David Fishwick has first-hand experience of the difficulty of trying to set up such a bank. Nevertheless, his low-overhead venture has succeeded in giving 5% to savers, loans to those that could not get them from High Street banks and all its profits to charity. If he could inspire others to do something similar, we could have a small revolutionary change in banking that could bring genuine competition, choice and innovation to UK banking. — It would take a change of legislation and a significant change of heart by the regulators to help create that. If proposals for community banking were included in the Finance Bill, the future banking landscape could look a lot brighter than it does now and Britain could be a good deal richer in so many ways.

Evidence 1. David Fishwick isn’t a banker: he sells minibuses in Lancashire and he does it very well. A classic entrepreneur, he built his business from scratch and he’s now one of the biggest minibus suppliers in Europe. When in 2008 the banking crisis hit, it became clear to David that his hometown of Burnley was suffering badly from the credit crunch. Many of his customers could no longer get loans from the high street lenders and David realised that unless he stood in to help, his business would begin to suffer too. So he did something about it and lent the money himself. His firm continued to flourish and his customers’ businesses survived. 2. By 2010 the recession had deepened. The banks were still not lending and the whole area continued its decline. More businesses collapsed, properties remained empty; and unless someone stood in to help, things would not get better. So, he planned the next logical step: his own tiny, tiny bank based on a startlingly simple idea. He’d take deposits from those individuals who could spare the capital and give them a good return for doing so; he would then lend that money out to people and businesses that could make good use of it. The deliberately low overheads would ensure profit, which could be given away to good causes. The savings would be guaranteed by Mr Fishwick and be backed up by insurance. It was good old-fashioned banking that everyone gained from. No pressure to buy “products”, no credit scoring, no bonuses and no risk to the taxpayer. 3. David hired a firm of solicitors66 to apply for a banking licence based on this model but he was completely cold-shouldered by the FSA who refused to even meet him to discuss the proposition without seeing £10m from him first. He didn’t have £10 million to spare but he was determined to put money back into the local economy before it was too late. So David did it anyway. In 2011, he turned an empty flower shop into “Burnley Savings and Loans” (BSL) and worked outside the FSA’s regulations. It worked. People queued to put money into BSL and businesses were not only saved but they now flourish. And, after the first six months, BSL turned in enough profit to make five charities in his High Street very happy.67 4. The size of the Burnley operation is deliberately very small but scalable: at the moment only £100k is lent out every month and only £100k is taken in from savers. Savers receive 5% AER and the rate for borrowers varies, depending on risk. Although credit history is looked at in most cases, judgements are made individually by what is in effect a Bank Manager, not by a credit-scoring computer. Default rates are no worse than those of High Street banks. 5. As the FSA refused to discuss the idea of David getting a deposit taking (banking) licence, BSL presently operates a form of peer-to-peer lending scheme similar to companies like Zopa and Funding Circle. Unlike those models, however, BSL is not an Internet-based lender and it still seeks a full banking licence. 6. Although BSL (as it exists now) is unique in Britain, the spirit of small community-based banking that directly benefits the communities in which it is based is not new. Neither is the idea of simple straightforward banking. In the past a plethora of Savings Banks, Building Societies, Local Banks, and even a Municipal Bank, meant people had real choice and there was little chance of catastrophic failure. 7. Big is not better when it comes to banks. It’s dangerous, remote and inflexible. Other countries that did not allow big banks to swallow up almost all smaller institutions still have small, and intermediate size banks that are strictly controlled and limited and in many cases are set up specifically to benefit the communities that they are in. They are generally successful, safe and a force for good, not greed. It is perhaps no coincidence that some of these countries (eg US and Germany) were among the first to climb out of recession. 8. David has met people from several interesting and novel banking concepts while setting up his venture. In the UK he has met representatives from High Street banks, relatively new entrants like Handlesbanken from 66 JMW, Manchester. 67 After the fist 180 days of operation, BSL made just under £10,000 profit. Five gifts of £2,000 each were given to charity shops in Burnley’s main town centre. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 898 Parliamentary Commission on Banking Standards: Evidence

Sweden and in Scotland, the only remaining Savings Bank in Britain. In the US, a typical community banker in New Jersey showed David around his five branches. In Germany, he was introduced to the Sparkassen banks, and saw what is probably the smallest bank (with a banking licence) in Europe. These are all very different, but they all have several things in common: Bank managers, local control and benefit to the community in which they operate. Bangladesh’s Grameen Bank is another that David hopes to visit soon—a revolutionary model of micro banking that has had an astonishingly positive effect on society, not only in Bangladesh, but also in countries through the world—including the USA. 8.1. In the United States, 7,000 Community banks constitute 98% of all banks, including commercial banks, thrifts, stock and mutual savings institutions, with more than 50,000 locations throughout the United States. Assets may range from less than $10 million to over $10 billion. Community banks are the primary source of lending for small businesses and farms, funding nearly 60% of all small business lending under $1 million.68 David visited Bob O’Donnell, Chairman & Chief Exec of New Jersey Community Bank. He started the bank in 2008 and he said he “put the keys in the door of the bank the moment Wall Street collapsed.” Even in those difficult times, it’s been a success. The 5-year business plan for NJCB predicted that they would make money in their 36th month; they actually turned a profit in their 15th. He has turned down more loans than he has accepted, but he says this is the only way you can be sure you will make a profit and not fail. “What is the point of putting someone in more debt when they can’t afford to pay you in the first place? You are creating more problems for them if you give them a loan.” 8.2. In Germany earlier this year, David visited the Sparkassen in the town of Hann in North Rhine- Westphalia; one of over 420 Sparkassen (savings banks) in Germany. These public-owned citizens’ institutions boast a business philosophy orientated toward the common good.69 It’s the largest non- government financial supporter of culture and sports in Germany, and ranks amongst the most prominent sponsors of social projects as well as initiatives in science, research and education. It’s hugely successful too—with over 50 million customers in 15,441 different branch offices and during 2011 the Savings Banks accounted for more than 42% of all loans to enterprises and the self- employed and 42% of deposits.70 Perhaps the localised nature of the lending and the personalised nature of the decision-making processes in these banks is a key reason in Germany’s economic resilience, founded on local family-owned enterprises? Also in 2011, these Savings Banks made a total contribution of€504 million to charitable causes, art and culture, social projects, sports, education and the environment. In Bavaria, David visited Peter Broad in what is probably the smallest bank with a banking licence in Europe. The Raiffeisenbank Gammesfeld is still successfully and happily serving its village—as it has done since it was founded in 1890. 8.3. In Scotand, he saw the first and last savings bank in Britain. The first71 is now a museum but it was here that the idea of socially responsible banking was born. The last and the only Savings bank to avoid being swallowed up by the TSB is still alive and well serving 60,000 customers in Airdrie and the small towns nearby. Founded in 1835 in part of a hat shop, there are no shareholders but a board of trustees. It too is successful but modest. It opened its eight branch last year in Falkirk—the first outside Lanarkshire. 9. Small banks are popular. The struggle to create Burnley Savings and Loans as a small but effective alternative to the big High Street banks was documented by Channel 4’s “Bank of Dave” series earlier this year. The response to the series was overwhelming and the company already has a two-year waiting list to put money in and a waiting list for loans. Clearly there could be more “banks” like Dave’s providing they were safe and beneficial. Even the FSA had to admit that the venture was “commendable”.

Proposals 10. Many things need to change: 10.1. The present regulatory culture needs to change from one of prevention to one of encouragement, with appropriate safeguards. 10.2. We need more competition in banking. Moves to create that by hiving off chunks of the big banks to other smaller banks is a good idea but it doesn’t go far enough, and can hurt the global reach of major banks. There is still no real competition for ideas, and different banking models that can drive change. There is simply insufﬁcient stratiﬁcation and diversity in the banking market. Real competition will simply not evolve in the present regulatory climate: the regulatory approach has to change and become more open-minded (and principles- and proportionality-based). 10.3. The capitalisation requirements should be much closer to those actually required by the EU. At present, the EU require€5 million (£4 million) to be set aside. The FSA in practice ask for £10 million “just to be safe”, because their view is that something which is only £4 million in size does not have enough capital to be able to support infrastructure suitable to a full blown bank. In order to operate at all, the level of critical mass required to operate as a bank at £4m implies in fact 68 Source: www.icba.org and FDIC 2011. 69 Finanzgruppe Deutscher Sparkassen- und Giroverband Financial data, Dec 2012. 70 Together with the Landesbank Groups (regional grouping of Sparkassen). 71 Rothwell Parish Bank, Rothwell, Dumfries and Galloway. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 899

investment of £10 million. In practice, it is possible—as has been demonstrated by “Bank of Dave” and similar peer-to-peer type projects—to navigate around the need for a “banking licence” (a Part IV permission under FSMA 2000), taking the smaller operations outside the ambit of FSA control, and thus, bizarrely, into unregulated territory. This capital requirement is therefore yet another restriction that effectively prevents novel alternative small banks from forming. 10.4. The authorisation process should be more encouraging. At present, it takes too long, costs too much and it requires would-be banks to make huge investments in staff and IT before they have any idea if they are likely to be allowed to open. 10.5. The regulators (and the regulations) should be more open-minded to innovative models of banking. It is unlikely that if any of the hugely positive models above (See “evidence”) would be approved if they applied for a licence now. What would be approved is more of the same sort of banks that got us in trouble in the first place. 10.6. We need to create a new class/type of bank: Smaller, with capital requirements that are proportionate to the size of the operation. These community banks could remain small or be starter banks for full- scale banks. They could be quite novel, providing real alternative ideas and competition. David has very low overheads, for example, which enables him to be very competitive. They may fail; if they do, they would not be bailed out. Only the savers’ money need be safeguarded and not necessarily by government guarantee—again, David has his own guarantee, backed up by insurance. 10.7. The Bank’s “consumers” need to become “customers” again. Bank customers don’t consume anything and they should not be (mis-)sold “products”. Banking is actually quite simple. 11. The response to the banking crisis in Britain has so far been focused in one direction: making sure that the circumstances that brought about the crash of 2008 cannot happen again. This is perfectly understandable but all the re-arranging of the deckchairs will make no difference in the long-term unless we realise the fundamental problems that have crept into banking in Britain. Banking can be moral and banks can create wealth. That wealth should, however, be in the hands of the people who put the money in the bank, the people that run businesses, people that live in the communities where the bank exists. The wealth should not just be trousered by the banks and the bankers themselves. It’s surely immoral. 12. We need to sow the seeds for the future. There are great entrepreneurs, local councils, charities and others out there that could provide banking in a small, low-overhead way. Not Credit Unions, not Building Societies, but small versions of the real thing: Community Banks. These could deliver real competition and, if they then meet the requirements, grow up into fully-fledged banks with real benefits—not only to their customers, but also to the community that they serve and by providing a real alternative to the banking landscape as a whole. 31 October 2012

Written evidence from Timothy Bush Introduction 1. I gave oral and written evidence to the House of Lords Economic Affairs Committee (EAC) for its inquiry of 2010–11 into “Auditors Market Concentration and their role” and felt that the conclusions and the analysis of the final report gave appropriate weight to that evidence. The EAC report conclusions expressed considerable concern about accounting standards in banks (IFRS) and that was carried forwards in Grand Committee. Unfortunately nothing much seems to have progressed despite that pressure from the EAC. That is odd, as both Houses of Parliament have been consistently astute when looking into this area (paras 44, 55, 56 and 57). 2. Rather than repeating my evidence to the EAC, which set out fundamental defects in International Accounting Standards (“IFRS”) and UK GAAP copies of IFRS as applied in the accounts of UK banks, I elaborate more on the conflicts of interest that gave rise to faulty accounting standards in the first place. I also cover the root causes of a lack of proper analysis and action to resolve the ongoing problem due to further conflicts, several years now after the events that first caused banks to collapse in 2007/8 (para 18). The standards required to be set under the law are in fact contrary to UK and EU law (paras 47 and 63). 3. The Walker Review (2009) in particular concluded—wrongly—that the banking crisis was essentially a liquidity crisis. It was not, it was a capital crisis. A lack of liquidity is just the symptom. The Bank of England now accepts that, though it too had given evidence to the Treasury Select Committee (TSC), regarding Northern Rock, that problems were liquidity rather than capital (latent losses).72 The distinction is critical both reputationally, and financially for particular parties, especially the auditors, and their regulator (para 10). 4. The consistent feature of capital crises that firstly manifest as liquidity problems (eg City of Glasgow Bank 1878, Johnson Matthey Bank 1984) is banks’ accounts overstating asset values above their recoverable amount, thus masking that they are profoundly insolvent, incapable of being going concerns, and without the prospect of normal additional shareholder funding from rights issues (shareholders would just be throwing good money after bad). Credit markets then correctly surmise the real condition and withdraw funding. 72 Further details provided in Appendix 1 (not printed). cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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5. Accounting standards systemically overstated capital, and still do (para 23 and 24), and the Basle regime did not and does not adjust for it correctly (para 36). As of August 2012, particular banks (especially RBS) are trading at such a large discount to net asset value (shareholders’ funds per the accounts) that the only logical conclusion is that they are overstating their assets and the market knows this. 6. The fact that banks’ accounts are still following faulty accounting standards in my view makes any normal market capital raising (via a public prospectus) very difficult to envisage (para 27). It has been somewhat overlooked that as well as being an ineffective prudential regulator, the FSA was also the listing authority (handling prospectuses for new capital) at the time that banks raised new capital only to fail shortly afterwards (para 29). Both the prudential regime and the prospectus regime depended on reliable accounting numbers. As does governance. There are significant issues regarding pay—indeed tenure of executives and business models too—wherever there are any false profits. 7. The Financial Reporting Council (FRC) has made errors contrary to the structure of the law (para 47). The FRC has been overly reliant on people with a vested interest in not promoting the scope of the law (the solvency aspect of the true and fair view requirement) for auditor-defensive reasons (paras 8 & 49)). The FRC then had an ineffective policing model, itself defensive, rather than seeking the outcome required by the law (creditor and shareholder protection).

TheAccountingProfession and LitigationRisk 8. The crux of the matter is that IFRS masks insolvency, and corporate insolvency is an auditor liability issue. The accounting profession (and their lead regulator, the FRC) has a particular problem in admitting faults with accounts of banks due to the application of defective IFRS. 9. Firstly, elements of the profession created IFRS in the first place, and the FRC depended on these elements for advice in assessing whether the recondite standards were fit for purpose. 10. Secondly, capital shortfalls masked by the accounts can be matters for litigation against auditors, as in the case of Johnson Matthey Bank. In that case the Bank of England was then plaintiff against the auditors having extended lender of last resort funding to that bank. 11. Thirdly, the regulator (the FRC’s Financial Reporting Review Panel—“FRRP”) appears not to have paid much attention to the accounts of banks despite the radical changeover to IFRS in 2005, whose implementation cost >£200 million for some banks. A large part of the cost of IFRS implementation arose because the banks had to appoint accountants (auditors, other than their own auditors) for implementation advice. 12. Further to bank collapses the FSA then commissioned accounting firms to look at the collapses of HBOS and RBS. That approach was almost bound to come up with insipid analysis and toothless outcomes if the core problem was systemically related to the accounts (or the internal books) of banks and could thus rebound on them as auditors in other banks. For breach of fiduciary duties (insolvency) auditors and directors have joint and several liability. 13. It is interesting that the FSA seems to have made no attempt to pursue directors of failed banks for breach of fiduciary duties. Indeed the FSA’s entire regulatory approach seems to have been designed to deal with matters de-linked entirely from fiduciary duties, which is broadly the maintenance of capital for the benefit of creditors and the shareholders as suppliers of capital. That is because the FSA’s entire regulatory approach was unfortunately based on another “risk” model instead, and that model also came from elements of the US accounting profession (para 41). 14. Proper accounts are fundamental to so many things that can be usually taken for granted, that a failure at accounting standard setting level, can create system-wide failure, and thence embarrassment (and litigation risk) for other parties. Proper accounts are essential for normal corporate governance and market conduct, including:- — Companies disclosing capital and reserves properly, crucial to being a going concern. Essentially, unsecured creditors need comfort that it is true share capital and reserves that is funding the company in addition to them. — Companies not making unlawful dividends, ie the accounts disclose that profits are realised or not and that reserves are distributable or undistributable. — Prospectuses, for raising new capital in the event that a reported loss requires more capital. — Making an acquisition of another company, without the acquiree pulling the acquiror down due to faulty accounts hiding losses, as Atlantic Computers did to Ferranti plc (1993), and HBOS did to Lloyds TSB (2008/9). 15. Particular banks’ accounts; HBOS, RBS, Alliance & Leicester, Northern Rock and Bradford & Bingley fail those objectives, as did Cattles plc, a non-bank doorstep lender since 1927. What is remarkable about the losses that were in the portfolios of these companies is that these levels of losses arose despite the emergency dropping of interest rates to 0.5%. On the basis of pre-2008 interest rates the inherent losses would have been even larger. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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16. As Lord Forsyth identified at the EAC,73 there are significant vested interests in playing down the role of systemically faulty accounting standards in banking collapses. This table shows some of the issues. Party Issues arising with an insolvency rather than liquidity problem in a bank Auditors 1. Accounts masking insolvency create auditor litigation risk. 2. Auditors promoted one model of IFRS globally. 3. Some firms were particularly keen on the IASB model, and led endorsement in the UK and EU. The Bank Is not permitted to lend as lender of last resort to an insolvent bank. If it does and it is left bearing losses then it may need to sue the auditors (Johnson Matthey). The FRRP (FRC) Reviews accounts for compliance with the law. It did not look at banks from 2005–2007 (the genesis of the crisis). FSA—as prudential regulator Uses audited accounts for the Basle Regime. The FSA decided to let IFRS “bed in for 2 years” before reviewing the full consequences of the switchover in 2005. FSA—as the listing authority Accounts are central to prospectuses. The FSA is also the owner of the listing regime, which also failed for bank capital raisings. EU Commission Common accounting standards were a central plank of “The Single Market” project. The EU Commission adopted standards contrary to the true and fair view of EU (and UK law). BIS/FRC BIS officials supported IFRS on the advice of the FRC for use in the EU.

Delays inFixing IFRS (aConcern of the EAC)That is now aMatter ofUrgency 17. IFRS has been described as “pro-cyclical”. In my view that is an inaccurate and dangerous euphemism. IFRS masks the destruction of capital and in banks this makes its replenishment, other than by taxpayer funding, impossible. Capital destruction is not cyclical, because without the regeneration of capital (in the form of true profits) the cycle never gets back to where it started. The private sector (losses in banks, or the perception of them) harms the public sector directly (support for banks). Distorted capital ratios also results in banks not lending according to a normal profit/growth model for a share capital funded company. Again, RBS demonstrates this dysfunction (see also para 70). 18. As the EAC rightly concluded, there are problems in getting the problems with IFRS fixed.74 Almost two years after the EAC enquiry started, IFRS has not been fixed. 19. Poor accounting is like any addiction, it is easier to fall into than it is to get out if it. The core faults in assessing IFRS for adoption for banks lies with a tight circle of interconnected people in the International Accounting Standards Board (“IASB”), the FRC, the FSA and EU Commission, many of whom are still in place. The IASB is not fit for purpose. The US standard setter FASB and the IASB have now failed to come up with a joint standard on provisioning three years after being tasked by the G20 to do so. The US standard setter had in fact proposed a return to prudent general provisions (full expected loss). The IASB rejected that, and the FASB has, logically, pulled out of the IASB model which is merely a complicated extension of its existing flawed (incurred loss) model. 20. The UK is especially vulnerable due to its allowing IFRS for companies’ own accounts (as opposed to group accounts). With the majority of IASB members being from non-IFRS using countries (a “West Lothian problem”), and the majority of the EU having not opted for IFRS for companies own accounts, the UK has opted into something with competitive disadvantage with little ability to affect the outcome. France has outlawed IFRS for companies’ accounts, so has less difficulty.

The UK adoption route (IFRS in banking companies) causes the statutory capital maintenance regime to break down—it overstates assets and leaves out losses 21. The IFRS model of the IASB causes the Companies Act capital maintenance disclosure regime to fail in companies. It was Bank of Scotland as a company—with its faulty accounts—that caused HBOS Group to fail, Bank of Scotland was not a going concern. 22. That regime requires audited accounts to support demonstrating solvency (or the prima facie insolvency) of limited liability companies and for the audited accounts to support the lawful distribution of proﬁts (realised 73 EAC “Auditors Market Concentration and their Role” Evidence session, Q87, 26 October 2010. 74 EAC, “Auditors Market Concentration and their Role”—Conclusions, para 132. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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profits, and including unrealised prospective losses). Both of these things require a “true and fair view” which in law means accounts prepared using prudence (including no unrealised profits) and accruals (matching costs to revenues irrespective of the timing of payment or settlement). 23. As the EAC inquiry correctly identified. IFRS frustrates both of these objectives because IFRS: — books unrealised gains (mark-up-to-an-up-market), and even unrealisable gains (mark-to-up-a- model based on something else going up); and — leaves out “losses no matter how likely” from bad debt provisions. It can therefore state loans above the ultimate recoverable amount, with no assurance on what the right amount is. That constitutes a material uncertainty. It is worse the higher risk the lending. 24. Both the EAC and the TSC identified that auditors had signed off banks as being going concerns, when in they were in fact about to fall over. IFRS masks material uncertainty. However it has also emerged that IFRS:- — leaves out bonuses from the accounts if the cash payment is deferred for 18 months. This is especially material with investment banks. Remarkably, the amount is not even charged a year later when the payment is then only 6 months away. The amount remains uncharged until paid. That contravenes the most basic principle of accruals (matching costs irrespective of timing of settlement). It is another manifestation of a backward looking approach adopted by the IASB; and — leaves out costs of de-risking and de-gearing in connection with open financial positions, however likely the loss. Again IFRS does not book likely losses connected with risk. It books the cost once there is contractual close out. That is not only opaque, it creates an incentive not to close out loss making positions.75 25. Since the EAC’s final report, the Sharman Report76 has been produced on the subject of going concern and banks. The subtext of the final report is that IFRS has a faulty definition of going concern, and IFRS accounts cannot be used by directors to assess whether a company is a going concern as it is imprudent. Given that means that directors cannot use IFRS to understand their own companies’ true financial position, it is hardly surprising that creditors and shareholders cannot either. 26. As the Sharman Review was led by the FRC, it may have been difficult to overtly challenge the misguided strategy of the FRC to have committed unreservedly to IFRS without any “Plan B”. My own experiences within the FRC is one of inconsistent public and private views on the subject of IFRS.

The FSA, IFRS and theFailure of theProspectusRegime 27. A very serious conflict of interest that has not received the attention it deserves, is the difficulty that was posed by the FSA as prudential regulator also being the listing authority. The FSA took the UKLA from the demutualised London Stock Exchange and was hence responsible too for prospectuses for capital raising. 28. There has therefore been a direct conflict between the FSA wanting a bank to raise capital and the Listing Authority requiring high standards to protect subscribers in a capital raising. 29. I note that the FSA reports into RBS and HBOS (commissioned from accounting firms that had also audited failed banks) fail to refer to the fact that “clean” 31 December 2007 accounts were also used for clean prospectuses in 2008. Bradford & Bingley was nationalised within six weeks of raising new capital (underwritten by institutional investors). HBOS and RBS were not much better. Both companies had produced accounts that declared dividends on a going concern basis. That condition, absent unforeseen circumstances, should have been robust for 1 year from when the accounts were signed (the UK auditing standard). 30. HBOS cancelled its dividend before the 2008 AGM. That was a red-flag that there was a latent foreseeable problem within its books. Accounts in law are for tabling at the AGM, a governance function, but HBOS loan losses have now been more than twice what it appeared to have had as shareholder’s funds in its 2007 audited accounts. Such losses are unprecedented in modern times. The losses have been disastrous for shareholders of HBOS and Lloyds-TSB. 31. Despite the move of prudential regulation to the Bank, the recent appointment of the former Chairman of KPMG (the firm which audited HBOS and Bradford & Bingley) to the Financial Conduct Authority, which will contain the UKLA, may create challenges for a full review of the abject failure of the FSA prospectus regime. Accountants can carry liability exposure for some years after retirement as partners.

IFRS and the Basle Regime 32. The Basle Regime (capital adequacy) was conceptually predicated on the accounts of a bank representing the going concern position of a bank properly. Basle then requires additional non-shareholder capital and subordinated debt to absorb losses in the event the bank is a “gone concern”. A bank is a “gone concern” when share capital and reserves are wiped out by falls in asset values (the recoverable amount of loans). 75 Comments by Stephen Hester in February 2012. See Appendix 2. 76 The Sharman Report—Going Concern. FRC—2012. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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33. The Basle Regime is a product of the Bank of International Settlements, “the banks’ bank”. It is essentially a system to secure the interbank market on a going concern basis, and failing that on a gone concern basis. The objective is to help ensure “risk free” interbank lending. 34. Given that the policy objective that Basle is aiming for is risk free interbank lending, it is particularly ironic that from 2007 to late 2008, increased LIBOR spreads (a classic symptom of doubts about capital adequacy) were read as a liquidity problem rather than a symptom of the failure of the statutory capital maintenance regime of company law systems that the Basle Regime depended on. 35. The attached paper from PWC in 2004, “Joining the Dots”,77 sets out how the IASB in 2003–4 had, somewhat surreptitiously, moved from an expected loss model to a new model that could result in a bank having losses that are neither covered by provisions for bad debts or capital. In other words, the standards could mask insolvency. The paper did not point out that the true and fair view standard of the law was required for accounts to give a clear picture of company solvency (paras 49,52, 56). 36. The PWC paper is correct that IFRS can make an insolvent bank appear solvent. The rest of the paper is fatally incorrect in stating that the Basle regime had been adjusted to fix it. The adjustments made to correct for IFRS firstly were only partly (50%) against shareholder funds. The other part of the adjustment (50%), was to “Tier 2 capital”, an illogicality as that type of “capital” is only invoked once a bank has already collapsed. To correct any imprudence in an accounting standard 100% of any deduction should be against shareholders’ funds, as it is that which determines whether a bank is capable of being a going concern. The FSA team responsible for Basle policy was also responsible for IFRS. 37. More seriously than that, instead of taking all inherent loan losses into account, the Basle II adjustment PWC refers to only looked for losses on existing loans arising within one year, the same model that the IASB is still proposing for its proposed standard for bad debt provisioning. A rational shareholder (and unsecured creditor) would consider all losses relevant irrespective of timing. 38. A loan is merely a term contract. A bank is a collection of contracts receivable and contracts payable. All future losses are relevant in coming up with a number to reflect what an asset will recover. A loan contract that will fail in year 12 of a 25 year, is like any other loss on that a contract, but with IFRS and Basle such losses are not taken account of. The loss profile of RBS loans as shown in the accounts of the Asset Protection Scheme indicates that losses on RBS’s bad lending are material for at least years 0 to year 5 of loan life. (*Note: Given that the IASB had an expected loss model in 2003, it is somewhat odd that it has not been able to reconstitute it, 3 years after being asked to by the G20).

Solvency II for insurance companies—”enterprise risk management”—a faulty going concern model similar to IFRS 39. The faulty going concern description within IFRS is about management’s internal perception of the risk of it not being able to raise new capital. The Sharman Review wisely recommends changing it. The IFRS model of going concern is different to the Company Law concept of going concern, which is about telling the facts to the members prudently so that markets know that a company is a solvent going concern and are thus likely to support it or not if it needs help. The first test of going concern is the generation of true profits. 40. Worryingly, the same flawed going concern definition also appears in Solvency II (the pending EU- Commission led regime for insurance companies). The same flaw arises in elements of the Basle regime, in Basle II’s “internal ratings approach” too. The reason for the same flaw cropping up is not a random coincidence. 41. IFRS, Basle and Solvency II draw on the “Enterprise Risk Management” approach of the “COSO” (Committee of the Sponsoring Organisations of the Treadway Commission) model from the USA. It is sponsored by the US accounting profession. It is conceptually flawed. 42. Rather than starting with the fact that limited liability status of any company is a risk to the creditors and an opportunity for the shareholders to leave losses with creditors, the COSO approach itself is a risk to shareholders and creditors. COSO has the company itself trying to second guess the market, in the absence of it giving the actual market reliable audited numbers. From that model also flowed the “mark to model” approach in IFRS itself. The now discredited Value at Risk approach, also flows from such a model. COSO essentially accommodates risk models that management like to use, rather than a critical shareholder capital model that they ought to have. COSO is the antithesis of what is needed for a free and transparent capital market. The COSO model downplays “accounts” and “books”, things that are in law auditor matters, and instead creates woolly abstractions, such as “internal control” and “financial reporting” instead. 43. A speech of Callum McCarthy, then FSA Chairman, of 13 February 2006,78 reveals that exactly the same risk model was used by the FSA to manage itself. Rather than addressing risk, the COSO model is more like a vehicle for consultancy. It is analogous to students setting, and then marking their own exam papers. 77 Appendix 3A 78 Speech of FSA Chairman http://www.fsa.gov.uk/library/communication/speeches/2006/0213_cm.shtml cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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The regime for setting accounting standards broke down, contrary to law 44. Particularly noteworthy for a Parliamentary Commission is to consider how the consistently wise counsel of the Treasury Select Committee (2001–2010)—which had looked at accounting standards post-Enron and also on the matter of Equitable Life—was positively ignored by the accounting standard setters. In particular the TSC (and evidence from the Bank of England) saw the centrality of the “true and fair view” objective as the safeguard in case of faulty accounting standards (as had occurred in the case of Enron). The ICAEW also warned against mark to model in its evidence to the TSC.79 45. However, the EU Commission then endorsed IFRS that failed to give a true and fair view and the Accounting Standards Board copied the errors (FRS 26). But, the EU Commission’s locus—like the ASB’s— was to adopt accounting standards under the law.80 That law is the true and fair view. Parliament created it in 1947, and the EU reinforced it in 1978 and 1983 as the EU wide model (the 4th and 7th Accounting Directives). As with Greek entry into the euro-zone, expediency tended to trump what was correct. 46. Post crisis, the FRC is prone to citing legal opinion (Martin Moore QC,81 citing earlier Hoffman/Arden advice) that following accounting standards will normally ensure that accounts give a true and fair view. However, the FRC is reciting only part of the story. The QC opinion is, naturally, presumptive that the accounting standard setters are correctly setting standards under the law.82 47. The FRC seems to have wrongly assumed that the QC opinion is saying that true and fair view is the result of following anything that is in accounting standards irrespective of what the standard setters chose to put in, ie sanctioning “garbage in garbage out”. It is in fact the other way round, the QC opinion is in fact setting out how standards should be set to be consistent with the true and fair view requirement of the law which is the primary requirement of the EU Accounting Directives and UK Company Law. 48. The requirement for accounting standard setters to comply with the law is also contained in — the Foreword to ASB Accounting Standards. The ASB must set standards consistent with UK law, and the EU Directives, which includes the true and fair view principle of the Accounting Directives; and — the IAS Regulation 2002 of the EU Parliament and Council. The Regulation states that the Commission can only endorse IFRS that are not contrary to the true and fair view principle of the Accounting Directives. 49. True and fair view is correctly (consistent with UK law) interpreted in two European Court Justice case as: — the functional standard required of accounts to disclose proper proﬁt to then deliver lawful dividends;83 and — the requisite accounting requirement not to overstate net assets (shareholder capital and distributable and non-distributable reserves).84 50. The FRC made the same error in 2004–5 (that true and fair view is only the product of following accounting standards) when adopting IFRS by statutory instrument, and Alun Michael MP as Minister intervened to put in what is now section 393 of the Companies Act. Section 393 speciﬁes the overall true and fair view requirement, notwithstanding the use of IFRS. The Minister saw through the FRC’s then position on the basis of alternative legal advice.

Statements made by the former IASB Chairman (Sir David Tweedie) following press articles 51. Following various letters and articles in the Financial Times, including an article by Lord Lawson, Sir David Tweedie, chairman of the International Accounting Standards Board 2001–2011 (and the UK standard setter prior to that) wrote a letter to the Financial Times.85 In that letter he states that the distributablity of profits was not a matter for accounting standard setters to be concerned with. When one looks at the law (whether UK or EU case law, ICAEW legal advice (para 52) or merely the statute itself). That letter requires as good deal of explaining. 52. Attached is the ICAEW (Institute of Chartered Accountants in England and Wales) technical advice on the 1985 Companies Act under Counsel Opinion86 for the period Sir David was setting firstly UK and then International Standards. it is clear from that advice that: — Accounting standard setters should be concerned with distributable profits (para 1 of the appendix). 79 ICAEW Evidence to Treasury Select Committee, 10 April 2002. http://www.publications.parliament.uk/pa/cm200102/cmselect/ cmtreasy/758/2041005.htm 80 See IAS Regulation 2002, setting out the true and fair view Principle, ICAEW TECH 1982. 81 Opinion on True and Fair View and the structure of the law, Martin Moore QC for the FRC 2008 82 Appendix 3D 83 ECJ Case C-234/94,1996 “Tomberger”. 84 ECJ case C-275–97, 1999, “DE + ES Bauunternehmung”. 85 Appendix 3B 86 Appendix 3C cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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— Demonstrating whether profits are distributable requires the fundamental concepts of prudence and accruals (para 4–7). — Distributable profits are needed for accounts to give a true and fair view (para 15). 53. The ICAEW has been unable to come up with equivalent advice on IFRS under the 2006 Companies Act. My supposition is that Counsel will not sign off on a revision to the above 1985 Act advice, because IFRS positively conflicts with the capital maintenance provisions of the Companies Act. That is because IFRS have been adopted that are contrary to the true and fair view principle of the law needed for the Companies Act to function. 54. I note that Sir David Tweedie did not give evidence to the EAC in 2010.

The 1947 Companies Act—the function of a balance sheet and the true and fair view 55. To complete this evidence, I enclose extracts from the 1945 Cohen Report87 (Lord Cohen) to The Secretary of State (Hugh Dalton MP) on Company Law Reform which states the function of a balance sheet, and recommends true and fair view as the legal standard for company accounts. That then became the 1947 Companies (Amendment) Act. “Function of balance sheet.—As stated in the evidence of the Institute of Chartered Accountants, ‘the function of a balance sheet may be stated briefly to be an endeavour to show the share capital, reserves (distinguishing those which are available for distribution as dividends from those not regarded as so available) and liabilities of a company at the date as at which it is prepared, and the manner in which the total moneys representing them are distributed over the several types of assets.” 56. Para 105 then recommends true and fair view as the standard that then went into the 1947 Act. “Section I24(i) [Companies Act 1929] be amended so as to provide that the balance sheet shall give a true and fair view of the state of affairs of the company; that for this purpose it shall classify under headings appropriate to the business of the company the share capital, reserves, provisions, liabilities and asset of the company, shall distinguish between the amounts respectively of the fixed and of the current assets and shall state how the amounts at which the fixed assets are stated have been arrived at.” 57. The Cohen Report in defining the function of accounts for which the true and fair view standard is for, explicitly rejected the model that the IASB has in fact followed (valuing, and especially overvaluing things). What the Cohen report described as unwise is precisely what can cause a bank that overvaluing its assets to collapse, due to it not being a going concern. “Moreover, if a balance sheet were to attempt to show the net worth of the undertaking, the fixed assets would require to be re-valued at frequent intervals and the information thus given would be deceptive since the value of such assets while the company is a going concern will in most cases have no relation to their value if the undertaking falls”.

The governance of the FRC from 2002 ceased to involve the Bank of England 58. It is interesting to note that when the FRC was established in the early 1990s the Chairman was a joint appointment of the Governor of the Bank of England and the Secretary of State for Trade and Industry (responsible for Company Law and thus all company accounts including banking companies). Rather than merely being a “great and good” figurehead for the organisation the appointment was someone who was also accomplished in the subject matter. The first Chairman was Sir Ron Dearing, the second Sir Sydney Lipworth. 59. In 2002 that arrangement was changed. Since 2002 the Bank of England ceased to appoint the Chair of the Financial Reporting Council. On the retirement of Sir Sydney Lipworth in 2002, the FRC has had DTI (now BIS) appointed Chairs with less obvious expertise in banking or accountancy. Given the intense vested interests at play, that was not wise in my view. The Bank as well as being a contingent creditor of banks also had the sharp eye of a potential plaintiff. 60. The problem of the FRC setting and approving faulty accounting standards was then compounded by the FRC ceasing to appoint QC’s as chairs of the Financial Reporting Review Panel, which has a statutory role in assessing accounts for compliance with the law. The FRRP Chairman had been Sir Richard Sykes QC (Erskine Chambers, the leading Chambers in true and fair view and capital maintenance, the same chambers as Martin Moore QC). 61. Following the retirement of Sir Richard Sykes QC as FRRP chairman, the FRRP was no longer chaired by a QC with expertise in accountancy law. The FRRP is now set on a course of assessing accounts for compliance with standards. That was peculiar as Sir Richard Sykes’ tenure had found instances where compliance with ASB standards was the cause of the problem with the accounts (Liberty International plc). Essentially Sir Richard Sykes was not only finding faults with companies’ accounts, but also with the outputs of the ASB. The Liberty case involved FRS 10, an ASB copy of the then international standard. 87 See Cohen Report to the SoS 1945, then enacted as the 1947 Companies Act Sections 147–149. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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62. Given that banks’ accounts, in following IFRS, may not give a true and fair view, such a compliance led approach has in my view been a strategic error by the FRC. 63. I attach to this evidence a letter from the Accounting Standards Board Chairman in 2005, which is unequivocal that IFRS does not match with company law (Appendix 3E, para 10 and 11). A later meeting in February confirms this (Appendix 3F, page 3). The accounting framework has diverged from the law. Unfortunately what the Chairman does not flag in either the meeting or the letter is that the matter is not trifling, the problem could mask the insolvency of a banking company. 64. Given that “following standards” (rather than delivering according to the spirit of the law) is an auditor defence. I can only conclude that whether by accident or design, that as soon as the Bank of England ceased having a role in FRC governance, the FRC then followed a compliance-with-standards model, that may have suited the defence model of particular accounting firms. That model proves fatal if, as has occurred, the standards themselves become faulty. That is a recipe for a “garbage in garbage out” model of reporting and auditing that upsets normal governance, oversight and investment processes.

Conclusions 65. My ultimate conclusion is that banks will not be stabilised until IFRS fully complies with the existing law which was eminently sensible and had worked. It had in fact been a global standard, other than in the USA, prior to the introduction of IFRS in 2005. The true and fair view model not only applied in the EU, but numerous current and former UK territories. 66. In the meantime section 395(1)(b) Companies Act 2006, which gives the option to use IFRS for companies, including for banking companies, should be repealed. A Bill enabling this (the Bill of Steve Baker MP88) was tabled in the 2010–11 session. 67. The UK has the highest % of assets to GDP faultily accounted for than any other nation (due to the size of the banking sector, and the total dependence on IFRS). The problem is too large for those parties that have made mistakes to own up to. Consideration should be given to a moratorium for liability for auditors of banks which used IFRS as the accounting framework. The complexity of negligence and potential negligence, of auditors and standard setters, does not create the right environment to move forwards. 68. Parliament should approach Martin Moore QC directly in order to talk through his opinion independently of any spin that the FRC (or BIS officials) might have chosen to put on it. 69. Standard setters and relevant regulators should be held to account. Clear breaches of law were knowingly made over an extended period of time, thence causing other parties (directors and auditors) to fail to discharge their statutory duties. There is no more fundamental a statutory duty than demonstrating solvency. The impact was not merely banks getting into difficulty (false accounting before the insolvency event) but the tax payer bailout funding not being value for money either (the problem with false accounting after the insolvency event). 70. There are significant problems in RBS and conflicts of interest that the accounting is inextricably linked with. The governments’ “B Shares” convert, wiping out the free float minority interest (shareholders other than the government), in the event that the Basle ratio falls below 5%. The Basle ratio is based on IFRS numbers. 71. Given that management have an interest in existing shares, and hence an interest in not being wiped out on conversion, there would appear to be a direct incentive to affect both the numerator and the denominator in the capital ratio. The capital ratio is:- IFRS based capital/risk weighted assets = capital ratio 72. There are therefore two basic ways of boosting the capital ratio:- — to overstate capital (overstate assets and understate losses in the accounts); and — not extend lending, ie preserve the Basle ratio by not growing the asset base. See also Appendix 2 for problems with RBS accounting per press articles. 73. The RBS IFRS accounting problems in particular seems to be prejudicial to the wider economy. There are structural reasons as to why Project Merlin is not working if there are accounting, and remuneration incentives not to lend. 74. IFRS is also incentivising RBS not to de-gear/close out existing risk positions where it knows it will make a loss on close-out (IFRS only requires booking that loss on actual close out, not on the expectation of a loss). The implications of that must be that the benefit to the capital ratio of de-risking (the reduction in the risk weighted assets, the denominator) would be more than offset by the losses that would be taken on closing out the risk positions (reducing the numerator). 75. A rational shareholder (as does UK GAAP) would recognise that there is an economic loss to the shareholders of RBS. The accounting is not booking losses, and hence the capital ratio is not reflecting them. 88 Financial Service Regulation of Derivatives Bill http://services.parliament.uk/bills/2010–11/ financialservicesregulationofderivatives.html cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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In my opinion, the problems with RBS are deserving of special Parliamentary attention, over and above the conclusions I have given in para’s 65–69 above. 21 August 2012

Written evidence from Cormac Butler Introduction 1. For 20 years I have acted as an advisor and consultant on risk management, and have trained over 100 Central Bank regulators around the world. I am a former consultant with Lombard Risk Systems London and have also worked with Peat Marwick and PriceWaterhouseCoopers. I graduated from the University of Limerick, Ireland with a degree in Finance and have published two books on ﬁnancial risk management (Financial Times) and accounting for ﬁnancial instruments (Wiley). I have just completed research with a Dublin professor examining the combined effectiveness of the new Basel rules with the International Financial Reporting Standards (IFRS) to be published in November 2012.

Executive Summary — The interaction of banking regulation and accounting rules coupled with short-term bonus incentives continues to permeate the banking sector causing many banks to operate in a dysfunctional manner. — If banks are permitted to conceal losses a situation could easily arise where bankers award themselves bonuses for entering into loss making transactions. I have shown a simplified example in Appendix One how this can happen. — I am concerned that in previous House of Lords enquiries, advice on the legality of hiding losses in this manner was potentially misleading. — Banks continue to use “off balance sheet” structures similar to the type used by Enron and Lehmans. Here too, I believe that House of Lords committees were misled on the use of these structures. — At least two accounting committees are at risk of misinterpreting a legal opinion by Mary Arden QC. They have concluded for instance that banks are permitted to conceal losses from shareholders and regulators if the International Accounting Standards Board (IASB) permits them to do so. Other legal opinions from the same author however make clear that a different conclusion should be reached. — Banks (even supposedly successful banks) find it difficult to raise capital and borrow money despite the extra demands faced upon them by the new Basel rules. This makes them too heavily dependent on Quantitative Easing policies and other initiatives by the UK government. Transferring credit risk from the private sector to the government in this way can only lead to more dysfunctional banking. — The issue isn’t so much that the accounting standards are flawed; banks have survived flawed regulation in the past. Instead the problem is that shareholders and regulators were not aware that banks were allowed to hide losses, particularly between 2005 and 2010 and as a result were unable to take corrective action soon enough. There is still worrying evidence today of investors being reassured that banks are forced to tell shareholders and regulators of all losses. — As with the accounting rules, the regulatory rules on Tier One and Tier Two capital, known as Basel 2 (and now Basel 3) have created a distortion in the way banks lend money. I have illustrated this in Appendix Two.

Responses to the Committee’s Questions — To what extent are professional standards in UK banking absent or defective? How does this compare to (a) other leading markets (b) other professions and (c) the historic experience of the UK and its place in global markets? — The banking sector has suffered from a type of ‘regulatory capture’ whereby bankers developed complex structured products that appeared to be profitable but were in fact loss making and very difficult to understand. Through these structured products banks were able to exploit the lack of resources available to regulators by concealing risks and hidden losses and awarding themselves bonuses for artificial profits. This indicates a lapse of professional standards. — In 2005 retail banking was affected by company law rule changes that potentially permitted banks to conceal losses on straightforward retail and corporate loans. As a result, destructive lending practices like the ‘125%’ mortgage emerged. Accountants should have seen this and warned shareholders to take action quickly. Their failure to do so is another potential lapse of professional standards. However, the EU rules that permitted this were applied differently in the UK and Ireland compared to the rest of Europe. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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— Internally bank risk management divisions suffered since banks were reluctant to measure hidden losses and leverage as this would have a negative impact on bonuses. This impeded the development of professional standards.

What have been the consequences of the above for (a) consumers, both retail and wholesale, and (b) the economy as a whole? 2. Appendix One illustrates the consequences of the lapse in professional standards. In essence, banks lent money without examining too thoroughly whether the borrower had the ability to pay. Banks were able to reward themselves with bonuses for reckless lending. In many cases these lending practices were potentially illegal. 3. Awarding bonuses to enter into loss making transactions will of course make a bank dysfunctional. Since banks are still finding it difficult to borrow money, over-reliance is placed on government support. In effect, the government are now more exposed to the credit risk of banks operating in the private sector. This could lead to huge problems and may partly explain why customers, both retail and corporate are having difficulty borrowing money. 4. For financial sectors and in particular banks to succeed they must be able to raise private capital. This task becomes impossible if the annual reports of banks are misleading.

What have been the consequences of any problems identified in question 1 for public trust and in, and expectations of, the banking sector? 5. Public trust has broken down significantly with shareholders continuing to steer away from banks. With no equity holders to absorb the credit risk, banks are over reliant on the government for funding and guarantees which introduces a new set of problems. What has emerged in the last five years is that the Basel rules have forced banks to raise more capital but because of weak corporate governance, there is the belief that banks are continuing to conceal losses making the raising of capital difficult. Therefore, in many cases, even banks that are not hiding losses are forced to raise more capital than is necessary.

What can and should be done to address any weaknesses identiﬁed? To what extent are such weaknesses subject to remedial corporate, regulatory or legislative action, domestically or internationally? 6. It would appear that the Urgent Issue Task Force (an accounting profession technical committee) misinterpreted a legal opinion when they approved standards that permitted banks to conceal losses. I believe that the committee should examine this area and remind auditors and bankers that concealing losses is contrary to the requirements of company law. In 1993 Mary Arden QC stated in a legal opinion that it would be extremely unlikely that banks would face litigation if they followed the accounting standards to the letter. This may have created some complacency within the accounting profession. However, Arden made it clear in an earlier opinion in 1983 that it is potentially illegal to change accounting standards unless shareholders know exactly the consequences of those changes and what to expect. In 2008 the architects behind the International Financial Reporting Standards issued an assurance to shareholders of banks that losses must be recognised immediately under the IFRS rules. However, auditors interpreted the accounting standards very differently, claiming that they are permitted to delay the recognition of losses on certain loans. It is relatively easy to clear up this confusion and there is also an urgent requirement to do so.

What caused any problems in banking standards identified in question 1? the culture of banking, including the incentivisation of risk-taking; 7. Under the current incentive system bankers are encouraged to gamble excessively. When they succeed their bonuses are inflated but when they fail they can walk away from losses. This encourages banks to leverage up their exposure and to conceal this leverage through off balance sheet activities and also to hide losses by exploiting company law loopholes following changes in 2005. 8. The banking sector appears unwilling to permit any reform that has an adverse effect on bonuses. There is, under the current system a strong correlation between the ability to hide losses and the size of bonuses. It appears that both bankers and auditors are anxious to keep the status quo. Evidence provided to previous House of Lords Committees suggests that it is technically very difficult to reform practices that encourage banks to reveal all losses. This is misleading. Prior to the rule changes in 2005 banks did reveal losses without too much complication. 9. In addition, previous House of Lords Committees were told that the requirement to reveal losses is the responsibility of the regulator and not the accountant. This too is misleading and should be challenged by the current inquiry. 10. Although a difficult problem to solve, the area of Institutional Investors v Private Investors should be examined more thoroughly. In essence, Institutional Investors have considerable voting power but do not normally use this to vote against the destructive practices of some banks. This may be because institutional investors are spared these losses, being able to pass them on to pensioners and savers who invest in funds. Private investors normally take the long-term view and would almost certainly have voted against initiatives cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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to hide losses if they were aware that they existed. Even though they, as a group, clearly have less voting power than institutional shareholders, they could, if they had known about hidden losses, have made an impact, given that it is potentially illegal to hide losses.

Conclusion 11. An artiﬁcial situation has developed in the banking world that remains uncorrected. Company law is designed not only to protect shareholders but also to make sure that shareholders run their bank in a manner that protects creditors. Accounting standards were developed so that shareholders could see how the bank was performing through a ‘true and fair’ set of accounts, which is often the only source of information that a shareholder has about the company. 12. The accounting profession, appear to have undermined this protection by concealing losses from shareholders and regulators. Evidence by the accounting profession to previous House of Lords Committees indicates that neither bankers nor accountants are over anxious to correct the situation. I have referenced below recently published newspaper articles to illustrate the problems of ignoring company law89 and the consequences to the accounting profession.90 A third article shows the impact of the Libor scandal on banking.91

APPENDIX ONE ILLUSTRATION OF HOW BANKERS AWARD THEMSELVES BONUSES FROM DESTRUCTIVE LENDING. On 1st January 2010 Bank X grants a ten year rolled up loan for £10,000,000 to a property developer. Interest is agreed at 10%. The developer agrees to pay 10,000,000 X (1+10%)^10 = £25,937,423 in ten years’ time (the interest is effectively rolled up). The bank does not look for collateral and the documentation is very weak. On December 31st 2010, it becomes clear that the property developer is in difficulty and there is only a 70% chance that the loan will be repaid. Under the Incurred Loss rules (currently used by the IFRS), the bank is required to record a profit (ie interest income of 10% =£1,000,000) but under the prudent rules, in use prior to 2005, the bank would be required to show a loss of approximately Euro 3,300,000. These types of transactions are clearly destructive and can easily lead to the destruction of a bank. Yet, because most bonuses are based on IFRS figures, the bank would more than likely pay a bonus to its directors for entering into such a transaction. This practice continues to exist despite the credit turmoil that the UK and Ireland have suffered.

APPENDIX TWO ILLUSTRATION OF THE DANGEROUS INTERACTION BETWEEN THE BASEL 2 RULES AND THE IFRS RULES. (Extracts from research by Flynn/Butler to be published in November 2012 Journal of Risk Management in Financial Institutions vol 6.1 published by Henry Stewart Publications) There are two aspects of bank risk, the first is uncertainty and the second is insolvency. A problem with the Basel regulations (designed to measure the risks of banks) is that they conflate uncertainty with insolvency. Both concepts have separate characteristics and must be regulated differently. The simple illustration below shows how Basel enhances leverage through its Risk Weighted Asset system. A bank with shareholders’ funds worth€10,000,000 is undecided between specialising in the Irish mortgage market or in corporate loans. Basel regulators believe that because mortgages are property backed, they contain less risk and therefore assigns a weighting of 10%. Corporate loans on the other hand are given a weighting of 50%. Regulators generally require that banks hold enough shareholders’ funds to cover 8% of its risk weighted assets. Working backwards, ie€10,000,000/(8%X10%) =€1,250,000,000, the bank can issue€1.25 billion worth of loans. When adjusted by the risk weighting 10%, this gives Risk Weighted Assets of €125,000,000 and 8% of this figure is€10,000,000. Had the bank instead specialised in corporate loans, the maximum amount of loans it could make would be €250,000,000. The risk weighted assets in this case would be€250,000,000 X 50% = 125,000,000 and when multiplied by the 8% requirement this comes to€10,000,000 which is the shareholders’ funds that the bank must hold. Most Irish bankers bonus or incentive schemes encouraged bankers to look carefully at the weightings that Basel applied to each category of loans and to specialise in those loans with a low weighting (in the above example Irish mortgages). This would almost certainly have increased incentive payments. However, as we 89 http://www.irishtimes.com/newspaper/finance/2012/0604/1224317205259.html 90 http://www.irishtimes.com/newspaper/finance/2012/0604/1224317204706.html 91 http://www.irishtimes.com/newspaper/finance/2012/0716/1224320204869.html cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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continue the illustration, what is a lot more important is the ‘yield’ or proﬁtability on the loan rather than the Basel weighting. Consider two banks A and B. Bank A concentrates on loans that have lenient regulatory requirements. Its loans are given a rating of AAA. Since the regulations are lenient, a number of other banks are competing for these types of loans and so the yields (the interest rate that customers are willing to pay) have fallen. Bank B specialises in loans that other banks avoid but which have more severe regulations applied because of their perceived riskiness Regulators force banks to hold more capital against risky loans compared to non- risky loans. Bank B therefore focuses on high yielding loans that other banks would not touch. The lack of competition allows Bank B to charge a relatively high rate of interest. The probability of default on these loans is higher and the recovery is lower. The details of each loan are shown below: Bank A Bank B 1 year ﬂoating rate 3% 3% 5 year swap rate 5% 5% Probability of default 7% 10% Recovery of collateral 80% 65% Shareholders’ funds in bank € 10,000,000 € 10,000,000 Yield on loan 4.80% 10.00% Risk Weighting 10% 50%

At a superficial level, Bank A is less risky than Bank B. Bank A specialises in loans where the probability of default is only 7% as against 10% for Bank B. The recovery from selling collateral is 80% for Bank A and only 65% for Bank B. Because A’s loans are ‘safer’ than Bank B’s, the regulators give a Bank A’s loans a low weighting of 10% (a low weighting allows the bank to lend in large quantities with minimal restrictions—in other words increase leverage) while Bank B’s loans, reflecting the supposedly higher risk, get a weighting of 50%. The reality however is quite different. Bank A is moving towards insolvency and is therefore a lot riskier than Bank B, even if the future cash flows of Bank B are more uncertain. The Basel rules have tended to penalise solvent loans where the yields are high (and therefore profit making) and encouraged insolvent loans where the yields are low. These low yield loans are loss making but the losses are hidden because of flawed IFRS. Because A’s loans are deemed ‘safer’ by the regulator than B’s, the regulators give Bank A’s loans a low risk weighting of 10% while Bank B’s loans, reflecting the supposedly higher risk, get a weighting of 50%. Under the Basel II rules the maximum amount that A can lend is approximately€1,250,000,000 while for B the maximum amount is€250,000,000. The five-fold restriction on B’s lending simply reflects the fact that B’s loans are given a weighting of 50% which is 5 times higher than that of A. The regulators require that banks effectively finance 8% of risk adjusted loans with shareholders’ funds. For Bank A the loans are€1,250,000,000 and the risk adjusted loans are 10% X€1,250,000,000 =€125,000,000. Banks must finance 8% of this figure with shareholders’ funds which is€10,000,000. Bank A Bank B Maximum loan size € 1,250,000,000 € 250,000,000 Risk weighted asset € 125,000,000 € 125,000,000 Basel percentage 8% 8% Required Regulatory Capital € 10,000,000 € 10,000,000

Bank A’s loans have a Basel weighting of 10% while Bank B’s loans have a Basel weighting of 50%. The leverage factor for A is 125 and for B is 25. Leverage here is deﬁned as a bank’s assets divided by shareholders’ funds. The leverage factor for A is calculated as follows: €10,000,000/(8%X10%) =€1,250,000,000. When this is divided by shareholders’ funds we get 125. For B,€10,000,000/(8%X50%) =€250,000,000 giving a leverage factor of 250,000,000/10,000,000 = 25. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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The Income Statement as calculated in accordance with International Accounting Standard rules is shown below: Accounting Proﬁt Bank A Bank B Interest Income € 60,000,000 € 25,000,000 Interest expense -€ 37,500,000 -€ 7,500,000 € 22,500,000 € 17,500,000

The laws of supply and demand come into force here. Because of its low weighting, Bank A faces severe competition from other banks and so has to charge a low yield. It charges 4.8% which when multiplied by €1,250,000,000 comes to€60,000,000. Bank A is borrowing on the interbank market and borrows for one year only, intending to roll over the loan at the end of the year. Therefore, the interest it pays is the one year libor interest which is 3% X€1,250,000 =€37,500. For Bank B, because it faces less competition, it can charge a relatively higher yield. It charges 10%, giving interest income of 10% X€250,000,000 =€25,000,000. As with Bank A, it borrows on a floating rate basis for one year and so pays 3%. From a superficial point of view, Bank A looks more profitable and is safer. The reality is however very different. If we do an ‘expected loss’ calculation, we see that Bank A although appearing profitable, is almost certainly doomed to bankruptcy while Bank B is likely to remain profitable. In effect, in their published accounts Bank A has not recognised an expected loss while Bank B has not recognised an expected gain. In essence, the IFRS prevents banks from recognising expected losses and expected gains. Prior to 2005 banks were required to recognise expected losses (or provision for bad debts) immediately but not expected gains. LOAN VALUATION Bank A Bank B Year 1 € 60,000,000.00 € 25,000,000.00 Year 2 € 60,000,000.00 € 25,000,000.00 Year 3 € 60,000,000.00 € 25,000,000.00 Year 4 € 60,000,000.00 € 25,000,000.00 Year 5 € 1,310,000,000.00 € 275,000,000.00 Break even yield 6.400% 8.500% Value of loan € 1,166,661,619.03 € 264,777,407.80 Expected loss/gain -€ 83,338,380.97 € 14,777,407.80 Credit spread 1.4% 3.5% Swap rate 5.0% 5.0% Required yield 6.4% 8.5% Actual yield 4.8% 10.0%

*Interest€60,000,000 + principal repaid€1,250,000,000 =€1,310,000,000. The break even yield for Bank A is obtained by reference to the probability of default 7% and (1— Recovery) = (1–80%). 7% X (1–80%) = 1.4%. When this is added to 5% we get the required yield of 6.4%. If however the bank only obtains a yield of 4.8% it is not recovering the full cost of the loan. In other words it is operating below break-even and is therefore doomed to bankruptcy. The Irish authorities, along with regulators do not seem to realise that the Basel rules have encouraged banks to confine themselves to loans that are property related, loans to governments and loans that have received AAA rating by the credit rating agencies. The regulations for instance encourage lending to governments, including Greece. In Irelands’ case property loans were the cause of the country’s current problems. In mainland Europe, loans to governments and investment in complicated structured securitisation products, rated AAA by the rating agencies, caused devastation in the banking sector. Such loans are given a low weighting by the Basel rules which banks find attractive because this permits high leverage. The reality is that regulation has altered the laws of supply and demand, resulting in too many bankers chasing too few regulatory lenient loans. They have accepted lower yields as a result and these yields are so low that they have encouraged insolvency or bankruptcy. The policies that the Irish government along with the Basel committee are pursuing suggest that the banking crisis has still a long way to run and that banks will remain dependent on the European Union for financing. The Basel rules are encouraging banks to enter into short term loans and government loans. Long-term loans that are not property related are heavily penalised because of liquidity risks. In summary, the Basel rules are encouraging banks to take on insolvent loans rather than profitable loans. The low weightings given to insolvent loans (loans to governments, property backed loans and securitisations rated AAA by the rating agencies) has caused an oversupply of such loans leading to yields which were offered well below break-even. Nevertheless because these loans were given a low weighting by the Basel committee, banks anxious to increase leverage (and bonuses) entered into loss making loans because the flawed accounting cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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rules permitted them to record an accounting profit. Had auditors forced banks to reveal the expected losses on these loans banking directors would have found them unattractive and avoided them. Patrick Honohan, the current govenor of the Central Bank of Ireland has highlighted the consequence of allowing bankers to mislead their shareholders through flawed annual reports—a major source of Operational risk. In essence, by misleading the shareholder into believing that appropriate controls are in place the regulator has assumed that banks were meeting their ‘fiduciary duties to shareholders’ and therefore appropriate controls were in place. [Extract from The Irish Banking Crisis Regulatory and Financial Stability Policy 2003–2008]92 The Financial Regulators (FR) approach to principles-based regulation relied on the integrity and competence of the Boards and senior management of regulated entities. It also relied on ensuring that these entities have the appropriate compliance systems and controls in place as well as a robust internal audit function. In the case of one persistently problematic firm—call it Bank A—significant concerns existed within the Central Bank and subsequently the FR about the effectiveness and strength of the Board and governance structures within the organisation. Moreover, serious deficiencies in systems and controls, and failings in the bank’s internal audit unit function, were routinely identified from at least the year 2000 onwards. The model of supervision applied placed considerable reliance on the Board of Bank A’s fiduciary duties to its shareholders. The FR relied on the assurances provided by the Board and senior management of Bank A and in a general sense it can be said that these assurances proved to be insufficient to ensure sound governance. Nevertheless, the FR persisted with a principles-based approach to the regulation of this institution and the soft moral suasion means of enforcement (although at one point a condition was imposed on its license relating to a governance issue), when it was clear for a number of years that it did not meet the basic requirements of a firm appropriate to this form of regulation. It should be noted that attempts were made to move beyond moral suasion in relation to dealing with Bank A. In one instance prosecution of Bank A was given detailed consideration but other less intrusive prudential measures were taken. Ultimately, however, these proved to be ineffective. 28 August 2012

Written evidence from the Campaign for Community Banking Services Executive Summary The observations are conﬁned to the community banking expertise and area of interest of the submitting organisation but conclude that the corporate structure and culture of the big UK banking groups is a signiﬁcant factor in decision making affecting UK retail customers to the detriment of many small businesses, vulnerable individuals and the communities which they inhabit. Recommendations are made which would improve social responsibility, convenient access to banking and competitive choice for individuals and small businesses.

Evidence 1. The Campaign for Community Banking Services (CCBS) is a coalition of 20 national charities, consumer and small business organisations which share concerns about the decline in local access to, and choice in, banking services particularly the closure of local bank branches and the impact of this on community sustainability, ﬁnancial exclusion and carbon emissions.

2. The CCBS response to the Commission’s call for evidence is necessarily limited to the perceived impact of the corporate structure and culture of UK banking on branch closure policies 3. 44% of bank branches in the UK have been closed since 1990 with implications for competitive choice generally but, most importantly from a CCBS viewpoint, some 1200 communities have lost all physical banking presence and, CCBS published research identified at 31 December 2011 887 communities with only one bank remaining (no choice for branch dependent consumers) and 444 with only two banks. In 14 years of monitoring only 3 cases have been identified where a closing ‘last bank in community’ has been replaced by a competitor; this typifies the absence of competition between the dominant banks at this level. The process of quitting seems to be one of ‘get out first’ or ‘follow my leader’ as to be last draws the most public opprobrium and this has been exampled very recently in the Tankerton case study (Reports section of the CCBS website) and the much publicised nationally case of Woodhall Spa in Lincolnshire where there has been agreement on business opportunity but none of the big banks, including Santander and Co-operative, were prepared to entertain filling the void left by HSBC’s closure of the community’s only bank on August 17th 2012. 92 Central Bank of Ireland. (Patrick Honohan Chairman). The Irish Banking Crisis Regulatory and Financial Stability Policy 2003–2008. p. 64. Dublin 2012. http://www.bankinginquiry.gov.ie/ The%20Irish%20Banking%20Crisis%20Regulatory%20and%20Financial%20Stability%20Policy%202003- 2008.pdf (accessed 22 February 2012) cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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4. 94% of communities having only one or two banks are dependent on the Big 4 banking groups: Barclays, HSBC, Lloyds and RBS. Branch closures, especially in vulnerable communities, have accelerated as these groups became more dominant in the market and widened their horizons to include investment banking and international banking activities. Also there has been a growing move to recruit externally for top executive positions from other industries and countries, including the USA, Canada, Australia, Spain and Portugal, which has contributed to a feeling that the UK retail market is distanced from the principal decision makers and in some cases control of the UK Retail Division itself has been handed to non UK executives, most notably in the case of Barclays, Lloyds and RBS. 5. All four groups have been active in closing branches in vulnerable communities, with an adverse knock- on impact on the retail provision in the communities concerned (see Tankerton case study in the Reports section of the CCBS website). The biggest sector to suffer from bank branch closure is small businesses, 60% of which visit a bank branch at least weekly and 10% do so every day according to research by the Federation of Small Businesses. It is relevant to the subject of the Inquiry that the rate of closure has been highest in the case of the most globally run bank, HSBC, which has reduced its share of ‘last bank in town’ from 20% in 2003 to 10% in 2011. 6. HSBC is also notable for being the only one of the Big 4 to have declined, repeatedly, to give any level of pledge to maintain a banking presence where it is ‘last bank in town’. The pledges given by the other three vary widely in qualifying criteria and availability and, as voluntary initiatives, are not endurable in the way that a neutral shared branch (as advocated by CCBS and operated throughout the USA in a retail banking context) would be. Details of shared branching are available in the Reports section of the CCBS website under the title “Bank Closure Problems—One Solution Fits All”. HSBC is also unique in not allowing its PCA customers access to post ofﬁce counters, even for withdrawals. 7. All four banking groups have become totally resistant to public opinion and argument so once a closure decision is taken it will be implemented in 12 weeks, a notice period which has become to the banks an irritation rather than a period for consultation with the community. The situation in the USA, for example, is different in that regulators there have powers under the Community Reinvestment Act to ensure that banking service to low and middle income communities, by branch and ATM, is adequate.

Recommendations 8. CCBS recommends the Commission to look at: — Making ‘last bank in community’ pledges uniform and mandatory on all banks. — An independent assessment of neutral shared branches as an alternative to branch closure and a way of opening up competition amongst established and new entrant providers. — A UK equivalent of the US Community Reinvestment Act to protect banking access in vulnerable communities. — Imposing a public consultation requirement on banks prior to closing branches. — Separating UK Retail Banking completely from the investment and international activities of the UK banking groups. — Recruitment criteria for top executive positions in UK retail banks. 24 August 2012

Written evidence from CBI 1. The CBI’s submission to the Parliamentary Commission on Banking Standards focuses on the challenges facing the banking sector around culture, behaviour, and standards. It sets out the “business user” view on what matters, and how CBI members believe these issues should be addressed. 2. Our starting point is a need to restore confidence that banks are working for the economy. Banks do, and will continue to, play a critical role in all parts of the economy and society, so it is vital that they are working effectively. The situation today, though, is that an expectation gap currently exists between what business is getting from banks and what banks perceive they are delivering for business. A change in culture within banks is required to help repair the breakdown in this relationship, which, if left unaddressed, will hold back the ability of business to drive economic growth. 3. Driving this change starts and finishes with culture. So change needs to focus within individual firms, where culture first takes root. Boards need to instil the right culture and behaviours throughout the firm, underpinned by effective corporate governance with the right internal controls and incentives. Individuals need to be held accountable for their actions, with the right penalties in place to deter any individuals from erring from the values and standards set from the top. There are many structural reforms already underway in the banking sector, particularly in the UK as a result of the Independent Commission on Banking ring-fencing proposals. These will primarily help drive financial stability, but the separate governance structures under the Vickers’ proposals will also have an important impact on culture on each side of the ring-fence. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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4. Business is clear it wants the banking industry to change, and in this paper we attempt to give some suggestions for ways in which this could be achieved. But the industry itself also needs to set out a vision of what success would look like ﬁve years hence; built on responsible behaviour, rooted in a culture that places the customer at its heart, and focused on delivering for Britain’s businesses and citizens. 5. In this paper, the CBI argues that: — The breakdown in the relationship between business and banking is impacting on the ability of business to drive economic growth and prosperity. — Increasing levels of trust, which must be underpinned by a change in culture, is key to ensuring banking can support business’ needs. — The biggest drivers of a change in culture will be a re-casting of the values that banks seek to represent. This culture has to be driven by putting the customer front and centre of everything; trust will only be earned by sustained behaviour change and consistently delivering on promises about products and services. For this to happen: (a) Systems and procedures within ﬁrms must drive values throughout the organisation. (b) Individuals need to understand the behaviours expected of them and be held accountable for their actions. — Beyond the important structural reforms already set in motion, we think a continued focus on competition is important, but do not believe that further structural reforms will be effective in driving culture change.

The Breakdown in the Relationship between Business and Banking is Impacting on the Ability of Business to Drive Economic Growth and Prosperity 6. The recent scandals in the banking industry that have lit the touch-paper for the Parliamentary Commission are different from the issues that contributed to the financial crisis, the response to which rightly demanded an explicit focus on financial stability. The manipulation of LIBOR; interest rate swap and PPI mis-selling; accusations of money laundering and the breaking of sanctions against foreign nations—all strike at a deeper malaise, at a culture in parts of the industry at odds with much of that which is positive about British business and society. 7. Beyond those scandals, businesses’ everyday interactions with banks also point to an erosion of trust in the relationship between business and banking. Frustrations over constantly changing terms and conditions; a lack of price transparency that undermines choice and competition; and the outright mis-selling of products and low customer satisfaction, have all fuelled mistrust in banks’ advice and ability to support business. Against a back-drop of sluggish economic growth and constrained access to finance, this creates a perfect storm. 8. This trust deficit is rooted in a deficient culture in parts of the banking industry, based on standards and behaviours that do not stand up to scrutiny. 9. The breakdown in the relationship between banks and business impacts in two main ways: firstly, it becomes harder for banks to play their proper role in the economy. But secondly, the reputational spill-over from banking to business is also hurting trust in business more broadly, questioning its “licence to operate” and increasing the threat of broad-brush regulation. This is neither good for economic recovery, nor for the long term health of the UK as a place to do business.

Increasing Levels of Trust, which must be Underpinned by a Change in Culture, is the Key to Ensuring Banking can Support Business’ Needs 10. Increasing levels of trust in banking will be the foundation to improving relationship with business and ensuring banks can play their full part in supporting the economy. The level of distrust that exists in the banking industry acts as a block to an effective relationship between banks and their customers. 11. UK businesses and the wider economy need a strong and stable banking system. CBI members are also clear that they need the banking industry to fulfil a number of specific functions, including: — Providing basic payment mechanisms and cash management. — Providing lending and other forms of finance for working & investment capital. — Facilitating access to capital markets. — Helping businesses manage risk. — Offering real choice and diversity in products and services. — Working for their customers, helping them to overcome problems and get the products and services that are in their best interest. 12. The provision of these core services is fundamental and essential to the operation of the economy. Indeed, many of these products and services are already available to business, provided by the UK’s financial services sector. But their provision is neither universal nor consistent, and a breakdown in trust occurs when cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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widespread availability and accessibility of these products, on which business relies to survive and thrive, is not the norm. 13. Solutions to these problems need a forensic approach. The big picture is that the transition to a “new normal” in bank finance, caused by tougher regulation and changed risk appetite, is altering the lending landscape, rather than these constraints being driven by culture and standards. 14. That said, business is clear that it is not currently getting the service it needs from the banking industry. In large part this is because banks have over time lost the values that placed the customer at the heart of how they did business. 15. Banks need to re-establish their core values, so that they are re-focused around delivery for customers. 16. These values need to be honest and realistic; they need to be driven through the organisation from top to bottom; and deviation from these has to be both unacceptable and, when this does occur, a priority issue for the firm’s leaders. 17. What are the values that business wants from the banking industry? In one sense, they are not too dissimilar from those that the wider business community aim to hold themselves. 18. One of the key drivers of trust in business of any kind is whether the business consistently delivers what it promises. It is striking that the banking industry does exceptionally poorly on this count; both compared to a number of other drivers of trust (for example, “treating staff well”) and compared to other industries (for example, four times the number of people think supermarkets consistently deliver on their promises compared to banks). 19. Business also wants a number of specific things from banking, all of which are rooted in banks acting in the customer’s—rather than their own—interest, including: (a) Being offered products they want, rather than those that the bank wants to sell them. (b) Transparency around the price of products and services, rather than the opaqueness that can come from cross-subsidisation. (c) Accessible, straight-forward, and honest communication. 20. A large contributor to the trust deficit in all of these areas—and therefore a key area on which the Commission should focus—relates to a lack of transparency in much of what the banking industry does. For example, not only would better transparency of pricing increase the possibility of real choice and competition, it can help build the trust that comes from the idea that what you see is what you get. 21. The banking industry undoubtedly needs to change. Some of this will happen (and already is happening) through self-assessment and a desire to improve on the part of the industry. But other elements may need some prompting from policymakers, legislators, and regulators to see real change delivered that improves the relationship many have with their banks. 22. Care should be taken, however, to avoid any new proposals cutting across the extensive list of reforms already taking shape, many of which are now in the implementation phase. We would therefore urge the Commission to consider in its deliberations any reforms already underway in these areas—either in the legislative or implementation phase, in Europe or domestically—before it considers any additional measures that could supplement these efforts. This would help to avoid duplication and unintended consequences, both within the financial system and to the economy more widely. 23. We need to be clear what success looks like here: the return of the values and behaviours which promote customer-focused banking that supports business and plays its full part in UK society.

The Biggest Drivers of a Change in Culture will be a Re-casting of the Values that Banks seek to Represent and an Increased Focus on Ensuring the Good Behaviour of Individuals 24. Changing the banking industry must be rooted in changing the culture in firms and the behaviour of their employees. We believe that a focus on firm level systems and the responsibilities and behaviours expected of individuals is an area which has the potential to effectively drive change. 25. Culture is influenced by many things, but we believe the reforms required can be broadly framed around the following themes: (a) Systems and procedures within firms: (i) Corporate governance structures. (ii) Incentives. (iii) Relationship with customers. (b) Accountability of the individual: (i) Code of conduct. (ii) Personal and professional development. (iii) Enforcement and sanctions. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 916 Parliamentary Commission on Banking Standards: Evidence

(a) Systems and Procedures within Firms Must Drive Values Throughout the Organisation 26. The culture at the top of a firm affects the behaviour throughout. The tone is clearly set by individuals, but the systems and processes surrounding the way a firm conducts itself, including how messages are cascaded down throughout the organisation, clearly have a significant impact on the overall behaviour of the staff.

(i) Corporate Governance The trust that stems from strong risk controls, compliance, and internal audit is key to restoring banking’s reputation; so these functions need to be more visible at all levels, from board agendas to managerial objectives. 27. The clear values that should drive the organisation and its employees need to be set and monitored by the board, with those values that are crucial for trust between customer and bank to remain strong being given higher priority than currently the case: (a) Risk: if a risk is too complicated for a well-composed board to understand, it is too complicated to accept. (b) Compliance: failures of compliance are drivers of the loss of trust in banking and so must be given greater visibility at the highest level in an organisation. 28. In addition, individual members of the board should be clear about the roles and duties for which they are responsible—whether concerning risk, compliance, or internal audit. These should be well explained from the outset, and aligned with the expectations of the regulator. 29. Corporate governance structures need to ensure that the right values are cascaded down throughout the organisation, rather than being focussed solely on board level activity. (a) Systems for upward challenge need to be clear and respected, including clear procedures for escalating problems to more senior levels when they occur. (b) Compliance needs to become more independent to avoid conflicts of interest that may arise through an employee’s desire to satisfy senior colleagues rather than raise compliance issues. (c) Internal audit should be brought forward to be “live” in decision making rather than being post- decision and process focussed, elevating it to a “partnership role” with other senior decision making. (d) Corporate governance structures need to be flexible enough to take account of differing ownership characteristics. 30. The FSA “Significant Influence Function” should promote the right credentials and help avoid “group think”. (a) We welcome the FSA’s more intrusive SIF process, and believe it should now be increasingly concerned with roles relevant to business conduct. (b) This may require employees below senior management to go through the SIF process, especially in large firms where there needs to be a realisation that thorough monitoring of important procedures around compliance, risk, and internal audit may require an increased level of responsibility at business unit level.

(ii) Incentives Remuneration strategies should be based on more rounded metrics 31. Rewards (both in terms of career progression and remuneration) should have greater emphasis on behaviours & non-ﬁnancial metrics, including outcomes for customers and adherence to codes of conduct. 32. Incentive triggers should be based on organisation-wide performance, helping to deter individuals or teams from acting purely in their own, rather than their customers’, interests. Furthermore, the trend for longer time horizons for performance-related elements of pay should continue, in order for banks to be able to use claw-backs for individuals at board level and below (for example, for material risk takers).

(iii) Customer relationships Increased collaboration between banks and their customers must be encouraged 33. Greater emphasis should be placed on fostering a mutually beneficial relationship between customer and bank. Bank staff taking the time to mentor businesses through the application for finance process is an important step in improving this relationship, and work is already underway here to assist this by boosting relationship manager skills and ensuring there are robust appeals processes for businesses that are initially turned down for finance. 34. Increasing the overall financial literacy of customers would reduce the risk of issues occurring—both regarding attempts to secure finance and concerning episodes of mis-selling. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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(b) Individuals Need to Understand the Behaviours Expected of Them and be Held Accountable for Their Actions 35. The behaviour of a signiﬁcant number of individuals in the banking industry is repeatedly highlighted in Parliament, the media and society at large as being out-of-step with the norms and standards we expect from members the business community, as well as perhaps from members of society in general. In short, banking appears to have fallen far from the days of “my word is my bond”. Individuals need to understand the behaviours expected of them in the industry, and be held accountable if they fall short of these.

(i) Code of conduct 36. The implementation of a professional code & ethical standards with “teeth” is required. A single standard of baseline ethics is required across the entire industry, which firms can then use as a minimum standard on which they can base their own individual, firm-level codes of conduct. Although individuals at more senior levels in an organisation may be required to adhere to stricter standards, the underlying code of conduct must be universal. The code needs to be observable, and deviation from it needs to be punishable. 37. Codes of conduct must be “live” in banks—constantly evolving and being refreshed—and the code and foundation standard should be compatible with the extensive number of technical qualifications on offer in the industry. This is especially important to keep the UK open to the international workforce. 38. Punishment needs to be a significant deterrent. Many professions operate along the lines of a register, from which individuals can be struck off if their behaviour fails to reach the standards expected of them. More work needs to be done to construct something appropriate and workable for the banking industry, but the idea behind such a register is simple: someone who has been struck off should not be able to find employment in the banking industry again. 39. In parallel, the FSA approved persons code of conduct should be updated and consideration should be given as to whether it should apply to lower levels of management in firms.

(ii) Personal & professional development must be improved 40. Internal training should include increased explanation of behaviours expected at the relevant level— including regulatory duties. These sessions should be regularly updated, including through discussion with the regulator as to their expectation of required behaviours. 41. Human Resources have an important role to play in promoting the culture throughout a ﬁrm, and should ensure conduct is a mainstay of development programs and clearly outlined in induction training, including the relevant punishments for inappropriate behaviour. 42. A number of other professional bodies require individuals to undertake compulsory continuing professional development (CPD), with a set number of hours required each year, as one way to maintain professional standards in the industry. The medical and accountancy professions both provide relevant examples of this.

(iii) Enforcement and sanctions must act as material deterrents 43. There should always be—and indeed already are—tough criminal sanctions for those engaging in fraudulent or unprofessional behaviour, but such behaviour should be dealt with by the criminal authorities rather than the regulator. 44. The FSA already has extensive powers that can be used as material deterrents, including the ability to fine, suspend, or revoke approval entirely, of those who engage in unprofessional behaviour. If the Commission believe that further steps are necessary in this area, we believe an exploration of whether the authorities are currently using the full extent of their powers would be beneficial before consideration of further powers. 45. It should be noted, however, that there have been significant changes in the regulator’s approach in recent years. Working in partnership with the industry, the regulator has been able to take a more robust approach to investigation and prosecution of wrong-doing—which we applaud.

Beyond the Important Structural Reforms Already set in Motion, we think a Continued Focus on Competition is Important, but do not Believe that Further Structural Reforms will be Effective in Driving Culture Change 46. The systems and frameworks within ﬁrms are integral to fostering the right sort of culture, and to encouraging behaviour that the public and business can be conﬁdent is in line with the standards we would expect of those who work in one of the UK’s pre-eminent, globally facing industries. 47. There are, however, a number of structural tweaks that could be made to the industry to improve the relationship between business and banking. Implementing reforms already underway to the structure of the banking industry itself, bringing a renewed focus on the level of choice the industry offers to customers, and cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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improving the way banks are regulated are all vital elements to ensuring a vibrant sector that serves those who rely on it.

(i) Competition in the right areas needs to be boosted 48. As consumers of banking services, businesses are more concerned with being offered a wide range of products and services that meet their needs than by the absolute number of providers. A diverse range of products and services for business to choose from is more likely, however, when there are a diverse range of ﬁnance providers in the industry. Lowering barriers to entry on both the demand and supply side should therefore be a priority.

Supply side barriers 49. Capital and liquidity requirements, and the FSA authorisation process, are onerous for smaller firms— ”challenger banks”—as well as “challenger brands” (for example, mutual and co-operatives), giving large incumbents a significant advantage. The Commission should consider how to reduce these regulatory barriers to increase competition, without sacrificing financial stability. 50. Significant investment is required in infrastructure to break into market, including to establish branch networks, which are especially important for attracting SMEs. Greater infrastructure sharing should be encouraged, for example by increasing the types of transactions, such as deposit taking, that bank branches will execute for other banks’ customers. 51. Mutual and co-op models operate for the benefit of their workers or customers, and tend not to have high return expectations (reducing risk taking behaviour)—a more diverse range of ownership models would be beneficial for the “banking” market.

Demand side barriers 52. Reducing the current opaqueness in pricing and products would improve dialogue and shared understanding between banks and customers, and increase comparison of products. Efforts to increase transparency should be high up the agenda of the Commission. Data also needs to be made more accessible for effective use on comparison websites. 53. Changes due by September 2013 will increase the ability of individuals to switch their bank, increasing competition for customers. Increasing awareness of these changes is important.

Non-bank finance 54. Bank finance should not be the only source of working or growth capital for businesses. Encouraging a diverse source of finance provision through boosting non-bank finance options should be a continued objective. For example, increasing the use of equity finance and deepening the use of non-bank debt, such as corporate bonds, would increase real choice for businesses when seeking finance.

(ii) The powers and approach of the regulator should be constantly reassessed and fine-tuned to counter inappropriate behaviour, but wholesale change is not required The regulator should focus on product governance in an attempt to head off potential consumer redress episodes at an earlier stage 55. Whilst there is a need to balance financial stability and conduct of business with the desire to allow for innovation, we believe consideration should be given to whether the balance should now be redressed from recent years back towards favouring product certainty over innovation. 56. Ensuring products are fit for purpose before they reach market and during the sales process—rather than rely on ex post-facto consumer redress—would help increase trust that products were appropriate for customers, and reduce the number of episodes of consumer redress for banks that do much damage to trust between business and banks. 57. The Financial Conduct Authority should therefore focus on product governance throughout the product life cycle, rather than the products themselves. This would include focusing on the process of designing new products including the approval process; financial promotions and marketing; the sales process; and customer satisfaction and complaints monitoring.

The regulator should take an increased interest in internal systems that contribute to culture 58. As well as being concerned with the products on offer in banks, the regulator should also take an active interest in incentive structures and cultural behaviours within the industry. It should take a macroprudential view of how incentives are shaping behaviour in the industry, including by conducting on-going reviews of incentive structures as part of its wider regulatory duties. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 919

59. This will also help take account of incremental changes to incentives, which over time may have contributed, for example, to the creation of a sales driven culture in parts of the industry. 60. However, if the regulator is to take on the above objective, and therefore be given more power over banks’ systems and structures, the accountability and scrutiny it itself faces will have to rise. This is an area where Parliament can provide a welcome boost.

(iii) Altering the physical structure of banks will not prove an effective driver of cultural change 61. The proposed reforms to the structure of the banking industry, based on the Independent Commission on Banking’s recommendations, provide the background to any debate on structural reforms to the industry, and are an integral part of the future of the banking industry and how it interacts with its customers. 62. The governance aspects of ring-fencing will be an important driver of behaviour change, providing both sides of the ring-fence with governance structures tailored to the specific business lines included in each. And the competition measures included will further help to increase choice for business customers. 63. The Independent Commission on Banking took extensive evidence on the idea of full separation of retail and investing banking and, after careful consideration, rejected the idea. We believe that the expert Commission reached a sensible conclusion, and recent events do not change the fundamentals of this position. 64. Indeed, we consider the culture of consumer retailing—or, more specifically, a sales obsessed culture— to be a bigger driver of behaviour in retail banks than any perceived culture being transmitted from investment banks. The over-extension of a number of pure retail banks in the period leading up to the financial crisis would support this view.

Conclusion 65. Culture is at the heart of many of the current problems with the banking industry, and the Parliamentary Commission’s work on this is a welcome step to improving the relationship between business and banking. 66. There clearly must be a change in culture in the banking industry. But change will only come if the outcome from reform is greater than the sum of its individual parts—a wholesale change in the values that drive individuals and banks in the industry, with the tone set at the top and cascaded down through ﬁrms, is needed. 67. Practical changes are required; designed for the long term and allowed time to bed in. 68. Only then can we realise a sustainable future for a successful banking industry: one built on values and behaviours that promote customer-focused banking; committed to providing real choice to consumers and delivering what it promises; and one that plays its full part in supporting UK business and contributing to the wider well-being of society. 69. CBI members are keen to be involved in the on-going work around the standards and culture in the banking industry—an issue that, notwithstanding the wider economic challenges facing the economy, is undoubtedly a top priority for the business community. 18 September 2012

Written evidence from CFA UK 1. Recent events have demonstrated that banks have often placed their own interests ahead of those of their customers and ahead of their responsibilities to the market. 2. The factors that have enabled banks to engage in inappropriate practices and run regulatory risks can be attributed to a number of systemic governance failures: — Ineffective governance within banks — Insufficient discipline from the market — Ineffective regulation — Moral hazard 3. The banking sector’s problems cannot be solved by measures aimed at the symptoms of those problems. 4. A radical approach is required and we propose the following solutions— (a) Regulation must be made more effective. (i) Regulators must supervise more effectively and ensure that financial institutions adhere to their regulatory obligations. Buyer beware has to be balanced with seller beware. (ii) Regulators should enforce more effectively by making sure that the financial and non-financial costs of inappropriate behaviour materially outweigh any benefits that have accrued from such conduct. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 920 Parliamentary Commission on Banking Standards: Evidence

(iii) The regulator should remove regulatory approval for firms to operate if a firm is unable to demonstrate its ability and willingness to adhere to the regulatory requirements. (b) All bank staff should be aware of their regulatory responsibilities and adhere to them. They should understand the need to place client interests first and to uphold the integrity of the financial system. All staff should be required to abide by and adhere to a code of ethics and standards of professional conduct (such as CFA Institute’s Code of Ethics and Professional Standards) and firms should be required to demonstrate their ability to implement such codes and to monitor employee behaviour against them. (c) Bank governance systems need to be more robust to increase the likelihood that profitable, but inappropriate activities are challenged earlier in future. (d) Mechanisms for providing information to the market about bank governance should be improved. In addition, the regulator and policymakers should continue to act on the systemic risk of individual bank failure so that banks that take inappropriate risks or act inappropriately can be allowed to fail. The risk of permanent loss is required if internal governance is to be improved and if market discipline is to operate effectively. 5. In support of our submission we include the following material that we refer to in our response: (1) Overview of CFA UK (2) Summary of the Code of Ethics and Standards of Professional Standards (3) CFA UK position papers on ‘Financial Amnesia, Effective Regulation and Stewardship (4) Letter to the Joint Parliamentary Committee on the Financial Service Bill (5) Letter to the Treasury Select Committee on the proposed Financial Services Bill.

Responses to the questions posed by the Parliamentary Commission on Banking Standards 1. To what extent are professional standards in UK banking absent or defective? How does this compare to: (a) other leading markets 6. CFA UK is not well placed to assess the relative level of professional standards globally. However, it is worth noting that irrespective of standards elsewhere, a minimum level of professional behaviour should be required in the UK market. It is also notable that the recent examples of poor professional behaviour in the UK have occurred under a light-touch regime and have sometimes come to light as a consequence of regulatory activity in other regimes.

(b) other professions 7. Investment is a profession and its participants understand their responsibility to protect the public from incompetence and unethical behaviour by maintaining professional and ethical standards. The investment sector (or buy-side) has had its own share of embarrassing cases of poor practice, but a large number of those that work in the sector are members of a professional body and are conscious of their duty to maintain appropriate standards. The same should be true of finance more generally and banking in particular. Some have argued that professional and ethical standards should not apply in wholesale markets—such as the money markets— because all participants can operate on a ‘buyer beware’ basis. However, that assumption fails to take account of participants’ responsibility to maintain a fair market so as to promote trust and, ultimately, to provide a public benefit in effective price formation. 8. What the recent banking scandals reveal is the routine placing of personal or firm interest ahead of that of the market and clients. The banking sector, unlike the investment sector, appears to be far from operating as a profession. It is possible to point to any number of failures. With reference to the specific standards expected of CFA UK members, standard I(a) of our code requires members to understand and comply with all rules, laws and regulations governing their professional activities, standard I(c) requires members not to knowingly make any misrepresentations, while standard 1(d) demands that members should not engage in any professional conduct involving dishonesty, fraud, or deceit. In addition, standard II(b) states categorically that members must not engage in practices that distort prices. 9. It appears that some banks have paid lip service to professional ideals and ethical business culture within their marketing communications, but have not embedded those ideals and behaviours within their firms. If they had, their names might not be making headlines for the wrong reasons. That would also have been less likely if the UK had enjoyed a regulatory approach that focused on symptoms rather than on causes. Individuals in the banks concerned appear to have acted with little fear of penalty from a regulator, their firm or a professional body. This collective wilful blindness would be less likely to happen in the medical or legal profession, where professional codes of conduct are rigorously enforced and individual transgressions are penalised with appropriate severity. 10. CFA UK’s forthcoming paper on the stewardship of client assets—to be followed by papers on conflicts of interest and fee and compensation structures—is designed to provide practical guidance for investment cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 921

professionals committed to maintaining appropriately high standards. The society is also working on mechanisms to enable investment professionals to seek informed guidance on ethical and professional issues. and (c) the historic experience of the UK and its place in global markets? 11. The UK has a proud and long banking tradition. CFA UK advises that the Parliamentary Inquiry should respect this tradition by addressing shortcomings in professionalism and ethics whilst at the same time trying to avoid maligning the whole industry.

2. What have been the consequences of the above for (a) consumers, both retail and wholesale, and 12. The consequences of different instances of unprofessional behaviour within the banking sector differ. Mis-selling resulted in direct loss to consumers, but the misreporting of Libor rates will have benefited some market participants and disadvantaged others. All market participants, however, suffer as a loss of trust in the financial sector. A reduction in consumers’ willingness to engage in financial transactions might lead to opportunity costs or direct costs in future.

(b) the economy as a whole? 13. The cost to the economy of the loss of trust in the banking sector has, to date, been limited. Such a loss of trust, as a consequence of poor professional practices, should have led to an increase in the cost of borrowing for banks and, in particular, for banks which are perceived to run greater governance risks than others. The central bank’s understandable desire to provide extremely low cost funding to banks in order to recapitalize bank balance sheets and reduce systemic ﬁnancial risk means that there has been no discernible increase in banks’ effective funding costs.

3. What have been the consequences of any problems identified in question 1 for public trust and in, and expectations of, the banking sector? 14. As described above, public trust in the banking sector appears to be even lower than before. UK banks were once considered trusted providers of financial guidance, advice and services that placed the customer first. Revelations about inappropriate practices that have been taking place for close to a decade (in some cases longer) have demonstrated that these UK banks have placed their customers’ interests second was not a one- off isolated episode.

4. What caused any problems in banking standards identified in question 1? The Commission requests that respondents consider (a) the following general themes: — the culture of banking, including the incentivisation of risk-taking; — the impact of globalisation on standards and culture; — global regulatory arbitrage; — the impact of financial innovation on standards and culture; — the impact of technological developments on standards and culture; — corporate structure, including the relationship between retail and investment banking; — the level and effectiveness of competition in both retail and wholesale markets, domestically and internationally, and its effects; — taxation, including the differences in treatment of debt and equity; and — other themes not included above; 15. Various asymmetries appear to have influenced banking behaviour adversely. First, large global banks appear to have understood that they had become too big to fail. As a consequence, they could take on more risk than they should on the suspicion that they would be bailed out. We are all aware of the systemic consequences of this understanding. Secondly, compensation structures within the banking sector rewarded risk-taking. There was an asymmetry in the impact of gains and losses on compensation. 16. A more competitive banking sector might have meant that banks could not become too big to fail. Similarly, the shift in investment banks’ corporate structure from partnerships to publicly-listed companies meant that the incentive for bank boards to monitor credit growth and to control risk closely was reduced as their risk of personal loss became limited. 17. It is important to recall that there were almost no groups within society that noted the dangers of credit growth within banks and the growth of the banks themselves. Society appeared to benefit from the banks’ success. All of us chose to believe that asset prices were justifiable and too few noted the danger of bank leverage or the impact of risk asymmetries on behaviour. The regulatory framework failed in its primary responsibility to ‘take away the punchbowl’, but we all enjoyed the party while it lasted and none of us cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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(consumers, the media, parliament or the professional bodies) should now comfort ourselves by pinning the blame for the banking sector’s failings solely on the banks. 18. CFA UK described the reasons why societies fail to identify credit bubbles and proposed some mechanisms for accelerating their observation in its position paper ‘Financial Amnesia’. and (b) weaknesses in the following somewhat more specific areas: — the role of shareholders, and particularly institutional shareholders; — creditor discipline and incentives; — corporate governance, including — the role of non-executive directors — the compliance function — internal audit and controls — remuneration incentives at all levels; — recruitment and retention; — arrangements for whistle-blowing; — external audit and accounting standards; — the regulatory and supervisory approach, culture and accountability; — the corporate legal framework and general criminal law; and — other areas not included above. 19. The following interdependent governance failures all contributed to banks being able to undertake inappropriate activities and engage in unacceptable practices— — the role of shareholders, and particularly institutional shareholders; — creditor discipline and incentives; — corporate governance, including — the role of non-executive directors — the compliance function — internal audit and controls — remuneration incentives at all levels; — the regulatory and supervisory approach, culture and accountability; — the corporate legal framework and general criminal law; — Other—moral hazard and senior management . 20. In our position paper ‘Financial Amnesia’, CFA UK set out how regulatory failure contributed to the crisis. Essentially, the regulatory failure was attributed to the following factors: (a) Organisational constraints—insufficient resources, bureaucratic weaknesses and/or an ineffective mandate. (b) Poor management and policy-maker focus—regulators and policy-makers appear to respond to market failure by issuing new rules (which would suggest a structural failure in regulatory activity) rather than by reviewing the regulator’s failure to supervise and enforce within the existing structure (which would require acknowledging management or operational failure). (c) Capture—Regulatory bodies are vulnerable to lobbying and capture by those they should be supervising. The relationship between the market and its regulator is close. The regulator can come to depend on the market for resources and information and regulators may become reluctant to rock the boat—a fear that is heightened if individuals working for the regulator consider that they may be employed in future within the market. (d) Behavioural factors—halo effect (overawed by those that are being regulated) regulatory myopia, groupthink, status quo bias. (e) Light touch plus caveat emptor results in a flawed regulatory philosophy—this philosophy was based on a “market knows best” paradigm which underpinned the “light touch” mandate. In addition, the buyer beware principle meant all the regulatory focus was on the supply-side of the market. Relatively few resources were invested in ensuring the demand side of the market for financial services was a potent source of discipline on financial firms. 21. Regulators are the last line of defence and need to ensure that they can act in the manner that maintains trust and confidence while having the courage to hold failing financial market participants to account. Regulators must also not fall into the trap of choosing approaches based purely on paternalism or libertarianism as has been the case since the Great Crash. For regulators to be more effective they need to learn from their own mistakes and become more courageous in their actions by supervising and enforcing the rules that already exist. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 923

22. In our paper “Effective Regulation” we propose the following measures to address the failings we identified above and these are as follows— 1. Enhancing financial capability—so that consumers become a more robust source of market discipline on firms. Caveat emptor (buyer beware) has to be balanced with caveat venditor (seller beware). 2. Change the regulatory philosophy—Establishing a regulatory philosophy and approach which acknowledges that we live in a world that can act irrationally and inefficiently for protracted periods. Rather than facing a binary choice between the market mechanism and command and control, the regulatory philosophy should embrace libertarian paternalism (nudge theory). 3. Practical policy-making— (a) Being evidence-based, so as to ensure that the design of laws, policies and regulations are accountable, consistent, proportionate, targeted and transparent. (b) Consistency with, rather than conflicting with, existing laws and policies. (c) Sensitivity to gaming. Practical regulation and effective monitoring would also minimize the consequences of gaming (for example regulatory and tax arbitrage or even evasion) on society. These efforts would ensure that costs of gaming would outweigh the benefits for those considering undertaking the activity. (d) Dynamism. Governance is a complex system that requires evolution and learning for the policy levers to remain effective in the present and the future. (e) An appropriate emphasis on the monitoring of the policy, combined with a credible threat of enforcement. 4. Supervision and enforcement- Regulation alone is not sufficient. Even the best designed regulation will be ineffective if it is not credibly supervised and enforced. The regulatory failure that contributed to the financial crisis was less about the regulations and more about an absence of effective supervision and a credible threat of enforcement. 5. Accountability—Just as market participants need to be held to account by their shareholders and the regulator, so the regulator should also be held to account. CFA UK believes effective regulation will strengthen UK’s position as a leading global financial centre. By fulfilling the essential role they play in enhancing the quality of market integrity, regulators will be able to further strengthen the UK’s position as a leading global financial centre.

23. As we have cited in our position papers and responses related to ﬁnancial regulation the key remedial action is making the interdependent sets of checks and balances more robust. Boards need to be more effective; investors need to be able to convey their concerns effectively and without fear of retribution.

24. In the wake of major corporate and accounting scandals including those affecting Enron, Tyco International, Adelphia, Peregrine Systems and WorldCom we note the enactment of The Sarbanes–Oxley Act of 2002 as a means of ensuring investor protection through Public Company Accounting Reform. SOX-type laws have been subsequently enacted in Japan, Germany, France, Italy, Australia, India, South Africa, and Turkey and have done much for improving the confidence of fund managers and other investors with regard to the veracity of corporate financial statements93. Given the current lack of confidence in the culture and control environment of banks’, we call attention to “SOX” measures in respect of Corporate Responsibility94 mandating senior executives’ individual responsibility for the accuracy and completeness of corporate financial reports and propose investigation into a similar framework for the role of Chief Compliance Officers/Chief Operating Officers in respect of the health of the bank’s Governance, Risk and Compliance capability.

25. Finally, the regulator needs to more effective in supervising and enforcing the relevant regulations. The quality of regulation in the UK financial services sector has fallen short and been a contributor to systemic governance failure. Regulators are the last line of defence, as we have seen; when they fail the consequences for the rest of us are significant. No new laws or regulations are required just the desire, willingness and ability to supervise and enforce existing ones. Quality of regulation is the priority. 93 Article quoting fund managers at Eaton Vance and T. Rowe Price. http://www.businessweek.com/magazine/content/07_05/ b4019053.htm 94 Title III consists of eight sections and mandates that senior executives take individual responsibility for the accuracy and completeness of corporate financial reports. It defines the interaction of external auditors and corporate audit committees, and specifies the responsibility of corporate officers for the accuracy and validity of corporate financial reports. It enumerates specific limits on the behaviors of corporate officers and describes specific forfeitures of benefits and civil penalties for non-compliance. For example, Section 302 requires that the company's "principal officers" (typically the Chief Executive Officer and Chief Financial Officer) certify and approve the integrity of their company financial reports quarterly. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 924 Parliamentary Commission on Banking Standards: Evidence

6. Are the changes already proposed by (a) the Government, (b) regulators and (c) the industry sufficient? Respondents may wish to refer to the Financial Services Bill and the Government’s proposals for the Banking Reform Bill. They may also wish to refer to proposals by the Bank of England and the Financial Services Authority on how the Financial Policy Committee, Prudential Regulation Authority and Financial Conduct Authority will operate in practice. 26. In our previous submissions about the Government remedies we have expressed concern that they are unlikely to achieve the progressive change hoped for. “The strategy for reform is not to create an ideal set of rules and then see how well they can be enforced, but rather to enact the rules that can be enforced within the existing structure.” (La Porta et al95) 27. Effective regulation involves the design of policies, rules and laws that are successfully monitored and supported by the credible threat of enforcement. The new framework is focused on new architecture rather than making the existing one work more effectively. The tripartite system failed because insufficient emphasis was placed on supervision and enforcement. In our opinion, the risks of regulatory failure have not been reduced. 28. We welcome initiatives undertaken by the Financial Reporting Council in respect of the Stewardship Code, Code for Corporate Governance and Guidance on Audit Committees. Particularly we feel that proposals in respect of assurance reporting96 alongside a suitably expanded remit of internal audit committees could, and should, be investigated for implementation by banks as a means of providing markets with the necessary information regarding internal controls so as to enable market discipline to be enforced. 29. CFA UK believes that effective regulation is essential for the laws of demand and supply to function appropriately. History has demonstrated that market discipline cannot be reliably imposed by all regulated financial firms. The high risk of market failure makes the regulator the last line of defence for maintaining market integrity and, thereby, trust and confidence. Sadly, the evidence demonstrates that the regulator is also prone to failure. CFA UK calls upon regulators to learn from financial and corporate history and to make material changes in their regulatory approach to deliver the following outcomes: (i) Firms conduct themselves to the highest professional and ethical standards and place clients’ interests first. (ii) Enhance financial capability so that consumers become a more robust source of market discipline on firms. It is essential for the demand side to be a source of market discipline. Caveat emptor has to be balanced with caveat venditor. (iii) Establish a regulatory philosophy and approach which acknowledges that we live in a world populated by people who do not always act rationally and imperfect markets. Rather than facing a binary choice of market mechanism or command and control, the philosophy should embrace asymmetric paternalism. This would create an environment of market command with robust control mechanisms and make it possible for firms to fail without endangering the system or imposing major costs on the rest of society.

7. What other matters should the Commission take into account? 30. The Commission should seek evidence from the UK Government that the new Financial Services Bill will necessarily deliver a better outcome.

Conclusion 31. The crisis in the banking sector was the result of a systemic governance failure that was characterized by banks willing to place their interests above their customers; ineffective corporate governance; insufficient market discipline and ineffective regulation. Banks like other providers of financial services have regulatory obligations. From the late actions taken by the FSA in recent years it appears that some banks have been engaging in activities for a considerable length of time that placed their customers’ interests behind their own. In some cases regulatory inertia exacerbated consumer detriment, while fines levied on these banks may have been considered no more than the cost of doing business. 32. The introduction of a Code of Ethics and Standards of Professional Conduct for bankers would be welcome as part of the solution. The greater requirement is for more robust checks and balances within the financial system. 33. We look forward to collaborating with the inquiry. 24 August 2012

95 La Porta, Rafael, Lopez de Silanes, Florencio, Shleifer, Andrei and Vishny, Robert W., "Investor Protection and Corporate Governance" (June 1999). Available at SSRN: http://ssrn.com/abstract=183908 or DOI: 10.2139/ssrn.183908 96 Assurance Reporting: In March 2011 the Institute of Chartered Accountants in England and Wales (ICAEW) published a Stewardship Supplement to its Technical Release AAF 01/06—Assurance Reports on the Internal Controls of Service Organisations. It covers assurance reports on internal controls of service organisations made available to third parties, and is referred to in the guidance notes in the Stewardship Code. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 925

Written evidence from Prof. Jagjit S. Chadha

1. Properly functioning banks and financial institutions allow individuals and firms to separate in time and space the generation of their income and the pattern of their expenditures. In this sense, financial institutions transform the maturity of money because they fund themselves by accepting short-term deposits, which we can think of as savings from current income, and then plan to return these with interest at some future point when they are required. Returns on deposits are generated by making loans to individuals and firms, who we can think of as requiring funding, and this activity typically involves screening loan applicants, monitoring their performance, seeking collateral, deciding on an appropriate interest rate spread over funding costs, as well as loan maturity. In this sense, banks manufacture returns from the raw materials of deposits by selecting assets into which that money is placed at a return sufficient to cover their costs and provide a return for holders of bank liabilities, which are both deposits and equity in the bank. Such activity is essential to the development of a market economy as it allows intertemporal trade in expenditure units and ought to act to smooth expenditure patterns and so ultimately the business cycle and hence benefit society.

2. The key weakness of the banking system, which has been exposed so thoroughly since 2007, flows from the very reason for its existence, because banks transform the maturity of their funding, they are vulnerable to sharp deteriorations in the confidence of their funders, or depositors, which may quickly lead to insolvency. Such a deterioration in confidence may be triggered from the revelation of actual business conditions or simply emerge from the sky, from what economists call a sunspot, as a sudden decision by depositors to withdraw deposits. But it now seems well established that the ongoing financial crisis not only resulted from excessive leveraging by many banks and the employment of fragile funding models but also because the systemic risks of individual bank behaviour were not properly monitored by the regulatory authorities. And while it might be the case that with sufficient maintenance of professional behaviour confidence may have been bolstered, this does seem rather marginal compared to the actual business models employed and encouraged by the authorities. In the event individual banks, and the system as a whole, has contributed to rather than attenuated the volatility of the economic cycle by first helping to prolong the economic expansion and enabling economic imbalances to be funded by financial intermediation and, following the crash of 2007–8, creating a legacy of undercapitalised banks with many poorly performing assets and a restriction of funding channels. This legacy acts to constrain current and future activity as banks reign in their lending activities. And so while it is clear that banks have not delivered on their main objective of helping to smooth the paths of aggregate expenditure and income over time, the difficult question facing this Commission is the extent to which Standards in Banking have played a role in this failure.

3. One possible analysis is that the banking system played a rather cynical game of chicken with the authorities and managed a Pyrrhic victory. The regulatory regime that was adopted from the 1980s onwards involved light touch, which implied that banks could mostly run their own books subject to limited controls on capital and informal liquidity requirements. The carrot was the promise of returns to the shareholders and employees with taxes collected by the state. The stick was that if a bank was poorly run, the authorities would let it fold. In this sense, like any private sector industry the market would be able to select and promote success and punish failure, so that capital and labour could be re-employed. Banks on the other hand gambled with the proposition that even if they took on excessive risk, the systemic implications would be so great that the stick would not in the end be wielded and the state would step in to provide support. The Run on the Rock and the partial nationalisation of UK banks following the collapse of Lehman Brothers, as well as a host of other measures to bolster financial sector liquidity, tells a tale of state support and intervention rather than market determination and a gambit won by the banks. The extensive nature of this state support has placed public finances under strain and we have therefore discovered that there is a significant degree of mutual risk-taking by the banking sector and state, which implies an ongoing case for some greater regulatory constraints to be placed on banking. The obvious issue here though is not to impose extensive controls on banks such that we re-enter the postwar period of capital and lending constraints that led to significant financial repression and yet ensure that the business of banking continues and resumes its basic role of smoothing the economic cycle.

4. A number of further analytical problems have also been highlighted by this crisis, which have exacerbated these issues: (i) risk transfer, or shifting, whereby financial market participants only bear the positive return from any investment or trade and not the loss, can artificially bid up asset prices—this concept has applications as diverse as the question bankers’ bonuses to the development of new instruments eg CDOs and to the implications for fiscal sustainability; (ii) herding behaviour in which similar operating practices by individual banks in the sector not only raises overall risk but also leads to the incomplete transfer of information from the private to the public sector—under these circumstances some heterogeneity is to be encouraged; (iii) opaque bank balance sheets, which are not sufficiently transparent in real-time and may not capture the extent of all contingent claims, and so do not allow holders of bank liabilities to draw up a full picture of a bank’s riskiness, or indeed that of the whole sector; (iv) internal governance in banks, though rightly concerned with profitability, did not necessarily consider reputational or systemic issues and tended to act in a manner that obstructed attempts to tighten regulation; and (v) indifference from the regulatory and monetary policy makers to the problems of an exuberant financial sector, which is currently being addressed with the development of so- called macro-prudential instruments.97 97 See Chadha (2012) for evidence to the Treasury Committee on Macro-prudential Tools: http://www.publications.parliament.uk/ pa/cm201213/cmselect/cmtreasy/writev/macropru/mpt13.htm. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 926 Parliamentary Commission on Banking Standards: Evidence

5. The academic debate has suggested the design of a number of optimal contracts between agents that may alleviate some of these banking problems, which we might think of as negative social externalities, and in general these require some limitations to be placed on bank behaviour—in terms of holding more capital and liquidity as a buffer stock, or even in a time-varying manner over the business cycle; possibly by placing limits on exposure to certain fast growing sectors; or in deciding to what extent deposit contracts can be paid out and the scale of deposit insurance. These contracts are designed to ensure that risk-sharing is properly allocated across individual banks, the sector as a whole, the state and households in proportion to their likely returns, or possible gains. It makes little sense to allow banks to accrue excess returns and then lay-off risk to the state and the household sector in extremis. Much of any residual risk in a market economy, what we might call aggregate risk, is insured by the appropriate operation of monetary and fiscal policy—note that we have learnt in this crisis that even bank re-capitalisation tends to be an arm of monetary and fiscal policy. And so when considering new policy initiatives with respect to Standards,98 I would like to suggest a simple selection criterion: Does the proposed policy maintain the freedom of banks to structure their assets and liabilities in order to maximise profits subject to the constraint that economic risks to society have been properly accounted for in the calculations of any individual bank. I think the proper role of what we have called Standards in Banking is to ensure, as far as is practicable, that no enduring gap exists between private returns to the bank and social returns, which would of course be less than private returns in the presence of negative externalities. Put this way Standards are simply about getting the bank and the banking system to understand how to coordinate more formally its actions with those of society in general. 24 August 2012

Written evidence from the Chartered Banker Institute

EXECUTIVE SUMMARY

The Chartered Banker Institute (the “Institute”), the oldest banking institute in the world, has driven an agenda of ethical professionalism throughout its existence. In 2000, approval was received from the Privy Council to award the “Chartered Banker” professional designation to individuals meeting the Institute’s highest standards and qualification requirements for ethical, professional and technical competence. — In October 2011, the Chartered Banker Professional Standards Board (CB:PSB), a voluntary initiative supported by nine leading banks in the UK, was launched, encompassing some 350,000 individuals working in UK banking. In its first year, the CB:PSB published: — A Commitment to Professionalism in Banking, signed by Chairmen and Chief Executives of the banks; — The Chartered Banker Code of Professional Conduct; — A Framework for Professional Standards; and — The Foundation Standard for Professional Bankers, which is currently being implemented by CB:PSB members. — Professional standards in UK banking are not absent; they continue to be promulgated by the Institute without any statutory or regulatory basis and individuals and some organizations continue to uphold and promote them. In contrast to many other professions, however, the proportion of practitioners meeting professional standards is relatively low, and it may be said that professional standards in banking are, therefore, deficient. — The number of qualified banking professionals has fallen substantially both as an absolute number and as a proportion of those employed in the industry as a result of: — Banking ceasing to be viewed as a profession (wrongly, in our view); — Lack of requirements or encouragement and for individuals to gain a professional banking qualification and become a member of a professional body; and — A general change in banking culture from stewardship to sales. — Internationally, there is greater encouragement and support for the appropriate professional qualification of bankers. — In order to rebuild public confidence and trust the current extensive macro-prudential, structural and regulatory reforms need to be supplemented by equally extensive cultural reforms to enhance and sustain a culture of customer focused, ethical professionalism in the UK banking industry. — We believe that the revitalization of professional standards in banking is beginning, primarily driven by independent professional bodies including the Institute, and industry initiatives such as the CB:PSB which has made significant progress in codifying professional standards for bankers for the first time. These provide an excellent foundation on which to move forward but there is still a long journey ahead. 98 I would rather not comment on them one by one at this stage, though would be pleased to comment on specific proposals at some later date. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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— We believe that the industry, supported by regulators and policy-makers, could accelerate the implementation of professional standards by building on the work of the Institute and the CB:PSB by: — Ensuring greater numbers of bankers in senior, and key customer-facing and customer- supporting roles meet agreed professional standards. — Encouraging senior executives, and other key individuals within banks, to hold relevant, Chartered level, professional banking qualifications. — Encouraging and supporting greater numbers of bankers in key customer-facing and customer- supporting roles to achieve relevant professional banking qualifications. — Encouraging employers to require senior executives, other key individuals within banks, and bankers in key senior, customer-facing and customer-supporting roles to be members of a professional body for bankers (with the possibility of being “struck off” for misconduct). — Working more closely with professional bodies in banking to investigate potential misconduct cases. — Seeking evidence of an individual’s positive commitment to and promotion of professionalism in banking when considering their suitability for Significant Influence Functions and other key roles.

Introduction The Chartered Banker Institute—the only remaining professional body for bankers in the UK 1. The Chartered Banker Institute (“the Institute”) is the trading name of the Chartered Institute of Bankers in Scotland, the oldest banking institute in the world, established in 1875. The Institute is the only remaining professional banking institute in the UK, and operates in England, Wales, Scotland and Northern Ireland. The Institute has driven an agenda of ethical professionalism throughout its existence; promoting professional standards for bankers, providing professional and regulatory qualifications for retail, commercial and private bankers in the UK and overseas, and offering professional membership to qualified individuals. It is one of very few educational and professional bodies remaining in the UK to focus stringently on professional ethics, values and behaviours for bankers. 2. The Institute received Royal Charters of incorporation in 1976 and 1991. In 2000, approval was received from the Privy Council to award the “Chartered Banker” professional designation to individuals meeting the Institute’s highest standards and qualification requirements for ethical, professional and technical competence. The Chartered Banker Institute is the only body to able to award this designation. 3. A Chartered Banker is a highly-qualified, professional banker with a detailed knowledge of the modern banking industry, banking operations, and the ethical and professional requirements pertaining to banking. For an individual to become a Chartered Banker requires Masters-level study of modules in: (a) contemporary issues in banking, (b) credit & lending, and (c) risk management, plus a choice of elective modules in subjects including retail banking, corporate banking and private banking. All students must also complete a Masters- level module in Professional Ethics and Regulation. 4. Post qualification, all Chartered Bankers must satisfy the Institute’s Continuing Professional Development (CPD) requirements, including mandatory annual ethics refresher training, to continue to use the “Chartered Banker” designation. Chartered Bankers, and other qualified members of the Institute, are bound by a Code of Professional Conduct and may be “struck off” if they breach this, although the consequences of being “struck off” are not as serious as they are for regulated professionals such as doctors, teachers, etc where a Practicing Certificate or similar is required to continue to work in the industry. As a non-statutory body, the Institute lacks investigatory powers and often, therefore, may only act to discipline individuals following an investigation by a regulator or another competent body. 5. Independent, UK wide surveys conducted for the Institute in November and December 200999 show remarkable public resonance for the term “Chartered Banker”. 41% of retail customers said they would place more trust in a Chartered Banker to give them financial advice than other well-known designations. 57% of business decision-makers said they would rather be a customer of a bank where their Relationship Manager was a professionally qualified Chartered Banker. 6. In 2000, the Institute was the first professional body to introduce formal study of professional ethics for bankers. In addition to the Chartered Banker qualification, the Institute offers a wide range of lower-level professional banking qualifications, all of which involve study of professional ethics. Currently, there are more than 17,000 individuals holding a professional banking qualification from the Institute: — 4,000 Chartered Bankers — 6,500 individuals holding or studying for other professional qualifications and members of the Chartered Banker Institute 99 YouGov surveys carried out online among (a) 2011 GB adults aged 18+ (6–9 November 2009) and (b) 1,020 small business decision-makers (December 26–29, 2009). Data is weighted to be representative of the GB population. See Appendix 1 for further details. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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— 6,785 individuals holding lower-level professional qualifications not leading to membership of the Chartered Banker Institute In addition, over the past 3 years, a further 17,000 individuals have completed a training programme delivered by an employer, university, college or other training provider, and accredited by the Institute against our professional and qualifications standards. 7. As a Chartered, professional education body and a registered charity, the Institute has a duty to work in the public interest. An independent Council governs the Institute, comprising 13 qualified members currently working for UK banks, 9 other qualified members and 2 lay members. The Institute is committed to working with banks, policy makers, regulators and customer representatives to raise professional standards in the banking sector. The Institute is an FSA Accredited Body, working to raise professional standards for regulated retail financial advisers, but has a much wider remit working to raise professional standards in banking more broadly.

The Chartered Banker Professional Standards Board (CB:PSB)—established in 2011 to enhance and sustain professionalism in banking 8. In 2008, the Institute began work leading to the launch of the Chartered Banker Professional Standards Board (CB:PSB) in October 2011, drawing on the findings of the Future of Banking Commission and others. The CB:PSB is a voluntary initiative supported by nine leading banks in the UK100 (encompassing some 350,000 individuals working in UK banking—77% of the approximately 450,000 individuals working in UK banking in total) and the Chartered Banker Institute. The CB:PSB’s overall aim is to promote a culture of professionalism amongst individual bankers, by developing and implementing industry-wide professional standards which enshrine the very best ethical, professional and behavioral qualities. The CB:PSB is supported by an independent Advisory Panel comprising representatives of retail, business and corporate customers. 9. In October 2011, the CB:PSB published the Chartered Banker Code of Professional Conduct101 which sets out the ethical and professional attitudes and behaviours expected of bankers. Banks supporting the CB:PSB have agreed to subscribe to the Code and are in the process of implementing and embedding the Code’s principles in their organisations. At the same time, the CB:PSB published the Framework for Professional Standards, setting out how professional standards for bankers would be developed and implemented for the first time in the UK. 10. The Code will be supported by a series of professional standards, the first of which, the Foundation Standard for Professional Bankers102, was published on 2 July 2012. The Foundation Standard sets out how individuals working in the banking industry can develop and demonstrate that they have the knowledge and skills to perform their role, that they take responsibility for acting ethically and professionally and that they build relationships, based on honesty, integrity, fairness and respect. 11. The publication of the Code, Framework and Foundation Standard is not only a first for the CB:PSB but also a first for the UK banking industry. CB:PSB member banks have agreed, via a published Commitment to Professionalism in Banking103 signed by Chairmen and Chief Executives of CB:PSB member banks, to fund the work of the CB:PSB, to subscribe to the Code, and to implement the CB:PSB Professional Standards in their retail, commercial and wholesale UK operations. Significant progress in implementing the Foundation Standard, which is to be monitored by the Institute, is expected by June 2013. Further work to develop standards at an Advanced level, and for wholesale/investment banking, is currently underway.

Responses To Specific Questions 1. To what extent are professional standards in UK banking absent or defective? How does this compare to (a) other leading markets (b) other professions and (c) the historic experience of the UK and its place in global markets? 12. Professional standards in UK banking are not absent; they continue to be promulgated by the Chartered Banker Institute without any statutory or regulatory basis. The CB:PSB has, since its launch in October 2011, made significant progress in codifying professional standards for bankers, for the first time. 13. It would be fair to say that professional standards in banking have been deficient for some time, however. The number of qualified banking professionals has fallen substantially both as an absolute number and as a proportion of those employed in the industry over the past 25 years, a significant shift from the days in which all retail and commercial bank staff were expected to gain their banking qualifications in order to advance their career. In the 1980s, there were as many as 150,000 members of what was then the Chartered Institute of Bankers (CIB),104 and approximately 10,000 members of the Chartered Institute of Bankers in Scotland 100 Barclays, Clydesdale & Yorkshire Bank, HSBC, ING Direct UK, Lloyds Banking Group, RBS, Santander, Tesco Bank, Virgin Money 101 See Appendix 2 102 See Appendix 3 103 See Appendix 4 104 Now the IFS School of Finance, a degree-awarding institution. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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(CIOBS). CIB membership had fallen to no more than 22,000 by 2010,105 with CIOBS/Institute membership remaining relatively constant at 10,500106. It is clear, however, that of the approximately 450,000 individuals employed in UK banking today, only a small proportion are professionally qualified in banking and members of a recognized professional body for bankers. In particular, only a small proportion of senior bankers are members of a recognized professional body for bankers. 14. This is in contrast to many other professions, such as accountancy, law, teaching, medicine, etc where there is a statutory requirement to meet agreed professional standards and/or hold professional qualifications. This may be because many in the industry, plus policy-makers and regulators, ceased to view banking as a profession. In our view, banking is a profession: many interactions between banker and customer are characterized by an asymmetry of information in the bankers’ favour, bankers require specialized professional knowledge and skills, and there is a clear public interest in the successful and sustainable operation of the banking system. This view is supported by bank customers, 88% of whom believe that all bankers should take professional banking examinations.107 Almost three-quarters (73%) of British adults say that the availability of professionally qualified staff is either “very important” or “fairly important” to them when choosing a specific bank branch to visit.108 15. This does not necessarily mean that standards of ethical, professional and technical competence are completely absent from the banking industry, though. Many individuals working in banking are highly trained and do maintain high standards of personal and professional behaviour, but there has, until recently, been little encouragement for the majority to demonstrate this without individuals choosing to gain a professional qualification in banking and become a member of a professional body for bankers of their own volition, and often at their own cost. This is in contrast to most other professions, where membership is either a statutory requirement, or simply “expected” by customers and employers. 16. In addition, a significant proportion of individuals employed in the banking industry may be members of non-banking professional bodies and other organizations, including the Chartered Insurance Institute, Chartered Institute of Securities and Investments, CFA Institute, Chartered Accountancy bodies, etc—in part reflecting the increased specialization of banking in recent years. 17. We are pleased to report that in recent years—prompted in part by the banking crisis and in part by the Institute’s higher profile—the number of individuals studying professional banking qualifications with the Institute has increased substantially, from 600 in 2008–9 to more than 3,200 in 2011–12, albeit mostly at lower qualification levels. We have been particularly pleased to see the industry support for the Institute’s “Professional Banker Certificate”, launched in 2010 as an introductory professional banking qualification, and including study of professional ethics. To date, nearly 4,500 individuals employed in UK banking have gained this qualification. We anticipate numbers continuing to rise in future years, and hope to see (a) greater numbers qualifying as Chartered Bankers, and (b) more senior bankers seeking qualification. 18. Internationally, there is greater encouragement and support for the appropriate professional qualification of bankers than there has been in the UK in recent years. In 2011, the Institute conducted a survey of similar banking institutes overseas. Whilst the survey results are not complete—not all countries responded—it is clear that in general, internationally, and particularly in the European countries surveyed, there are far stricter and more comprehensive qualifications requirements for bankers, usually set and enforced by central banks and/or national regulators. At least nine European countries have mandatory national standards and/or qualification requirements for some or all bankers, and six European countries reported efforts to develop ethical and/or professional requirements for bankers. 19. Whilst achievement of professional qualifications is an important indicator of the health of professionalism in banking, greater take up of professional qualifications and membership of professional bodies does not, by itself, mean that professional standards or professionalism are present or have improved. Prior to the launch of the CB:PSB in October 2011 and publication of the Chartered Banker Code of Professional Conduct, and the CB:PSB’s Foundation Standard for Professional Bankers, there was no single set of agreed professional standards for banking in general109. Now that the CB:PSB has begun to codify these, a benchmark for the current level of professionalism and professional standards in UK banking can be established and, hopefully, improved on in years to come. This requires the adoption and implementation of the Chartered Banker Code of Professional Conduct and the CB:PSB’s Professional Standards on an industry- wide basis, encouraged and supported, if possible, by regulators. 20. We believe, therefore, that a revitalization of professional standards in banking is beginning, primarily driven by independent bodies such as the Chartered Banker Institute, and initiatives such as the CB:PSB. There is still a very long journey ahead, however. 105 Based on circulation figures for “Financial World”, the IFS magazine (2010). 106 This masks a fall in numbers in the 1990s and early 2000s, followed by a rise from 2006 onwards. There are a further 6,785 individuals holding professional banking qualifications not leading to membership. 107 YouGov survey carried out online among 2011 GB adults aged 18+. Data weighted to be representative of GB population. Fieldwork ran from 6–9 November 2009. See Appendix 1 108 YouGov survey carried out online among 2031GB adults aged 18+. Data is weighted to be representative of the GB population. Fieldwork ran from 10–13 September 2010. See Appendix 5 109 Except for qualifications requirements for groups of regulated individuals, such as mortgage advisers and, recently, the introduction of professional qualifications and CPD requirements for retail investment advisers. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 930 Parliamentary Commission on Banking Standards: Evidence

2. What have been the consequences of the above for (a) consumers, both retail and wholesale, and (b) the economy as a whole? 21. Trust in banks and bankers has fallen since the start of the financial crisis in 2007/8, although the crisis accelerated a decline in trust that was already evident, caused by the growth of a sales culture in banking (and associated mis-selling of products such as endowments and PPI) during the 1990s and 2000s. The report for the Question of Trust launch by Professor Christine Ennew, University of Nottingham,110 shows that customers do have greater confidence and trust in “their” banker (ie the individual bank employees they encounter) than in their bank, and greater confidence and trust in their bank than in the banking industry overall. 22. A YouGov survey conducted for the Institute in August 2012111 shows just how low levels of trust are today—only 26% of customers have some trust and confidence in individuals working in banking, banking institutions and the banking industry. A published survey of UK adults by YouGov, conducted as the news of the Libor fixing scandal became public, found that: — 85% thought behaviour of senior executives and bank bosses hadn’t improved; — 82% thought behaviour hadn’t improved since the banking crisis; — 60% didn’t trust high-street banks to look after their money; — 49% thought most main high-street banks were dishonest; and — 45% thought the main high-street bankers were incompetent.112 23. Professor Ennew’s report also shows that a feeling of “forced” trust, people purchasing financial services products because they have to, or feel they have to, has risen by almost 50% since the start of the financial crisis. The research also shows that customers who “actively” trust financial companies will hold more financial products than those they are forced into buying. 24. One notable consequence for consumers—and banks and their shareholders—of a deficit of professional standards and professionalism in banking—has been the significant sums paid out by the banks in consumer redress (estimated at some £20 billion over the past two decades). 25. The financial crisis itself cannot be blamed on the absence of professional standards alone—there were clearly many, well documented, causes including low capital adequacy ratios, unsustainable banking models as well as regulatory and oversight failures. A deficit of ethical and professional competence, however, may well have been a significant contributory factor. It is important, in our view, that the issue of professional standards and professionalism should not be seen only as an individual conduct issue. The lack of professional competence, and the lack of high levels of ethical professionalism at senior levels of the industry in particular can have systemic impacts too, impacting on overall financial stability.

3. What have been the consequences of any problems identiﬁed in question 1 for public trust and in, and expectations of, the banking sector? 26. See response to Question 2 above.

4. What caused any problems in banking standards identified in question 1? The Commission requests that respondents consider (a) the following general themes: — the culture of banking, including the incentivisation of risk-taking; — the impact of globalisation on standards and culture; — global regulatory arbitrage; — the impact of financial innovation on standards and culture; — the impact of technological developments on standards and culture; — corporate structure, including the relationship between retail and investment banking; — the level and effectiveness of competition in both retail and wholesale markets, domestically and internationally, and its effects; — taxation, including the differences in treatment of debt and equity; and — other themes not included above; and (b) weaknesses in the following somewhat more specific areas: — the role of shareholders, and particularly institutional shareholders; — creditor discipline and incentives; — corporate governance, including: — the role of non-executive directors; 110 “Trust and Retail Financial Services—A Report for the Question of Trust Campaign”: Prof. Christine Ennew, Financial Services Research Forum, University of Nottingham, 2012. 111 Provisional results from survey commissioned y Institute but not yet published. 112 Results from YouGov survey of 1,760 adults between 28–29 June 2012, summarized in “Chartered Banker” magazine August/ Sept 2012. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 931

— the compliance function; — internal audit and controls; and — remuneration incentives at all levels; — recruitment and retention; — arrangements for whistle-blowing; — external audit and accounting standards; — the regulatory and supervisory approach, culture and accountability; — the corporate legal framework and general criminal law; and — other areas not included above. 27. The Institute believes that the decline in standards and the substantial fall in the number of qualified banking professionals has largely been the result of: (a) the increasing career specialism of individuals employed in financial services and lack of demand for well qualified, experienced, generalist bankers with all round experience; 9b) a shift away from banking as a structured lifelong career; (c) changes in recruitment and onboarding practices; (d) recruitment of non-bankers (eg sales and marketing specialists) directly into senior roles; (e) increased use of technology (eg credit scoring) has reduced the need for highly-skilled qualified professionals exercising professional judgement; (f) a regulatory focus on firms, not individuals (both are required); (g) a “tick box” approach to regulation and compliance which devalued professional judgement at all levels, from judging the appropriate amount of capital to set aside to “Know Your Customer” rules; (h) lack of encouragement and support, until recently, for professional banking qualifications and membership of professional banking institutes from employers, regulators and policymakers; and (i) a general change in banking culture from stewardship to sales. In many cases, previous cultural banking norms of thrift, prudence and professionalism were no longer valued or inculcated from the top to the same extent as they had been in the past. 28. The drivers of these and other changes in banking culture do not come entirely from within the banking industry itself, however. Demands from the 1970s onwards for a more innovative banking industry, for an industry more responsive to its customers, and for greater shareholder returns, together with broader societal changes, led in part to the decline of a banking culture based on stewardship, thrift, prudence and professionalism.

5. What can and should be done to address any weaknesses identified? To what extent are such weaknesses subject to remedial corporate, regulatory or legislative action, domestically or internationally? 29. Rebuilding public confidence and trust in banks and bankers requires, in our view, the current extensive macro-prudential, prudential, structural and regulatory reforms to be supplemented by equally extensive cultural reforms to enhance and sustain a culture of customer-focused, ethical professionalism in the UK banking industry. Whilst there is some disquiet at the “lengthy” timetable for implementing the Independent Commission on Banking’s reforms, it will take longer still to fully reform the culture of banking, which in our view requires the further development and implementation of the CB:PSB’s Professional Standards across the banking industry at all levels, from the top down (from Chief Executive Officers to Customer Service Officers). A culture of professional competence, built around a Code of Professional Conduct and supported by detailed professional standards, needs to be developed. We need to rebuild the banking industry’s human capital in parallel with our efforts to rebuild banks’ financial capital. 30. We would like to see many more individuals—particularly those at senior levels in the banking industry— gain professional qualifications in banking and become active members of a professional body for bankers, bound by a Code of Professional Conduct and facing sanctions when this is breached. In particular, we believe that a significant increase in the number of Chartered Bankers in the UK would help rebuild public confidence and trust in banks and bankers, given the high levels of trust placed in the Chartered Banker designation by retail and business customers. For this to happen, greater support from employers for individuals to study for and maintain professional qualifications, and greater encouragement from regulators for professional qualifications and professional body membership are required. 31. As noted above, strong industry support for the CB:PSB’s Professional Standards already exists, and there is considerable work ongoing in the CB:PSB’s member banks to implement the Foundation Standard for Professional Bankers. There has also been a significant increase in the number of individuals gaining professional banking qualifications, or following a banking training programme accredited by the Institute in recent years. We believe, therefore, that we can state with some confidence that the re-professionalization of banking is beginning to take place, but we also understand that it will take some time until the numbers of cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 932 Parliamentary Commission on Banking Standards: Evidence

individuals meeting the CB:PSB’s Professional Standards and/or holding professional banking qualifications are sufficient to make an appreciable difference to customers and the general public. 32. The cultural change required cannot be regulated for, although regulators and policy-makers can do much to encourage, support and “nudge” it forwards. The change in attitudes, values and behaviours required must come from and with the positive support of the industry itself if it is to be sustainable, and we believe that the CB:PSB provides a good example of the banking industry doing this. The banking industry continues, in our view, to have the key role in developing the CB:PSB initiative further. 33. In particular, the industry, supported by regulators and policy-makers, could accelerate the implementation of professional standards by building on the work of the Institute and CB:PSB by: — Ensuring greater numbers of bankers in senior, and key customer-facing and customer-supporting roles meet agreed professional standards; — Encouraging senior executives, and other key individuals within banks, to hold relevant, Chartered level, professional banking qualifications; — Encouraging and supporting greater numbers of bankers in key customer-facing and customer- supporting roles to achieve relevant professional banking qualifications; — Encouraging employers to require senior executives, other key individuals within banks, and bankers in key senior, customer-facing and customer-supporting roles to be members of a professional body for bankers (with the possibility of being “struck off” for misconduct); — Working more closely with professional bodies in banking to investigate potential misconduct cases; and — Seeking evidence of an individual’s positive commitment to and promotion of professionalism in banking when considering their suitability for Significant Influence Functions and other key roles.

6. Are the changes already proposed by (a) the Government, (b) regulators and (c) the industry sufficient? Respondents may wish to refer to the Financial Services Bill and the Government’s proposals for the Banking Reform Bill. They may also wish to refer to proposals by the Bank of England and the Financial Services Authority on how the Financial Policy Committee, Prudential Regulation Authority and Financial Conduct Authority will operate in practice. 34. As alluded to above, proposals in the Financial Services and Banking Reform Bills will not, by themselves, promote the extensive cultural change required in banking. This needs to come from extensive changes promoted from within the industry itself, encouraged and supported by regulators and others. In this context, we believe in particular that the work of the CB:PSB will help, over time, to enhance and sustain the customer-focused, ethical professionalism in banking that customers, colleagues, regulators, shareholders and policy-makers quite rightly expect. Over time, the number of individuals meeting the CB:PSB’s Professional Standards and/or holding professional banking qualifications will grow to an extent that will make an appreciable difference to customers and the general public. We are only beginning this journey as an industry, however. 35. In its first year of operation, the CB:PSB has published the Chartered Banker Code of Professional Conduct (subscribed to by CB:PSB member banks), a Framework for Professional Standards and the Foundation Standard for Professional Bankers, which is currently being implemented by CB:PSB members. These provide a foundation for considerable further work, including further standards development. 36. We believe that the CB:PSB and the CB:PSB’s Professional Standards provide a solid and sustainable platform on which to rebuild the culture of the banking industry around a set of customer-focused, cultural norms. Together with the macro-prudential, prudential, structural, regulatory and other reforms being implemented, we believe they can help rebuild customer trust and confidence in banks and bankers, as well as pride in the banking profession itself. The lead time to establish an initiative such as the CB:PSB is not insignificant and we would encourage the Commission to support its further development and endorsement by government and regulators rather than start another, similar initiative.

7. What other matters should the Commission take into account? 37. No comments Annexes available on request: Chartered Banker Survey, This is the “gold standard” customers really want, Feb/March 2010 Chartered Banker Professional Standard Board, Chartered Banker Code of Professional Conduct, Oct 2011 Chartered Banker Professional Standard Board, Foundation Standard for Professional Bankers, July 2102 Chartered Banker Professional Standard Board, Our Commitment to Professionalism in Banking, Oct 2011 28 August 2012 cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 933

Written evidence from the Chartered Institute of Personnel and Development Background 1. The CIPD represents the HR profession and is the leading independent voice on workplace performance and skills. Our primary purpose is to improve the standard of people management and development across the economy and help our individual members do a better job for themselves and their organisations. 2. Public policy at the CIPD exists to inform and shape debate, government policy and legislation in order to enable higher performance at work and better pathways into work for those seeking employment. Our views are informed by evidence from 135,000 members responsible for the recruitment, management and development of a large proportion of the UK workforce. 3. Our membership base is wide, with 60% of our members working in private sector services and manufacturing, 33% working in the public sector and 7% in the not-for-proﬁt sector. In addition, 76% of the FTSE 100 companies have CIPD members at director level. We draw on our extensive research and the expertise and experience of our members on the front-line to highlight and promote new and best practice and produce practical guidance for the beneﬁt of employers, employees and policy makers.

General Comments 4. Recent events in UK banking have profoundly destabilised public confidence in the sector. The behaviour of bank bosses and senior employees of financial institutions has been roundly condemned, with the Treasury Select Committee’s recent report on LIBOR branding recent behaviour “disgraceful”. We agree with this assessment but stress that the problem extends beyond particular individuals or institutions: — Recent events in UK banking have generated significant criticism from many quarters, but CIPD research points to a breakdown in workplace trust preceding the financial crisis and existing across most industry and public service sectors. — These events have highlighted to many that failures in the system are as much, if not more, due to leadership and what had become acceptable corporate behaviours and cultural values, as they are due to the regulatory framework. — It is not possible to legislate for culture change, but it is important that better codes of practice, better leadership development and definitions of corporate values that employees at all levels can be held accountable to are promoted and strongly encouraged. — The HR function has a critical job to do in this respect as the function responsible for understanding corporate cultures and leadership behaviours, and promoting the practices and interventions required to change corporate culture over time. — It is also critical that HR leaders have the insight and ability to educate and where necessary to stand up to the leaders of the business in challenging behaviours that are out of step with espoused values. 5. It is apparent that there is already some consensus for change and action among the banking community and beyond to achieve a decisive shift in behaviours and values, but this will take time. The Lord Mayor’s “Restoring trust in the City” initiative and the set up of the City Values Forum is evidence of a wider interest in encouraging organisations to operate to a higher standard, incorporating performance against values and behaviours alongside the financial considerations. Solutions to this problem will require efforts from a range of stakeholders including regulatory bodies, professional institutions in the sector, business leaders, HR and behavioural experts, together with government: — Government and the financial service regulators must ensure that there are structures in place to facilitate a more sustainable business environment, by encouraging businesses to report on human capital metrics and holding financial institutions to account by shining a light on both best practice and wrongdoing. — Businesses and business leaders must aspire to higher standards in their operations, by consistently demonstrating the right values in their own behaviours, communications, and actions, and by utilising their HR teams to understand and reinforce the leadership development and people management processes necessary to sustain the right corporate cultures aligned with their business strategy. — The professional institutions in the financial services sector such as the Chartered Banker Institute, the BBA, the Chartered Institute for Securities and Investment, and the City HR Association should all play a part in setting standards of behaviours or codes of practice, working with other relevant bodies including academics with deep understanding of behavioural change. We now turn to address the specific questions outlined in the terms of reference.

Question 1: To what extent are professional standards in UK banking absent or defective? How does this compare to other leading markets, other professions and the historic experience of the UK and its place in global markets? 6. The term “professional standards” can be understood in two ways: ﬁrstly, as tangible professional standards as they relate to speciﬁc technical competencies and skills; and secondly, as they relate to standards cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 934 Parliamentary Commission on Banking Standards: Evidence

of behaviour and practice. Both can be said to have been somewhat absent or deficient in UK banking in recent times, but it is important to differentiate between the two; because whilst the former relates to something tangible that is either present or absent at a particular time, the latter relates to the “culture” of an organisation or sector, which is more deeply ingrained and shapes its outlook, operations and interactions. 7. “Culture”, for these purposes, may be understood as a set of collective behaviours, attitudes and assumptions that shape the way an organisation operates, and how it is perceived both internally (by its staff) and externally (by its clients and the public). The CIPD does not believe it is possible to legislate for culture change. We agree with Sir David Walker’s assertion, that behavioural change is needed and that this is unlikely to be achieved through legislation. It is more likely to be accomplished through clear identification of best practice and non-statutory routes. 8. The destructive culture evident in some banking organisations results from: — A singular focus on financial gain and business growth, with a tacit if not explicit disregard for how that growth is achieved thereby setting a tone within the organisation that can encourage rule-bending and dysfunctional behaviours in pursuit of high personal and collective rewards. — Disproportionate risk and reward, where high levels of reward outweigh understanding or perception of risk by individuals or groups. This issue has been present for a long time and continues to grow. — A lack of focus or understanding by organisations about their people, their behaviours, and the emergent corporate cultures that have been at the heart of the current problems. Almost all financial institutions espouse corporate values that include integrity, but without clear definition and accountability, it carries little weight in influencing behaviours. Performance management practices that take little account of behaviours vs results, and leadership that is not consistent in reinforcing the right behaviours, and doesn’t listen to or take action on wrong behaviours, all are part of creating an inappropriate culture. 9. Traditionally, the corporate culture in the UK and how it is perceived around the world has always stood as a high standard for ethical business practices. In our research work on trust and corporate values, this has consistently been observable, but there is now a recognised diminution in the perceptions of behaviours in the UK banking sector. Surveys on trust such as the Edelman Trustbarometer show declining trust and belief in all types of businesses doing the right thing. This has been impacted by behaviours of all kinds of leaders in all kinds of sectors. Against that context, the route back to higher levels of trust in the banking sector is much harder. 10. However, there are many examples of positive corporate role models in how values are expressed, purpose is clear and understood to be more than just enriching the corporate stakeholders, and leaders are held accountable at all levels for properly representing the values and expected behaviours. These provide positive case studies of what can be accomplished, but cultural shift can only start from the top and it is ultimately the top corporate officers who have to be held responsible for the cultures that exist in their businesses. 11. As the representative body for the HR profession, we aim to develop standards and insights on best practices and to disseminate these through HR practitioners who develop and enable the processes and practices that reinforce corporate cultures. We encourage codes of practice and behavioural standards in the HR profession itself through both our Profession Map and our Code of Conduct. In this vein, we are working together with and welcome the work of the Chartered Banker Institute and the City Values Forum in developing a set of professional behavioural standards for those working in financial institutions. Articulating, disseminating and driving best practice will be vital in achieving sustainable change for the better, and professional standards and codes of conduct have a key role to play in this.

Question 4: What caused any problems in banking standards identified in Question 1? Culture 12. The CIPD believes that the underlying factor contributing to the problem in banking standards is one of culture, where excessive focus on financial gain has often come at the expense of a more sustainable, responsible business outlook. This culture can be most identified in the investment and commercial banking operations, but there is also evidence of a “bleed” across into retail banking arms for example in the inappropriate selling of mortgages and other financial products. 13. This emergent culture is due on the one hand to a loss of sight of core purpose—an intensive focus on making money for the institution and its shareholders without an adequate alignment to a broader social and economic purpose. Perception of an organisation’s purpose directly affects the way its staff behave—if employees see the purpose of their company, and their own role, as only to generate profit, then this is what they will aspire to achieve. It also serves to incentivise risk-taking among employees seeking huge financial rewards and recognition as “top talent”. 14. This culture has gone unchecked for so long as to become accepted as “conventional wisdom”, with the attitude that this cannot and will not change—which is attributable in part to the lack of influence and focus of the HR function in these institutions. Organisations need to re-evaluate their purpose—placing importance on the social value of what they do, as well as the financial—and re-considering their duty to their stakeholders, cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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not just their shareholders. This purpose, and corresponding values, must be clearly articulated to employees, who in turn must be engaged and committed to these. There must be channels for employee voice and staff should feel able and supported to challenge wrongdoing when they witness it.

Remuneration 15. Remuneration practices based on incentives to keep so-called “top talent” have established disproportionate financial rewards in critical areas of the banking sector which have not only led to rewards for failure, but have incentivised the sort of behaviours that led to the financial crisis and have damaged trust in the financial system. Furthermore, the way that remuneration practices are devised and implemented have further entrenched the problem. Risks relating to reward have not been adequately assessed or managed, and many organisations have reported difficulties with the implementation of their reward practices. 16. This high remuneration culture in specific areas of the banking sector have become systemic to the point where individual institutions are extremely fearful of changing their practices or policies for fear of losing their people. Tackling this issue would likely require stronger regulation or intervention unless voluntary alignment across the sector could be achieved. 17. CIPD research exploring reward professionals’ approach to remuneration shows that the majority of organisations prefer pay confidentiality to transparency. In addition, many organisations have difficulty linking remuneration strategy to their overall business strategy, and communicating performance standards to their employees. The good news is that some organisations are aware of these problems and are taking steps to address them—69% of organisations we surveyed reported being prepared to manage reward-related risks in the future. However, more needs to be done by individual organisations and the sector as a whole.

Recruitment and retention 18. A further consequence of the perception of the banking industry has been the effect this has had on recruitment and retention. A somewhat self-reinforcing, monolithic working culture has been created, with the same types of people recruited time and again. This is due in part to the low value that has been placed on diversity throughout the sector as a whole, and in part to “self-deselection” from the recruitment process by those who either believe that they do not possess the characteristics required to succeed in the sector, or feel that it is not for them. The consequence of this is the reinforcement of “groupthink” that results from lack of diversity and diverse ways of thinking and approaching problems. 19. Lack of diversity in recruitment is reinforced by rewarding the same behaviours and personality types based on delivery of ﬁnancial performance above all, and leads to lack of diversity up through the organisation. This is manifested for example in the relative lack of women in mid to senior levels of the banking sector.

Performance management 20. Good management is crucial to the success of any organisation. The way people are managed, their skills utilised and how they are driven to succeed has a great impact on behaviours and business outcomes. However, when it comes to management capability, the UK lags behind its key international competitors in implementing good practice. This is no less true when it comes to banking. Too little attention and resources are focused on development of good leadership and people management skills, and this has to be addressed as part of the solution. Behavioural codes of practice, proper alignment to good corporate values, must be reinforced through measurement and holding people accountable. 21. CIPD research has highlighted that firms with a more qualified management workforce and dedicated programmes of management development perform better—this is not only a question of treating employees well. Banks and financial institutions must pay greater attention to the people management skills and leadership capabilities of their managers, and invest in training and skills development in this area, to build the foundation for lasting sustainable business activity.

Question 5: What can and should be done to address any weaknesses identiﬁed? To what extent are such weaknesses subject to remedial corporate, regulatory or legislative action, domestically or internationally? 22. We reiterate that we do not believe it is possible to legislate for culture change, but that it is possible to identify good practices, to encourage investment in the embedding of these practices, and to enhance human capital measurement and reporting to hold corporate leaders more accountable. Culture change must start from the top.

Government and regulatory authorities 23. It is not the role of government or regulators to tell CEOs how to manage and reward their people, but they can challenge and insist on the implementation of better standards of practice. A key task will be to continue to hold banks and ﬁnancial institutions to account by shining a light onto both best practice and wrongdoing. It will also be important, in the interest of securing sustainable business practice, to enable frameworks that facilitate a more sustainable business environment. The Employee Engagement Task Force cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 936 Parliamentary Commission on Banking Standards: Evidence

was a welcome step in the right direction—the challenge now is to ensure that the thinking behind it is sustainable and that it is translated into action.

24. Encouraging or requiring more consistent reporting of organisational and human capital metrics that provide more visibility on how an organisation is focusing on its people and understanding cultural and organisational dynamics would be a signiﬁcant way of reinforcing change. In the CIPD’s view, the Revised Guidance for Directors on the Financial Reporting Council’s combined code (UK Corporate Governance Code) should be updated to highlight the importance of effective public reporting of Human Capital Management (HCM) metrics. HCM information can show how an organisation recruits, develops, rewards and manages its people, its leadership pipelines and capabilities, and aspects of culture and workforce engagement, and how this underpins sustainable, rather than short-term organisation performance. Investors with better information on the importance of HCM to long-term shareholder return are more likely to ask critical questions of business leaders and put a premium on best practice.

Business leaders and Corporate Governance

25. Business leaders must acknowledge their vital role in driving behaviours and culture, and seek to understand the cultures and norms that have emerged in their businesses. Externally, there is a need to develop a stronger sense of their purpose and wider appreciation of their stakeholders. Internally, working through their HR functions they should devise and implement effective and consistent management and leadership practices that embody the right values and behaviours.

26. Boards must also demand more understanding and information on the organisational and cultural dynamics and behavioural norms, backed up by better human capital metrics. Experience of positive business cultures and how to manage cultural change should be sought out in Board members who can ask the right questions and challenge the corporate management.

27. Evaluation, reward and selection of corporate ofﬁcers through the Board and the Board sub-committees should pay much closer attention to behavioural styles and understanding, and it is critical to ensure that the necessary experience exists on Boards to make these judgements.

28. Leaders and Boards must continue to address the problem of excessive and misaligned remuneration practices. These must be re-examined in light of the organisation’s values and sense of purpose and properly aligned with these. CIPD employer guidance on managing reward and its associated risks is available from our website. Although problems with remuneration have become entrenched over time and will be difﬁcult to change, things can change, if there is a concerted and deliberate effort on the part of organisations to “move as one” and act together.

29. Finally, it is crucial, in banks as for any organisation, to ensure that there are proper channels in place for employee engagement and employee voice, and that this is visible to senior leadership. A healthy workplace culture must allow, and indeed encourage, challenge and criticism—particularly where this relates to irresponsible practices or wrongdoing. Some businesses already include consideration of these issues in their company reports—other businesses might wish to consider doing this as well. Government may or may not wish to legislate on this in due course.

HR practices and the HR function

30. The HR profession also has a vital role to play in driving and sustaining good corporate governance, including risk management, remuneration, recruitment, retention and employee voice. The role and capabilities of HR needs greater attention from businesses, which has historically been lacking. Businesses and business leaders often get the HR they deserve by the value and attention they place on it. HR needs to be held to account in understanding and enabling the development of good corporate culture, and will need to respond in ensuring it can conﬁdently express this in business risk and value terms.

31. As the representative body for the HR profession, the CIPD will continue to encourage and drive innovation and best practice through our membership, holding the profession to account and supporting our members to become the business-savvy, insight driven professionals modern organisations need.

32. We are working with the City Values Forum, the Chartered Banker Institute and the City HR Association to promote professional standards in the City. We support the Chartered Banker Institute’s Foundation Standard for Professional Bankers and hope that organisations subscribing to the Standard will be held to account for their performance.

33. Crucially, if these things can be done right in banking, where they have been deemed to be at their most serious and difﬁcult to address, then there is the potential to drive good and sustainable practice and competitive advantage across a wider range of business sectors. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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References Chartered Institute of Personnel and Development, Code of professional conduct, July 2012. Chartered Institute of Personnel and Development, Good management: A new (old) driver for growth?, October 2011. Chartered Institute of Personnel and Development, Human capital management: Introducing and operating human capital management processes, September 2008. Chartered Institute of Personnel and Development, Managing reward risks: An integrated approach, October 2009. Chartered Institute of Personnel and Development, Reward Management, May 2012. Chartered Institute of Personnel and Development, Reward risks, November 2011. Chartered Institute of Personnel and Development, View from the City: How can human capital management and reporting inform investment decisions?, November 2010. Chartered Institute of Personnel and Development, Where has all the trust gone?, March 2012. 28 August 2012

Written evidence from the Chartered Institute for Securities & Investment The Chartered Institute for Securities & Investment (CISI) is the leading professional body for securities and investment professionals. It is a not for proﬁt organisation devoted entirely to raising standards of professionalism in the sector through a focus on individual practitioners and aspiring practitioners. Its three core aims are: to establish entry standards and initial competence; to maintain competence (continuing professional development); and to build trust in ﬁnancial services.

Executive Summary The banking industry has suffered serious ethical failures in both the retail and wholesale areas, but even costly failures in wholesale standards ultimately affect the retail customer, who is always at the end of any transactional chain. Consequently, we all pay. Accepted professional standards of academic achievement, professional competence, ethical behaviour and continuing professional development (CPD) are not a requirement of any part of the banking industry, except where they have been introduced recently (effective 1 January 2013) for practitioners providing investment advice to retail customers. There seems no defensible reason why similar standards should not be mandated across the industry. Two specific recommendations which we make are that: (1) All new products introduced by banks should be subject to a review process for ethical compliance, using a “traffic light” scoring system; and (2) Banks should have an Ethics Committee, reporting to the Board, which will review and monitor the firm’s compliance with, and adherence to, its own published standards of ethics and integrity. We do not argue that these on their own provide a complete panacea, but they do go a long way towards ensuring that an industry which likes to think of itself as a profession is forced to behave like one.

Background We believe that a root cause of many of the problems displayed by banks was a change in culture, coupled with a devaluing of professional standards. The retail banking industry turned itself into a marketing operation with the adoption of a target-driven culture, emphasising product sales at the expense of customer service. The wholesale banking industry imported a lottery level bonus culture, without adequate consideration of the potential consequences, whilst strong barriers to entry prevented new corporate competitors entering the market and driving down super normal proﬁts and pay. These changes were compounded by advances in technology which changed the culture from face to face interaction, exempliﬁed by the motto ‘my word is my bond’ to one that became remote from the end user of investment: the individual consumer. Ultimately, the consumer is the end user of wholesale as well as retail transactions. This meant that there should have been a strong focus on individual professionalism to mitigate the risks presented by massive growth, increasingly complex instruments and short term transactional remuneration, but instead the ‘light touch’ regulatory regime was also applied to requirements of professionalism. These cultural changes, with the emphasis on short-termism, have left numerous wrecks, ranging from split capital trust, precipice bonds, PPI and LIBOR, to international money laundering. The culmination of almost cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 938 Parliamentary Commission on Banking Standards: Evidence

continuous public censure has so corroded trust in banks and banking that every subsequently publicised “wrongdoing” is assumed to be the result of deliberate action, both individual and corporate, driven by greed. As a result, the news of huge fines imposed by regulators even generates a kind of perverse satisfaction that banks (and bankers) are simply getting their just desserts, forgetting that once again, it is the consumer who bears the ultimate cost. The fundamental question is: what, if anything, can be done to change this seemingly irreversible negative view? Is there something that the industry itself can do, or are we reliant on the “dead hand of regulation”? We believe that an important part of the answer is that banking has to decide whether it is a profession or a trade. If it believes it is a profession, then it has to behave like one and accept or adopt the generally recognised requirements of a profession, based on four core standards: (1) Entry standards which cover academic standards and objective, relevant examinations; (2) Ethical standards both on entry and throughout one’s career; (3) Continuing professional development (CPD); and (4) Recognition that a licence to practice as a professional must be withdrawn in the event of failure to keep to the standards set. This can be achieved through a multi-faceted approach, which would see action taken by individual firms and professional bodies working with the education providers, as well as the employing firms, backed by regulation, in a major drive to raise standards, particularly of ethical behaviour. Professional bodies have demonstrated that they have a valuable role to play in providing an ethical framework of training and setting standards for individual behaviour, which does not contain any corporate bias. This has been acknowledged by the FSA when framing the requirements of the Retail Distribution Review (RDR), which has established a mandatory set of professionalism requirements. Its continued reluctance to establish similar levels of professionalism more broadly across the industry is a surprising and ultimately indefensible stance. In terms of public acceptability, there needs to be a visible application of penal sanctions for significant failures. These sanctions should encompass the whole range of possibilities, from substantial financial penalties and/or banning from any industry involvement, to custodial sentences for serious wrongdoers. One might ask why, if this can be an outcome of the Bribery Act, similar sanctions cannot be a part of any Financial Services Act, since the outcome of financial wrongdoing can be systemically destructive. Highlights of our suggestions (set out in answer to Question 5) include the point that banks should create an Ethics Committee responsible for ensuring that the bank’s policies and procedures contain an ethical dimension (to act with honesty, openness, transparency and fairness), and that these are followed in practice. To this end, the majority of its members would be from outside the bank and the Board (which has other duties, as well as ethics). The Committee would: (a) Input into the bank’s remuneration strategy; (b) Produce an annual report to the Board (to whom it reports); and (c) Have the power to call for any information it requires to fulfil its duties.

1. To what extent are professional standards in UK banking absent or defective? There are structural deficiencies, but there are also examples of ‘best practice’ both by corporate financial institutions and by individuals working in firms. The recent series of revelations about UK banking (PPI and LIBOR) shows that some parts of it have clearly fallen below acceptable minimum professional standards— although both these recent problems occurred some years earlier, while other parts of the industry eg infrastructure finance, have continued on a sound footing. This failure may, at first glance, be surprising given that there is no shortage of Codes of Conduct in financial services—the Lord Mayor’s “Restoring Trust in the City” initiative found more than 50 codes, but it is one thing to have a code and quite another to monitor and measure the extent to which any person follows it with a professional pride that goes beyond cursory compliance. The fundamental problems are that: (1) Some individuals exist in isolation and do not understand the impact of their actions outside the bank (or even their department), a trend reinforced by technology limiting human contact; (2) Senior management does not do enough to promote adherence to such codes; and (3) Individuals feel they are rewarded more for short term financial results than for intangible factors, such as putting the customer first. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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Professional standards are being formalised in the retail sector (through the RDR) and will be in place from 1 January 2013. However, no such standards are planned for the wholesale sector by the UK regulator. The table below illustrates the difference between the two sides of the industry. Area Wholesale Retail (from 1 January 2013) Qualifications (Entry None needed. Used to be required, but it Mandatory requirement raised from standards) is now the responsibility of the CEO to Level 3 (roughly A level) to Level 4 satisfy the FSA that staff are competent. (first year degree) from January 2013. Those who do take exams take them at Level 3 (roughly similar to A levels). Continuing Professional None specified, apart from the Highly specified: 35 hours per year, of Development requirement for staff to be competent. which at least 21 hours need to be structured. Regular audits by professional body. Code of Conduct General overarching rules. Specific sign-up to Codes of Conduct of approved professional bodies, with the sanction of ejection for serious breach. Membership of a Not required. In effect, a requirement. Professional Body

1b. Comparison with other professions Banking is split. The wholesale side of the business has fewer professional standards than many other professions. It has no mandatory qualiﬁcations, no integrity requirements, and membership of a professional body with its Code of Conduct and CPD requirements is voluntary. This compares with solicitors, accountants, barristers, doctors and shortly, the retail investment advice sector, where the RDR has addressed exactly these issues. See detailed points on professionalism in Question 4.

1c. The historic experience of the UK and its place in global markets Historically, many retail bank staff were qualified and members of a professional body. The qualifications were wide-ranging and included such subjects as law relating to banking, finance of international trade and practice of banking. After 1986 (the ‘Big Bang’) this started to change, and qualifications increasingly focused upon the sales of products to customers. However, in those firms associated with stock broking, the legacy of high level qualifications continued as a matter of professional pride and competitive edge, linked to the historic legacy of the London Stock Exchange motto ‘my word is my bond’, so that two tiers of professionalism have existed within retail. So there are now mandatory qualifications in giving financial advice, mortgage advice and insurance, as well as in banking conduct (eg complaints handling, treating customers fairly). Some banks selling PPI 10 years ago published internal ‘score cards’ or ‘name and shame’ lists of the percentage of ‘penetration’ of PPI when providing credit. The approach to staff and customers was “Why would you not want to buy PPI insurance for the loan”? The culture of retail branch staff encouraged competition to sell products such as PPI, precipice bonds, endowment mortgages and structured products including interest rate swaps to business customers, to meet their short term internal targets, rather than to consider whether these products were actually suitable for their customers. As Martin Wheatley has said “This has been a sorry episode for many of us [total compensation has been estimated at £8 billion], but it is important that we all continue to deliver what is fair for consumers, and learn from the experience”.

2a. What have been the consequences for consumers? Both retail and wholesale customers have suffered and this has led to a breakdown of trust in banks.

3. What have been the consequences of any problems identiﬁed in Question 1 for public trust in, and expectations of, the banking sector? The 2011 annual Edelman Trust Barometer graphically demonstrates the huge loss of trust suffered by the banking industry in the UK between 2008 and 2011 (from 46% of the public who, in 2008, considered that banks could be trusted to do what is right, to 16% in 2011), and this was before the latest problems. This compares with a rating of 51% across 23 other countries. See Appendix A. The practical consequences of this include a greater reluctance by individuals to deal with ﬁnancial organisations for essential services, such as saving for a pension. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 940 Parliamentary Commission on Banking Standards: Evidence

4. What caused any problems in banking standards identified in Question 1? The Commission requests that respondents consider (a) the following general themes [only relevant ones to professionalism selected]. The culture of banking, including the incentivisation of risk-taking After the Big Bang in 1986, there was a gradual cultural shift in investment banking. To quote the FT of July 7 2012, “As trading profits in securities and derivatives rose inexorably in buoyant markets, the power of the traders rose in their organizations at the expense of the more staid corporate financiers. The individualistic, bonus-driven ethos of the trading floor permeated institutions in which the idea of fiduciary obligation to customers was ebbing away.” We have a clear view on risk-taking and remuneration, particularly of bonuses. We support the concept of paying people an element of remuneration in recognition of achievements that are over and above what would normally be expected and/or a legitimate share in the profits of their organisations. However, the amount and method of payment should be subject to certain factors, such as co-operation with others, compliance with procedures and training of others, which should be relevant as well as profit; and that a bonus should take into account the contribution of the team/division and the overall performance of the firm/company, as well as that of the individual. The huge difference in bonuses between investment and retail bankers is bad for the industry, for their firms and for society. For example in 2011 the average pay, including bonus, of investment bankers at Goldman Sachs was £157k ($235,787), JPMorgan was £123k ($184,589) and Morgan Stanley was £92k ($137,548). In contrast, Lloyds Bank employees (mainly corporate and retail banking) in 2011 had an average salary of £20k and enjoyed an average bonus of just £3,900. The simple answer is in the quotation above—investment banking can be much more profitable, and prudential requirements make high barriers to new entrants. The influence of Wall Street with its fast paced technologically-led activities has provided a shock to the service-focused retail industry, whose individuals were believed to embody concepts of service and stewardship of the resources entrusted to them.

Other themes not included in the stated questions: The neglect of professionalism in banking There is now no doubt that banking must become a profession, but it has a considerable way to go demonstrate that it meets the professional standards identiﬁed by the Professional Associations Research Network (PARN) in research undertaken for the FSA in 2009. PARN found three core pillars of professionalism: (1) Entry standards, complaints and discipline; (2) Continuous learning; and (3) Ethical behaviour. Applying these criteria to banking reveals: (a) There is no minimum entry requirement (except for the small category of retail investment advisers covered by the RDR); (b) A complaints procedure (but this is restricted to consumers and some small businesses); (c) Discipline by the FSA (very limited, since most banking staff are not Approved Persons subject to FSA discipline); (d) No CPD requirement (except for retail investment advisers); (e) Some support for ethics in the FSA’s Approved Persons Principles (but again, limited to Approved Persons and with a systems and controls focus); and (f) Comparatively low academic standards, lack of penetration in mainstream degree courses to encourage professionalism prior to entry to employment. So, much remains to be done in a sensible and proportionate manner.

The regulatory and supervisory approach, culture and accountability The Regulatory and Supervisory approach The FSA or the FCA should adopt a high visibility deterrence policy against individuals, including senior management, in firms which are disciplined—otherwise only shareholders (and arguably customers) pay the fines. It is surprising how many banks are fined millions of pounds, but how few individuals who took the decisions are. For example not a single person has been disciplined by a regulator for PPI failures, or for institutional money laundering (where major banks have been fined many millions of pounds for failures to prevent it), or for data protection (where firms’ procedures have clearly not been followed). It is only in market abuse cases and in fraudulent trading where individuals regularly are disciplined. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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5. What can be done to address any weaknesses identified? To what extent are such weaknesses subject to remedial corporate, regulatory or legislative action, domestically or internationally? We have a number of proposals for the Commission. We would be happy to expand upon these in giving oral or written evidence. Individual Professionalism “….and any poor practice which unreasonably shifts income to the (wholesale) industry is at the expense of some end retail customer. There are no free lunches, and shoddy wholesale practice is not a victimless act, even in those cases where it is not defined as a crime….” Lord Turner at the FSA’s Annual General Meeting in 2012 In summary, we believe that the recent professionalism changes introduced to the retail advice sector should and could be applied right across the spectrum. This recommendation is especially poignant since the industry itself, via its trade bodies, opposed the decision of the regulator to abandon mandatory examinations in the wholesale advice part of the industry. The retail advice part of the industry is about to implement comprehensive and rigorous standards that could be replicated very cost effectively in the wholesale area: the thinking and infrastructure has already been put in place for retail, so why not apply it right across the sector? (a) Code of Conduct We think it essential that everyone in the banking sector (wholesale and retail) should subscribe to an approved Code of Conduct. A Code of Conduct without enforcement is ineffective; hence in the RDR there is an MoU between a number of accredited professional bodies and the regulator, with a duty on those professional bodies actively to enforce adherence by their members to an approved code, with the sanction that failure to do so could lead to suspension or expulsion of the member from the industry. This would go a long way in making individuals responsible for their actions. (b) Ethics Training and Testing Ethics training and testing can and should be undertaken, linked to scenarios based on genuine dilemmas faced by practitioners. More than 6,000 of our professional members have taken our online integrity test, which is designed for finance professionals, by finance professionals. The test uses a series of relevant scenarios with multiple steps and pathways, giving several opportunities for the individual to make the right decision if their initial one was inadequate or wrong. We have also delivered training seminars and workshops allied to this test in over 20 countries, to students and professionals, from a wide variety of backgrounds. We propose that all banking employees, including senior management, should be trained and tested and be subject to regular refresher training. Additionally and ideally, an ethics test should be required prior to entry to the sector, which is something this Institute is actively planning to introduce in support of a greater visible commitment to ethics for the graduate recruit intake of major banks. (c) Qualifications and Continuous Professional Development (CPD) As mentioned earlier in the ‘Neglect of Professionalism’ we believe that there needs to be mandatory appropriate entry qualifications and CPD in banking (both wholesale and retail) if banking is to be a profession. It is surprising that individuals who may routinely handle large sums of money may be unqualified, when private wealth managers who generally handle rather smaller sums, have to possess specific mandatory qualifications. Competence is made up of knowledge, skills and behaviour (ethics). Qualifications can cover the first and third element—indeed the FSA has mandated knowledge and ethics for qualification curriculums as part of its RDR programme to raise behavioural standards in the retail investment advice sector. This is why our retail exams contain 20% of content which focuses on standards of ethical behaviour. Why should not all individuals entering the wholesale banking industry take an ethics test as part of overall entry qualifications? This would not only restore the mandatory qualifications position in force before the FSA abolished it for the wholesale sector (in 2007, under its ‘light touch’ approach), but would also ensure that professional staff understand how their roles and responsibilities in the banking industry impact upon society. We also suggest that everyone in the sector needs to maintain their competence through actively undertaking and recording relevant regular CPD. We recommend that the Committee considers applying the same criteria to wholesale banking as will be the standard in some parts of the retail industry and for all individuals to hold a statement of professional standing (SPS), linked to compliance with a Code of Conduct and completion of CPD. It is disappointing that the FSA and the FCA have the power to do this, but have failed to prioritise it, and two amendments which would have rectified this anomaly, in the Financial Services Bill have, so far, failed. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 942 Parliamentary Commission on Banking Standards: Evidence

Corporate Ethics (a) Ethics Committees We suggest that banks should create an Ethics Committee responsible for ensuring that the bank’s policies and procedures contain an ethical dimension (to act with honesty, openness, transparency and fairness) and that these are followed in practice. To this end, the members would be from outside the bank and the Board (which has other duties as well as ethics). The Committee would have input into the bank’s remuneration strategy (as the Remuneration Code requires for Risk), would produce an annual report to the Board (to whom it reports) and would have the power to call for any information it wanted on the business such as an ethics review (see next). The BAE Committee is an example. (b) Ethics Review We also propose that the Ethics Committee should have the power to commission a periodic ethics review by outside experts to see how effectively its ethics policies are in fact working. Elements to be checked might include procedures for ensuring that decision-making takes ethics into account, adherence to this requirement at all levels, ethics support and advice, whistle blowing and regular training as part of CPD. We see this report as giving the Ethics Committee the basic information which it needs. The report could be less frequent for smaller banks. The CISI has helped to develop such a programme which is now in use but we would expect there to be others also providing this service. (c) New Product Ethics certiﬁcation As part of the sign-off for any new loan, or product, the bank should add certiﬁcation that the loan or product meets four fundamental ethical principles, namely, that it is: (a) Honest; (b) Open; (c) Transparent; and (d) Fair. This can be simply shown on the marketing material in the form of a red, yellow or green indicator, where green indicates full compliance with the principles.

Conclusion

Ethical standards of banks and their employees are beyond normal rule making. Such standards have to be part of the culture of every ﬁrm and individual. But we can no longer rely on a tacit assumption that everyone knows the difference between right and wrong and so leave it to each bank simply to create its own culture of ‘doing the right thing’—as recent events have shown. Therefore, structures are needed to encourage and support this culture.

Our proposals would help to instill and nurture this. The regulators’ failure to establish clear and minimum levels of professionalism, which can be monitored, measured and harnessed with real enthusiasm right across a sector that recognises its need to change, is puzzling, illogical and out of date. It also continues to pose risk to the ultimate consumer as the complexity of organisations, technology and products continues to develop so rapidly. 22 August 2012

Written evidence from the Chartered Institute of Internal Auditors

Summary of Key Points — Given the lack of the appropriate culture at the top of some institutions internal audit was not well placed to ensure that the governance of the organisation was effective and that appropriate behaviours were adopted. — If internal audit had been able to play its full and proper role in risk management in affected institutions, warning bells might have been sounded earlier and action to avoid or mitigate some of the worst effects of the crisis on consumers and the economy as a whole could have been taken. — In light of the perceived weaknesses in internal audit’s response before and during the crisis the Basel Committee on Banking Supervision has issued principles and guidance on the internal audit function in banks. IIA supports these. — Audit committees did not adequately understand or deliver their role and responsibilities in ensuring that the risks were being managed effectively, or were aware of the range and scope of risk. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 943

— Internal audit could be a more effective source of assurance to the board. IIA believes that the role of internal audit should be strengthened and, to this end, should feature more prominently in regulation and guidance. The FRC’s Code of Corporate Governance and the supporting Guidance for Audit Committees need to be updated and brought into line with international best practice. — Positive whistleblowing policies must be a key element in establishing the right tone and culture throughout an organisation. — Professional internal audit standards in the UK are not defective.

The Chartered Institute of Internal Auditors 1. Established in the UK and Ireland in 1948, the Chartered Institute of Internal Auditors (IIA) has over 8,000 members. It is the only professional body dedicated exclusively to training, supporting and representing internal auditors in the UK and Ireland. We are part of a global network of 170,000 members in 175 countries.

2. Members of the IIA work in all sectors of the economy: private business (including most FTSE 100 organisations), government departments, utilities, voluntary sector organisations, local authorities, and public service organisations such as the National Health Service. All members work to the same global International Standards and Code of Ethics, which are part of a globally agreed International Professional Practices Framework and have been recognised in the Financial Reporting Council’s Guidance for Audit Committees and adopted in UK central government’s Government Internal Audit Standards and in the internal audit standards for the NHS.

3. The IIA offers a postgraduate level professional qualiﬁcation in two stages, leading to the designation “CMIIA” (Chartered Internal Auditor), with an ongoing requirement for professional development and adherence to professional standards.

What is internal audit?

4. All organisations face risks in everything they do. It is the role of senior management and the board to put in place frameworks and processes to manage all types of risks and to monitor how successful they are at managing them. Internal audit provides assurance to the board on the effectiveness of these frameworks and processes.

5. To perform their role effectively, internal auditors must build strong relationships with line managers, audit committee chairs and members, chief executives and board chairmen. These relationships enable the internal auditor to champion effective risk management, challenge those responsible for it on its success and use their knowledge of the business and the management of risk to act as a catalyst for improvement in an organisation’s risk management practices.

6. Internal audit is a function that belongs to the organisation and sits within the governance structure; but it must be independent of the areas it evaluates and internal auditors must be free from undue inﬂuence from management, or indeed, anyone else, so that their judgments can be as objective as possible. To help safeguard their objectivity and independence, the head of internal audit should report directly to the audit committee.

7. Internal audit is essential to the long term success of an organisation. This is because, alongside non executive directors, executive management and external audit, internal audit is one of the four cornerstones of good corporate governance. Without it, the board would lack information and insight into how well the people within the organisation are managing their risks.

Three lines of defence

8. The three lines of defence model has been increasingly applied to corporate governance, and particularly risk management, over recent years. The IIA ﬁnds it useful to help demonstrate the different roles in governance and the interplay between them.

9. The IIA believes that risk management is an essential part of management. The ﬁrst line of defence is formed by line managers and staff who own the risks that they take every day.

10. In larger organisations, there are specialist risk management, control and compliance functions which support this work. They form the second line of defence. They facilitate risk management activities, advise line managers and help ensure consistency of deﬁnitions and measurement of risk.

11. Internal audit provides the third line of defence. It is part of the governance process but sits outside of the risk management process. Internal audit regularly evaluates the effectiveness of each element of the risk management process and of the process overall, ie the performance of the ﬁrst and second lines of defence. Internal audit may (and indeed should) use the outputs of risk management activity in forming its conclusions. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 944 Parliamentary Commission on Banking Standards: Evidence

Responses to the Commission’sQuestionsRelating toInternalAudit 1. To what extent are professional standards in UK banking absent or defective? How does this compare to (a) other leading markets (b) other professions and (c) the historic experience of the UK and its place in global markets? IIA believes that, as for all listed companies in the UK, internal audit in the banking sector needs to be carried out by professionally qualified staff from an appropriate range of backgrounds in order to ensure that the information and analysis required by the board, and in particular the audit committee, is sufficient to meet both the internal control and risk management needs of the organisation. Professional standards in the UK are not defective. IIA members adhere to a global set of standards prepared by IIA Global, representing over 175,000 members worldwide. However it is widely documented that internal audit focused too heavily on internal processes and controls prior to the banking crisis, and it could be argued that boards and their audit committees, had they been focusing more on strategic level risks to their organisations, could have strengthened internal audit by supplementing specific internal audit skills with other specialist competences. In light of the perceived weaknesses in internal audit’s response before and during the crisis the Basel Committee on Banking Supervision has issued principles and guidance on the internal audit function in banks. IIA supports these. In the UK, at the invitation of the FSA and with their participation as observers, the IIA is currently undertaking an exercise to draft new guidance on internal audit for the financial services sector. We should have concrete proposals by March 2013 and hope that the PRA and FCA will support them across the financial services sector, but in particular in the systemically important financial institutions (SIFIs).

2. What have been the consequences of the above for (a) consumers, both retail and wholesale, and (b) the economy as a whole? If internal audit had been able to play its full and proper role in risk management in affected institutions, it is conceivable that warning bells would have been sounded earlier and action to avoid or mitigate some of the worst effects of the crisis on consumers and the economy as a whole could have been taken.

3. What have been the consequences of any problems identiﬁed in question 1 for public trust in, and expectations of, the banking sector? Public trust in the banking sector has been undermined by the high risk strategies run by many institutions, which ultimately caused their downfall. Effective internal audit regimes would at least have raised questions about the appropriateness of the risk proﬁles of those institutions, although we recognise that warnings may not necessarily have been heeded given the expectations, common culture and herd instinct of the sector as a whole.

4. What caused any problems in banking standards identified in question 1? The Commission requests that respondents consider (a) the following general themes: — the culture of banking, including the incentivisation of risk-taking; IIA believes that remuneration packages encouraged staff, from the trading floor up to senior executives, to take short term views on risk that benefited themselves, rather than long term views on the good of the organisation and its shareholders. Very few within the executive management and boards had sufficient knowledge or understanding of the features and risks of complex financial instruments. It is questionable whether audit committees adequately understood or delivered their role and responsibilities in ensuring that the risks were being managed effectively, or were aware of the range and scope of risk. Given the lack of the appropriate culture at the top of some institutions internal audit was not well placed to ensure that the governance of the organisation was effective and that appropriate behaviours were adopted. — the impact of globalisation on standards and culture; — global regulatory arbitrage; — the impact of financial innovation on standards and culture; — the impact of technological developments on standards and culture; and — corporate structure, including the relationship between retail and investment banking; The merger of retail and investment banking made it more difficult to construct a single risk management structure that could be effectively overseen by internal audit. If these activities had been separate, the audit of these two very different risk profiles might have been more effectively carried out. — the level and effectiveness of competition in both retail and wholesale markets, domestically and internationally, and its effects; — taxation, including the differences in treatment of debt and equity; and — other themes not included above; cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 945

and (b) weaknesses in the following somewhat more specific areas: — the role of shareholders, and particularly institutional shareholders; — creditor discipline and incentives; and — corporate governance, including — the role of non-executive directors; — the compliance function; — internal audit and controls; and — remuneration incentives at all levels. Internal audit should provide assurance to the board—and to the audit committee in particular—on the identification, management and mitigation of risk. In the case of the financial crisis it is clear that internal audit was part of the structure in banks and insurance companies that went wrong. Particularly important was that internal audit and audit committees tended to be focused on process and internal controls within the organisation, and were not looking at the wider strategic risk picture. However, while internal audit must strive for independence and objectivity, it does not operate in a vacuum. The internal audit function must be free to challenge and empowered to look into all parts of an organisation’s operations, not shying away from particular areas. Internal auditors are commissioned by the audit committee to support its oversight functions. Internal auditors should show initiative raising issues themselves providing additional information and analysis. But if they in turn do not receive the necessary support from the audit committee and its chair their effectiveness in key areas can be fatally undermined. The audit committee and Chair must recognise the critical importance of maintaining internal audit’s objectivity and independence and that, if they do not do so, it is very difficult for internal audit to play an effective role in providing assurance and in producing the information and input that is required. — recruitment and retention; and — arrangements for whistle-blowing; It is clear that positive whistleblowing policies must be a key element in establishing the right tone and culture throughout an organisation. Internal audit plays a central role in this, eg as a first point of contact for whistleblowers, as an instrument to deal with information given by whistleblowers to the board, its chair, or its audit committee, or as a whistleblower itself. It is not clear whether the whistleblowing arrangements themselves were inadequate in the run-up to the financial crisis or whether warning voices were drowned out because the prevailing culture, led from the top, did not support questioning the overall risk strategy. — external audit and accounting standards; — the regulatory and supervisory approach, culture and accountability; — the corporate legal framework and general criminal law; and — other areas not included above.

5. What can and should be done to address any weaknesses identiﬁed? To what extent are such weaknesses subject to remedial corporate, regulatory or legislative action, domestically or internationally? Internal audit could be a more effective source of assurance to the board. It has a strategic value which could be better harnessed. For example: — In helping the board to develop a greater awareness about the changing nature of risks and their potential impacts, and in challenging current assumptions. — In helping to create the right culture and behaviours within the board and throughout the organisation towards the management of risk. — In promoting a clearer and more forward looking perspective in the board and senior management on the need for more effective risk management in the achievement of strategic objectives. The independence and objectivity of internal audit should be enhanced and preserved by ensuring that they are not undermined by the functional and administrative reporting arrangements. The Basel Committee on Banking Supervision’s principles for internal audit (June 2012) recommend that “The bank’s internal audit function must be independent of the audited activities, which requires the internal audit function to have sufﬁcient standing and authority within the bank, thereby enabling internal auditors to carry out their assignments with objectivity.” On administrative reporting, there has to be some link into the organisation and this should be with the most senior manager in the organisation. However the audit committee should be responsible for — the appointment of the head of external audit; — the determination of the work programme of internal audit; — the determination of the objectives of the head of internal audit; — the appraisal of the head of the internal audit’s performance against those objectives; and cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 946 Parliamentary Commission on Banking Standards: Evidence

— the remuneration of the head of internal audit, ensuring that it is arrived at on a different basis from other members of the management team, and not linked to short term ﬁnancial performance. The Basel Committee recommends that remuneration “should be structured to avoid creating conﬂicts of interest and compromising independence and objectivity.”

The internal audit team must have sufficient expertise to perform its role effectively, and it is the responsibility of the head of internal audit to acquire human resources with sufficient qualifications and skills to audit to the required level. This does not necessarily mean that all internal auditors must be qualified with the IIA’s.

Qualifications, although we would argue that it is necessary for the head of internal audit and a significant proportion of his/her staff to be appropriately qualified. However internal audit teams are likely to need external expertise in order to give the right mix of skills and ensure there is full understanding of the risks that are being managed. This could be bought in from outside or through rotating staff from elsewhere in the organisation. The Basel Committee guidelines recommend that a bank’s external auditors should not be used to provide internal audit functions. Where outsourcing arrangements are in place the head of internal audit should maintain oversight and ensure that the use of experts does not compromise the independence and objectivity of the internal audit function.

IIA believes that the role of internal audit should be strengthened and, to this end, should feature more prominently in regulation and guidance. We recognise that companies should be given ﬂexibility to establish their internal audit arrangements according to their size and circumstances. But given the speciﬁc terms of the OECD Corporate Governance Guidelines on where internal audit should sit in an organisation, the IIA International Standards stating that the head of internal audit should have “direct and unrestricted access to senior management and the Board”, and “organizational independence” where he/she “reports functionally to the Board”, and the Basel Commission’s Principle that internal audit be “independent of the audited activities”, IIA believes the FRC’s Code of Corporate Governance and the supporting Guidance for Audit Committees need to be updated and brought into line.

Currently the FRC UK Corporate Governance Code does not adequately promote internal audit’s independent and objective support to the Board on risk management and internal control issues. We believe the FRC should strengthen the Code by specifying that internal audit functions should be directly accountable to the Board, where appropriate through an audit committee. While the FRC’s Guidance on Audit Committees is more speciﬁc about the relationship between internal audit and the audit committee, some of the recommendations there need to be brought into the Code itself. In particular the Code should specify that the board has ultimate responsibility for resourcing and tasking internal audit and the appointment, remuneration and functional management of the head of internal audit.

The FRC Guidance on Audit Committees should also specify that the audit committee should ensure that internal audit’s standing and authority in the organisation is commensurate with preserving its independence and objectivity. This could include speciﬁc guidance on functional and administrative reporting lines.

In contrast, the requirements in the public sector are much clearer. The Code of Good Practice for Corporate Governance in central government departments and similar guidance for local authorities are clear that “the board should ensure that effective arrangements are in place to provide assurance on risk management, governance and internal control. In this respect, the board should be independently advised by: … an internal audit service operating in accordance with Government Internal Audit Standards”.

7. What other matters should the Commission take into account?

At the invitation of the FSA, and with their participation as observers, the IIA is currently undertaking an exercise to draft new guidance on internal audit for the ﬁnancial services sector. We should have concrete proposals by March 2013 and hope that the FSA/FCA will consider how they should be implemented. 27 September 2012 cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 947

Written evidence from Chartered Insurance Institute Summary Importance of professional standards — Professional standards, comprising the three pillars of qualifications, continuing learning and ethical conduct are crucial ingredients of a properly functioning financial services market. Changes in culture and behaviour are as important as improving levels of technical knowledge. This is because information asymmetries between customers and intermediaries put the public at a disadvantage—they require appropriate products and competent advice in order to ensure that their needs are met and to ensure there is public trust and confidence.

Role of professional bodies — Professional bodies have a crucial role to play in promoting higher professional standards and taking action when standards of practitioners fall short. Professional standards—particularly ethical conduct— can play an important role above and beyond adherence to regulatory rules. — The CII has demonstrated that it is possible to raise standards of behaviour across the insurance and financial advice community through voluntary, industry-led initiatives. We believe this has many public interest benefits—not least improved levels of trust and confidence.

Move towards “banking profession” becalmed? — The move towards a professionalism in banking similar to law, accountancy and increasingly insurance, appears to have declined over the past couple of decades. Membership of banking professional bodies remains low. There is one area where this is reversing—namely bancassurance—where introduction of the Retail Distribution Review to raise the standards of ﬁnancial advisers is seeing a stronger focus on professional standards.

Using the regulatory review as a catalyst for changing behaviour — Since regulatory review process began we have argued that whilst the structure of the new system will be important, it will be the judgements undertaken by supervisors and the conduct of firms, which will make the difference between regulatory success and failure. Delivering the right culture will be critical. There is a role to be played here by the new regulator, professional bodies as well as firms and individuals. We have argued that professional standards can act as a measurable proxy for culture, and it should be enshrined within the fabric of the new Financial Services Bill. — The current reforms to the FSA and financial services regulation in the UK is a great opportunity to kick start professional standards in the banking industry and to consolidate improvements in behaviour made elsewhere within financial services to embed higher professional standards.

Amending the Financial Services Bill — At a minimum, the Bill should ensure supervisors within the Financial Conduct Authority focus not only on whether individuals in “signiﬁcant inﬂuence functions” are competent, but also the extent to which organisations as a whole, are making a credible effort to embed and grow professional standards as part of a wider effort to improve culture. — It is worth pointing our regulatory system should help encourage and recognise initiatives beyond regulatory compliance that support voluntary efforts to embrace higher professional standard.

Delivering a cultural step-change — But the Bill creating a new regulatory system must also be accompanied by a “real” change in regulatory culture and not just one on paper. We all know that regulation is going to be more intense—but it must be targeted on the right areas—and the level and commitment of professional standards exhibited across ﬁnancial services must be one of them. — Financial services ﬁrms must listen to the concerns of the public and embrace a cultural change in standards. Industry-led regulation is a powerful force in delivering this change rather than waiting for regulatory imposition.

Background and Introduction about the CII 1. The Chartered Insurance Institute (CII) is the world’s leading professional body for insurance and financial services with over 105,000 members in more than 150 countries. We are committed to protecting the public interest by maintaining the highest standards of professional and technical competence as well as ethical conduct. We are a not-for-profit organisation governed by a Royal Charter, which sets out our public interest remit “to secure and justify the confidence of the public and employers” in the profession.113 113 Chartered Insurance Institute, Charter and Bye-Laws, Art 3(a). cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 948 Parliamentary Commission on Banking Standards: Evidence

2. Our members are predominantly practitioners working in general insurance (such as underwriting, claims and broking) or life insurance, mortgages; or financial planning (such financial advisers) which has expanded particularly rapidly in recent years. As a result, the CII has a strong insight into how professional standards (by which we mean a proven commitment to ethical behaviour, qualifications and continuous learning) impacts upon these sectors—improving outcomes for consumers by driving and enhancing good behaviour. 3. This submission focuses on the role of the professional body in raising professional standards in financial services, before drawing some lesson for banking which can be applied from other parts of the financial services sector. We then discuss how the Financial Services Bill can be amended to cause a step-change towards higher standards in banking and to consolidate gains being made in other sectors.

Q1: To what extent are professional standards in UK banking absent or defective and what are its implications? How does this compare to (a) other leading markets and (b) other professions? 4. In answering Question 1, we start by discussing why professional standards are an important part of a healthy financial services market and then discuss examples of what can happen when standards slip or have atrophied over time. 5. Banking is a diverse sector and while there are clearly issues of professional standards across the different area of banking, these do not appear to be the same across the board, for example in retail banking (excluding financial advice) there seem to a deficit in basic qualifications and skills whereas in wholesale banking, including the sector covered by LIBOR issue, there seems to be problems in terms of behaviour and culture rather than technical standards or qualifications.

The importance of professional standards 6. A commitment to professional standards is an important cornerstone of a properly functioning financial services sector working in the public interest. This is primarily because the market suffers from significant information asymmetries. For example in general insurance, customers are unlikely to have the time or expertise to fully understand the risks they are exposed to, the benefits of insurance, or the price and value of insuring against those risks. Insurers and intermediaries are much better placed to understand these issues, but customers need to be able to trust that the products, services and advice provided to them will be appropriate. 7. Without trust, customers will be deterred from buying the financial products that they need or from seeking the appropriate advice, leading to a growth in the proportion of the population that is underinsured and a rise in the “savings and protection gap”. Professional standards play a pivotal role in this mix by demonstrating to the customer that practitioners are sufficiently competent and honest to deliver products and services that are in the customer’s interest. Professional standards are therefore a necessary condition for a competitive market and help to underpin the integrity of the financial system. 8. This is not just the CII’s view. In a short article responding to the LIBOR scandal Adam Phillips, Chair of the Financial Services Consumer Panel, wrote: 9. “It has been a long time since “Big Bang” and cultural change is overdue in financial services. Change needs to be embraced at all levels in organisations. This is why the Consumer Panel is advocating imposing a duty “to act honestly, fairly and professionally in the interests of consumers” on the face of the Bill currently before the Lords”.114

Why professional standards can help raise trust and confidence? 10. Professional standards are generally broken down into three constituent parts—the so-called three pillars of professional standards: — Qualifications: Qualifications to provide practitioners with an appropriate level of knowledge and understanding. This acts as a signal of quality to consumers as well as ensuring expertise. — Continuing professional development (CPD): Undertaking continuous learning helps practitioners keep their knowledge and understanding up to date which is essential in an industry that changes rapidly. — Ethics and integrity: A commitment to act in the interests of consumers is crucial to ensuring honest selling practices and good conduct. 11. Breakdowns in behaviour linked to poor standards of professionalism have been noted as key causes of consumer detriment. For example, on the retail investment side, the FSA’s Retail Distribution Review was initiated following a suspicion that low levels of competence and ethical conduct were in part responsible for the widespread mis-selling of financial products over the previous decade. In subsequent research by the regulator across a thematic review of platforms advice, the FSA found that practitioners exhibiting higher professional qualifications were far more likely to give customers appropriate advice than those who were not as well qualified.115 114 Phillips (July 2012) Why honesty, fairness and professionalism could become a byword for providers, article for Macro. 115 FSA (June 2010) Consultation Paper 10/14: Delivering the RDR http://www.fsa.gov.uk/pages/Library/Policy/CP/2010/10_ 14.shtml cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 949

12. But for professional standards to be deemed effective in the public’s mind there need to be professional bodies with ethical codes and disciplinary procedures with teeth, able to police these standards and discipline practitioners when their standards fall short.

Q2: What caused the problems in banking standards? 13. In answering this question, we focus on the role of professional bodies in embedding and strengthening professional standards across ﬁnancial services. We begin by setting out what good looks like for a professional body and describe efforts made by the CII to raise the bar in general insurance as an example of promoting higher professional standards.

The role of professional bodies in driving professional standards—what good looks like 14. At a minimum, strong professional bodies must focus on three areas to ensure that practitioners are sufficiently knowledgeable and behave appropriately. The three areas—or “pillars of professionalism” as they are sometimes include: — Entry standards: At the very least, a professional body should provide a minimum level qualification necessary to work in the appropriate part of financial services and work with employers to embed this. Strong professional bodies will go further than this—seeking to drive up qualification standards by offering more advanced qualifications and demonstrating the benefit that this can have to consumers. This can be done through voluntary initiatives embraced by the industry to raise standards. For example, the CII has introduced Chartered status (degree level) for general insurance and financial advice practitioners who meet qualification standards (as well as other behavioural and learning requirements) equivalent to those in other professions such as accounting. — Continuous learning: Continuing professional development is a vital component which goes to the heart of what a good professional body does—CPD is an important part of a doctor or lawyers’ professional duties. Just because practitioners have done an appropriate qualification at some point in their career does not necessarily mean that they are up to date with the latest developments and therefore continually able to provide the best quality services to customers. This is a standard view across all leading professions. Good professional bodies will ensure that their members do enough CPD and of sufficient quality to ensure that competency levels are maintained and keep improving over time. CPD must be rigorously checked and policed to ensure the profession as a whole is committed to this. — Ethics: Professional bodies must uphold a stringent code of ethics which members must adhere to. Good professional bodies will go further and produce learning support to help provide practical support. Good professional bodies will also police the code—where there are complaints made about members, or where there are other forms of evidence of unethical conduct. Professions must have sufficient teeth to discipline members using independent disciplinary processes which are robust and will meet the test of public confidence. 15. In addition to these three strands, the governance of professional standards requires oversight by a an appropriate disciplinary process and a professional standards board to regularly review professional standards requirements imposed by the body on the industry, and thought leadership to develop and articulate the body’s vision of what the professional body should seek to be doing in the years ahead. We deal with each in turn below.

Professional Standards Board and independent disciplinary process 16. For many years the CII has had a Professional Standards Board with strong lay membership which oversees policy and standards for CII members including professional conduct issues. This Board is now independently chaired, (currently by a past president of the Law Society). This includes consumer and other representation chosen using Nolan principles. 17. The CII has a long established Code of Ethics supported by a disciplinary process (including both a Disciplinary and Appeal Committee, which are independently chaired). Our Professional Standards Board recently oversaw a revision to the CII Code of Ethics and a placed renewed emphasis on both the Code, and support and resources for members to understand ethical issues in a more practical way.

Higher professional standards Goes beyond regulatory compliance 18. When professional bodies get these elements right and when the industry is willing to embrace higher standards the market beneﬁts. There is some FSA research which shows that practitioners with higher qualiﬁcation levels are more likely to provide better quality of advice. A research paper prepared for the FSA by Jackie Wells and Mary Gostelow found. 19. “Professional bodies play an important role as a proxy that enables consumers to place their trust in a professional. Knowing that a professional is regulated, meet certain standards of knowledge and is subject to a code of ethics facilitates trust even when the individual professional is not known”.116 116 Wells and Gostelow (Nov 2009, updated March 2011) Professional standards and consumer trust, prepared for the FSA. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 950 Parliamentary Commission on Banking Standards: Evidence

20. Professional bodies can do more. Professionalism is more than the sum of its parts in terms of qualiﬁcations, CPD and ethics for individual practitioners, and the CII has sought to understand how ﬁrms can embed professional standards at an organisation-wide level.

Going beyond the minimum at a firm wide level 21. Professionalism in insurance and financial advice does not just refer to the characteristics of individual advisers, brokers or underwriters. Firms as a whole can also make a commitment to professionalism—and we think this applies equally to the banking sector. Key to this is for a firm to embed a culture which is aligned with the consumer interest—demonstrated by a measurable commitment to best practice running throughout the organisation. 22. While no-one in general insurance would proclaim everything is perfect, indeed far from it, in recent years there has been a growing commitment—shared by the leaders of the profession—that more was needed to raise professional standards. We are now embarking on this journey and below we provide two examples of how the sector is demonstrating such a commitment.

Case Study 1—Chartered firms 23. To become a CII Chartered firm, the business must ensure staff members acquire and retain the necessary knowledge and skills to deliver the highest quality services and advice. They must also work in an ethical manner that places clients’ interests at the heart of the services they provide. Chartered status, granted by the Privy Council, gives insurers and financial planners parity with other professional firms and distinguishes the Chartered title holders from competitors. 24. For example, Chartered broking firms must meet a number of key requirements including: — A minimum of one of the board’s members must personally hold the CII Chartered Insurance Broker title. — One of the firm’s board or highest management team (who, as an individual, holds the Chartered Insurance Broker title), must take on the role of Responsible Member. — The entire board or highest management team together with a minimum of 90% of customer facing staff must be members of the CII. — Access to a Chartered Insurance Broker must be available to customers. — Firms must have a professional development programme in place. — Firms must have core values that align with the CII’s Code of Ethics. 25. A corporate Chartered title is therefore a commitment to an overall standard of excellence and professionalism. A firm which holds each of these elements is one whose strategy is focused on delivering quality products and services to the consumer—epitomised through the achievement of rigorous learning and development for employees and a proven commitment to ethical practice. 26. A commitment to firm-wide professional standards is of course only one part of the mix of indicators that regulators will have to look at when assessing the level of risk posed by firms to consumers. But by failing to understand a firm’s commitment to best practice in this way, they will miss an important part of the picture. While the concept is still a relatively new one, it is increasingly developing support as it offers a powerful to reinforce professional standards at a firm level in addition to an individual level. 27. This initiative continues to show strong industry take up. By the end of 2008 there were around 200 chartered firms and this increased to 370 at the end of 2011. There are now over 500 chartered firms as of July 2012. We are currently reviewing the rules and standards which underpin these firms with a view to strengthening them to reinforce public confidence.

Case Study 2—Aldermanbury Declaration 28. In co-operation with leading figures in the general insurance market, the CII formed a task force in 2009 to raise professional standards in general insurance. For this initiative to really make a difference, it was clear from the start that it would need buy-in from industry leaders across the sector. The result was the Aldermanbury Declaration published in March 2010 which called on the industry to commit to a common framework of professional standards for its practitioners. The Declaration seeks to deliver the following benefits: — Better outcomes for customers. — Improved standards of risk management. — A more confident, trusted profession. — More talented people attracted to a career in insurance. — Increasingly rewarding careers for those within insurance. — Reinforcing the reputation of the London wholesale insurance market. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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29. By the first anniversary of the Declaration, 200 firms including all major insurers had signed up to this commitment. We believe these proposals are ambitious but realistic and have called on all firms signing up to implement the changes by December 2013. 30. Firms that have signed up to the Aldermanbury Declaration have made a long-term commitment to professionalism suggesting that their management are determined to improve outcomes for consumers. 31. Both the Chartered firms and Aldermanbury Declaration initiatives, reflect a growing movement towards higher professional standards across general insurance and financial planning. This movement is not the result of regulatory enforcement but a voluntary drive to improve across the sector. The insurance industry is by no means perfect, but we believe that many firms are on the right path and by signing up to the Declaration have made a demonstrable commitment to commit to higher professional standards. 32. We believe it is important that voluntary initiatives like these to improve the professional standards of both individuals and firms should receive greater recognition and support form regulatory and other bodies to help encourage others to do likewise.

Measuring the impact of our initiatives 33. We believe it is very important to improve our understanding of how our ﬁrm-wide initiatives, and professional standards in general, affect outcomes for consumers. To meet this aim, we are currently developing a series of indices which will attempt to measure over time these impacts. 34. For an in depth discussion paper on the approach we are taking please see our paper “Measuring Professional Standards -Demonstrating positive outcomes from doing the right thing”: a discussion paper— February 2012).

Banking professional membership becalmed 35. Whilst general insurance is by no means perfect, it is making progress towards a building the appropriate pillars for a proper profession. Banking—whether it is wholesale or retail- with the exception of the financial planning area—appears to made little progress towards higher professional standards and numbers of members of professional bodies—a good proxy for this -remain low in proportion to the total banking workforce. 36. The chart below (Figure 1) shows the number of members of all major professional bodies headquartered in the UK. The CII holds by far the largest number of insurance and financial services members with currently 105,000 (the vast majority in the UK), but with a small but increasing number of members in banking. Accountancy, law and surveyors are also well represented. What is noticeable, in the context of this parliamentary inquiry, is the small proportion of members of specific banking bodies.

Figure 1 PROFESSIONAL BODY MEMBERSHIP

Source: TheCityUK. 37. It is interesting to note that the CII—which traditionally had little or no membership in banking institutions—has seem rapidly grown in what might be termed bancassurance over the past few years. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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Impact of the Retail Distribution Review 38. The FSA’s Retail Distribution Review (RDR) began in response to a widespread perception of public detriment in retail investment and financial advice. 39. The RDR will introduce a number of changes to financial advice, including (amongst others) raising the mandatory qualification level for providing financial advice from Level 3 (equivalent to A Level) to Level 4 (equivalent to first year degree level) as well as other professional standards requirements like mandatory CPD. The RDR therefore provides an opportunity for all professional bodies in the financial advice space to show how they could support increased professional standards in the distribution of retail investment products. 40. Throughout the RDR process, the CII has argued for a “step change” in professionalism for the benefit of consumers. As well as publicly supporting the regulatory changes through consultation responses to government and submissions of written evidence to various parliamentary inquiries, we have continued to support our members in making this change by providing a range of activities including free regional conferences, specialist podcasts to help with CPD, business transition workshops, gap fill sessions and more. 41. Our efforts have not gone unnoticed. There appears to have been a flight to quality to robust professional bodies like ourselves. We are increasingly been seen by the industry—including by banks that employ financial advisers—as the professional body of choice. According to FSA statistics last year the CII has 74% of the total regulated adviser population who are members of a professional body (and 54% of all advisers in the market). There is evidence that penetration of this segment has continued to increase apace since this FSA research was produced. As a consequence of the CII’s ability to prepare the industry for the RDR, we were amongst the first tranche of professional bodies to become an FSA Accredited Body in September 2011 allowing us to issue Statements of Professional Standing to financial advisers. There is no doubt that the RDR represented a challenge for the advisory community, but it is a challenge that good professional bodies must help ensure delivers the best possible outcomes for consumers. Figure 2 sets out in more detail where membership of regulated financial advisers now sits.

Figure 2 ALL RETAIL INVESTMENT ADVISERS, BY PROFESSIONAL BODY MEMBERSHIP (N BANK AND BUILDING SOCIETY MEMBERSHIP IS B\BS) SOURCE: ATKIN ET AL (DEC 2011), RESEARCH: PROGRESS TOWARDS THE PROFESSIONALISM REQUIREMENTS OF THE RETAIL DISTRIBUTION REVIEW, A RESEARCH STUDY FOR THE FSA.

Q3: Are the changes already proposed by (a) the Government, (b) regulators and (c) the industry sufﬁcient? 42. In responding to this question, we focus on the changes to ﬁnancial services regulation currently underway which will see the creation of a new regulator called the Financial Conduct Authority. We believe that this regulatory review provides an opportunity to kick-start the road to increased professional standards within the banking sector and help consolidate improvements made elsewhere. But for this to occur, the cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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Financial Services Bill should make greater provision for professional standards in its “have regards” and the new regulators must embrace a cultural change and actively promote cultural change within firms. 43. We believe that professional bodies with the resources, disciplinary teeth and a vision that goes beyond the Victorian conceptualisation of what such a body should be for are vital to delivering financial services in the public interest. There is a role for professional bodies above and beyond “regulation”—especially in the promotion of better conduct as opposed to simply providing firms with the means to fulfil their minimum regulatory requirements under “Training and Competence”. Until recently it is clear that large parts of the banking industry have not been proactive in engaging in this agenda.

What needs to happen? 44. So how can this situation be improved? One thing is desperately needed: Government should provide a strong indication that minimum standards will no longer be sufficient—firms must seek to build and grow professionalism beyond compliance. 45. The current review of financial services regulation in the UK provides an opportunity to drive up professional standards right across financial services (and not just in the banking sector). Since HM Treasury’s very first consultation paper on reforming financial services regulation in 2010, the CII has argued that, whilst the structure of the new system will be important, it will be the judgements undertaken by supervisors and the conduct of firms, which will make the difference. Our argument has been echoed across the policymaking community. Most notably, former FSA Chief Executive Hector Sants said that regulators should “ensure firms have the right culture for their business model—the right ethical framework—to facilitate the right decisions and judgements and we should intervene when we find those frameworks are lacking”.117 And our arguments around culture and regulation were also referred to during the Financial Services Bill Second Reading and committee stage debates in the House of Lords.118

Improving culture through professional standards 46. Since news of the recent LIBOR scandal first broke, the debate is no longer about whether or not culture within the banking sector needs to improve, but how to do it and how to use legislation for this purpose. The CII has, over the last two years, consistently argued that a commitment to professional standards can act as a proxy for good culture and behaviour. We believe that the Financial Services Bill could be drafted in such a way as to stimulate an increase in professional standards across the financial services sector. At a minimum, it must allow supervisors within the new regulatory bodies to focus, not only on whether those individuals in “significant influence functions” are competent, but also the extent to which organisations as a whole, are making a credible effort to embed and grow professional standards. Where it is found that firms lack such a commitment to improve behaviour, supervisors should act. Currently, there are no such provisions within the draft legislation and this oversight should be urgently addressed.

Amending Clause 5 to direct the Financial Conduct Authority 47. In the recent House of Lords debate on clause 5 of the Financial Services Bill which pertains to the objectives of the Financial Conduct Authority, a number of amendments were suggested that would help to ensure that supervisors properly consider professional standards. One was related to the Integrity objective— to broaden the definition of integrity within the financial system to include the “level of professional standards exhibited by those working in financial services”. The other was to reinstate the Joint Committee’s probing amendment from December 2011—a duty on firms to behave with “honesty fairness and professionalism” which has support from both the Financial Services Consumer Panel and the FSA. In responding to these amendments, Lord Sassoon intimated that this Banking Standards Committee would be responsible for issues associated with raising professional standards across financial services. We would therefore recommend that this Committee takes on board both amendments to the Bill noted above and ensure that the FCA (and PRA) are given a clear signal to focus on this as part of their new focus. We believe they would send a clear signal to firms that the new regulators will take professional standards seriously and this will act as a catalyst for firms to put organisation-wide programmes in place to raise standards of competence, ethics and conduct. It will be the kick start that the banking sector needs to develop a much more professional culture—a transition that appears to have seriously stagnated in recent times. 48. This is of course, just a start. Ultimately, in order to meet the public interest test, financial services in general (not just banking) must ensure its own house is in order where there is risk of public detriment rather than relying on regulatory imposition. The recent Aldermanbury Declaration supported by general insurance leaders is a case in point. If the latter continues to be the case, then the public’s trust in the industry could be irreparably damaged. Proactive Professional bodies which actively promote higher standards, including public reprimand and disciplinary action where required, can play their part. The challenge for financial services, and banking in particular, may be considerable following the recent scandals, but, buttressed by a complementary regulatory framework, we can drive forward higher standards and help the industry regain the public’s trust. 117 Hector Sants (Oct 2010) “Can culture be regulated? Speech to Mansion House Conference on Values and Trust”. 118 Baroness Hayter (2012) Financial Services Bill, Second Reading. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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Q4: Remuneration and Compensation 49. There is no doubt that remuneration has a strong impact on how firms behave. This is an area where both regulators and firms can do more through increased transparency as well as by aligning incentives more closely to the longer term interest of stakeholders including the public interest. The financial sector has a chequered history in developing innovative products and services some of which have been mis-sold in part because of the incentives which were offered. 50. It is worth pointing out that this has been traditionally less of an issue for the insurance sector which has traditionally been more focused on long terms returns. As a 2011 Mercer survey of remuneration noted: 51. “Despite recent moves by the industry to increase base pay, the report highlights that the banking industry differs significantly from the insurance industry in the structure of its pay packages. A comparison of data between the banking and insurance industries shows that while the industry as a whole is shifting pay mix in favour of increased base pay and longer-term incentive payouts, the insurance industry already has much less emphasis on short-term incentives as a proportion of total compensation”. (source: Mercer’s 2011 Pan-European Financial Services Executive Remuneration Survey.) 52. Whilst there are various corporate governance changes and proposals for encouraging greater long- termism currently being proposed by BIS and others, one area which might be looked at is in more detail is encouraging a rebalancing of both corporate and individual remuneration schemes not only to be more longer term in nature but also to have a greater bias (and transparency of this) to elements which impact the consumer or the public in general.

Conclusions and Recommendations Importance of professional standards 53. There needs to be greater recognition of the importance of professional standards within and beyond the new regulatory regime. Professional standards in terms of qualiﬁcations, continuing learning and ethical conduct are crucial ingredients of a properly functioning ﬁnancial services market. This is because information asymmetries between customers and intermediaries can put the public at a disadvantage—they need appropriate products and competent advice in order to ensure that their needs are met.

Role of professional bodies 54. Professional bodies have a crucial role to play in promoting higher professional standards and taking action when standards of practitioners fall short. 55. Chartered Insurance Institute has demonstrated that it is possible to raise standards of behaviour across the insurance and financial advice community through voluntary, industry-led initiatives (like the Aldermanbury Declaration). We have also supported more regulatory focused efforts like the professionalism strand of the FSA’s Retail Distribution Review for financial advice. We believe this has many public interest benefits—not least improved levels of trust and confidence.

Move towards “banking profession” stuttering 56. The move towards a “professionalism in banking” similar to law, accountancy and increasingly insurance, seems to be stuttering over the past few years. Membership of banking professional bodies remains low, other than in areas covered by financial advice requirements. 57. We think the current reforms to financial services regulation in the UK is a great opportunity to kick start professional standards in the banking industry and to consolidate improvements in behaviour and culture made elsewhere within financial services.

Using the regulatory review as a catalyst for changing behaviour 58. Since the beginning of the regulatory review process, the CII has argued that whilst the structure of the new system will be important, it will be the judgements undertaken by supervisors and the conduct of ﬁrms, which will make the difference between regulatory success or failure. Promoting and encouraging the right culture will be critical. 59. We have argued that professional standards can act as a measurable proxy for culture, and it must be enshrined within the fabric of the Financial Services Bill.

Amending the Financial Services Bill 60. At a minimum, the Bill should encourage supervisors within the Financial Conduct Authority to focus, not only on whether those individuals in “signiﬁcant inﬂuence functions” are competent, but also the extent to which organisations as a whole, are making a credible effort to embed and grow professional standards. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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61. Where it is found that ﬁrms lack such a commitment to improve behaviour, supervisors should act. Currently, there are no such provisions within the draft legislation and this oversight should be urgently addressed.

Delivering a cultural change 62. But the Bill must also be accompanied by a “real” change in regulatory culture and not just one on paper. We all know that regulation is going to be more intense—but it must be targeted on the right areas— and the level of professional standards exhibited across financial services must be one of them. 63. And, crucially, financial services firms must listen to the concerns of the public and embrace a cultural change in standards. Industry-led regulation can and must lead the way in this regard, rather than waiting for external regulatory imposition. 24 August 2012

Written evidence from the Christian Council for Monetary Justice This review is an independent look at what prevents people from being allowed to choose for themselves in services that are publicly-funded. This may or not include what is available to people in terms of choice in the banking sector, a substantial part of which is now in some sort of public ownership. If a contribution on the banking sector is within your Terms of Reference then the Christian Council for Monetary Justice hope that the following may be of use to the reviewers:

Background 1. There are two kinds of money in circulation: — Cash, consisting of notes and coins, issued by the State. — Credit, aka “central bank money”, issued by monetary and financial institutions. 2. There are fundamental differences between these two kinds of money: — for Cash, the authority of the issuing agency is in the UK the Sovereign, ie The Crown or HM The Queen. — “credit money” requires “interest money” that nobody issues. 3. The effects of interest are equally debilitating for the public and the private sector of the economy: — every interest payment requires borrowing from Peter to pay Paul. — mainly the people in monetary and financial institutions benefit from interest payments. — the growth of compounding interest on interest is exponential, ie unsustainable http://forumnews.wordpress.com/understanding-exponential-growth/. 4. Increasing the money supply is decreasing the value of the currency due to printing “money”: — The value of “money” is deflated as the money supply is inflated willy nilly. — The function of money changes from “medium of exchange” and “store of value” to “tool for control”, since debts are legally enforceable. 5. Credit becomes cash or “money”, behind the bank counter, means: — The quality conditions under which Cash is produced, the correctness of paper and printing for notes and the quality of metal for minting coins, are not applied. — No quality control means absence of quality, if not counterfeiting…. 6. Governments facilitate this process of Credit becoming “money”, aka laundering, means: — By borrowing money as national or http://publicdebts.org.uk/ public debt, the supply of credit money is increased, ie the value of the currency is debased to the detriment of the nation. — By demanding taxes to pay interest to the financial economy, the real economy is debilitated. — No matter which party wins an election, governments have been perpetuating the process of borrowing more and more through the budget deficit http://publicdebts.org.uk/2010/06/22/the- emergency-budget-in-another-light/. 7. There is a trend that has led to virtually replacing Cash with credit money from 50/50 after WWII to 3% Cash in the money supply.

Recommendation Currently there are proposed remedies for making choice of banking services more real for most people. Generally they propose incremental regulatory procedures to disable nasty bankers from behaving greedily and destructively. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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The Christian Council for Monetary Justice, not well equipped for action, but active in debating possibilities, has advocated, for the UK, ending usury—and fractional reserve banking—by getting the Bank of England to take away from commercial banks the creation of most of the money in use. This can be achieved in a single step when government instructs The Bank to issue, free of interest, all the money needed for the real economy as repayable debt. Any willing existing agency, such as high street banks, mortgage lenders, or credit unions, could administer the distribution of this interest-free credit for an administrative fee. This single step could be expected to crowd out undesirable features of the current system and to hugely benefit people engaged in healthy economic activity. The real economy of goods and services, in this context, is seen to include finance for public infrastructure, industry and business (but not for financial services), for residential property purchase and for affordable short term credit for consumables. 24 August 2012

Written evidence from the Church of England’s Mission and Public Affairs Council Summary — A flourishing economy requires sound banks. Simply waiting until memories of recent scandals fade would not be an adequate strategy for rebuilding public trust. Regulatory and cultural changes are necessary. — Money is, as a Doctrine Commission report of 2003 said, “a human good and an essential instrument for any human society which aims at human flourishing.” At the same time, the Biblical claim that “the love of money is the root of all evil” holds true because, ultimately, treating money as an end rather than a means is dehumanising for creatures made in the image of God: “You cannot serve God and mammon (wealth)”. — The roots of the crisis in banking are, therefore, ethical. We discuss this below in terms of a culture of the virtues which could answer the question, “What would it mean to be a good banker?” A strong and virtuous professional culture in banking is the best way to guard against abuse without constraining innovation. — Inadequate levels of competition have distorted the proper operation of markets and increased the problems of “too big to fail”. The banking sector has violated some of the fundamental principles of the free market economy: free entry and exit, the avoidance of monopoly and oligopoly, and independence from external subsidy. We hope the Commission will look at ways to introduce greater competition—and perhaps greater local connectivity. — The nature of risk—and the basis of remunerating people for managing risk—has been badly misunderstood within the banking sector. Those who have been handsomely rewarded for risk taking have not been those who have borne the consequences of those risks. — Improving the public’s experience of retail banking—even though it should be, rightly, more distinct from investment banking—may do much to restore public confidence in the banking sector more generally. — Globalisation has made it harder but not impossible for national governments to shape and regulate the context in which banking takes place. The crisis is an opportunity for concerted international regulatory action to make the interconnected international financial sector more resilient.

The Church of England and Public Ethics 1. The Mission and Public Affairs Council is the body responsible for overseeing research and comment on social and political issues on behalf of the Church of England. The Council comprises a representative group of bishops, clergy and lay people with interest and expertise in the relevant areas, and reports to the General Synod through the Archbishops’ Council. 2. Part of the responsibility of the MPA Council is to offer insights from its experience and its ethical tradition on matters of public concern. The crisis in British banking (and the wider global banking context) affects every citizen—and will affect generations to come—and so is a legitimate area of concern for the churches and for Christian ethics. 3. The Church does not presume that it possesses unique specialist knowledge which can solve the problems which the Parliamentary Commission is investigating. The approach which the church has taken over many decades is to apply Christian ethical reasoning to practical problems in a way which avoids the Scylla of bland generalities and the Charybdis of unwarranted speciﬁcity. This approach, sometimes known as “middle axioms” was developed by the Church of England in response to the crises of the 1930s following a previous ﬁnancial crash and the subsequent deep recession. We believe that the approach can offer useful insights to the similar problems of today. 4. As is well known, the great Abrahamic faiths (Christianity, Islam and Judaism) are traditionally uneasy about the morality of usury. It is, however, too simple to argue that the church cannot, therefore, support an cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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economic model in which interest and indebtedness are central features. This is not the place to explore the extensive literature about Christian ethics and usury—suffice to say that, along with Judaism and Islam, Christianity has always recognised that money, interest and debt are not merely technical problems for economists but are moral questions for everybody. In a modern market economy, interest and debt may be unavoidable, but they are not amoral matters.119 5. Importantly, Christian ethics is not simply a matter of applying theological insights to contemporary dilemmas as if everybody shares the same religious starting point. Our responsibility is to join with others in exploring the nature of the Common Good in a complex society. 6. The widely-accepted notion of the Common Good is, in itself, a challenge to the kind of atomised individualism which characterises a great deal of public discourse. Applying the notion of the Common Good to questions of banking is significant on two counts: it affirms the principle that morality is evaluated by broad social outcomes as well as individual conduct, and it makes it easier to consider banking as an activity in which the majority of the population has a direct stake and in which every citizen of the world has at least an indirect interest. 7. In the response to your specific questions which follow, we have not attempted to answer every point as there are some areas where we have no special insight to draw upon. We have restricted our responses to those where we believe that the Christian ethical tradition, and our experience as a church which is present in every community of England, have something useful to say.

Responses to the Commission’s Questions Q1. To what extent are professional standards in UK banking absent or defective? How does this compare to (a) other leading markets (b) other professions and (c) the historic experience of the UK and its place in global markets? 8. We have no doubt that there are many people involved in banking who aspire to high standards of professional conduct—such standards and such people are rarely entirely absent from any profession. But the critical factor is not the personal standards of individuals but the corporate context which can promote and sustain, or undermine, such standards. 9. There is evidence that in many professions, but notably in finance and banking, practitioners who have a strong moral sense which they seek to live by in their private lives believe, rightly or wrongly, that such standards and ethics are impossible to apply in the corporate world. They are certainly clear that the culture of their working environment does little or nothing to encourage virtues such as truth-telling, loyalty and prioritizing what is right over what may be expedient.120 10. There is also evidence that the culture of banking has changed in the last 25 years or so. In 1991, a study of professionals in different sectors suggested that many in retail banking, who had entered the profession believing it to be about serving the customers’ financial interests, were dismayed that the job had come to value the sale of financial products as the objective, with little thought for customers’ needs.121 The shift from a culture of personal service to one of maximizing sales appears to be more marked in banking than other sectors. 11. Public disquiet about the scale of bonuses, especially in investment banking, has shed some light on a culture where large bonuses are valued, less for their monetary worth than for their significance as status indicators within the industry. This in itself suggests that the culture of banking has lost touch with matters of virtue—in short, there seems to be no reflection upon the question, “What would it mean to be a “good” banker?” beyond the crude measure of monetary profit. To speak of professional standards in a culture with no internal discussion of what it might mean to be virtuous in that culture, is to be part of a very attenuated and morally inadequate discourse. 12. This is not a problem confined to the banking sector. Across a range of professions the trend in recent years has been for money and material rewards to have an increasing impact on culture and standards. But in the financial sector the trend seems to have been more acute than in those where there is perhaps a stronger sense of working as part of a collective endeavour for a wider good where value cannot be measured solely in terms of the bottom line. 13. Professional standards are closely linked to the idea of character. Professionals are regarded, not merely as “hands” to do a task set by others, but as people whose character is shaped by an understanding of the virtues and the “internal goods” associated with their profession. Self regulation is often regarded as intrinsic to professionalism, although no profession works completely outside laws, rules and structures imposed by society at large and sometimes enshrined in law, for the sake of the Common Good. 14. One important dilemma with which every profession has to contend is whether reliance on character, formed as part of professional education, training and culture, is enough to ensure high standards. The medical 119 See: Peter Selby, Grace and Mortgage: the language of faith and the debt of the world, London: DLT: 1997 (reprinted 2008) for an accessible discussion of a Christian approach to questions of debt and money. 120 See: Richard Sennett, The Corrosion of Character, New York and London: W W Norton, 1998. 121 Rachel Jenkins, Changing Times: Unchanging Values? Manchester: The William Temple Foundation, 1991. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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profession, for example, was deeply discomfited by the exposure of the activities of Dr Harold Shipman and one consequence was an increased bureaucratisation of GP’s work which necessarily supplemented the traditional reliance on trust with the more tangible safeguards of process and audit trails. 15. There are dangers in trying to draw too many parallels between the Shipman case and what has happened in the financial sector over the past few years. The Shipman case was essentially about the inadequacies of the system to pick up and prevent extreme, almost unimaginable behaviour by one individual. It did not call into question the ethics or competence of the medical profession more generally. 16. The financial crises and emerging scandals of recent years have, in contrast, raised profound concern not simply about the ability of the system to prevent extreme and criminal behaviour by individuals but about the system itself and a whole cadre of professionals within it. The question is not whether systems have been adequate to identify and deal with the bad apples but whether the whole orchard needs replanting. 17. Smarter regulation is, therefore, part of the answer, but only part. The sharp question is how banking can restore its internal professional standards in ways which communicate trust both within the industry and with stakeholders throughout the community. 18. An exploration of the ways in which banking serves the common good, the virtues required of bankers and the structures and culture which might nurture and sustain those virtues, is needed to prevent the current crisis simply leading to further impersonal and rigid regulation in which professional judgment is either stifled or emerges in rule-bending. 19. To sum up: — the crisis of professional standards in banking is one of corporate culture into which individuals have been drawn, rather than one caused by wicked or wrong-headed individuals subverting an otherwise benign culture; — further regulation and the regeneration of a culture of virtue are both needed. — some, smart, new regulation of the banking industry is needed to assist in rebuilding a more virtuous corporate culture by making overt the agreed boundaries within which good bankers must operate. — practices of virtue in professional contexts need to be reinforced by examples and role models and often by a new set of principles and boundaries.

Q2. What have been the consequences of the above for (a) consumers, both retail and wholesale, and (b) the economy as a whole? 20. Consumers are participants in the economy as a whole so, considering consumers of banking services in the widest sense, it is impossible to separate (a) and (b). 21. The impact of recession on the most vulnerable is both well documented and deeply injurious to a cohesive society. And, in so far as all gain from greater social cohesion, all lose when social bonds are damaged through widening material inequality and the exclusion of significant numbers of people from meaningful employment. 22. It has frequently been observed that the banks had been driven to create ever more inventive financial instruments which helped to contribute to continual economic growth and therefore tacitly served the political priorities of successive administrations as well as boosting their own profits. Economic growth is a good thing but only to the extent that it is sustainable, realistic and achieved morally. 23. A flourishing economy in a functional society needs banks in which people can trust—the small saver as well as the major commercial client. The damage done to the reputation of banks by the current crisis could prevent the banks playing their most effective role in promoting recovery. Restoring trust frequently requires symbolic, as well as merely effective, change to take place. 24. One insight from the Christian tradition of penitence and forgiveness is that it is often not enough to put matters back to where they were before things went wrong; some demonstration of a change of heart by means of restitution and a visibly robust refusal to let the same failings occur again, is necessary before a bad situation can be made good. Exactly what kind of action by the banks, or by the government, would be necessary to restore trust in this way would probably emerge if the debate about banking ethics were to take place openly in the public realm. 25. We believe that the restoration of public trust in the banking industry would be in the interests of all. To achieve this is not just a matter of technical “fixes” but may require public, corporate, contrition for past failings, demonstrably robust structures to ensure that old mistakes are not repeated, and possibly some symbolic steps to assure the public that the corporate culture has changed.

Q3. What have been the consequences of any problems identiﬁed in question 1 for public trust in, and expectations of, the banking sector? 26. Many of the failures in the banking sector lay in the investment banking arm. But the public experience of banks, which does much to shape perceptions of the sector, stems mainly from their engagement with the cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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retail arm. This, in itself, suggests that the carry-over of risk from one arm to the other has done damage to public confidence in retail banking. The future degree of separation between the two arms, or ring fencing between them as proposed in the Vickers report, should help with this. 27. Clearly the widely reported bonus culture, and the headline salaries, bonuses and remuneration packages of very senior bankers—packages that have not been visibly affected by the financial crisis which has brought austerity to the doorstep of most families—has gravely harmed the public perception of banking. 28. This is not simply an outworking of an undesirable politics of envy. It reflects a deeply felt and sound belief that what has happened is unjust. The fact that those who presided over actions by their banks that were disastrous for the common good walked away with large pay-offs has simply fuelled the damaging notion that the whole culture of banking conspires to facilitate personal greed, with huge rewards for success and only slightly smaller rewards for failure. 29. The residual belief (exploited by numerous advertisements for banks) that banks are friendly, family- oriented, institutions which have the customers’ needs as their raison d’etre, has taken a possibly terminal blow. Our social culture is not so rich in benign and trustworthy institutions that this loss can be greeted with equanimity.

Q4. What caused any problems in banking standards identified in question 1? The Commission requests that respondents consider (a) the following general themes: — the culture of banking, including the incentivisation of risk-taking; — the impact of globalisation on standards and culture; — global regulatory arbitrage; — the impact of financial innovation on standards and culture; — the impact of technological developments on standards and culture; — corporate structure, including the relationship between retail and investment banking; — the level and effectiveness of competition in both retail and wholesale markets, domestically and internationally, and its effects; — taxation, including the differences in treatment of debt and equity; and other themes not included above; and (b) weaknesses in the following somewhat more specific areas: — the role of shareholders, and particularly institutional shareholders; — creditor discipline and incentives; — corporate governance, including: — the role of non-executive directors; — the compliance function; — internal audit and controls; and — remuneration incentives at all levels; — recruitment and retention; — arrangements for whistle-blowing; — external audit and accounting standards; — the regulatory and supervisory approach, culture and accountability; — the corporate legal framework and general criminal law; and — other areas not included above. 30. (i) Risk. The question of the incentivizing of risk is a good example of how a failure to consider ethics in terms of the Common Good can distort judgments. The rhetoric of the risks taken within the banking sector tends to exclude the demonstrable fact that the consequences of banking failures have been borne by the people of the nation, and indeed of the world, and not just by the so-called risk takers. 31. This would appear to be an example of the kind of blindness to the Common Good which can develop within a culture with strong internal behavioural norms, a very strong focus on the shared end rather than the ethical means, and a substantial disconnection from the concerns of a wider community and society. Jobs in investment banking in particular have been characterised by extraordinarily long hours and intensive focus on the job to the neglect of wider social hinterlands. Whilst such intensive single-mindedness has long been recognised as bad for the well being of the individuals concerned (even though they may regard their remuneration package as sufficient compensation) the disconnect from other people’s lives has contributed to an excessively narrow interpretation of the nature of risk. 32. The point is not that bankers should avoid risk but that the banking industry should work to a much wider calculus of the extent and nature of the risks which banking practices impose on people way beyond the cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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industry. A culture which is alert to the notion of the Common Good would not have misunderstood the social nature of financial risk in such an egregious way. 33. (ii) Globalisation. To a great extent, the City of London has developed a competitive edge by shrewdly going with the grain of globalization—in itself on balance a good thing and in any event a fact of life—and seeking to ensure that its regulation of the financial sector is, at worst, no more burdensome than that of other potential competitors. The balance struck has been a conscious and in many ways justified national choice. The view sometimes expressed that globalization has imposed identical constraints on all economies and taken away all national sovereignty in economic matters is a myth. 34. What the crisis has revealed, however, is the extraordinary interconnectedness of the international financial sector and the need not only to review the UK’s regulatory framework but to seek to generate some common international approaches to rebuild global resilience. Just as it would be misguided for the UK to throw away its competitive advantage by unilaterally introducing onerous regulations or tax regimes it would be dangerous to engage in a competitive, deregulatory chase to the bottom. 35. (iii) Innovation and technology. The problem seems to have been that innovative models and products were developed without the framework of a strong ethical corporate culture. This, plus the increasingly impersonal nature of trading as a result of developments in IT, has tended to detach trading from being a transaction between persons and to obscure any sense that whole communities might be directly affected by a particular transaction. 36. “My word is my bond” only works if it is possible to identify with whom the bond is supposed to be forged. The impersonal nature of trading is one factor in the miscalculation of risk and one factor in the diminution of the reputation of the industry. If old ways cannot be returned to then new ways of demonstrating the personal and “real-life” implications of a transaction need to be sought. 37. (iv) Corporate structure. Many, including Vickers, have suggested that the retail and investment arms of the banking sector should be separated. The point made earlier, that the reputational damage to the retail sector may be hard to restore if some separation is not achieved, gives force to this argument. Moreover, the activities and, perhaps most of all, the professional qualities required to flourish in the two sectors, are significantly different. We would, however, commend to the Commission for further thought and evidence gathering the question of what the implications of separation will be for the cultures of the two sectors and what will be needed to ensure that both are conducive to the common good. To put the matter more bluntly, the effect of separation must not be to create an ethically mature and consumer friendly retail sector sitting alongside an even less well regulated and socially irreseponsible investment banking sector than in the past. 38. (v) Competition. In seeking to understand the nature of the current financial crisis, MPA staff have held informal discussions with a number of practitioners in different City of London institutions. We have been very struck by the widespread view among practitioners in, for example, the foreign exchange and insurance sectors, that the banks have enjoyed an unwarranted oligopoly which was neither in the nation’s nor, ultimately, the City’s, interest. 39. We do not have the specialist knowledge to know the exact impact of the relative lack of competition between British banks. We do note, however, that monopoly (or near monopoly) has always been regarded by market theorists as inimical to the proper functioning of markets, and yet that the market system of itself (as Adam Smith among others noted) contains an inbuilt tendency towards monopoly. 40. We do not regard it as an accident that a sector of the economy which most robustly championed the free, unregulated, market economy should have found itself a victim of that innate tendency toward monopoly. Adam Smith recognised that markets need to operate within an external moral structure if they are to flourish, but that markets of themselves do not sustain such moral structures. This points back to our earlier observation that whilst some external regulation may be needed to restore probity to the banking sector, an internal discourse of ethics and virtues within the sector is also a worthwhile objective for reform. 41. This sense that banks have been championing a free market ideology whilst claiming exemption from its rigours has been exacerbated by the suggestion that the banks have become “too big to be allowed to fail”. The principle of free entry and exit is fundamental to a market economy and yet the exit of a bank from the market place is seen as unthinkable. The ready acceptance by the banks of vast public subsidy also appears to violate the free market principle that the banks have commended to everybody else. Competition is fundamental to the operation of a viable market economy and the way the banks in Britain have evolved into an oligopoly seriously violates that principle. 42. This affront to the principles of the open market is not merely a theoretical or ideological problem but a moral one. The Governor of the Bank of England was right to warn that the notion that the banks were too big to fail and therefore had to be bailed out by public funds created “moral hazard” since such an implicit guarantee disconnected the behaviour of the banks from its moral consequences. 43. The virtual demise of the mutuals as they were swallowed up in the retail banks has also diminished competition in the sector. Having competition, not simply between companies of similar size, shape and ideology but between different sorts of financial institutions which can approach banking operations with different priorities, is clearly advantageous if achievable. 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a diminution of real competition in the sector as well as the loss of a distinctive banking ethos which might, conceivably, have proved more robust in preserving the moral dimension of finance and banking. It may not be possible to create the conditions in which new mutuals might emerge and flourish, but the key question demanding attention is that of diversity of banking models and priorities as a mark of a sector demonstrating genuine competition. 44. We do not feel qualified to respond in detail to the other areas suggested for comment within Q4. However, some of the points already made could be applied to a moral evaluation of these other areas of concern.

Q5. What can and should be done to address any weaknesses identified? To what extent are such weaknesses subject to remedial corporate, regulatory or legislative action, domestically or internationally? 34. The UK banking sector was, for a period, extraordinarily successful on its own terms. It should be an aim of public policy to enable the sector to rebuild its reputation, its resilience and its international competitiveness. There is no conceivable national interest in talking down one of the key sectors which has contributed greatly to the nation’s wealth and stability over centuries. 35. But the banks’ contribution to wealth creation has to be soundly based and ethically robust. The activities of the financial sector have become too detached from the material reality which ultimately measures wealth, too driven by poorly managed borrowing and too vulnerable to theoretical risk assessment tools that place undue weight on mathematical probabilities and make insufficient allowance for the messiness of the human condition. 36. Redressing these imbalances and neglects is essentially a conceptual rather than a technical problem. Technical fixes, additional regulation and reformed structures may help but, as we have already suggested, the central task is to encourage and sustain a pervasive culture of banking which is framed within a concept of the virtues. Reliance on regulation alone will only lead to a frantic search for loopholes and a de-professionalising of the industry in a way which could diminish its capacity for innovation. 37. There is an important role here for the senior figures in banking who, so far, have not come out of the crisis at all well. As top bankers have been exposed to the public gaze (a hitherto rare experience) their capacity to speak of their activities in ways which connect to public disquiet has been found sadly wanting. 38. The public, as a result, now has little trust in such figures to overcome past structural failings let alone to engender the kind of new corporate culture which would act as a future safeguard. A new and humbler style of leadership will be necessary if the banks are to redeem their reputations. 39. As noted above, the differences between the regulatory regimes in different national economies within the developed world challenges the claim that globalization must lead to the detachment of banking from politics. A system of regulatory checks and balances is a matter for political decision, in discussion with, but not ruled by, the sector. The banking sector and the government should work together to evaluate the strengths and weaknesses of different regulatory regimes to see what lessons ought to be learned from other countries. 40. We hope that the Commission will give particular attention to the question of competition within the sector and, in particular, to ways forward which might restore the human scale of banking and rebuild relationships between banks and local communities. 41. When it comes to specific programmes for change, the devil is, as usual, in the detail and we are not qualified to promote any particular solutions or programmes as if they were self-evidently good.

Q6. Are the changes already proposed by (a) the Government, (b) regulators and (c) the industry sufficient? Respondents may wish to refer to the Financial Services Bill and the Government’s proposals for the Banking Reform Bill. They may also wish to refer to proposals by the Bank of England and the Financial Services Authority on how the Financial Policy Committee, Prudential Regulation Authority and Financial Conduct Authority will operate in practice. 42. They are likely to help. But none of them appears to capture the sense in which the current crisis in banking is simultaneously a technical/economic and a moral/ethical crisis. This is not surprising since the capacity of any national institutions to speak cogently about ethics, virtues etc has been gravely diminished in the last 25 years or so. The banks have, to some extent, led the way in promoting the privileging of contracts over personal trust and the “creed of the bottom line” but they have been far from unique in this. 43. The opportunity now exists to embark on a major reorientation of a whole industry in an attempt to recapture an internal and external culture of “virtuous banking”. By this we mean that the sector would operate to a set of, initially imposed but ultimately internalised, understandings of what it means to be a good bank. Such ideas are not communicated in rule books but by narratives and examples which communicate the nature of virtuous banking. 44. Perhaps this can best be communicated by a simple example. The philosopher Alasdair MacIntyre saw such virtuous practices embodied in the fishing fleets of the New England coast where each boat is a business in competition with each other. But when a boat gets into difficulties, the other boats think nothing of cutting cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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their nets (at enormous financial cost) to go to the aid of the stricken crew. This is of course because of (a) the belief that human life is more precious than any possessions and (b) a recognition that mutual solidarity is an integral part of the common good. 45. A culture of the virtues is entirely consistent with a market economy which is pro-competition but it seeks to recognise that the ultimate “bottom line” is measured in terms of human, not financial, outcomes and that, in the end, every player is dependent not just on the law and regulation but on the ethical conduct of those with whom he is competing if his own work is to have sustainable outcomes. 46. The banking sector is a good deal more complex than the fishing sector. Nevertheless we offer the illustration to highlight the kind of culture shifts that we believe are necessary if banks are to avoid both a repetition of the hubristic failures of recent years and being smothered by excessive regulation that is more likely to cover backs than effectively promote the common good. 24 August 2012

Written evidence from Church of Scotland Q1. To what extent are professional standards in UK banking absent or defective? How does this compare to (a) other leading markets (b) other professions and (c) the historic experience of the UK and its place in global markets? 1. Over recent years we have seen serious deficiencies in the professional standards and monitoring of banking which as a profession has been seriously lacking over other professions such as solicitors, teachers, doctors etc. Professional conduct has deteriorated over the last 10 years. At the level of individual employees, the bonus culture may have had a part to play in encouraging bank employees into mis-selling products to customers, but more concerning is the mounting evidence of systemic malpractice where scandals such as the mis-selling of PPI, the mis-selling of complex financial products such as interest rate swap agreements (IRSAs) to small and medium sized enterprises and the LIBOR rate-fixing scandal are all arguably driven by greed at a corporate level. We are particularly concerned with the apparent disregard for customers, especially small customers, displayed in the mis-selling scandals. 2. Other professions are policed by their professional bodies and we would recommend that something similar should apply in the case of bankers. We believe that the Chartered Banker Institute is well placed to undertake this task. 3. One of the problems has been that the Chief Executives/Senior Executives of Bank’s have not actually been qualified bankers. We feel that there should be a requirement that Senior/Chief Executives hold suitably certified banking qualifications, and that the Chartered Banker Institute (or other governing body) be given the ability enforce standards, including the ability to strike off those who do not come up to required standards of competence and ethics.

Q2. What have been the consequences of the above for (a) consumers, both retail and wholesale, and (b) the economy as a whole? 4. A healthy banking industry is founded upon trust, and it was precisely because customers trusted their banks that the banks were able to perpetrate betrayals of that trust, as in the PPI and IRSA mis-selling scandals. The result is the considerable erosion of trust in the banking industry. Excessive charging and sale of products which customers do not require or which are unsuitable for them has been part of the culture over many years. A lot of hard work will be required to regain that public trust- effort which the banks currently show little appetite for, preferring instead to concentrate on rebuilding their own balances. 5. Although many of cases (particularly of Interest Rate Swaps) involve mis-selling in breach of the FSA’s Conduct of Business Rules, and of the EU Markets in Financial Instruments Directive (“MiFID”), such breaches are (on the whole) actionable only by private individuals and not by companies. The legislation was originally designed to prevent strategic lawsuits by Financial Services Professionals against each other. However, since the typical SME which will have been mis-sold an Interest rate Swap is a limited company, the practical effect is that such clients are deprived of any adequate redress for mis-selling. Although there are administrative remedies available in the form of a complaint to the Financial Services Ombudsman, this is limited to only the smallest of claimants, and subject to a relatively low limit of compensation which can be awarded. 6. The net effect of all of this is that it creates a climate in which Banks can be perceived as having breached the Conduct of Business Rules with impunity. The Banks are adopting an aggressive and hard-nosed attitude in resisting any claims on the basis explained above. 7. The ﬁnancial instruments used by Banks have become so complex that even many in the market (including those responsible for running the Banks) did not fully understand the nature of the instruments, let alone their attendant risks. Regular education of executives, particularly in understanding investment risk, must be introduced. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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8. Also even in a low interest rate climate the banks have not passed the benefits on to the consumer. The cost of credit cards for example has not changed despite the fact that interest rates are at their lowest level for decades. 9. We have also seen the rise in “payday loan” companies who are charging exorbitant interest rates and who in many cases seek to flaunt regulation in respect of advertising etc. As, in some instances, the banks are not willing to lend, we have seen an explosion in this market place. The FSA must ensure that existing legislation prohibiting the charging of excessive interest rates is properly enforced. We would recommend that, as is the case in some other countries such as France, a maximum charge for consumer credit should be introduced. The Church of Scotland Special Commission on the Purposes of Economic Activity, in their report to the General Assembly of the Church of Scotland in May 2012, recommend that this initially be set around 40% APR (please see http://www.churchofscotland.org.uk/__data/assets/pdf_file/0009/9765/Economics_ Commission_email_and_web_version.pdf)—higher than the French rate (approximately 25%), but much lower than the thousands of% now being charged by some companies.

Q3. What have been the consequences of any problems identiﬁed in question 1 for public trust and in, and expectations of, the banking sector? 10. Public trust in banks is probably at their lowest level ever. The grudging acceptance of liability for PPI mis-selling (after protracted litigation) and the hard-nosed resistance by the banks of claims for mis-selling of complex ﬁnancial instruments, such as Interest Rate Swap Agreements, serves only to compound public distrust.

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12. We feel that even the Boards in many of the Banks did not actually understand some of the Treasury instruments being used to finance their books, so education is required here. 13. Financial innovation in banking for the benefit of the customer is at the lowest level with little of benefit to customers being introduced by Banks in the last 10 years. On the contrary, the new and innovative offerings introduced by Banks in the early 1990s through Egg, Intelligent Finance, Smile, and similar institutions have all been withdrawn or run down as the individual Banks build their capital base. We have seen a widening of interest rate margins, as a result of their desire to build their capital base. This has resulted in charges for credit remaining static throughout the years with the interest rates being offered to savers being drastically reduced. 14. By contrast, some Banks appear to have been assiduous over the same period in innovating for their own benefit and to the prejudice of customers. It appears that some LIBOR fixing was indulged in for the purpose of manipulating the perceived value of the Banks themselves. The principal driver for the sale of complex financial instruments was the perceived need for the Banks to increase their capital base. 15. The sale of IRSA’s (Interest Rate Swap Agreements) and other complex financial products was not a case of isolated salesmen seeking to earn commission (though that may also have been a driver), but was systemic to the extent that it was frequently made a condition of the client being granted a loan that he should enter into an IRSA (whether or not that was a suitable or appropriate product for that client, within the terms of the Conduct of Business Rules and MiFID.) This situation might have been ameliorated by a greater separation between retail and investment banking divisions (though any such separation would also have to address devices such as the imposition of a requirement for a customer to purchase what might be an unsuitable product as a condition of obtaining a loan). 16. We would be in favour of legislation to separate Retail elements of Banks from investment banking , perhaps along the lines suggested in the report of issued by the Independent Commission on Banking chaired by Sir John Vickers’ in 2011. The much needed competition in the market place should be obtained through the acquisition and separation of Brands held by existing banks.

Q5. What can and should be done to address any weaknesses identified? To what extent are such weaknesses subject to remedial corporate, regulatory or legislative action, domestically or internationally? 17. We feel that recent scandals have shown that Chief Executives have often not had effective supervision from their Board of Directors, and that auditors both internal and external have also failed to identify weaknesses. The Board of Directors need to have more control over the audit functions and in banking the appointment of auditors should be jointly agreed with the regulator. Also the audit plans each year should also be agreed with the regulator to assist in preventing the problems of the past. We would also recommend that there be a requirement that auditors be changed on a regular basis (eg every three—five years). 18. Certain of the recent abuses, such as Interest Rate Swap mis-selling have been the result of what is arguably corporate misfeasance at a systemic level, and there is need of this being reined in. Arguably MiFID and the Conduct of Business Rules, if properly observed, would go a long way to achieve this, but so long as a significant number of injured customers are deprived of meaningful redress, it generates an atmosphere of apparent impunity. At the very least, the FSMA should be amended so as to permit all victims of mis-selling to obtain proper redress through the courts. 19. The FSA has shown significant weaknesses in policing Banks probably because of inexperience within their own ranks. Problems with recruiting and retaining and suitably qualified and experienced staff need to be addressed, as does the issue of “regulatory capture” which many banks have pursued. 20. We are also concerned that many tax havens, which are used by many institutions which operate within the City of London to deprive countries of their legitimate tax income, are British Overseas Territories and Crown Dependencies or are otherwise under British influence. It is inconsistent for the UK government to have committed to maintaining overseas aid while, at the same time, supporting tax havens which deprive developing countries of the tax funds that they need for their development 21. Bonuses, by definition, skew behaviour. The withdrawal of the bonus culture particularly at senior levels within retail banks would help the behavioural culture of Bankers. The Church of Scotland Special Commission on the Purposes of Economic Activity, which reported in May 2012, called for recognition of “the corrosive effects on business ethics of the current unhealthy dependence on the “bonus culture”, and [a] return to more traditional forms of remuneration for work undertaken.” (please see http://www.churchofscotland.org.uk/__ data/assets/pdf_file/0009/9765/Economics_Commission_email_and_web_version.pdf) 22. Failing this, there is a need to at least rein- in bonuses levels. The idea put forward by the Hutton report, that an element of any putative bonuses should be at risk of being lost due to poor performances should be considered. 23. Taking excessive risk should become a criminal offence; many at the top in banking have reaped rich financial rewards, with no threat of prosecution. In addition, we feel that non- executive directors should also be liable to sanction, in the event of their failure of provide proper oversight. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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24. Consideration should also be given to other changes to Board structures- for example a requirement that employees sit on Boards, along the lines of the German “mitbestimmung” model, and that shareholders have a real inﬂuence over appointments to Boards.

Q6. Are the changes already proposed by (a) the Government, (b) regulators and (c) the industry sufficient? Respondents may wish to refer to the Financial Services Bill and the Government’s proposals for the Banking Reform Bill. They may also wish to refer to proposals by the Bank of England and the Financial Services Authority on how the Financial Policy Committee, Prudential Regulation Authority and Financial Conduct Authority will operate in practice. 25. That the Business Secretary could recently describe the banking sector and the City of London as being like a “massive cesspit” should be a matter of profound shame; however we shouldn’t be content to lay blame and responsibility solely at the door of the financial institutions, but should acknowledge that we all have contributed to the decline in our economical prudence. There is an eternal relevance to St. Paul’s assertion that “the love of money is the root of all kinds of evil”. When the love of money overwhelms the love we have for others, society inevitably erodes. 26. We would encourage UK government support for greater international tax transparency at the EU, G20, OECD and other relevant decision-making bodies, specifically including the disclosure of profits made and taxes paid in each country in which they operate, as well as the automatic exchange of information between tax jurisdictions on a global level. We would further urge the ending the UK’s support for tax havens.

Q7. What other matters should the Commission take into account? 27. The Church of Scotland Commission on the Purposes of Economic Activity was asked to look at how the Church could help bring a fresh vision to economics. In their report they argue that it is necessary to: — Reduce inequality. — End poverty. — Ensure sustainability. — Promote mutuality. 28. The way in which our economy is structured means that many people are marginalised by market forces. This is of concern to the church- that the weakest in society should be disadvantaged- or even taken advantage of. 29. Banks are not simply businesses, but provide an essential economic service. It is necessary that they operate on principles which are driven not simply on proﬁt, but take cognisance of the wider effects which their actions have on society. 24 August 2012

Written evidence from Citizens Advice The Citizens Advice service provides free, independent, conﬁdential and impartial advice to everyone on their rights and responsibilities. It values diversity, promotes equality and challenges discrimination. The service aims: — to provide the advice people need for the problems they face; and — to improve the policies and practices that affect people’s lives. The Citizens Advice service is a network of nearly 400 independent advice centres that provide free, impartial advice from more than 3,500 locations in England and Wales, including GPs’ surgeries, hospitals, community centres, county courts and magistrates courts, and mobile services both in rural areas and to serve particular dispersed groups. In 2011–12 the Citizens Advice service in England and Wales advised 2 million people on nearly 7 million problems. Debt and welfare beneﬁts were the two largest topics on which advice was given.

BureauEvidence onConsumerIssues inBanking Citizens Advice Bureaux advise a significant number of clients who are experiencing problems with their banks, with issues ranging from difficulty opening a basic bank account to refusal to cancel a continuous payment authority. The impact of these issues on people who are often on a very low income can be severe, leading to debt, financial difficulty and bankruptcy. For some people it means difficulty paying priority debts, which can lead to the disconnection of utilities or even homelessness. In this document we provide evidence of the impact of a range of issues clients report difficulties with relating to banks. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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In 2011–12 Citizens Advice clients reported 129, 092 issues relating to financial products. These included: — 20,001 about bank and building society accounts, including issues such as opening and operating accounts, terms and conditions and accessing cash. — 3,397 issues related to credit, store and charge cards, including issues such as contract terms and conditions, fraudulent use and equal liability under Section 75 of the Consumer Credit Act. — 5580 about unsecured personal loans. — 14763 about payment protection insurance. Because of the way our statistics are collated, financial product issues involving debt are categorised separately. In 2011–12 we dealt with 2,137,860 problems about debt including: — 138,523 issues regarding bank and building society overdraft debts. These issues include problems with dealing with debt repayments, overdraft charges, enforcement by bailiffs, creditor harassment and court action. — 295,536 issues regarding credit, store and charge card debts. — 279,192 problems about unsecured personal loan debts. One of the most widespread underlying causes of these issues are staff incentives to sell products which make a profit for the bank, rather than considering which product is best for the customer’s needs and circumstances. The case of payment protection insurance offers an apt illustration of how these incentives can not only lead to consumer detriment but have sizeable financial consequences for banks themselves. The sheer scale of payment protection insurance mis-selling and resultant refunds has also been opportunistically taken advantage of by a claims management industry which has caused further consumer detriment. Following the 2005 super-complaint by Citizens Advice to the OFT regarding payment protection insurance, over £1 billionn has been paid back to consumers with banks anticipating that this will eventually rise to £6 billion. While the FSA’s investigative work on PPI is concluded, we await with interest the outcome of their wider investigation into financial incentives in the financial services industry. Below we have summarised some of the problems clients bring to us regarding their experience of banks as well as some of the key issues affecting the retail market which are a cause for concern for us.

TheBasicBankAccountMarket Many of the banking issues we receive evidence about fall within the broad category of access to basic banking. Simply being able to open an account is an ordeal for many people and an impossibility for others. In addition, the difficulty in access to basic banking has side-effects which go beyond the immediate effect on those who are excluded. Our understanding is that the current policies and practices of the banks and building societies who offer basic bank accounts is leading to a disproportionate concentration of such accounts with two banks in particular. This is primarily because those two banks are more likely than other banks to offer an account to people in financial difficulties, but also because they will usually allow undischarged bankrupts to open accounts. Given that basic bank accounts at best make very little money for banks and often incur a net loss in the short-term, a disproportionate concentration of the market in a small number of banks is unsustainable in the medium to long-term. In effect, banks with more reasonable access policies end up losing money as a result of being a socially responsible corporate citizen. This leads to an incentive to make such accounts less attractive or to restrict access, an incentive which will only grow if current trends continue and which would be regressive and lead to additional detriment for consumers. While there are potential new innovations in the pipeline, such as de-facto accounts, pre-paid cards and the proposition being developed by ABCUL for a basic account accessible through the Post Office, the question of how to ensure everyone has access to an account is missing from discussions at present. Ensuring access is paramount since the direction of travel in payments and benefits is very much towards services which require access to a transactional banking account. Unless every consumer is able to open such an account, the consequences of being financially excluded will become more pronounced as time goes on and alternative ways to pay bills and receive payments disappear and the additional costs of using them increases (ie the poverty premium). In one very important aspect this runs counter to the Government’s aspirations to make work pay: quite simply, if an individual is unable to open a basic banking account it is already very difficult to receive their pay and will become even more so in future. We want to see a universal service obligation which would mean that anyone can open a basic bank account regardless of their financial history or existing debts, and particularly undischarged bankrupts. We also want to see banks following the FSA’s guidance on acceptable forms of ID, so people without a passport or driving licence can open an account using other forms of identification such as award letters from the DWP. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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We note that the European Commission appears minded to take action on providing universal access to a basic banking product with suggestions that the recent recommendation that member states ensure universal action could be put on a more formal footing. Citizens Advice believes that it would be eminently possible to ensure universal access to a basic bank account without recourse to legislation but given the persistent failure of the UK banks to provide it we would be supportive of a Directive on the subject.

Access to cash An issue which both Citizens Advice and the Treasury Select Committee have investigated recently is the decision by RBS Group to restrict access to non-RBS Group ATMs for their basic bank account customers. Parts of Lloyds Banking Group (namely Lloyds TSB and Bank of Scotland) already operated the same restrictions. Citizens Advice carried out an extensive survey online and in bureaux and found that while the majority of respondents (96%) found it easy to access their cash for free, 12% of basic bank account customers who held an account with one of the banks that restrict ATM access found it difficult. We also received a large number of case studies from individuals who found it difficult to access their cash following the decision. While RBS did make an extensive effort to ensure customers who had a problem could be moved to an account which allowed access via the LINK network, this put the onus on the customer, many of whom are reluctant to challenge their bank or sceptical that it will achieve anything. Our report also identified a concern that the effect on the flow of interchange fees may lead to a tit-for-tat situation whereby an increasing number of banks remove access to the LINK network for their basic bank account customers, as well as an extant threat to the sustainability of some of the most socially important free ATMs in deprived areas. The report concluded that RBS Group and Lloyds Banking Group should restore access to the LINK network for basic banking customers and that all banks should ensure customers have access to counter services in branch—something which other banks do not provide. The full report is available online: http://www.citizensadvice.org.uk/access_to_cash

DifficultyOpening aBankAccount While the difficulties that clients experience in opening a bank account often relate to basic banking products, they do extend to other banking products as well. Generally speaking the barriers to opening a bank account fall into the categories of insufficient proof of identity, existing debts or poor financial history, bankruptcy or a criminal conviction. We also consider clients who try to open a basic bank account but are told they must open a packaged account instead to be experiencing difficulty opening a bank account.

Insufficient proof of identity Legislation aimed at tackling money laundering requires prospective customers to have photo ID in order to open an account. However, many low income consumers do not have a passport or driving licence and some do not have documents to prove their address. They often find that banks are unwilling to accept the alternative forms of identification which the FSA recommends they can accept instead. A CAB in the East Midlands reported a case in which a 22 year old Belorussian client was having difficulty opening a bank account due to a lack of acceptable identification. The client moved to the UK with his mother and step-father in 2002 and received indefinite leave to remain in 2011. His Belorussian passport expired in 2005 and he was not yet eligible to apply for a British passport, and he did not have a driving licence. As a result he could not open a bank account putting him at financial disadvantage, particularly as he was due to begin a university degree. The adviser felt that if UKBA was satisfied with the identification documents the client had, there should be a way of satisfying the bank whilst still complying with anti-money laundering legislation. A CAB in the South West reported a case in which an unbanked client had been unable to open a basic bank account because he did not have a passport or driving licence. The bank refused to accept alternative forms of ID. The client had a refund cheque from his fuel supplier for over £1,000 but was unable to cash it without a bank account, or paying significant commission to a cheque cashing company. The client was particularly stressed as his partner was expecting a baby in the coming weeks and they were keen to buy heating oil for their central heating before the baby was born. The client also needed the money to buy a car seat for the baby in order to bring his wife and child home from hospital in a taxi. A CAB in the East of England reported a case in which a client needed to open a bank account in order to accept a job offer. However, the client had no forms of ID except his birth certificate and no proof of address as he was living rent free with a friend and as such no banks would let him open an account. The client was very distressed and felt trapped, as he would be able to find himself permanent accommodation—and proof of address—if he was able to accept the job but the prospective employer would not pay him by any means other than bank transfer. The client was keen cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 968 Parliamentary Commission on Banking Standards: Evidence

to move off beneﬁts and into work and was concerned that his friend would not be happy with him living there for anything beyond the short term. A CAB in the South East reported a case in which an unemployed client living in temporary accommodation was struggling to reintegrate himself into society following a prison sentence for drink driving. He was unable to open a bank account due a lack of ID, and none of the banks in his town would accept letters from the Jobcentre or DWP as proof of identity. The client was concerned that not being able to open a bank account would prevent him getting a job.

Bankruptcy Only two UK banks will offer accounts to undischarged bankrupts, with the other banks explicitly excluding them. This is based on an extremely narrow interpretation of the Insolvency Act 1986 which some banks claim could see them held liable for money that is paid into a bankrupt’s account and disposed of without notifying the Trustee. There is no evidence that this has ever happened and the policy of those banks puts some of the most financially vulnerable people at risk of further detriment, including potentially losing their job. A CAB in the North West reported a case in which an undischarged bankrupt was struggling to gain access to banking products. His application for a basic bank account was turned down by nine banks and building societies before he was able to open a basic account with a tenth bank. However, as he could not set up direct debits with his account he had had to make alternative arrangements, including asking a family member to set up direct debits using her account. This caused the client worry and stress, as well as placing the family member in an invidious position. A CAB in the North West reported a case where a 31 year old client was declared bankrupt and found his existing account frozen as a result, although he was keen to note that he was not in any debt to his bank. The client tried to open a basic bank account with another bank but was refused on the basis of his bankruptcy. This has left the client with difficulty in paying his household bills. A CAB in the South East reported a case where a 52 year old undischarged bankrupt had not been able to open a basic bank account despite making several enquiries. The client wished to open a basic bank account to pay in his navy pension cheques. Although his salary was paid into his wife’s bank account he was having to cash the pension cheques on the high street and paying a commission of 5%, costing him an extra £10 a month. Although discharged, the client was still required to pay the Trustee in Bankruptcy an Income Payment Order of £700 per month, meaning the additional £10 a month was an expense he and his wife could ill afford. A CAB in the West Midlands reported a case in which a 52 year old undischarged bankrupt wanted to open a basic bank account but was struggling to do so due to his debt to one of the two banks which offer accounts to people in such circumstances. The CAB advised him to try the other bank but the client was concerned that he would be rejected and felt he was being left with no choice of provider. A CAB in the East of England reported a case in which a couple in their 30s with dependent children were jointly declared bankrupt after their income reduced and costs increased on the birth of their first child. They both had banked individually with the same bank and their accounts had been in credit when they were declared bankrupt. Midway through their bankruptcy the bank reopened one of the accounts without conditions. However, they refused to reopen the other partner’s account and would not offer a reason why. The couple had also attempted to open individual basic bank accounts with another bank and one had been refused, both before and after discharge. An application to open a joint basic bank account was also refused before and after discharge. There was nothing on the client’s credit reference files to explain their treatment and they were not offered any explanation. Meanwhile, the husband was using his wife’s account and they had to plan their cash withdrawals in advance to make sure each has enough money when required. Although they stressed they did not have any relationship problems, they did note that the husband would face severe difficulties if the marriage broke down. A CAB in the South East reported a case in which a 56 year old client who was discharged from bankruptcy three years previously had not been able to open a basic bank account despite repeated attempts with various banks. The client was annoyed as she wanted to pay her bills by direct debit to save money. Upon application to one of the banks which does offer basic bank accounts to both undischarged and discharged bankrupts she was told she had to have been discharged for six years.

Existing debts/poor credit history Clients who wish to open a basic bank account to take control of their finances regularly find themselves turned away. Similarly, people with poor credit history can find themselves excluded even if they do not currently have any debts. A CAB in the North West reported a case where a 39 year old client working full-time and living with her two children and husband was struggling to gain control of her finances. The client had got into financial difficulty when her husband had gone onto statutory sick pay following back problems. They had a joint mortgage and a number of non-priority debts, including a debt she owed to her bank. The CAB advised that she should open a new basic bank account to avoid her bank unilaterally cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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using the right of set off to pay off her debt and to ensure an affordable repayment plan could be agreed. She tried to open a basic bank account with the building society her husband uses but was denied because of her poor credit score. The client was worried that another rejection would make her credit score deteriorate further so she instead began banking using her husband’s account. The client was worried that her husband’s back problems would lead to further banking problems if he needed to go to the branch since the account was in his name only and staff would not be able to speak to her about it. A CAB in the South East reported a case where a 29 year old client had built up an overdraft debt after her bank gave her an account with an overdraft she felt she should not have been given. The client had a basic bank account with the same bank but had had her debit card withdrawn and was only able to access her cash by going into the branch. Given the risk that her bank would use the right of set off to pay off her overdraft debt on her second account she attempted to take control of her finances by opening a basic bank account with another bank. However, because her credit history shows the debt to her original bank she was turned down by several banks. A CAB in the North East reported a case where a 50 year old client with non-priority debts who was working in three part time jobs was unable to open a basic bank account. She had been advised by the CAB debt specialist adviser to open a new bank account since she owed money to her existing bank, but when she told the new bank why she was applying for the account she was immediately rejected. A CAB in London reported a case where a client with learning difficulties who had a debt to his bank was advised to open a basic bank account with a new bank in order to take control of his finances. The client told the CAB that he had tried three banks, each of which had claimed not to have basic bank accounts despite the fact that they do. A fourth bank told him to go online and download the application form, despite the likelihood that he would require assistance to fill out the form. The client was highly distressed and felt his confidence had taken a knock after being turned down three times and given no help on the fourth occasion. In the meantime the client was worried about his current bank using the right of set off and putting him in financial difficulty. A CAB in the East Midlands reported a case where a 51 year old client with a poor credit history was not able to open a basic bank account. As the client was in full time employment and not receiving and benefits he was also unable to open a Post Office Card Account. The client was frustrated as he was adamant that he would repay all his debts but needed access to a bank account to keep control of his finances.

Sold an inappropriate account There is evidence that some banks inappropriately “up-sell” packaged accounts to customers who want to open a basic banking product. For consumers on low incomes or in financial difficulties these accounts are often unaffordable and the benefits they offer unusable. Some bureaux have reported that banks have sold packaged accounts to people who have specifically asked for a basic bank account to manage their money better. There is also another issue with packaged accounts, where banks have been selling them to customers who could not possibly hope to make a claim under the insurance products included, or who have no use for the other services provided as part of the account. The FSA is taking action to require banks to address this issue but it will not prevent banks trying to sell packaged accounts to people who would be better off with a basic or current account. We believe that the FSA should require banks to undertake affordability checks for customers before opening fee-charging packaged accounts. A CAB in the South West reported a case where a 50 year old single client on benefits with a poor credit rating could not open a basic bank account. He eventually found one bank which was willing to offer him a packaged account with a monthly charge of £13 that he felt he had no option but to accept despite his financial predicament. As a result the client found himself paying for the services included in the packaged account that he didn’t want, didn’t need and couldn’t afford. A CAB in the East Midlands reported a case in which a 47 year old client had attempted to open a bank account was told the only option open to him was a £13 per month packaged account. Believing the advice, the client had opened the account but due to being on a low income and having only a small sum of money in the account the monthly fee had put him into overdraft, incurring charges and fees. A CAB in Yorkshire and the Humber reported a case in which a 70 year old client had been sold a packaged account which included insurance that did not address his needs and which he was unlikely to be eligible for. The client was on a low income and with little disposable income and felt he had been pressured into taking the packaged account when he took out a loan from his bank. The £12 a month packaged account included worldwide travel insurance despite his age likely excluding him from eligibility and the fact that he was extremely unlikely to travel abroad. A CAB in the East Midlands helped a client with debt problems who had been advised by his bank to open a packaged account costing £10 a month despite being in debt and the account offering facilities he didn’t need and had never used. As his debt problems had mounted, the £10 a month fee had contributed to his financial problems. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 970 Parliamentary Commission on Banking Standards: Evidence

Criminal convictions/fraud We understand that all of the banks who offer basic bank accounts explicitly exclude people who have a record of fraud but in practice many exclude people with other convictions as well. People who are about to be released from prison often face challenges, although some banks have specific schemes to help people in these circumstances. A CAB in Yorkshire and the Humber reported a case where a client who had been imprisoned for fraud committed following the loss of his job was struggling to pay back £10,000 of non-priority debts and could not access a bank account. He had attempted to negotiate with his creditors but met with refusal, at which point he attended the CAB. He had been unable to open a basic bank account as a result of his fraud conviction, however this was creating difficulty for him in managing his finances and continuing his rehabilitation. A CAB in the East Midlands reported a case where a 17 year old student with a part time job had his existing bank account closed when two fraudulent cheques were paid into it. The client insisted he was the victim of the fraud but his bank insinuated he was implicated. The client was advised by his bank to open an account with another bank, which he did, only to find this account suddenly closed without explanation two weeks later. He had provided his employer with his new bank details and has been unable to access his wages which were paid into his new account before it was closed. In the meantime the client was using his mother’s bank account and had not received any pay for some time, leaving him reliant on the generosity of family and friends. A CAB in the West Midlands reported a case where a 29 year old client currently serving a prison sentence attempted to apply for a basic bank account under a bank’s scheme for prisoners. He met the bank’s criteria (namely having under two years remaining on his sentence, a release address and three year address history) but was turned down without explanation. The CAB adviser noted that being able to open a bank account is recognised as an important part of preparing prisoners for release and can help their rehabilitation and reintegration into society.

Transparency andLevel ofBankAccountFees There are significant issues created by both the level and transparency of bank account fees, particularly around overdraft charges and returned transaction fees. Our evidence from bureaux strongly suggests that our clients do not find the information provided to them to be transparent or easy to understand, which may contribute to the financial impact of becoming overdrawn or having insufficient funds in their accounts. We believe that the changes made by banks to their charging structures following the test case brought by the Office of Fair Trading have not ushered in a fair charging regime for the poorest and most vulnerable consumers for three reasons: — Firstly, bank accounts are essential to function within modern society. They are required for almost all jobs, for the receipt of many benefit payments and to obtain the best deals on utilities. People have no choice but to have an account and yet there are remarkably few safeguards to protect them from potentially toxic charges, or even to limit the amount charged. — Secondly, once people encounter financial difficulties—caused or exacerbated by charges applied to their bank account—it can be difficult or even impossible for them to open another bank account. — Thirdly, banks are still too slow to take action to stop people in financial difficulties from building up a large debt due to multiple charges. Recent research by Which? backs this up, finding that a combination of complicated fee structures and unclear or difficult to find information made calculating and comparing overdraft fees next to impossible for consumers122. Which? also found wide variation in the amount charged by different banks for various examples of overdrawn accounts and went as far as to call some of the fees “exorbitant”, observing that one bank was effectively charging over 2,000% APR on a £100 overdraft. Citizens Advice Bureaux regularly see cases of small overdrafts or failed payments quickly becoming unmanageable debts, examples of which are below. A CAB in the East of England saw a 32 year old client who had been briefly overdrawn and incurred significant charges as a result. The client’s account had become £30 overdrawn, but was returned to credit within hours. The same day the client was charged a £20 daily overdraft fee in addition to a £5 usage fee. These charges put the client’s account back into overdraft, meaning he was charged further fees: this time a £30 daily fee and £5 usage fee. In total, the client faced charges of £60 as a result of being overdrawn by £30 for a number of hours, with more than half of the value of those charges incurred by the bank’s own actions. A CAB in the South East reported a case in which a 20 year old client with partner and young child was charged excessive fees for a small overdraft. The client, who believed she had a basic 122 http://www.which.co.uk/about-which/press/press-releases/product-press-releases/which-money-magazine/2012/01/which-calls- for-actiononcomplicated-and-exorbitantbank-overdraft-charges/ cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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bank account without any overdraft facility, became overdrawn by £11 when a direct debit exceeded her balance. She paid back the overdrawn amount as soon as she was aware but then received a demand for £200 of fees from a debt collection agency acting on behalf of her bank. A CAB in London advised a client whose bank statement regarding overdraft fees was bafﬂing to both the client and adviser. The client had brieﬂy gone into an unplanned overdraft but had repaid the money in full and was now struggling to understand the charges she had received. It was very unclear what time period the various fees and charges covered and when they would be deducted from the client’s account, with a combination of “instant overdraft request fees”, “daily unarranged overdraft fees” and “paid item fees” amounting to several hundred pounds. As a single parent in temporary accommodation with two young children the client could ill afford to pay these fees, meaning they would likely put her bank into overdraft when they were levied, thus incurring further charges and fees. In November 2011, the Government announced that it had persuaded the banks to sign up to a voluntary agreement on bank charges which will apply to all full-facility current accounts offered by the major banks. By March 2013, banks will: — Provide annual statements so that customers can see how much their account costs over the year. — Provide consumers with alerts when their balance is low so that they can take action to avoid a charge. — Consumers will no longer be charged for going over their limit by a small amount. Whilst we welcome banks’ moves to provide better information services and a short grace period for customers who are about to go overdrawn, we do not think this is enough to deal with the problems CAB advisers are seeing. Citizens Advice believes that more fundamental reform of bank charges are urgently required, possibly including limits on the level and frequency of such charges.

ContinuousPaymentAuthorities Citizens Advice remains concerned about the reluctance of banks to follow the FSA’s latest guidance on implementing the Payment Services Regulations 2009 on cancelling continuous payment authorities (CPAs— a series of payment transactions using a credit or debit card) a pattern of behaviour which is putting many of our clients into serious financial difficulty if the company who holds the CPA refuses to cancel it. This legislation gives consumers great control over how their cards are used. Consumers can withdraw their consent to any payment transaction or series of payment transactions up to the close of business on the working day before the payment is due. Once consent is withdrawn, the payment service provider should not allow any further payments to be made. If any payments are taken, they are deemed unauthorised and the consumer should get a refund. In particular we receive a great deal of evidence from bureaux about CPAs with payday lenders which illustrates the difficulties clients are having in getting their banks to cancel the arrangements. In particular some bank staff and advisers still believe that continuous payment authorities cannot be cancelled and that you must ask the organisation taking the payment to stop taking money. The evidence below represents a snapshot of cases, covering a number of banks, from 2012, most of which have occurred in the last 3 months. In July 2012 a CAB in the North West saw a client with both priority and non-priority debts, including a payday loan. The CAB advised the client to stop the payday loan payment which was due so that they could work out a more equitable distribution or even insolvency. The bureau gave the client copies of the FSA leaflet on consumer rights with regard to continuous payment authorities. He took one to his bank and one to the payday lender. He returned later to say that both organisations said they couldn’t help and the payments would still be requested and paid. In April 2012 a CAB in the North West saw a client with mental health issues who had multiple non-priority debts, including payday loans. The client had continuous payment authorities set up to pay the payday loan companies. As the client had insufficient money to cover the payments he was becoming overdrawn and incurring regular charges from his bank. The bureau directed the client and his support worker to his bank with an extract from the FSA leaflet concerning continuous payment authorities. The bank said they were unable to do this. In July 2012 a CAB in the South West saw a client who had two payday loans but was unable to afford the repayments. The CAB rang the bank asking for the payments to be stopped and later confirmed this in writing. The bank wrote back to say this was not possible as they had to take the Visa International rules over the FSA guidance. As a result the client had her bank account cleared out by the payday lenders and so had no money for essential expenditure and had to borrow from her family. A CAB in the West Midlands reported a case in which a client was being helped to restructure her finances and begin paying off her outstanding debts but had to close her bank account down following her bank’s refusal to cancel a CPA. This created significant additional hassle for the client at a time of great stress. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

Ev 972 Parliamentary Commission on Banking Standards: Evidence

A CAB in the South West advised an unemployed client with a young baby who was unable to cancel a CPA set up to repay a mobile phone debt. Both his bank and mobile company incorrectly informed him it was not possible to cancel a CPA, putting him into further debt at a time when he and his partner needed maximum income.

HelpingPeople inFinancialDifficulties Although we advise clients on a large number of issues regarding debts to banks, they are less problematic creditors than we see in other sectors and in our experience they usually try to do the right thing. However, there are exceptions, and a lack of clarity on individual banks’ different processes can cause problems. This may manifest itself in customer confusion about who to speak to about their debt if it has been passed on to a debt collection agency or ambiguity about under what circumstances interest will continue to be charged. Clients who have had their debt passed on to a collection agency may in some cases experience aggressive or intimidating collection practices. While some banks will stop charging interest and refer the matter to their debt team as soon as it becomes clear a customer is in financial difficulty—which does have implications for customers’ credit records—others engage in more convoluted processes which some consumers struggle to understand, thus contributing to stress and sometimes further debt if they misunderstand the expectations placed upon them. We also continue to see issues with inappropriate lending, where a bank has not considered an individual’s ability to repay the loan. In particular this issue arises with debt consolidation loans being offered even when a customer is already struggling to meet their existing debt repayment commitments. A CAB in the South East advised a client who had run up a £400 debt with her bank as a result of being mis-sold a packaged account which incurred a monthly charge. The client had never used the account and the debt consisted solely of the monthly charge. The client had offered to pay back the debt at £30 per month but this was rejected out of hand by her bank, who demanded that she make full payment immediately or face formal default notices. At this stage she sought advice from her local CAB, who advised her to write to her bank to let them know she was seeking advice and to ask for a week’s grace in any proceedings. Upon receipt of the letter the bank phoned the client and offered to accept her original payment offer, before then suggesting £20 a month when the client expressed a wish to speak to the bureau first. At this point the bank representative spoke to a more senior colleague and announced that they would write the debt off entirely. The CAB adviser noted that it was only the good sense of the client in refusing to agree a payment plan with the bank until she had received advice which prevented her needlessly paying back hundreds of pounds, and it was only the mention of Citizens Advice involvement which prompted the bank to negotiate with the client in the first place. A CAB in the South East reported a case where a single parent who had given up work to care for his child, who had severe behavioural issues, following the breakup of his marriage had his bank debt passed on to two different debt collection agencies. The client had both an overdraft and loan debt to his bank and had attended a local branch to try to agree repayment only to be told it had been passed to a “debt management plan”. It transpired that the debt had in fact been passed to two different debt collection agencies, both of whom aggressively pursued him to agree repayment terms he could not afford. The client found it extremely difficult to make arrangements with two agencies as he had to revise his offers according to what the other was demanding. A CAB in the West Midlands advised a client who had taken out a loan with her bank 12 years previously and had increased the amount over the years to the point where it stood at nearly £12,000. Six years before the client sought advice she was made redundant and her payments were met through a payment protection plan. When this expired the client had an offer to repay £150 per month rejected and the matter was passed to the debt department. At this point the client was assured interest would not be charged, but several years after agreeing a £30 per week repayment the client was suddenly notified that interest had continued to be charged and that her bank intended to pursue the debt by obtaining a county court judgment. A CAB in Wales reported a case where a 20 year old client was given an inappropriate debt consolidation loan by her bank. She had run up a debt of £800 on a store card but began missing payments when she lost her job. The client then transferred the balance on to a credit card from her bank but quickly ran into problems making payments with that card and so transferred some of the balance onto another credit card from another provider. Having recently begun a new full time job the client met with her bank manager to discuss her debt problems, at which point it was suggested she take out a loan of £16,000 even though the loan would have far exceeded her debts and she had only just started her new job. Unfortunately the client left the job after one week following problems with the employer and when she approached the CAB for advice she had only been able to find work one day a week. As such her debts were spiralling further out of control. A CAB in Wales advised a 68 year old client who cared for her 47 year old disabled son and had been given a personal loan for £25,000, repayable over five years. The client has limited financial capability and understanding and mistakenly believed the repayments would be £6.60 per month rather than the actual £611 per month in reality. The client had not spent any of the money she cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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borrowed and asked the bank to take it back. However, they refused and after adding charges and interest the loan had grown to over £35,000. The client was accompanied to the CAB by a support worker from Age UK who reported that the client’s son’s carer had accompanied her to the bank and noted that the client was confused and vague during the discussions about the loan and that the bank staff themselves seemed unsure as to the wisdom of approving the loan. However, as the contractual cooling off period had expired, the bank refused to cancel the loan and accept the return of the money. A CAB in the South East reported a case in which a 66 year old widow was offered a loan by her bank to pay off an existing loan with the same bank on which she was already struggling to meet repayments. The adviser reported that the client was bamboozled with jargon and complicated terminology and so did not fully understand the implications of what she was agreeing to, nor did she have the right to cancel highlighted to her. The client was struggling to cope with the recent death of her husband and found the numerous calls from her bank extremely stressful.

TheRight ofSetOff Citizens Advice is concerned that banks’ use of the right of set off undermines efforts made by customers in financial difficulties and on very low incomes to manage their money. By unilaterally using the right of set off, banks prioritise payment of a credit card debt above more important commitments, where non-payment results in loss of home, liberty or disconnection of supply. Whilst the FSA’s new rules introduced in June 2011 requiring banks to leave customers will sufficient resources to pay their bills and essential living costs are welcome and, along with the new Lending Code guidance, have had a positive impact, bureaux are still seeing people who cannot pay for food or essential household bills because their bank has exercised their right of set off. The impact of the new rules and guidance is reflected in the decline in the number of issues regarding the right of set off reported to bureaux, with 713 in 2009–10 falling to 542 in 2010–11 and 488 in 2011–12 (this includes instances where banks have used the right of set off and situations where it is likely). Nevertheless, bureaux still record a significant number of clients reporting issues with the right of set off. A CAB in the North East of England reported a case in which a 70 year old client on state benefits found his bank had used the right of set off to pay a non-priority debt he owed to them. This left him with in financial hardship with difficulty paying utility bills and other essential living expenditure. His bank only refunded the money it had appropriated following the intervention of the CAB adviser on his behalf. A CAB in Wales reported a case where a 59 year old client had two current accounts and a loan with the same bank, with loan payments deducted from the first of his current accounts. When one month the client did not have enough money in his first current account, his bank used the right of set off to deduct the money from his second current account. As the second account was used to pay bills, this put the client into overdraft on the account and he incurred fees and charges as a result. A CAB in the South East of England reported a case in which a client who lived in private rented accommodation and had her housing benefit paid into her bank account ended up in rent arrears when her bank used the right of set off to set her housing benefit against charges on a loan she held with them. A CAB in the North West of England reported a case where a 57 year old client reliant on income support and carers allowance was repaying a credit card debt at £10 a month but found his bank had used the right of set off to appropriate his benefits payments to settle a monthly repayment it claimed he had missed. It transpired to have been an error and the money was eventually refunded but the client complained that opening an account with a different bank was problematic for him and as such was at risk of his bank using the right of set off again in future. 3 September 2012

Written evidence from the City of London Corporation

Introduction 1. The Mayoralty has played an active role in pursuing the contribution which the City of London Corporation can make in the area of raising standards and restoring trust in the banking industry. 2. The project, known as the Lord Mayor’s Initiative, launched in February 2011. Through a series of events and meetings, the City of London has worked with a wide range of stakeholders—including the banks themselves, professional bodies, trade associations, the regulatory community, academics and thought leadership groups—to identify the causes of the loss of trust in the banking sector, and to propose solutions. The City of London has, where appropriate, played a facilitating role in creating action plans to deliver those solutions, and to begin the task of bringing about substantial change where it is needed. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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3. Under the Lord Mayor’s auspices, the City of London has also created a discrete work stream focusing on the possible creation of a Banking Standards Council, particularly for UK retail banking. Given the importance of this issue, the Lord Mayor has hosted three specially-convened meetings—at the end of 2012 and beginning of 2013—involving senior representatives from the British Bankers Association, the Association of Foreign Banks, the FSA Practitioners Panel, the Lending Standards Board, the Chartered Banker Institute, the Chartered Institute of Securities and Investment, the Institute of Chartered Secretaries and Administrators, the Financial Reporting Council, TheCityUK, the City Values Forum and senior ofﬁcials from the City Corporation. 4. Separate discussions have taken place with the chairs of a number of UK banks, the chair-designate of the Financial Conduct Authority, and others. The meetings have also considered the progress made so far by the Chartered Banker Institute and its work on the Professional Standards Board (PSB). This initiative, led by nine UK banks, is designed directly to restore public conﬁdence and trust in the banking industry and promote a culture of professionalism amongst individual bankers.

Objective of the Lord Mayor’s Initiative 5. The objective of the Lord Mayor’s Initiative is to help facilitate an environment in which the whole banking sector can operate with the trust of the public, customers and other stakeholders. The current economic climate is fragile, and the banking sector plays a critical systemic role in fuelling economic growth. A more professional and accountable industry, operating more consistently to publicly recognised standards, will instil greater conﬁdence in all market participants, reinvigorate critical relationships, and play a key role in helping the country to emerge from recession. The City’s contribution to the national economy is well documented and a banking sector which has regained the trust of its stakeholders will optimise the conditions for maintaining the City of London as a place to do business, remaining attractive to global capital markets, attracting inward investment, and creating jobs. Measures taken to increase the professionalism and standing of the industry should also increase the attractiveness of the City as a place to invest.

The Banking Sector 6. The UK banking sector is an umbrella term which encompasses a vast range of activities—UK and overseas, retail and wholesale, simple and complex, ‘teller’ and ‘trader’. 7. The reputation of London as a global financial centre is built at least partly on the range and diversity of its banking activities. The corollary is that the complexity of the sector makes it difficult to introduce a one- size-fits-all solution, a reality which the Lord Mayor’s Initiative has sought to acknowledge as it has conducted its analysis of the work needed to raise standards and restore trust.

City Values Forum 8. The Lord Mayor’s Initiative has acted as the sponsor of a work stream—the City Values Forum—an ambitious programme of change initiatives aimed at tackling the underlying causes of the problems associated with the lack of trust in the banking sector. The appendix provides greater detail in respect of the individual components of the programme. It is intended that the practical outputs of the work stream will play an important part in the overall effort to bring about a change in the way in which companies and individuals operating in the sector do business. 9. Not only have some of the individual projects already started to come to fruition, they have also begun to achieve greater proﬁle, through media reporting. This is an important development because the exercise of restoring trust can only be successful if the signiﬁcant amount of work being undertaken is brought to public consciousness, allowing stakeholders to see that there is a credible, concerted and coordinated change management programme in place.

Banking Standards Council 10. The banking sector is a generic term which, in reality, refers to a very wide range of business activities. Creating a solution which would be considered ﬁt-for-purpose in all business contexts would not be straightforward, quick or necessarily appropriate. 11. The City of London considers that it is feasible—and more pragmatic—to develop a Banking Standards Council model by focusing initially on UK retail bank operations. There is already a critical mass of activity in this area, and systems in place to drive further progress, as a result of the work of the PSB. 12. Clearly the creation of a Banking Standards Council, focusing on UK retail banking, is an issue of signiﬁcant importance to everyone involved in the debate on banking standards. In reality, a substantial amount of work had already been undertaken by various parties in and around the area of standards. The City of London’s effort over the last few months—and the focus of the specially-convened meetings—has been on analysing the different stakeholders’ perspectives and contributions, and facilitating and supporting the discussions which are currently taking place. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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13. More work needs to be done to settle points of detail, but a critical mass of opinion is coalescing around the concept of what such a body would need to look like to be credible, and able to command conﬁdence with the public, customers and other key constituencies.

14. The current thinking within the City of London is that a Banking Standards Council could have the general responsibility for overseeing a Code of Conduct for the UK retail banking sector, and the development of professional standards, focusing on both the companies and the individuals working within them. The Chair, and a majority of the members, would be independent, with all relevant stakeholder interests represented.

15. The Council could, as necessary, provide a single point of contact for any individual, or organisation, seeking to pursue a complaint and provide, equally, a single point of contact for any individual, or company, covered by the scheme, as well as other stakeholders such as the professional bodies and trade associations. It would need to have an effective communications and marketing programme. The Council would operate best practice in terms of governance, transparency and accountability, with access to the workings of the Council, and its outputs, made possible through a website, publications, consultations processes, periodic open meetings, a formal annual meeting and an annual report.

16. The City of London appreciates that a proposed Banking Standards Council would need to work in close cooperation with a number of key stakeholders for it to be successful in achieving its objectives.

17. In relation to the regulatory environment, for example, the City of London acknowledges that the FCA is a new regulatory body which will need time to establish its modus operandi. It is particularly important that a proposed Banking Standards Council should avoid any risk of duplication of regulatory oversight, leading to the emergence of a ‘three peaks’ model of regulation. Whether a Banking Standards Council would have supervisory, enforcement and disciplinary responsibilities, or any other powers in relation to the regulatory regime, is a matter still to be resolved.

18. Nevertheless, the body would be in a strong position to interact with the FCA, to complement the FCA’s work and to comment on, and even make recommendations concerning, the operation of aspects of the regulatory system, for example in relation to the coverage of the Approved Persons Regime. On that particular point, for example, one issue which remains unresolved at the moment is the need, if any, for the proposed Banking Standards Council to hold a separate Register, and how that would link with those individuals on the Approved Persons Regime, a Regime which should continue.

19. The proposed Banking Standards Council would need to work closely with the banks on both issues of the Code of Conduct, and standards, to ensure maximum alignment and effectiveness. Bearing in mind the risks, and possible unintended consequences, of a one-size-fits-all solution, in some cases it would be better for the Banking Standards Council to recognise the systems already in place inside one firm, while working with another firm, for example, to strengthen its systems.

20. The same principles would apply to working alongside the professional bodies which have already done so much work in the area of codes and standards. The Banking Standards Council should, again, avoid duplication of these bodies’ work, while ensuring that, for example in the case of serious wrongdoing by an individual, at least one, if not both ‘regulatory’ bodies involved—the regulator and the individual’s professional body—took appropriate disciplinary action. This would address one of the key concerns expressed during the Banking Commission’s evidence session on standards that such actions had not been taken even in the most egregious cases of individual misbehaviour.

21. The PSB has, after its ﬁrst year of operation, made good progress in agreeing work programmes with some of the banks which are its members, and, focusing on this area initially would allow the initiative to achieve momentum, and establish credibility. The practicalities of extending the scheme to other parts of the banking sector, whether wholesale or non-UK could then be considered in more detail.

22. An example of where further work is already being undertaken relates to the operations of foreign banks in the UK. There are arguments on both sides for the inclusion or exclusion of (certain) foreign banks in relation to oversight by a Banking Standards Council. The City of London is working alongside the Association of Foreign Banks (AFB) to conduct a representative survey of its membership to understand how the operations of a Banking Standards Council might ﬁt within the existing regulatory systems and cultures applying to those banks, what standards regimes (if any) apply in their home countries, which matters would need to be addressed in terms of their participation, and the wider public policy issues which might arise. The City of London will wish to update the Banking Commission in due course on the outcome of the survey and discuss the results with the AFB.

23. In summary, a considerable amount of progress has been made in devising a possible Banking Standards Council model. The creation of a Banking Standards Council would send a powerful signal that there is a desire from the sector to restore trust and conﬁdence. While all the considerations relating to the role and responsibilities of the new body have not been resolved, it is encouraging that there is an emerging consensus to continue and complete this work. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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APPENDIX THE CITY VALUES FORUM The City Values Forum (CVF) was established in 2011 as an informal, voluntary working group to assist each Lord Mayor in his or her year of office, to act as a catalyst for co-operation and to co-ordinate the research, formulation and delivery of a series of work programmes. The CVF is already working closely with the Chartered Banker: Professional Standards Board, the Chartered Institute for Securities and Investment (CISI), the City HR Association, Cass Business School, the Financial Skills Partnership, the Institute for Business Ethics, TheCityUK, Tomorrow’s Company and a number of City Livery Companies on the following initiatives and several others which are under development. To date funding has been secured and work commissioned to deliver three initial programmes into the market this year:- (a) ‘Leadership with Integrity’—a programme for new managers across all sectors of the financial services industry currently being developed by Cass Business School. It will be accredited by the Institute for Leadership and Management (part of City & Guilds) and delivered by management training providers and by inclusion in the training programmes delivered by other institutions. The programme which will provide a foundation course in management and leadership will also have a particular focus on the importance of culture, values and integrity and will provide ‘hands on’ experience in the handling of dilemmas. The detailed course programme will be put out to consultation with employers, training providers and others in the April/May of this year with a view to running a pilot programme in the early summer. The aim is to have the course available in the market for a September intake. (b) ‘Performance with Integrity’—a new policy guide and best practice toolkit in performance management is being researched and prepared by a consulting team led by the City HR Association. This will help employers embed values at three crucial stages in the employment and career development process: recruitment, performance appraisal and management development. City firms who are members of the City HR Association are sharing their knowledge and experience freely so that other organisations can benefit. An exposure draft will be produced in April/May of this year for consultation with employers and professional associations and with a view to having this resource available in the market by September. (c) ‘Governing Values’—a practical management policy guide which will help Boards create a ‘clear line of sight’ through their businesses, to ensure that values are observed, delivered and lived. The guide which is being researched and developed by Tomorrow’s Company will signpost best practice in the governance of culture, highlighting the tools available to Boards of directors to assess the processes which integrate values into a business’s day-to-day operations. These will include Investing in Integrity, an evaluation process developed by the Institute for Business Ethics and CISI to assist companies to monitor their performance in this area. The Governing Values guide will go out to a series of consultation meetings in March/April, and will be available to launch in September. In addition the City Values Forum has a pipeline of three further programmes underway involving seven work streams—all of which are at an advanced planning stage for implementation later in the year, subject to funding. 1 February 2013

Written evidence from the City of London Corporation Summary 1. The City of London Corporation has as one of its main functions the promotion of the UK generally, and the City specifically, as the world’s leading international finance centre. The City is therefore appropriately placed to make a submission to the Parliamentary Commission on Banking Standards. 2. The banking industry is a vital part of the UK economy, providing finance to wider industry which in turn generates jobs and growth. The recent revelations about unacceptable practices in relation to LIBOR and other matters are thus all the more disturbing. This submission argues that: — The public want to see evidence of change in the banking industry and the industry has it in its power to demonstrate real change by articulating and living by new objectives, vision, culture, values and ethics. Valuable work towards this is already under way. — This process of change should include a review by the banks of their business models and product lines to ensure their policies and practices stand scrutiny when considered against these values. — At the same time, remuneration policies and compliance processes at all levels need to be seen to be in line with the new values. — Corporate governance needs to be strengthened, including the role of shareholders and non- executive directors. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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— The need is for better enforcement of and compliance with existing regulations rather than the introduction of yet more new regulation. — Banks should engage more actively with the public to promote better understanding of what they do.

Introduction 3. The creation of the Parliamentary Commission on Banking Standards is timely, given recent revelations about the manipulation of the LIBOR rate-setting process and the sustained period during which the industry has been under unprecedented public scrutiny for a number of reasons. The actions of a number of individuals have damaged domestic and international perceptions of the UK-based wholesale financial services industry for which “the City” is convenient shorthand. Without trust and confidence, the City and its markets would struggle to function. Sound regulation and its effective enforcement provide some assurance to customers and clients, but confidence in the City’s proper standards and corporate culture is a necessary complement to this.

A Global Centre 4. Banking is an increasingly globalised industry for which London serves as a unique global hub. The industry in the UK is internationally owned, staffed and managed. This concentration generates significant benefits for the UK as a whole in terms of employment, tax revenue and, crucially, the financing of economic activity. In the context of the Parliamentary Commission’s work, problems such as those seen in relation to LIBOR should be seen as problems of an international industry rather than somehow London-specific. This is not to diminish their seriousness. Rather it is an argument for a sense of perspective. London’s reputation has already suffered as a result of the crisis. There is a need to guard against measures which do further unnecessary damage to London’s relative standing.

Immediate Action 5. Prompt and effective remedial action is now needed with the banking industry itself to the fore, taking the initiative to put right the damage to its reputation and with it the standing of the wider financial sector. Above all, if it is to regain public trust the industry will need to demonstrate that it imposes upon itself high standards of conduct, and follows them consistently 6. It needs to demonstrate not just that it is living by the letter of the law but that it is willingly living up to the spirit of new values and high standards of integrity, corporate governance and customer service. This will require a change of culture where it is found to be needed and there are areas where it undoubtedly is. The banking industry points out (quite rightly) that it is an essential part of the modern economy: that it facilitates job creation, that it finances commerce and supports economic growth. To win back the public’s trust, the industry will need to show that it is genuinely seeking to fulfil this role and that it is not putting its interests ahead of those of its customers. The public will want to see that products or business lines, even where they might be technically legal, would not be pursued unless they are clearly to the benefit of the clients to whom they are being sold. The culture and values of banks and other organisations need to support this approach to doing business and remuneration structures need to be designed to reflect the culture and values. 7. For this action to be effective the banking industry should be encouraged to renew its efforts to communicate actively with the public in order to promote a better understanding not just of the changes it is making but of its wider role in society. 8. Over the past four years, starting well before the exposure of the LIBOR issue, a number of initiatives both inside and outside the industry have sought to begin the process of restoring trust in the financial services industry. One such is an initiative of the Mayoralty looking at Trust and Values across the industry. This has included, for example, the development with Cass Business School of a “Leadership with Integrity” foundation course and the formulation of a best-practice guide, “Performance for Values”, to help businesses embed values into management, recruitment and appraisal.123 Much of this work has focused not only on the moral imperative—that behaving correctly is the right thing to do—but also on the business advantages of being trusted and respected both by business peers and by customers and clients. While a structure of sound regulation and effective enforcement is regarded as an asset for a financial centre, so a reputation for good conduct is a business advantage for a company and for the individuals working in it. Furthermore, it is a sustainable asset, likely to help retain existing clients as well as to generate new business. 9. It is worth highlighting the work of the Chartered Banker Professional Standards Board (CB:PSB). Launched in 2011 by the chairmen or chief executives of nine leading banks (with, between them, 350,000 employees), the CB:PSB has produced a Code of Professional Conduct and a Framework for Professional Standards. The first of these standards, the Foundation Standard for Professional Bankers, has now been published setting out how individuals in the industry can demonstrate that they take responsibility for acting ethically and professionally. The CB:PSB’s founding banks have all committed to implement this Standard. This type of initiative, driven from within the industry itself, will be an essential part of the industry’s work to restore the public’s trust. 123 Further information on these and other similar initiatives can be provided if it would be useful to the Commission. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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CorporateGovernance andRemuneration 10. These two issues are linked. Individual remuneration is a complex area. It is not the task of the state to decide how much employees in the private sector should be paid. However, the procedures for determining remuneration in banking, with its capacity to cause systemic risk to the financial system, are a matter for legitimate public concern. 11. Recent changes to the rules applied to variable remuneration, at national and EU levels, and the banks’ own decisions in this area, have gone a long way towards addressing defects in the system. Continuing work already under way to tie remuneration more closely to sustainable, long-term performance; to introduce a right of claw-back, payment in shares with only a limited cash element and deferred payment; and greater transparency over the packages paid to the highest earners in a business, will do much to change the culture. 12. Clearly there have been examples of a failure in corporate governance in some banks. These are complex institutions and the structures of reporting and supervision they had in place failed in this regard. That is an issue for banks’ leaders, regulators and those conducting other investigations, but the essential message for regulators and for the owners and managers of companies is that the size and complexity of a business are not, of themselves, excuses for inadequate or faulty internal processes. 13. There is considerable scope for the reassertion of the rights and duties of shareholders as owners of a business and for further development of the roles of non-executive directors as, ultimately, the shareholders’ representatives. The work of the Kay Review will be a useful contribution to this. 14. The role of non-executive directors (NEDs) in a complex financial services institution is difficult and onerous. Their legal and ethical responsibilities are heavy and, post the LIBOR issue and other failings of recent years, are likely to become more so. The pool of talented individuals, with the right skills and background in business and elsewhere to be an effective NED, is limited. NEDs should take a more active role but whatever new measures are put in place must not further discourage such people from taking on an NED position. 15. Another issue which this raises is the question of the procedures within financial services companies for risk management and how they might be enhanced and improved. Clearly, in the case of LIBOR they did not work. In some institutions, the prospect of any difficulties with the acceptance of LIBOR in the market as a whole never became an item on the relevant risk register. Boards and senior management will need to re- examine their whole approach to determining risk. This process is undoubtedly already underway across the industry and should be completed as soon as possible. 16. This raises a broader issue of whether the banking industry or the wider financial services industry needs to be restructured. The City of London Corporation does not believe that some form of “Glass-Steagall” type separation of the different parts of banking is necessary or appropriate to tackle effectively the issues that have arisen. The plans stemming from the Vickers Commission should meet requirements here by introducing ring- fencing within an organisation of the different areas of its business to ensure that taxpayer support is no longer needed or potentially available to investment banking activities. 17. However, following the Vickers Commission’s recommendations on improving competition in the UK banking sector, the Office of Fair Trading is looking further at whether there are any regulatory or other changes that can usefully be made in this area. This is likely to be a more fruitful course of action. Increasing competition in the banking sector is likely to be an effective way of ensuring that remuneration, as well as other key decisions, is subject to more rigorous market pressures and thus can be set in a way that is justifiable.

A Regulatory Response 18. Inevitably, there will be political and media pressure for new, stronger and more prescriptive regulation of banking and ﬁnancial services in general. This is understandable. But the regulatory framework has already changed radically over the last four years and the priority now should be on the effective enforcement of existing regulations, rather than adding new ones, with adequate resources for doing so.

19. The City of London Corporation has no particular standpoint on possible new methods of calculating and setting interest rates such as LIBOR and a separate government review of LIBOR has begun work. But any new structure will have to be as transparent as possible and involve some form of oversight independent of the industry if it is to retain the conﬁdence of market participants and other stakeholders.

Conclusions 20. The emphasis of this submission has been on the need for demonstrable change in behaviour in the banking industry. In the aftermath of LIBOR and other failures of trust and standards the restoration of proper standards within the industry is critically important, arguably more so than the imposition of new rules.

21. Political, media and public indignation over the LIBOR issue and over other regulatory or perceived ethical failings should not, however, cloud the importance to the economy and the broader national interest of cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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the financial services industry. The existence of a competitive, efficient and diverse UK-based industry will make a significant contribution to economic recovery and the restoration of national prosperity. 23 August 2012

Written evidence from Donald R Clarke Summary This paper addresses certain limited but fundamental issues raised by the Commission, notably culture and separation of functions, and argues: — that the root cause of the recent banking crisis was the repeal of Glass-Steagall; — that investment and retail banking are totally different businesses and should never have been allowed to merge; — that cultural differences are at least as important as differences in business practice; — that the total separation of the two kinds of business is essential; — that everybody needs a clearing bank but not everybody needs an investment bank; and — that customers of the clearing banks should be free to buy suitable products from the investment bank of their choice. 1. I worked for 27 years for what is now called 3i but started life in 1945 as The Industrial and Commercial Finance Corporation, formed by the Clearers and the Bank of England as a commercial institution to provide loan and share capital to small and medium-sized businesses. Until its flotation in 1994 it remained in the same ownership, with the Bank of England owning 15% and holding the ring between the clearers; by then their original investment of £115 million had become worth some £3 billion. The post-war Government had wanted a financial mechanism to stimulate reconstruction of the economy: there is a strong argument for such an institution today. 2. I joined in 1964 and from 1968 until I retired as Finance Director in 1991 I was responsible for all its fund-raising. During most of my tenure, until the mid-80s, the clearing banks were essentially short-term institutions, taking deposits from the general public through a widespread branch network and providing short- term facilities, mainly by way of overdraft, to individuals and businesses. 3. With the Bank of England as lender of last resort they were able to lend many times the amount of their capital—on the reasonable assumption that the millions of depositors would not all want to take all their money out at once—and if any one bank got into trouble the Bank of England could apply its last resort facilities in protecting the depositors. 4. That was a very satisfactory arrangement which allowed the banks to make comfortable returns for their shareholders—through their ability to lend many times their share capital—without taking unnecessary risks. This was also good for the economy in general because it provided huge amounts of credit which would otherwise not have been available. 5. In this respect the clearing banks enjoyed a very privileged position. By having the support of the Bank of England they were able to borrow much more than any other commercial organisation which had a similar share capital. In return for this privilege the banks were subjected to close monitoring by the Bank of England and the amount they could borrow was determined by the Bank as part of its control mechanism. 6. In my time this monitoring was informal and friendly—but the Bank of England kept its ear to the ground, maintaining close contact with the City institutions, including us. By this means it was able to control the banks without formal regulation—of the kind The Financial Services Authority employed, with singular lack of success, from its formation until the crisis exploded in 2008. 7. A most important element in this informal control was that there were no rules for the banks to get round—just a nod and a wink from the Bank of England from time to time. I was present at a number of these meetings and can vouch for the effectiveness of its method. It was a satisfactory system for everyone and when one or two secondary banks, like Slater Walker, got into trouble in the 1970’s the Bank of England was able to take control of them without a general collapse of confidence in the system as a whole. 8. The proximate cause of the 2008 crisis was that the banks had been taking much greater risks than their privileged capital structure justified. Desperate to improve their profits by earning better margins than they could get by borrowing from you and me, and lending back to me and you, they started borrowing in large quantities from each other and from large non-banks—in effect moving from being retailers to wholesalers. 9. This change was reflected in their lending policies—tired of lending at small margins directly to you and me—or more likely our children—they tried to improve their margins by buying packages made up of small loans made by other banks—generally to people you and I wouldn’t lend a penny to. For the banks selling these packages it was a convenient way of offloading their riskiest loans, which, for some reason I can’t understand, were rated as being very low risk. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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10. Rating definitely needs investigation. It is normally a process of assessing the quality of governments, large companies and banks which is done by a small number of mainly American rating agencies. For a fee they will allocate a rating which can range from triple B at the bottom end—meaning a very bad risk—to triple A meaning the best possible risk. Triple A is normally reserved for major governments and the biggest companies, but for some reason these packages of “toxic debt”—comprising mortgages taken out by people who often had no means of repaying—were rated very highly, often as high as triple A, which allowed the banks to justify buying them as though they were high quality assets. 11. It was not the actual businesses which were being rated but the loan packages themselves, separately from the banks which were buying and selling them, and that is very odd. When I had 3i rated AA in the 80s we were subjected to the most rigorous scrutiny of our whole business, its policies, its investment methods and its assets. Unlike the banks in their recent behaviour, we never bought other people’s assets—we always made our own investment decisions, after detailed examination of the underlying businesses. 12. The Financial Services Authority, which was formed in 1997, took over banking supervision from The Bank of England but it didn’t seem to investigate very thoroughly the kind of risks the banks were taking on. This was probably because it was operating on Treasury instructions to supervise the banks “with a light rein”, but also because its staff did not have the Bank of England’s in-depth knowledge of the banking sector. 13. It seems to me particularly unfortunate that the supervisory role of the Bank of England was removed in 1997 because there had, not long previously, been a major change in the banking system, which in my view contained the seeds of the current disastrous situation. 14. It was in 1933, when the world was in the grip of the last global banking crisis, that the United States Government brought in legislation to compel the retail banks to stick to their basic activity and forbade them to take on investment business—like the sort of thing we did in 3i, but more particularly the kind of business carried on by merchant banks, or investment banks as they are known in the States. At that time the US Government thought the banking free-for-all was responsible for the crisis: does this sound familiar? 15. The reason they gave for the new legal separation of functions was the inherent conflict of interest between investment and retail banking. This piece of legislation—known as the Glass Steagall Act—remained in effect until 1991 when it was repealed by the Clinton administration—under intense pressure from the banks. The decision was influenced by a similar relaxation which had taken place previously in London and had given the City a big advantage over New York as a financial centre. 16. In my time the UK merchant banks were relatively small, independent institutions, under the Bank of England’s control but with a quite different function from that of the clearing banks. Essentially they existed to help governments and major companies to raise capital in the stock market and in the international bond markets. I used merchant banks, particularly the egregious S.G.Warburg, to help me raise capital for 3i and there is no question that they had a critical role in oiling the wheels of the capital markets. 17. The blurring of the demarcation line between these two quite different kinds of banks, following the repeal of Glass Steagall and the similar relaxation in the UK, had a dramatic effect on the clearing banks. It allowed them to set up their own merchant banking arms by poaching the highly specialised and highly paid staff of the merchant banks—or sometimes simply buying them. But not only did the two kinds of bank have different functions—they had totally different cultures. 18. The clearing banks were relatively staid and risk-averse, with staff—like our old friend from Dad’s Army, Captain Mainwaring—who typically worked their way up through the ranks and retired with a comfortable pension. All the chief executives of the banks who I met in my career had risen from the ranks. None had come in from outside. Bonuses were then unheard-of, as was profit-sharing. 19. The merchant banks, on the other hand, had a tradition—going back beyond the clearing banks—of buccaneering risk-taking on an international scale. They financed railways in Patagonia, issued bonds for the Imperial Chinese Government and, more recently, raised funds for 3i from the Central Bank of Saudi Arabia. They made their money from fees and commissions and from trading in their clients’ stock, using their own capital.They were staffed with bright, young, ambitious Oxbridge graduates, who were paid very well, with bonuses, profit sharing and generous share option schemes. You can see how different were the two cultures and how important it had seemed in 1933 to keep these radically different bodies apart. 20. In my opinion it was the repeal of the Glass Steagall Act, combined with the relaxation of the equivalent British separation of functions, that opened the floodgates. It allowed the banks to trade in securities on top of their normal short-term lending and at the same time to adopt both the risk-taking cultures of the merchant banks and their remuneration packages, while retaining their own privileged capital structures. It allowed greedy merchant banking practices into the sleepy but safe old clearing banks—typified by Captain Mainwaring—and the introduction of investment bankers into positions from which they could bet the whole bank—and destroy it—yet walk away with footballers’ pay packages 21. Any proposal to keep retail banking alongside wholesale and investment banking within an overarching banking group, even though ring-fenced in capital terms, would create huge conflicts of interest within the parent company. Allocation of resources, both financial and human, would inevitably be weighted towards the subsidiary producing the better returns, and accordingly able to offer the more attractive pay packages, resulting cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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inevitably in internecine warfare between the subsidiaries, with their wholly different cultures, and envy among the less well paid staff. 22. The banks should be forced to float off their UK retail arms into new, separately owned and managed banks, doing what they used to do, their depositors protected by The Bank of England’s last resort facility, their capital ratios set much more generously than those of the investment banks, and subject to close supervision by the central bank. Pay structures should be appropriate to the low risk business they would take on but with profit share and generous pensions. By virtue of their capital ratios returns would, as before, be acceptable to investors looking for safety rather than high returns. 23. The remaining wholesale/investment banks would be subject to quite different international regulation on which I am not qualified to comment. Justification for their pay packages would be of no concern to staff, shareholders and depositors in the clearing banks. Everyone needs a clearing bank to run current and deposit accounts, but not everyone needs an investment bank. It should be open to businesses to shop around for the exotic products of the investment banks without affecting their day-to-day clearing bank relationships. 17 August 2012

Written evidence from Sir Donald Cruickshank Supplementary Evidence from Don Cruickshank relating to the PRA’s and the FCA’s duties and powers relating to competition. 1. May I first submit as evidence my first report to the Chancellor titled : “Competition and Regulation in Financial Services: Striking the Right Balance”. This is Annex F of my full report of March 2000. It offers an analysis of the difficulty of trading off competition and regulatory, including prudential, objectives which is valid today. It describes the policy framework within which the Financial Services Bill should be written and how the various institutions involved in such decisions should be structured and incentivised. 2. This analysis, applied to today’s proposed legislation, concludes that: — The FCA and PRA should each be responsible for making this trade off. Both should have a primary competition objective in the form “to minimise the anticompetitive effects of requirements placed on authorised persons by the authority.” — The financial services sector should not have any unnecessary exclusion from general competition law. This would require modification of certain clauses in the Bill, mostly to amend surviving clauses from the FSMA, so that behaviour is only excluded from Chapter 1 (agreements between firms where this distorts competition) and Chapter 2 (certain forms of behaviour by dominant companies) prohibitions if it has been properly scrutinised by the FCA and/or the PRA. — The FCA and PRA rules should not be excluded from the scope and scale of complex monopoly investigations by the competition authorities under the Fair Trading Act 1973. — The FCA and PRA rulings should be open to review in respect of their effect on competition. This would be a route via the competition authorities for those who consider themselves to be disadvantaged by FCA or PRA rules. 3 It is recognised that these recommendations lead to complex drafting changes. My overarching recommendation is that the Commission subjects my analysis of 2000 and these recommendations to independent expert legal advice. The question to be posed to such experts would be to define precisely what amendments to the Financial Services Bill would be required to give effect to the principle of seeing the benefits of effective competition given proper weight in the deliberations of the FCA and PRA. Without such amendments, consumers will continue to be ill served, often in the name of achieving spurious or unnecessary regulatory oblectives.

Supplementary evidence from Don Cruickshank relating to exceptional sanctions on firms licensed to provide financial services and their employees. 1. In my first written evidence to the Commission I advanced the argument that the special nature of the financial services sector requires exceptional, even harsh, regulation compared to other sectors of the economy. In oral questioning on 23 October I elaborated as to the penalties that individuals should face if found guilty of egregious behaviour. You have asked me to expand on those thoughts and, by Mr Love, to answer the question: “How to so legislate for the UK without harming the UK’s competitive advantages in international financial markets. 2. My oral reponses were framed in the context of my experience in the US as a member of the audit committee of one of the largest firms in the world, active in all parts of the world, and I proposed something analogous to the US Foreign Corrupt Practices Act. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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3. However, may I suggest that that route might well be unhelpful (for the reasons advanced by Mr Love) and that, in fact, the UK already has legislation in place whose structure and penalties might relatively easily be adapted to deal with financial services as a sector. That legislation is the Bribery Act 2010. 4. My recommendation, therefore, is to amend the Financial Services Bill: — The additional clauses would apply to firms licensed to provide financial services in the UK, to all employees of such firms, and to all UK citizens working for similar firms elsewhere in the world. — The key clause would be to subject firms and individuals to civil and criminal penalties for improper performance, defined as being a breach of an expectation of good faith or impartiality or breach of a position of trust. — The test of improper performance would be what a reasonable person in the UK would expect in relation to the provision of the financial service in question. — The penalties for firms would be unlimited fines. The penalties for individuals would be unlimited fines and up to 10 years in jail. 5. I make no apologies for echoing the Bribery Act so precisely, including as to penalties. The reputation of the UK, the strength of its economy, and individual consumers are at least as likely to be harmed by failings in the financial sector as by bribery scandals. Financial services have very unusual characteristics—a judgement about fitness for purpose of a financial product may only be possible some time in the future; quality of service is dependent on the future behaviour of the producer, which may be unrelated to past behaviour; the information on which consumers can base a rational choice may be difficult to understand. So exceptional rules for breach of trust are proportionate.The UK’s bribery laws are similar to those of the US and tougher than elsewhere without undue harm to the country. This might suggest that echoing US sanctions, including jail terms, aimed at rooting out egregious behaviour in financial services markets would not necessarily be harmful. It would bring London and New York together. 31 October 2012

Written evidence from Sir Don Cruickshank Perspective — Take heed of David Walker’s evidence that standards are no worse than they have been at times in the past: consider the possibility that the decline in standards in ﬁnancial services over the past decade has been but calibrated to standards elsewhere in public life: and before you start drafting, read Trollope’s “The Way We Live Now”.

Causes ofImperative forGovernments to act toSaveBankingSystem — Basel 2 let the banks regulate themselves, especially as regards capital requirements. How else could an average post war gearing of c20 have become c50 in just six years from 2000? This was exacerbated in the UK by weak regulation in the form of the FSMA 2000 and by very poor application of competition law. — Central bank monetary policies caused a glut of money that the banking system had to process and encouraged too many people to insert their ﬁngers into the passing ﬂow for private gain — Boards failed to root out poorly structured incentivisation policies throughout the banks—not just at senior levels — Certain aspects of transparency are bad not good. Examples are: quarterly reporting, reserves policy, accounting standards (especially the move to US style rules based international standards), publishing minutes of authorities’ deliberations

Over-riding principle — The banking system is de facto part of the state and, therefore, regulation of, and competition policy with respect to, the state’s agents—those licensed to provide ﬁnancial services—should be exceptional and harsher than that applied to the rest of the economy. The Regulatory Contract between the state and banks needs to be toughened in favour of the state and the economy at large. In particular, the state has a legitimate interest in improving the management and behaviour of bank management.

What to do, within a new Regulatory Contract of exceptional regulation and competition policy: — Legislate for a Financial Corrupt Practices Act applying to anyone licensed to provide financial services (cf Foreign Corrupt Practices Act of the US, policed by the SEC and DoJ). — Legislate to provide that directors sitting on Audit/Risk/Governance committees of financial institutions are held to higher standards—civil and criminal—but in return, make compliance officers/internal audit/risk managers directly accountable to these committees and create the expectation that these committees will often and systematically seek independent advice. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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— Take all regulatory functions away from the regulated. The LIBOR scandal is just the tip of the iceberg here. — Ensure that Vickers is not diluted further by HMT ofﬁcials. — Charge somebody with competition powers to implement—not just investigate and report— personal and SME account portability. Without this change, competition in retail markets will not ﬂourish however many “new” banks come on the scene; free-in- credit (the root source of poor treatment of customers because of hidden and behaviour distorting cross-subsidies) will be sustained; and customers will never be better served.

What not to do — Do not let Basel 3 and EU policy initiatives overreact to events of the past few years (see perspective above). — Do not do anything that would weaken the UK’s competitive position in world financial markets. — Do not implement the huge concentration of power in the BoE that is inherent in the government’s proposals for banking reform. Therein lie the roots of future crises and ineffective regulation. — Do not call for or, worse, attempt to legislate for shareholders to bear the government’s supervisory role of the governance of financial institutions. Shareholders should buy or sell as they think fit. 18 October 2012

Written evidence from Nicholas Dorn, Erasmus School of Law, Rotterdam

BANKING CULTURE AND COLLECTIVE RESPONSIBILITY

Origin andBasis ofSubmission

The author, a sociologist working in a law school,124 researches and publishes on regulation of ﬁnancial markets, with speciﬁc attention to the policy, regulatory and market conditions that propagate or mitigate crisis.125 The work is carried out within a broadly socio-legal perspective. The focus for this submission is determined by the Parliamentary Commission’s terms of reference (for external readers, these can be found on its website). The views expressed here do not represent those of the author’s university.

Summary

S.1 Basic assumptions — There is wide interest in connecting issues of (i) occupational culture, (ii) compliance/misconduct, (iii) remuneration and (iv) clawback (the bonus/malus debate). — Individual-focussed measures (supervision, remuneration and measures in civil or criminal law) must be supplemented by a wider, whole-firm regulatory strategy. — Whilst attention has been drawn to “the tone at the top”, “the tone in the middle” and “the tone at the bottom” are as important. Collectively, mid- and lower-level staff see and know more than chief executives or boards. To reform culture, all levels need to be properly incentivised. — In cases of rule-breaking, recklessness or malfeasance, clawing back a proportion of past and/or present remuneration is a matter of economic justice. — However, questions about who to hold (co-)responsible and to target for recoveries need to be more imaginatively addressed than hitherto. Up to now, some of those working in the financial services industry have passively gained from the recklessness and misdemeanours of their peers—for example, through group bonuses—whilst not being at any risk of clawbacks unless they are also are flagrantly involved. All rewards for passive connivance should be withdrawn, indeed reversed. 124 Erasmus School of Law (ESL) is a constituent part of Erasmus University Rotterdam, the Netherlands. ESL locates law in its economic and social context: http://www.esl.eur.nl/home 125 This submission draws upon drafts of a book in preparation: Democracy and Diversity in Financial Market Regulation. It also draws upon the following: “Knowing markets: would less be more?” Economy and Society, volume 41(3), pp 316–334. “Regulatory sloth and activism in the effervescence of financial crisis”, Law & Policy, volume 33(3), pp 428–448. “Render Unto Caesar: EU financial market regulation meets political accountability”, Journal of European Integration, 34(3), pp 205–221. “Policy choices in financial market regulation: market rapture, club rules or democracy?”, chapter 2 in Alexander, K and Moloney, N (eds), Law Reform and Financial Markets, Cheltenham: Elgar, chapter summary at http://ssrn.com/abstract= 1946373. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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S.2 Recommendations — The Commission should recommend collective responsibility, ﬁnancial accountability and clawbacks—applying laterally to co-workers of miscreants, as well as vertically to management. This would animate the occupational culture, incentivising all levels of banking staff, in a proactive and precautionary manner, to bring informal pressure to bear against reckless or improper practices and, where that fails, to trigger formal investigation, via reporting and whistleblowing. — A forthright approach would be to go for such linked cultural and remuneration reforms across the whole sector. A more tentative and exploratory step would be to use the (partly) publicly-owned banks as a testing ground. An alternative would be to require such reforms selectively, as conditions of settlement with regulators. If monitoring over time ﬁnds that the changes seem positive, then that could provide ammunition for wider change across the industry.

S.3 Future work — Further thought needs to be given to the relationship between occupational culture within banking, and broader shifts of sentiment associated with the business cycle. — The relationship between (a) risk-taking and (b) the implicit public guarantees enjoyed by banks and liquidity support by central banks remains problematic.

CollectiveResponsibility:Why and how 1. Introduction. In this submission, a proactive strategy is proposed, looking at what could be achieved through an inculcation of collective responsibility and how that might be achieved. Secondly this submission explores why action against individuals—including criminal prosecutions—must be regarded as inadequate in terms of the Commission’s terms of reference. This submission then turns to the question, raised during the deliberations of the Commission, about “talent” and remuneration, addressing that question in the context of clawbacks. Finally, this submission opens up for discussion the question of whether and how occupational culture and collective responsibility might relate to the business cycle. 2. Scope. Reform of the occupational culture of banking is commonly mentioned as being a potential means of reducing misconduct by bank executives and staff, including “rogue” trading, frauds, mis-selling, insider trading and long-running and widespread market manipulation (eg Libor rate fixing).126 There is wide interest in connecting issues of (i) occupational culture, (ii) compliance/misconduct, (iii) remuneration and (iv) clawback (the bonus/malus debate). That interest in “connecting the dots” is articulated here. 3. Approach. However, this submission does not follow the tradition of conceptualising governance in bifurcated terms, as (a) broadcasting to all staff some morally anodyne “tone from the top” messages whilst, (b) occasionally and in a highly focused manner, applying forms of discipline such as clawbacks, sackings and/ or criminal prosecution. Such bifurcated conceptions do not mark a break with the thinking and mechanisms that brought the industry to its current position. A better integration of “carrots” and “sticks” is needed. 4. Economic justice. Certainly, in cases of rule-breaking, recklessness or malfeasance, clawing back a proportion of past and/or present remuneration (deferred bonus, present salary, other benefits, whatever can be made available) is a matter of economic justice. Clawback does not preclude criminal prosecution. 5. Targeting of clawbacks. However, the question of whom to target for recoveries needs to be more critically and imaginatively addressed than hitherto. There exists within bank management a notion that “only a handful of staff are usually to blame” (a few rotten apples).127 This is a self-serving line, because defining responsibility for scandals in terms of blame for a few individuals whitewashes those close by and above. It minimises the potential for clawbacks, because the pool for such recoveries is constructed as being small. Thus it ensures that the greatest proportion of the costs of misbehaviour and of regulatory fines continues to be un-recoverable. As for the future, the occasional handing over of a few scapegoats—those unfortunates for whom deniability is least available—is not effective in transforming occupational culture or practices within the industry. 6. All levels of staff. If the Commission’s terms of reference are to be met, then any individual-focussed measures must be supplemented by a wider strategy, engaging with the occupational culture of the whole sector and incentivising all levels of banking staff. It is true that focussing action against a small number of individuals dovetails with criminal law, thus allowing strong disapproval to be shown. However, as made clear in evidence on sanctions submitted to the Commission by learned legal experts, criminal law is a rather blunt instrument in this context. Without prejudice to the arguments favouring criminal prosecution, too much banging of that drum could detract from the search for wider, forward-looking and transformational regulatory strategies. 126 The scandals come so thick, fast and loudly that they hardly need documenting here, although there remain many questions over the efficacy of responses. See for example, “The metamorphosis of insider trading in the face of regulatory enforcement”, Journal of Financial Regulation and Compliance, 19(1), pp 75–84. “The Governance of Securities: Ponzi finance, regulatory convergence, credit crunch”, British Journal of Criminology, 50(1), pp 23–45. “Theorising the Security and Exchange Commission’s 2010 Settlement with Goldman Sachs: legislative weakness, reintegrative shaming or temporary business interruption for financial market power elites?”, with Levi, M, in Antonopoulos, G et al (eds), Usual and Unusual Organising Criminals in Europe, Antwerp: Maklu, abstract at http://ssrn.com/abstract=1788885. 127 As reported in Jenkins, P, “Time to rehabilitate bankers’ bonuses”, Financial Times, 4 March 2013. http://www.ft.com/intl/cms/ s/0/5867ba0e-84d2–11e2-aaf1–00144feabdc0.html cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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7. Collective self-discipline. What is needed is an approach that facilitates higher financial recoveries (economic justice), whilst also transforming the occupational culture of the financial services industry (preventative safeguards), by encouraging those working in the industry to more closely scrutinise and discipline each other. For this, the Commission should consider a form of collective responsibility and financial accountability, meriting collective clawbacks in cases of rule-breaking, recklessness or other malfeasance.

8. Vertical clawbacks. Financial responsibility and accountability should be extended both vertically and horizontally. Vertical clawbacks, extended to those who hold line supervisory or management responsibilities, are clearly merited. If superiors claim not to have known, then either they neglected their duties, tactically turned a blind eye or strategically ensured that they were never formally informed. If there is a reason for this logic not to extend to senior compliance ofﬁcers, legal counsel, chief operating ofﬁcers and indeed board members, let the argument be heard (c.f. evidence given by Lord Turner).128

9. Lateral clawbacks—affecting all those within the team, unit and/or bonus pool within which malfeasance occurs (for example, a sales team, prop trading desk or the department within which it sits)—would have the potential to positively incentivise a broader swathe of bank employees to take preventive action. A signiﬁcant (quite high) level of clawback would be appropriate for those working alongside or near the locus of undesirable behaviour. In the absence of such an incentive, nearby staff might possibly disapprove of the behaviour but shrug it off (on the basis that it is not really their business, since they themselves are not directly involved and hence would not be held to account); or they might observe the behaviour with some amusement or excitement (“so that’s how it works!”); or they might even facilitate it in small ways (carrying out tasks on request).

10. How widely? It could be for consideration whether a more modest level of clawback might be applied routinely across all departments and pay grades within a bank. On the one hand, such whole-staff accountability might have a broad reinforcing effect, in terms of occupational culture. On the other hand, it could be argued that staff in different departments, when they are distant from the behaviour disapproved of, would have little knowledge of or change to inﬂuence the behaviour. Nevertheless, such insularity and deniability needs to be reduced, encouraging all banks staff to look twice. This is partly a moral question but also partly an empirical question, answerable experimentally—by putting into effect various accountability regimes and observing their cultural consequences. In any case, there can be no argument against accountability for those who are close to malfeasance and observe it on an everyday basis.

11. Proportionality and fairness. Arguments against collective responsibility could be mounted from the perspectives of fairness and proportionality. In addressing such concerns, and it ﬁnding a balance, it can be argued that a strategy of collective responsibility would be merited on several grounds. Firstly, it could stimulate informal and formal controls within the industry, which so far have been noticeably absent, dormant or weak. Thus it could have a preventative effect and limit future wrong-doing. Secondly, targeting not only the one or few persons most centrally involved, but also wider sets of facilitating or knowing persons, would allow higher cost-recovery. Thus banks could recover closer to 100% of the costs of compensating wronged market participants and of paying regulatory ﬁnes—in contrast to past and recent recoveries of much smaller proportions of such costs.

12. Where to start. If the Commission is interested in making changes in bank behaviour, culture and remuneration, yet is uncertain over the applicability of such changes generally, then the (partly) publically owned banks could be a testing ground. An alternative would be to require such reforms selectively, as conditions of settlement with regulators, following misbehaviour or negligence by a bank or its staff. If empirical work were to ﬁnd that the changes seemed positive over time—considering for example ﬁnancial results, regulatory compliance and staff engagement and morale—then that could provide ammunition for wider change in the industry. A more forthright approach would be to go for cultural and remuneration changes “across the board” (in both meanings of the phrase).

13. Experimentalist approach. There are two ways in which the above strategy could be implemented: direction via legislation (as in the UK and EU debates on remuneration), or via codes of practice which the industry might prefer to offer, with a “comply or explain” obligation. Either way, since this area of “cultural engineering” is in its infancy, some flexibility in conceptions, requirements and modes of implementation could be useful in the early stages. What works, in which circumstances and why? It would be useful to explore variations in the implementation of cultural and remuneration reform in financial services: that points to top- down general principles, allowing for variations. If monitoring over time finds that some approaches lead to 128 Evidence 27 February 2013, Lord Turner’s answer to Q4495. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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more positive outcomes than others, then that could provide ammunition for wider change across the industry (accepting that in practice control measures typically provoke mixed reactions).129 14. Academia’s contribution. Until recently, much of what concerns the Parliamentary Commission (and policy-makers, regulators, the public more generally) has not been at the centre of public enquiry. Economics, the dominant conceptual frame of reference in the run-up to the crisis and continuing today, is not well equipped to address cultural issues, because of its somewhat dehumanised models of markets and its individualistic models of action. Law is sometimes more promising, as reﬂected in expert evidence given to the Commission by learned scholars, however the focus on criminal law is something of a millstone. For a more direct engagement with the Commission’s terms of reference, some conceptual tools and empirical methodologies are found in the social sciences generally and in regulatory studies and socio-legal studies in particular. A closer bringing together of policy-making and such intellectual and empirical resources would be helpful.

Limitations Inherent in Individual Accountability 15. Professional standards and culture are collective. It follows that focusing responsibility, accountability and clawbacks only upon those directly involved—and/or upon their immediate supervisors—would not sufficiently address the objectives of the Commission, concerning standards, culture, behaviour and risk- sharing. 16. Several limitations. In particular, focussing action only on a few bank staff—as is the current tendency— gives rise not only to lower cost-recoveries (see above) but also to further limitations: too narrow a focus in social terms, the danger of provoking counter-measures, and the mire (for present purposes) of criminal law. 17. Whole organisation issues. An atmosphere of fear can be created, however that may do little to create the broader cultural conditions in which the whole staff of a bank cooperate, internally and with regulators, to run a clean ship. Occupational culture, standards, behaviour and the prospects for self-control, positive influences upon colleagues and, when necessary, whistle-blowing are sector-wide and whole-firm issues. 18. Danger of stimulating deniability. Ironically, although accountability of supervisory and senior management seems morally justifiable, threat of tough action against those at the top can be counter-productive. It runs a risk of stimulating greater efforts to defend corporate and individual reputations, for example by ensuring that one does not know what one does not wish to know. Senior executives (chief executives, chief operating officers, corporate counsel, compliance and risk managers) may spend more of their time (and more of the bank’s resources) in categorising, managing and neutralising legal and reputational threats. 19. Practical limits of criminal law. Criminal prosecution of individuals may face difficulties (broadly agreeing with evidence given in the session on 17 January 2013). This does not imply that criminal prosecutions may not be appropriate, just that consideration may be given also to other remedies, preventative means and cultural signals. 20. Historical note. Criminal prosecution of senior executives and other prominent individuals meets additional problems. We have been here before: consider the travails of the Serious Fraud Office. The difficulties may not result from a lack of specific offence categories; more generally they have to do with the questions of intent and the criminal standard of proof, especially when sophisticated defence teams are deployed. 21. Not forgetting civil proceedings. One clear implication in practical (instrumental) terms is that civil proceedings have more leverage, even if they lack some of the symbolic power and moral opprobrium of criminal law. Whilst public and populist anger may be driven by a sense of justice being frustrated and by incredulity over excesses in the context of public subsidy for the banks, policy-makers need to balance issues of symbolism against consideration of effectiveness. 22. Some harmful behaviour cannot even be civilly proceeded against. Whilst the more intrusive regulation that has been provoked by the crisis has helped to bring to light evidence of widespread market manipulation 129 In my opinion the purpose of monitoring the implementation of cultural reform should be to get a sense of the emergence amongst bank staff of what, quite likely, would be a variety of responses and coping reactions. The three standard research response-categories to be found throughout the literatures on communication studies, cultural studies and regulatory compliance are as follows. (a) Shades of agreement and acquiescence, enthusiastic or otherwise, so more or less complying with the letter if not always the spirit of the reforms (bearing in mind however that compliance sometimes has unanticipated consequences, which need to be looked for). (b) Negotiated and innovative responses, including creative re-castings of the meanings and requirements of the reforms; and/or creating new or exploiting existing non-monitored channels, networks or pools (cultural equivalents of offshore trading or off balance sheet vehicles). (c) Outright opposition, ie resistance and sabotage using all the resources of firms, legal and other advisors, trade associations and lobbyists—or possibly resistance by certain sections thereof, while other sections might respond in terms of (a) or (b) above. We need to know. To look for, explore and comprehend the range of such cultural responses, qualitative methods will be most appropriate: semi-structured interviews, focus groups and “soundings”. See for example aspects of Hawkins, K, “Enforcing Regulation: Robert Kagan’s contribution—and some questions”, Law & Social Inquiry, 2013; also the sociological work mentioned in note 3 above. Such approaches differ from, but could complement, quantitative, “concrete” indicators of bank culture and ethics (see indicators work led by Roger McCormick in the context of the LSE’s Sustainable Finance Project, which seeks to develop such indicators and make them more accessible to the public on a comparative basis). cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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and frauds, the wider prudential, managerial and risk-management failures that caused the crisis were in many cases perfectly legal—the whole industry had an extended Ponzi moment (see paragraph 36 onwards). 23. Summary of this section. Prudential considerations demand forms of cultural change that cannot be delivered by individual scapegoating, civil proceedings or criminal prosecution. However, whole-organisation change could be driven by making remuneration a two-way street at organisational level (see paragraphs 4–12 above). In these terms, and contrary to some submissions made to the Commission, it is possible to legislate for cultural change. The conceptual hiving off of “culture” from “the economy” and “law” is profoundly unhelpful.

Limitations Inherentin“The Toneatthe Top” 24. Top down morality? Evidence given to the Commission to some extent reflects the contemporary tendency for regulatory bodies to conceptualise culture and behaviour in terms of “the tone at the top” of an organisation (inter alia see FSA evidence concerning “code staff”). On reflection, however, there are limitations to any approach that tries to engineer culture from the top downwards. Organisational life is not so simple, leaders sometimes dissimulate (visibly) and subordinates may respond to a wide variety of signals. Organisational life in investment banking, in particular, may be better likened to a collectivity of chameleons than to a flight of ducks. 25. Deniability. Those at the theoretical apex of the organisation may know the least about what is going on—partly because they are at some distance from the everyday lives, conversations, transactions and tactics of their subordinates, and partly because they may have a vested interest in not knowing in advance of any misdemeanours that might in the short-to-medium term be highly profitable for the bank.130 26. Board members. The stance above is even easier position for board members to take. That raises the question of what boards are for, however that is outside the current enquiry. The point for present purposes is the “accountability firewall”. 27. Implication for investigations. As with responsibility, so with regulatory investigations: instead of going only “up the chain”, interviewing those employees who are best-defended in terms of the skills of cloaking, dissimulation and misdirection (as police previously used to do in drug trafficking investigations, thus often wasting years whilst getting nowhere—“the trail peters out”) investigators should go both laterally (both within the organisation and without) and also downwards, until they encounter persons who are less bound by omertà. 28. Summary of this section. Without wishing to dismiss concerns over “the tone at the top”, it is fair to observe that “the tone in the middle” and “the tone at the bottom” are important. In some respects, more important, since middle and low level employees see more and know more (collectively) that the board does. If robustly incentivised, middle and level employees are more likely to act to correct abuses, either by bringing informal pressure to bear, or by blowing the whistle. At present, such incentives are lacking, since some of those working in the financial services industry can passively gain from the recklessness and misdemeanours of their peers—because they share in the fruits thereof, through group bonuses and/or promotion opportunities—whilst not being at any risk of clawbacks unless they are also are flagrantly involved.

Engaging with theQuestion of“Talent” 29. The talent discourse. Discussions in the Commission and more widely have identified an imbalance in the relationship between highly paid employees and the organisations that they work for. As has been observed within the Commission, the investment bank discourse on “talent” is deployed in such a manner as to push up remuneration generally.131 30. Heads I Win, Tails You Lose. Typically, none of these individuals will lose anything if things go pear- shaped: they simply won’t gain as much as they had hoped. If potential gains could be balanced by the prospect of losing significant amounts then at least individuals would be incentivised to scrutinise their own behaviours and the behaviours of those around them. 31. Group remuneration. For the wider set of colleagues within the same trading group as a “talented” trader or executive, the present prospect of sharing in any upside—whilst not be effected by any downside—may incentivise such colleagues to “egg on” the risk-takers. It certainly does not provide a constraint. Culturally speaking and in terms of prudential concerns, this is not helpful. 32. Public subsidy. The above observations call for some explanation of why hitherto the talent mechanism— a form of leverage, in effect—might operate so strongly in financial services but less so in, say, manufacturing. Part of the answer is to be found in the implicit guarantees enjoyed by all but the smallest (or least connected) banks. Despite political conditions commonly understood in terms of neo-liberalism, exceptional support for banks not only continues today but also has been extended. Such subsidy can take several forms: (i) partial state ownership, which in the UK was combined with a Treasury strategy that the supported entities should be 130 As a member of the Commission neatly put it in relation to executives: “This may have happened on my watch, but I was not watching, so therefore I am not responsible for it”. 131 Evidence, Q32256, David Bolchover: “The trader who wants x + y has a boss who wants 2x + 2y”. He says, “This guy who works below me is so talented. Please”—to the guy above him who earns 3x + 3y—“we can’t lose this guy. He can’t go to a competitor. And guess what? I am his boss, so, by inference, I must be even more capable and talented than him. So don’t lose me either.” cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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managed far as possible in a manner similar to before the crash;132 (ii) asset-buying by central banks, coinciding with conditions in which delivering banks lend less and less to the real economy; (iii) ambiguity over future bailouts/bail-ins. Continuation of such subsidies works against normalisation of the culture of banking, insofar as public insurance for private recklessness institutionalises the latter and underpins its claim to talent. 33. Impediments to change. Unfortunately, public and central bank subsidy for banking has deep historical roots.133 Best intentions aside, it may be difﬁcult to curtail. There are cultural issues here in policy circles, as well as in banking. 34. Distinguishing public ownership from public subsidy of risk. The measures advocated in this submission would be equally applicable to publically and privately owed banks. Whilst the Treasury seeks to re-privatise all aspects of banking, it is an unsettled matter whether long-term public ownership of some (utility) elements of banking might be merited on grounds of ensuring common infrastructure as a public good. According to political taste, that might be achieved through strategic stakes or 100% ownership, at any level of government (EU, national, regional or local). But whatever the ownership arrangements, a one-way bet on remuneration makes no sense at all. 35. Summary of this section. On the question of what “talented people” deserve, part of the answer must be the lack of negative incentive (malus) that might to some extent balance positive incentives (salary, bonus, pension arrangements, other beneﬁts). If more of a balance—underpinned by the reduction in, if not removal of public subsidies—were to result in fewer people declaring themselves to be so talented, so conditions in the industry would normalise.

Collective Responsibility Linked to the Challenge of the Cycleof Boomand Bust 36. Beyond “rationality”. Historical evidence suggests some limitations of “skin in the game” (financial risk-sharing) and also that there may be potential for negative consequences as well as positive. Consider the point made in the Commission that “Some of the banks that collapsed at the time of the crisis had some of the biggest shareholdings by executives and people who worked in the bank and that did not stop them taking those risks”. That is certainly true. 37. The importance of context. This draws our attention to wider settings in which incentives are experienced—“exogenous factors”, as described during some of the evidence given to the Commission (although of course the behaviour of the banks help to construct those factors, which therefore are as much endogenous as exogenous). As economists and sociologists of diverse political stripes have pointed out,134 as any market peaks, even experienced participants who have their own funds at risk are reluctant to exit, meanwhile naive late-comers and wannabes (including would-be “star traders”) hurry to join the party. 38. Boom/bust. Since governance arrangements should, ideally, be fit for all stages of capitalism’s inherent boom/bust (rapture/despair) cycle, it is worthwhile to think through these issues. Here summarised is Joseph Schumpeter’s three stages of slow initial development of a new market, followed by tulip-like mania (think subprime) and a fall into recession. — First, innovators and entrepreneurs—Schumpeter’s heroes—propose new ideas to investors and the best ideas (in the eyes of the investors) are funded. This investment leads to a general expansion of the economy, as jobs are created in supplier firms, employees have more money to spend, they put aside some savings (part of which circulate to become available to support new investments) and so on. In this phase, the financial sector is seen by Schumpeter as playing a valuable role: it supports the “real” economy (the latter really having that characteristic at that stage). — Second, the moment of danger arrives, as entrepreneurs and investors chase each other and, in a general atmosphere of overconfidence, make indiscriminative investments. As Leathers and Raines (2004, pp 672–3, see notes below) put it, writing just after the bursting of the “tech bubble” in 2001 but before the onset of the present crisis, “pure financial speculation occurs and may intensify into a speculative mania”. In this phase, people get carried along, taking up debts that will become burdensome in any downturn. The finance sector, or large parts of it, feels unable to stand back when things are going so swimmingly: in the familiar and hackneyed words of a previous chairman of the financial conglomerate Citigroup, Chuck Prince: “When the music stops, in terms of liquidity, things will be complicated. But, as long as the music is playing, you’ve got to get up and dance. We’re still dancing”. 132 CRESC, 2009, An Alternative Report on UK Banking Reform, Manchester: Centre for Research on Socio Cultural Change, see p14. More generally: Engelen, E et al, 2011, After The Great Complacence: financial crisis and the politics of reform, Oxford: OUP. 133 Dorn, N, “Lehman—lemon: ‘Too Connected To Fail’ as a policy construct”, Law and Financial Markets Review, 6(4), pp 271–283. http://dx.doi.org/10.5235/LFMR6.4.271 134 Minsky, H 2003, “The financial instability hypothesis”, pp 201–203 in Stilwell, F and Argyrous, G (eds), Economics as a social science: readings in political economy, North Melbourne: Pluto Press. Schumpeter, J. 1939, Business Cycles: A Theoretical, Historical, and Statistical Analysis of the Capitalist Process, New York and London: McGraw-Hill. Leathers, C and Raines, J, 2004, “The Schumpeterian role of financial innovations in the New Economy’s business cycle”, Cambridge Journal of Economics, 28, 667–681. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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— Third, the dénouement duly arrives, as many investments fail to pay off, causing losses that banks and other investors compensate for by withdrawing or withholding credit from other, economically marginal firms—whereupon failures multiply and “creative destruction” clears the decks for a resumption of the cycle. What happens then depends in part on policy. Schumpeter believed in a hands-off policy, allowing the decks to be cleared and new initiatives to emerge (“creative destruction” clearing the way for the next upswing).135 39. Possible implications: counter-cyclical cultural/clawback arrangements. The question is, to what extent is the above cycle-tendency hard-wired into the collective psyche in capitalist societies? If it is very strongly entrenched, then no amount of fluffing about governance, standards and culture would be worth the paper it is written upon. If, on the other hand, that tendency exists but is open to some extent to countervailing influences, then policy should seek to institutionalise such tendencies within occupational cultures (thus paralleling attempts to make bank capital provisioning counter-cyclical). There could be quite an agenda here. 40. Optimal conditions. In what used to be called “normal” times—ie in between boom (collective rapture) and bust (collective fear)—having one’s own funds at risk might be expected to induce good judgment and reasonable caution, since the lack of excitement one way or the other enables one calmly to weigh up pros and cons. This seems a reasonable proposition, subject to empirical test. 41. Taking away the punchbowl. At the height of the boom, in conditions of generalised over-optimism, wide sections of society get carried away—house-buyers, mortgage-packagers, ratings agencies, investors, banks, regulators and policy-makers. It is difficult at such times for anyone, be they policy-maker, regulator or bank board, to “take away the punchbowl”. In such a context, it might also prove difficult for bank employees to collectively discipline themselves, even if the measures advocated in this submission were to be in place. We don’t know, because we did not have such arrangements in place prior to the crisis beginning in 2007. This could however be a matter for empirical test for the future. 42. Flexibility. In manifest downturns—such as the present time—having even a very small proportion of one’s remuneration at risk may risk paralysis. Thus there may be a case for clawbacks, collective and otherwise, to be tapered to fit the times. 43. Summary of this section. The analytical and policy bottom line is that further thought needs to be given to possible interactions between the broader setting (including the waxing and waning of sentiment with the business cycle) and occupation culture, accountability and remuneration arrangements within banking. 25 March 2013

Written evidence from Jan Duijsters Summary — Current portrayals of an abysmal UK banking culture, which is both deep-rooted and long- established, are well founded. — The culture, allied to lamentable standards of people-management and business-management, not only visited severe impacts on individual members of staff but inevitably contributed to the situation we see today. — Huge rewards for failure are a factor leading to social disintegration. — Creative and radical policy responses are urgently required.

1. Preamble I refer to the malaise in the UK banking industry and in particular to the issue of an abysmal UK banking culture as currently portrayed in the media. I can assure you as far as I am able from personal experience that this portrayal appears entirely correct, with the culture being both deep-rooted and long- established.

135 By contrast, policy since 2008 has been to preserve structures, this however being at the price of bank delivering and declining investment. PWC, 19 March 2013, “Banks still long way to go to get rid of ‘bad’ loans”, London, http://pwc.blogs.com/north/ 2013/03/banks-still-long-way-to-go-to-get-rid-of-bad-loans.html cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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2. Declaration ofInterests

I have to declare various interests myself in that I was employed in Barclaycard (a division of Barclays Bank) from March 1980 to July 2000 at which time I was made compulsorily redundant. Throughout the 1990’s until redundancy I was employed in various roles in several departments in Barclaycard Northampton head ofﬁce, mainly working on systems and business projects. I am a “small shareholder” in Barclays PLC. I also have a Payment Protection Insurance mis-selling claim in progress against Barclays Bank.

3. ObservedCulture within Barclays Bank Barclaycard Division and someManifestations of thatCulture

The culture of the 1990’s was to ﬁrmly divide (separation of those whose were “in” — i.e. in favour with senior management—from those who were “out”) and manage by diktat and fear.

3.1 Brief historical commentary on the culture

This was not, to be fair, apparent during the 1980’s—I believe because Barclaycard and Barclays Bank as a whole was then still being run essentially by “old-bank” management, steeped in the traditional banking culture, most of whom had come up through the ranks often in branch banking where they would have earned appropriate professional qualifications. By the 1990’s many new brooms were coming into Barclaycard from Head Office and from outside the Bank and indeed from outside the banking industry straight into senior roles (perfectly acceptable up to a point, one has to widen the talent pool and bring in different strands of thinking about the world), but we can guess now that many must have become heavily influenced by what is now seen as the Bob Diamond-type of culture. Rational thought, intellectual rigour and logical analysis started to become alien concepts. On those who were known to be less than impressed with some (not all) of this senior management personally and/or their management style and/or some of their decisions and policies, the pressure was unrelenting. Cronyism was widespread. Several members of management sported extremely fancy job titles but did not have any discernable jobs to go with them, while others had no obvious knowledge of, or even interest in, finance and banking.

3.2 Treatment of (certain) individuals by (certain) senior management, drawing (largely) on personal experience

People who were out of favour with senior management were isolated and marginalised, denigrated, bullied and their promotion prospects limited. The examples I give below are of course drawn mainly from personal experience, but some of these measures would have been widely deployed against “undesirable” staff, while other staff may have encountered different forms of pressure. Many decent staff kept quiet with heads down and toed the party line for a quiet life.

3.2.1 Isolation and marginalisation — individuals regularly forced to work alone iewithout belonging to a team, quite inhibiting as this will lead to less-efﬁcient working and output (as any basic-level management course will prove through contrasting “go-it-alone” versus “working together” games)—no-one easily to bat ideas off or ask questions of, hence the staff member is potentially open to criticism for doing a poorer job than “expected”; — allocated to a desk which faced a blank screen and at one side was also a blank screen ie very much told to “sit in the corner”, quite inhibiting to productive work as well as demoralising; and — allocated no work at all (this was done on occasion to entire sections of staff as well as individuals).

In other words people could be put at a disadvantage by management and then criticised for not doing a good-enough job, but where nevertheless a good job was done it simply served to rile the management even more.

3.2.2 Denigration — constantly being labelled “negative” or as having an “attitude problem” (once very favourite epithets at Barclaycard), which I feel are generally objectionable; — held to be against the sales-at-all-costs culture and management-is-always-right cultures, which was true for those few individuals who were ever the ones taking nothing at face value, deconstructing everything, asking “awkward” questions, offering “madcap” ideas or playing devil’s advocate to stimulate debate, probing whether some activity or other was of real value long-term, etc.- so what I believe are good qualities in business were turned on their head by management and declared irrelevant and counter-productive (even dangerous and subversive); cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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— being downgraded “just like that” due to a person’s job role being downgraded by senior management fiat, and when anyone protested of course they were flatly told it shouldn’t matter—I can assure you it did—it was felt very personally, to the very core, and of course it meant that the member of staff personally had to make extreme efforts to recover that lost ground and claw the way back to their original grade, all very distracting from ongoing work and of course the management could then hold that against people as well—so a “double-whammy” and a situation where the individual can’t win; and — fault-finding was a priority egwhen presented with a written report certain managers would typically ignore the content, analysis and conclusions and home straight in on trying to locate typographical errors.

3.2.3 Bullying — I was once approached by a very senior manager (a “Head Of”, ie one grade below Barclaycard Director level) while working alone in a room and asked straight out why I didn’t resign (which approach I imagine was unlawful). I knew of course that this person found my natural manner of looking at work topics irritating (iethe questioning approach—no junior was allowed to question) and that I was something of his “bete noir” for reasons otherwise unknown to me. I later found in ordinary open ﬁling in my department several notes he had written to my then departmental manager calling my status and prospects into question; — arbitrarily being told at no notice that our (ieeveryone in my department at that time) morning and afternoon 15-minute breaks were abolished, and when I complained via the Trade Union I later found out from other staff that my manager was branding me a [quote] “ringleader” which I found offensive and was in fact incorrect as I was speaking for myself as opposed to speaking on behalf of any group; this ridiculous episode proves that it is not at all easy, comfortable or straightforward to be a whistle-blower even over such a minor matter; — allocation of totally pointless tasks — constantly having to not only adjust to but also learn and parrot the latest “fad”, a personal “favourite” was “Quality First” (an American import) involving ten “training” sessions and a casebound “textbook” which was heavier and no doubt much more costly than my A-Level Economics textbook. The thrust of the material is self-evident, but it does contradict one of the most basic business propositions that the success of any business action may be analysed in terms of the “Time-Cost-Quality triangle” Another fad which springs to mind was the “Barclaycard House” which purported to explain the “values” which held up the “pillars” of Barclaycard. These diversions were just insults to the intelligence, time-wasting, money-wasting and simply crass.

3.2.4 Promotion prospects limited or totally withheld — being told to take a job vacancy for a (fairly routine and “easy”) job which the member of staff had actually done years before, ie no career progression on offer, in fact just an open attempt at forcing the person to go backwards, a blatant demoralisation tactic; and — the periodic general threat of redundancy (Barclaycard-wide) deployed—this occurred at least twice in the 1990’s and only served to ramp up the climate of fear and suppression. Add to this the constant upheaval of departmental reorganisations as a means of disorientating the staff.

3.3 Limits to challenging senior management It can be asked why people such as myself didn’t do much more to contest the situation during their employment. This is simple to answer, in my case. As an ordinary working person with no signiﬁcant personal assets I had not only a job but a mortgage and a wife and family with two daughters (one of whom has a lifelong disability—autism—and requires a huge degree of attention and support) so sticking my neck out too far, I judged, could well result (bearing in mind the above sorry litany of management abuses and perversity) in someone concocting a pretext to have me sacked. We are only left to ponder about what some areas of this country’s business community had come to even then.

4. Inevitability of theCurrentSituation withinBanking This just might give a ﬂavour of one person’s view of the culture in just one corner of Barclays—and it is admittedly somewhat dated—but from this I believe anyone can readily imagine that such ill-informed and plainly unreasonable approaches to people-management and business-management grossed-up to Barclays Head Ofﬁce level and industry-wide level, would have inevitably led to the appalling situation we see today in multiple areas of the banking industry. Indifferent education, questionable motives, want of personal integrity, inability to communicate clearly, and otherwise experienced and reputable staff with long service records being cowed by senior management and rendered ineffective are all factors which must have come into play. It is not therefore at all surprising that the shameless attempts to rig LIBOR which are now so well known did occur and (apparently) no-one came forward at Barclays to blow the whistle in public during a period of years. Similar considerations probably lie behind industry-wide failures egthe development, marketing and sale cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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of Payment Protection Insurance and over-complex derivatives and securitised products, etc., and illegal trading with embargoed countries.

5. The hugeRewards forFailure and their long-termEffect onSociety We must ask why if someone resigns from their job and particularly if they resign due to failure they are entitled to any special payout, which the ordinary person neither receives nor expects to receive. We need to question why it is so startlingly different for the so-called “elite” of society. With the amounts originally being bandied about in the tens-of-millions of pounds just for failure (in Mr.Diamond’s case—although I understand he subsequently waived a large proportion) we can soon work out that the ordinary citizen is by this standard of just about no value. The public resent this greatly, and the impact on social cohesion will be corrosive. Just like the tax-avoidance scandals highlighted recently this is all just another staging-post on the dismal road to social disintegration, a complete separation of the elites from the public. Furthermore, if we look at the Barclays share price which peaked at well over £7 and is today under £2 I think on this account as on many others the public is right to ask how this justiﬁes even the current levels of Director and senior management salaries, let alone their prospective bonuses and payoffs.

5.1 Countering the scandal of reward for failure Although public policy responses are being prepared their effect will probably be less than dramatic certainly in the short term, but it is a start. Maybe more radical measures could be considered, egmoving from “one share one vote” to “one shareholder one vote” at corporate AGMs, or legislating for PLCs to arrange for the election of (and funding of) a statutory Shareholders’ Committee as a sort of “shadow Board” with suitable powers to eginvestigate, restrain, whistle-blow and refer to regulators. Possibly there should be a general power to simply set aside and declare null and void any reward-for-failure clauses in employment contracts, plus the establishment of simple legal frameworks for the recovery of unwarranted bonuses paid in prior years. However, it remains to be seen as to whether the standing of regulation and regulators can be restored and strengthened—the public wonders whether there can possibly be anything like an equal balance of power between the banking elites and their “regulators” given the huge disparities in remuneration, the level of the contacts they have around our society, and therefore their perceived status. At present the banking elites remain well-placed to hold the regulators in contempt.

5.2 Extending the criminal law Maybe extensions to the criminal law should be contemplated. There is a considerable disparity in personal risk where a petty criminal may be subject to a custodial sentence while those committing “high crimes” disadvantaging maybe millions of people possibly worldwide go unchallenged and generally unpunished. Fines imposed simply on banks do not harm any individual miscreant. They just affect those left in post clearing up the mess, and the shareholders, most of whom are powerless and could not conceivably have had any prior knowledge or involvement at all in any wrongdoing. If it is a crime to pervert the course of justice, perhaps it should also be a crime to pervert the course of ﬁnancial dealings. 24 August 2012

Written evidence from the Ecumenical Council for Corporate Responsibility LEARNING TO TRUST: REBUILDING A BROKEN CULTURE 1. Introduction The Ecumenical Council for Corporate Responsibility is a faith based member and investor coalition which works with religious investors in the UK and Ireland to promote corporate responsibility within the companies in which members invest. Membership spans all the major denominations and includes major church bodies, church related organisations, religious orders and congregations. There are approximately 85 corporate members who control and inﬂuence over £10 billion of assets.136

2. ECCR’s Christian Perspective Christians accept the responsibility to work for a society marked by justice, compassion, peace and environmental stewardship. This requires us to stand in solidarity with all people oppressed by poverty and exploitation and to work to change the structures, policies and practices that harm them and the natural world on which human life depends. As banks are a key economic intermediary, consideration of their activities must therefore inform our scrutiny of what makes a good society. 2.1. Christian groups deploy signiﬁcant funds as investors and have a speciﬁc responsibility to use those funds ethically. In 2011, to help inform investment decisions made by our members we produced a report on 136 For more information about ECCR see www.eccr.org.uk cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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the banking sector—The Banks and Society: Rebuilding Trust137. Since then there have been all sorts of developments—the Libor scandal, money laundering scandals, more debates about banking remuneration structure, and a growing awareness of the need for a cultural change. There are currently no “untainted banks” for investors to invest in and few for consumers to use. Moving an account for a more ethical option is a choice of greys. More than ever before there is a need for a new compact in our society, for relationships based on trust as well as regulation. ECCR has no wish to repeat what it has said before, but there are new points to make in the current debate and ECCR has a view about the need for cultural change that it wants to share. 2.2. Banks act as a place to store money and a source of funds for investment; they offer advice and facilitate transactions ranging from everyday purchases to international trade. By the way they react to changing economic policy they can influence the growth of the money supply and the effects of actions taken by central regulators. The relationship between banks and society should be mutually beneficial and based on trust. When Bob Diamond at Barclays referred to the need to create “a culture of integrity and trust” he was right, and pilloried for not being seen as an exemplar. Trust has been seriously eroded by the current economic and financial crisis, for which many hold the banks largely responsible. 2.3. In this submission we focus on: — Banks’ role as intermediaries in society. — Codes of conduct and building a culture of morality. — Banks’ social and environmental impact. — The need for transparency and better reporting. — Corporate governance and the ethics of risk management. — Remuneration.

3. Banks as Intermediaries in Society Economic stability ultimately requires social and environmental sustainability. Banks can both contribute to and help find solutions to a range of social and environmental problems. Amid discussions about how the banking system can be made “fit for purpose”, we therefore need to take account of environmental and social issues, including human rights issues. We consider that these issues have received insufficient attention in debates about banking reform to date.138 3.1. The primary task facing banks and regulators is to restore a financial system in which society can trust. Such a system must effectively manage risk, be financially sound, fully serve the needs of society and intelligently address concerns about injustice, inequality and the environment. While they cannot be held responsible for the actions of their customers and clients, banks have a responsibility to ensure as far as possible that their products and services enhance rather than undermine human rights, environmental sustainability and the public good. This is a responsibility common to all “organs of society”. Banks should not be involved in illegal activities or in activities likely to lead to illegal or immoral actions, or which are exploitative or designed to undermine the social contract with society. Due diligence is key.

4. Codes of Conduct and Building a Culture of Morality The various scandals over bad lending, rigging rates, mis-selling products, money-laundering, or excessive remuneration packages, have all highlighted that morality matters. A compact of trust in society is not based just on laws, regulations and effective supervision. It requires trust in those being entrusted with responsibility for people’s money—as savers, as investors, as movers of cash, as taxpayers, as employers. It is not enough that regulators can impose ﬁnes and punishments; if banks are to regain their reputation they must prove themselves trustworthy. That requires a moral stance, a culture that says everyone in the bank should be listening to their inner voices of self-restraint, should be knowing when not to do something even if thought to be legal, and even if it may not be found out. It requires every employee to know what is right and what is wrong, when customers’ and owners’ interests are being subordinated to personal gain. It requires knowing what is dishonourable and untrustworthy. 4.1. In a largely secular society traditional moral codes of conduct cannot necessarily be relied upon. The underpinnings of fear of a power beyond knowing are not there. It is, however, not sufﬁcient to put in place a rule based culture of box ticking to create a moral correctness that is not instinctive. 4.2. A belief that free-markets will turn everyone’s pursuit of self-interest into the greater good is nonsense. Economic decisions depend on how the decisions are perceived and how intermediaries respond to those decisions; they do not have quantitatively predictable responses as in maths or physics. The key component in making a market work is trust; the old city maxim of “my word is my bond” recognised this. 4.3. Behavioural economists have noted that most people are willing to cheat, given the temptation and opportunity, just a little, enough to feel we are not being dishonest. The “fudge factor” means we all want to 137 A summary of the recommendations made in The Banks and Society: Rebuilding Trust are included in section 10. The full report can be downloaded at http://www.eccr.org.uk/module-htmlpages-display-pid-86.html 138 Like all business enterprises, banks have a duty under the United Nations “Protect, Respect and Remedy” framework to respect human rights: www.business-humanrights.org/SpecialRepPortal/Home cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:27] Job: 027059 Unit: PG01

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benefit from cheating but view ourselves as honourable and honest. People are more likely to cheat when tired or stressed, when they have financial incentives to do so, where the morality is unclear. Such dishonesty is contagious; if some are doing it, others will try. If there is a belief that colleagues will benefit, even the best can make a wrong call—the Libor rate-fixing scandal was done to preserve the system as much as for gain.

4.4. Changing a culture requires not just the existence of a code of conduct but the belief of the individuals within a company that they will be held to that code, that it will be enforced as a term of employment. More than any other sector, the banks need to introduce such certainty. So many transactions are lacking in transparency; so often practices have been condoned to make the most of an opportunity for profit rather than to maximise customer service (the time it takes to clear cheques, for example). If banks are to regain a position of trust and respect they require a cultural change—an emphasis on the virtues of self-restraint, of service to customers and owners, of trustworthiness. Until a cultural change is embedded, regulators will just be fighting fires.

4.5. The complexity of financial reporting, and of the products offered by financial institutions (not just banks) means that such institutions must develop as part of their culture of compliance with corporate codes, a climate where “whistle-blowers” are welcomed and rewarded. From an early age children are taught loyalty to peers and not to tell tales on their siblings or mates. Such a culture is not acceptable in banks or other corporate environments. If an employee perceives another’s action as not being in accordance with the corporate code, she or he must say so. Fundamental to this is a clear statement of the code and training in its implications. In the US a recent well publicized case resulted in Glaxo SmithKline having to pay $3bn of fines to US regulators for illegal bribing of doctors; more than $150m went to four whistle-blowers, GSK executives, who reported the company to US authorities. The legal basis for this is “qui tam” a 13th century English law that gave private citizens a share of fines levied on taxpayer evasion. Abolished in the UK in the 1950s, the practice in the US has helped recover $27bn for taxpayers over the last 25 years. Why should British regulators and companies not adopt similar incentives? Compliance with a code is helped by people believing their non- compliance will be frowned on and punished. There is a strong argument for rewarding those who highlight wrongdoing that causes financial or reputational damage, as well as punishing the wrong-doers. The FSA and Bank of England should require such incentives for self-monitoring as preferable to more expensive, and less effective, external oversight.

4.6. This need for cultural change does not apply solely to banks. 42% of the public do not believe that British businesses behave ethically and fewer than a third would trust a business leader to speak the truth (Institute of Business Ethics). If every employee of a bank is to be held to that company’s values, then banks must make a commitment to training staff as well as to having codes of conduct. Many companies are beginning this journey—Arcelor Mittal has given all its employees all over the world training in how to recognise human trafﬁcking, the mining companies have sought to establish industry-wide standards against corruption in response to the Bribery Act proposals.

4.7. If this process is to continue then stock-markets must look beyond the next quarter’s ﬁgures. Marks and Spencer launched their “Plan A” setting out 100 ethical and sustainability targets which they held to in spite of City criticism. Regulation is an essential basis for good conduct but it is only the start. Bankers crusading against regulation are often eroding trust.

5. Social and Environmental Impact of Lending

There is a powerful business case for banks to take full account of social and environmental issues in their lending decisions. In the long term, no business sector or individual company can thrive while doing harm, yet our research found many examples of banks ﬁnancing projects or companies associated with environmental damage, the abuse of human rights or which have a negative effect on local communities. Banks arguably have a far larger impact on society and upon the environment as an indirect consequence of their lending decisions than through their day to day activities over which they have direct control.

5.1 As demand for ethical and sustainable investment products continues to grow, ethical banking will surely follow as the logical next step. Better integration of social, ethical and environmental issues is also important for banks’ risk management. Businesses are increasingly susceptible to the reputational impact of media and civil society revelations about negative behaviour. Barclays withdrawal from selling tax avoidance products on grounds of reputational risk is an initial recognition of this fact. The ﬁnancial backers of the corrupt, or those exploiting natural resources badly, or those seeking personal gain at the expense of those they should serve, should be held to account for the actions of those they have backed.

5.2. Why should any bank not espouse the values of the Global Alliance for Banking Values (GABV)? This network of 13 banks serves close to 10 million customers in 24 countries and has a combined balance sheet of over $26 billion. It has pledged to raise over $250 million in new capital and to “To touch the lives of a billion people with sustainable banking by 2020”. Member banks commit to: use money as a tool for enhancing the quality of life through human, social, cultural and environmental development; take responsibility for their long term impacts on the environment and society and show transparency, trust, clarity, and inclusiveness in delivering products and services. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 995

5.3. GABV lending supports renewable energy and affordable housing projects, small business expansion, micro-credit for the poorest communities in developing countries, and co-operative and civil society organisations.139

5.4. A range of tools are increasingly available to help potential customers choose a bank that most closely reflects their values. However, whereas all companies including banks must conform to strict rules about how they present financial information, and increasingly face more prescriptive guidelines on the disclosure of corporate governance information, there are few firm rules when it comes to issues primarily of social, ethical or environmental concern.

6.Transparency

Transparency is important for any business, and banks are no exception. It enhances accountability to shareholders, customers, employees, local communities and others. It enables shareholders to assess the extent to which the company is exposed to or is managing risk, enabling a better view of the business’s prospects, and hence informing shareholders’ investment strategies and their dialogue with company management.

6.1. For society generally, corporate transparency means better knowledge about companies’ policies on matters of concern, to allay fears and misunderstandings and encourage trust. Transparency allows a proper conversation with stakeholders affected by company decisions which can beneﬁt both company and community. By being open about their policies and activities, companies are also more likely to earn the respect of employees and customers. On the other hand, a perceived lack of transparency is likely to lead to negative perceptions, even if in reality a company has nothing to hide.

6.2. For stakeholders to have confidence that banks take ethics into account when lending or providing other financial services, banks need to be transparent about their policies and how they implement them. Banks should disclose all the policies they apply to decisions about lending, asset management and their other business services, as well as providing information on all corporate and government financing deals. ECCR would also like to see greater transparency about how banks are responding to challenges such as developing country debt, money laundering and tax avoidance—about which currently very little is said.

6.3. Most UK banks publish separate corporate responsibility reports and maintain websites providing information about their social and environmental impact. However, the type, quantity and quality of information—and the extent to which the information is independently verified—varies considerably. Banks generally provide more information on their direct activities—such as how they are working to be a good employer or how they are seeking to reduce the environmental impact of their branch networks, rather than the indirect, but potentially more significant social and environmental impact of their lending decisions. Yet, even those that use the Global Reporting Initiative (GRI) financial services sector guidelines as a basis for their reports140 often fail to provide sufficient information to answer many of the questions society is entitled to ask. There is an urgent need to address this information gap.

6.4. With regard to lending, some banks—including Barclays, the Co-operative, HSBC and Standard Chartered—publish or make available on request all the policies they apply to lending decisions. Others still fail to do this. As to transparency about individual financing deals, despite the occasional case study, no UK or Irish banks other than Triodos provide detailed or systematic information about the companies they lend to or arrange financing for. Royal Bank of Scotland recently published a breakdown of its financing to the energy sector and promised enhanced disclosure in years to come, but this remains the exception.

6.5. Because of the Equator Principles141 (EPs), transparency tends to be better around project ﬁnancing, though disclosure still remains at an aggregate level categorised by risk, industrial sector or geographical region. Some banks provide information about the number of deals declined under the EPs but generally without enough context to enable stakeholders to understand why.

6.6. Banks often cite commercial and client confidentiality as a reason for a lack of “deal transparency”. When social and ethical issues are involved such confidentiality is not the over-riding issue. Banks could make a greater commitment to transparency by stipulating in credit contracts that the names of corporate clients will be published. This approach is taken by Triodos, which publishes basic details of its commercial borrowers on its website. 139 GABV members include Alternative Bank (Switzerland), Banca Popolare (Italy), Banco de la Microempresa (Peru), BancoSol (Bolivia), BRAC Bank (Bangladesh), Cultura Bank (Norway), GLS Bank (Germany), Merkur Cooperative Bank (Denmark), Mibanco, New Resource Bank (USA), OneCalifornia Bank (USA), ShoreBank (USA), Triodos (Netherlands), Vancity (Canada) and Xac Bank (Mongolia). For more information see http://www.gabv.org/ 140 The GRI encourages more consistent, high quality corporate responsibility reporting by companies. Guidelines for the financial services sector recommend that companies provide information about issues such as financial inclusion, procedures for assessing social and environmental risks and for monitoring clients’ compliance with social and environmental requirements. For more information see https://www.globalreporting.org/reporting/sector-guidance/financial-services/Pages/default.aspx 141 The Equator principles are a financial industry benchmark for assessing and managing social and environmental risk for project financing. They have been subscribed to by over 60 financial institutions worldwide including Barclays, HSBC, Lloyds Banking Group, Royal Bank of Scotland and Standard Chartered. For more information see http://www.equator-principles.com/ cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

Ev 996 Parliamentary Commission on Banking Standards: Evidence

6.7. Few banks with asset management divisions, even among United Nations Principles for Responsible Investment (UNPRI) signatories142, publish detailed information about their socially responsible investment policies or how they put these into practice, either for mainstream funds or for designated “ethical” funds. HSBC, for example, provides an overview of the social and ethical issues it considers as part of asset management decisions and the principles guiding its engagement with companies in which it invests; yet it does not publish all of its policies or give examples of how it has engaged with the companies in which it invests. Other UNPRI signatories such as Irish Life Managers and Scottish Widows do not even provide this. Of the banks we have surveyed, Co-operative Asset Management is notable not only for publishing the policies underpinning its investments but for providing detailed information on how these are implemented and how it has sought to inﬂuence investee companies. ECCR considers that all banks with asset management divisions should follow this example.

6.8. Banks also need to be transparent to show that they are not party to the handling of the proceeds of crime. Their unique role on managing financial flows gives them a vantage point from which to see where money is derived from and for what it is being applied. Traffickers in drugs and people, perpetrators of financial frauds, thieves and rogues of all sorts use the banking system to move the proceeds of their crimes—yet there have been many examples of banks failing to spot this or reporting their concurs to the relevant authorities. There should be a positive recognition of the duty to report illegal activity and to assist law enforcement that trumps the duty of client confidentiality.

7.Corporate Governance and the Ethics of Risk Management The Banks and Society showed how banks corporate governance, risk management and their impacts on the societies they serve are inextricably linked.

7.1. Banks, like all businesses have to manage risk in their own interests and those of their employees and shareholders. Yet effective corporate risk management is widely viewed as a technical issue and rarely considered to be an “ethical” concern. Is it different for banks?

7.2. ECCR considers that it is. Banks occupy a privileged place in society. With a reputation for good judgment and prudence, a bank has been trusted as a safe place to deposit money, a responsible lender and a source of good ﬁnancial advice. Such trust, in part based on a reputation for managing risk, has been good for business and contributed to banks’ success. For many, the fact that banks have so spectacularly failed to manage risk is a major breach of that trust.

7.3. Furthermore, banks are not ordinary companies. Not only are they central to the functioning of any economy, they also enjoy an implicit—and recently explicit—subsidy from the public purse. This comes in the form of depositor protection schemes and the strong probability that the most systemically significant banks will receive government bailouts in the event of failure. The largest banks were deemed “too big to fail”. When they did fail, there were repercussions for almost all of humanity. Bailing out the banks has cost taxpayers worldwide trillions of pounds and resulted in huge government deficits and subsequent cuts in public spending. The global recession that followed has thrown millions out of work, and stopped the creation of new jobs for millions more joining the employment market, with a disproportionate effect on the poor and vulnerable. This situation, whereby the benefits associated with banking are privatised (enjoyed largely by senior employees and shareholders) but the risks of imprudent behaviour are socialised (transferred to the general public), is part of the “moral hazard”, long the subject of economists’ debates, and the avoidance of which is central to rebuilding trust.

7.4. In addition, because of banks’ interconnectedness through inter-bank lending, the sector is particularly susceptible to “contagion”. Failure or fear of failure of one major bank can start a landslide, and this high- consequence systemic occurrence was only narrowly averted. While limiting such systemic risk has primarily been seen an issue for regulators. Banks must identify, and be accountable for, risks they introduce to the ﬁnancial system and must apply the precautionary principle to all potentially risk-prone activities.

7.5. Dissecting how and why the banks failed to anticipate and manage key risks has been the subject of an immense amount of discussion. While regulators, shareholders, auditors and credit rating agencies have all been criticised, banks’ own boards of directors played a central role in the collapse. Many boards based their risk management strategies on what turned out to be unrealistic assumptions about continued economic growth, or continuing growth in value of a particular asset class (eg residential or commercial property) regardless of wider factors. Many board members simply failed to understand some of the more complex products and deals in which their banks were involved or the risks they posed. The UK Treasury Committee highlighted a failure to understand risks posed by the securitisation of mortgages, widely but falsely believed to be a method of dispersing and managing risk. 142 The UNPRI is a framework used by the investment industry to incorporate environmental, social and corporate governance (ESG) issues into their decision making and asset ownership practices. They are designed to apply to all assent management activities carried out by a signatory not just ﬁnds designated as being “ethical” or “socially responsible”. Being a UNPRI signatory is a useful barometer of an asset managers intentions, but it is not, in itself a clear indication of the extent to which an institution is guided by social or ethical considerations or that it necessarily invests in line with its customers’ values. For more information see http://www.unpri.org/ cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 997

7.6. A critical factor was over-reliance on quantitative risk management techniques and mathematical modelling. While required by regulators, these do not take into account social factors that can have major financial risk implications—for example, the widespread mis-selling of mortgages and other financial products to people who could not afford to repay them or did not need them. Over reliance on quantitative, depersonalised systems can result in a collective abdication of responsibility and a failure of financiers to accept the need for individual responsibility for failures of judgement and a failure to act to prevent harm. There is a strong argument for reverting to more lending decisions being taken locally and regionally on the basis of managers’ personal knowledge of companies and other customers rather than total reliance on centralised computer scoring. The example of Handelsbank143 is worth close examination. 7.7. Many banks have treated risk management primarily as a compliance issue and to meet regulatory requirements rather than actively anticipating and seeking to control risks. The result was a poor risk management culture and a tendency to view risk management as getting in the way of banks’ ability to undertake what they saw as attractive business. 7.8. In the UK the 2009 Walker Review of corporate governance and the House of Commons Treasury Committee both emphasised the need for a stronger, independent risk management function within banks, with the latter recommending board level risk committees. Most banks that did not previously have such arrangements have since put them in place and now make an annual report to shareholders on risk strategy and management. 7.9. The importance of non-executive directors (NEDs) is key. Their function is to act as a balance to the executive members in risk management. There appears to be a general consensus that the cadre of NEDs on any board needs to encompass individuals with sufficient specialist background to grapple with banking and risk matters in challenging executives. However, ECCR shares the Treasury Committee’s concerns that NEDs are drawn from too narrow a pool and that banks need to widen their search to encompass others with broader experience and different world views. NEDs need to commit sufficient time to perform the role well and there is a good case for them to limit their other roles such as trusteeships or directorships to ensure this. 7.10. Important as structural reforms are, banks need to go beyond the regulatory minimum and have a culture of diligent risk management right across the business. This will require longer term cultural change. The test is likely to come if and when markets recover and memories of the “credit crunch” start to fade. For such cultural change to become embedded there must be created in each bank a code of corporate governance and a training system that makes sure all employees are thinking about the moral issues involved when making their lending judgements. Compliance with the code must be understood to be a condition of employment, with individuals who cause loss and cannot show they have complied, being removed from their jobs. A money maker who cannot live in accordance with the bank’s value system cannot keep his job.

8. Remuneration In recent years the word “culture” has too often been linked to pay—”bonus culture”, “culture of greed”. The challenge banks face is to decouple the word and define their culture by good behaviour and the trustworthiness of their banks to clients, shareholders and society at large. Part, a painful part, of that process is going to involve normalising bankers’ pay and bonuses. The idea that an individual, taking large risks with another’s money, can reap substantial reward for himself regardless of whether he ultimately loses the principal’s money, does not bear any close examination. In the Lloyd’s of London insurance market it was once normal for agents to receive profit commission on any profits made but bear no loss if their judgement calls caused loss to those they acted for (Names). In most companies profits can be manipulated in the short- term. Arrangements to distribute profits but not losses to employees are therefore recipes for disaster. Lloyd’s stopped such arrangements in the eighties (though not their arcane accounting rules), why have the banks not learnt the lessons thirty years later? 8.1. Even before the financial crisis, some had questioned bank remuneration structures. Many governments, including those of EU states and the USA, have accepted the need to reform remuneration structures, and countries including the UK have started to act on this. Further changes are expected at the EU level, and remuneration continues to be under review internationally. 8.2. Income inequality in society is now an increasing problem. Income inequality in the USA means that the proportion of the national income going to the richest 1% tripled from 8% in the 1970s to 24% in the 2007. Such growth in inequality fuels social instability as is currently being seen across the globe from the US to China. There is a backlash developing to the growth of such inequality. As global citizens banks should be aware of this and be at the forefront of curtailing the excesses that have led to it. There is little evidence to date that the banks are succeeding in this task. In 2009 the UK Treasury Select Committee heard that a chief executive of one of the larger UK banks would typically have an annual salary of between £1 million and £1.25 million with perhaps four times as much in bonuses share options and pension and other benefits. In investment banks and investment banking arms of retail banks the total remuneration of senior executives could have been even higher. At the same time many banks have faced campaigns calling for them to pay all who work on their premises a living wage. 143 For more information see http://www.handelsbanken.co.uk/ cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

Ev 998 Parliamentary Commission on Banking Standards: Evidence

8.3. Much has been written about the extent to which bank remuneration structures were responsible for the financial crisis. Most commentators agree that—particularly in investment banking, remuneration packages gave incentives that were not aligned with the long term interests of shareholders. Bonuses were in some cases paid out in cash as soon as a deal was completed or based on a bank’s revenue for a single year and thus caused particular problems. Some bonuses were paid with little regard to whether a deal would be successful in the long term or whether overall profit levels were sustainable. All this contributed to excessive risk taking and promoted short term thinking rather than an emphasis on longer term returns. Performance and Reward, by ECCR member Patrick Gerard144, delineates the corrosive nature of “bonus culture” on overall business culture and practice. Remuneration structures, and particularly the bonus elements of these, need to be much more closely aligned to long term performance and shareholder value. 8.4. Belatedly shareholders are now taking action to challenge excessive pay awards. However, replacing large bonuses with even larger salaries, is not an answer, increasing, as it does, fixed costs. Banking is undoubtedly a field where employee individual efforts and flair can make exceptional profits and losses. Those with the flair feel they deserve a substantial share of that profit. They cannot make any profit, however, without the capital and platform of their employer. That platform must be sustainable without public subsidy. The logic is that bonuses must reflect long-term performance, and be able to be clawed back if the activities, profitable in the short-term, generate losses. This requires transparency about the way bonuses are calculated and the matching of deals with profits and losses over time—often considerable periods of time. 8.5. In this connection banks must pay particular attention to the way profits are calculated. Profits have always been capable of manipulation. Manufacturing companies can adjust them by stock valuations or treatment of overhead expenses, financial companies can adjust them by the purchasing of reinsurance or financial derivatives. Over the last decade such manipulation of profits has grown more widespread. Research has compared aggregate earnings per share reported by large US companies with the profits section of the US National Income and Product Account (part of the calculation of GDP). In any one year these figures might differ marginally but over a century they were in broad correlation; in the last decade they have diverged. Reported profits are now six times more volatile than National Income profits. The accounting practice of marking to market (listing the current value of assets recorded on balance sheets) makes it easier for companies to manage earnings—and can lead to inflation of bonuses. 8.6. The effect of the profits commission at Lloyd’s was to lead to periods of profitability (on which agents received bonuses) and then sudden losses and write-offs which were borne by the Names alone. The same has been happening in banking. Bonuses have been paid on profits but the losses have been borne by shareholders— or, in extremis, the public purse. The lesson is clear: give executives the incentive and the means to overstate profits and they will. Lessons must be learnt here by accountants as well as remuneration committees but the latter can act much faster. Bonuses should not be paid in cash but should be in stock and future cash, the future calculation being done over at least a five year period and adjusted for the subsequent development of the profitability of the business. 8.7. Remuneration mistakes, particularly at the upper end of the pay scale, represent a failure in corporate governance. The Walker Review and the Treasury Committee inquiry on executive pay gave considerable attention to the role of banks’ remuneration committees. The latter was particularly concerned that in some cases remuneration committees appeared to operate like “cosy cartels” offering huge pay packages to their board colleagues but without imposing targets in return. Again ECCR has sympathy with the view of The Treasury Committee that broadening the range of experience found on remuneration committees to include, for example, workers’ representatives would help combat this problem. Involvement of others based in the “real” world might also help. 8.8. Most banks say that generous pay packages are necessary to attract and retain talented employees and that in a global economy and with bankers’ skills in high demand, not paying the “going rate” would mean losing key staff to competitors. Like many other major companies, banks—including those now in, or partially in, public ownership—aim to offer pay packages comparable with others in their sector. This has resulted in a “ratchet effect”, continually moving compensation upwards, leading to suggestions that a global cap is necessary to prevent pay levels spiralling out of control. 8.9. It is a fallacy to suggest that high remuneration is an absolute requirement to attract, retain and motivate staff. The market for executive talent is not the perfectly competitive one that remuneration committees often imply. Excessive pay packages may attract staff who are concerned about their own personal rewards above shareholder or broader interests. 8.10 Any business graduate who has studied Maslow’s hierarchy of needs (first put forward in 1943) would advise that senior executives may be motivated to work hard and serve their company well for a whole variety of reasons including self-respect, job satisfaction, intellectual stimulus, innate creativity, leadership drive, joy in teamwork, a congenial working environment, meeting a formidable challenge, and a spur to excellence. Banks need to recognise that money is not the sole, or even the main, motivator at senior levels 8.11. Regardless of whether remuneration structures may have helped cause the crisis, there is a widespread view that senior bankers are simply paid too much. Top bankers’ pay exaggerates the social value of the job. 144 See http://performanceandreward.blogspot.co.uk/ cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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Excessive pay in any industry contributes to increasing economic inequalities, which are bad for society as a whole. There is compelling evidence that in less equal societies, quality of life, measured by a range of health and social indicators, is worse for virtually everybody. It is hard to refute the argument that bankers’ pay has contributed to rising inequality in countries like the UK and USA. 8.12. ECCR, reflecting its Christian roots, has particular concerns about differentials in pay between people at the top of a company compared to those at the bottom, saying that this is more important than the levels of pay outright. The Church Investors Group analysis of pay differentials across FTSE 100 companies leads them to suggest that a good rule-of-thumb would be for top executives’ total remuneration packages to be no more, and preferably less, than 75 times the average pay of the lowest-paid 10% of employees in any firm145. The One Society campaign, run in association with the Equality Trust, advocates an even lower figure for top-to- bottom pay differentials and argues that a ratio of 10:1 is achievable for many organisations. Every bank should look at what the ratio was twenty years ago and ask itself how it allowed the gap to grow so much and what effect that has on employee relations and on wider society tensions and perceptions. 8.13. Despite much rhetoric, actions to regulate banking sector pay have been relatively slow in evolving. In 2009 the Financial Services Authority became the world’s first bank supervisory body to develop detailed rules on remuneration, developing a code of practice which aimed to ensure that remuneration policies, structures and processes accurately reflect risk. In December 2010 the European Union’s Committee of European Banking Supervisors developed further rules that form a common basis for pay across Europe and are being incorporated into national regulators’ codes. 8.14. In the UK this has resulted in tightened restrictions on how bonuses are paid—deferring up to 60% for three years and banning companies from providing guaranteed bonuses for more than one year. It will also prevent so-called “buy-backs” whereby existing employers offer staff guaranteed bonuses to deter them from accepting a job offer from a competitor. Banks will have to be more transparent about pay. While they will not be forced to disclose the names of the highest earners, they will have to disclose aggregate information broken down by business area for senior management and employees who have a “material impact on risk”. 8.15. In spite of the British Bankers’ Association saying that the rules go too far, ECCR questions whether the rules go far enough.

9. Conclusions Banks are linchpins of modern society, enabling economic activity of all descriptions. They should make an overwhelmingly positive contribution to the economy and society. Since the financial crisis the socialisation of risk has introduced a new dimension into the relationship between the banks and society. While the exceptional rewards remain for the most part restricted to a select few, the costs of failure are borne by the public at large, with very little agreement so far about how society should be compensated. 9.1. Many banks acknowledge their wider responsibilities more readily than they did during the boom years, but it is hard to judge how far this now influences their performance. Mixed progress is apparent on issues such as equal opportunities, customer service and financial inclusion. Still greater challenges appear to lie with banks’ indirect impacts. Despite aspirational statements, there is still evidence (eg recent fines for SBC and HSBC in the States) of banks’ being connected with individuals, projects and transactions over which well- justified ethical concerns arise. Beyond a small group of financial institutions that have developed with ethical principles at their core, most banks fail to effectively integrate social and environmental considerations into their business model. ECCR’s research has shown that: — Most banks’ business model excludes a proportion of individuals and business from accessing financial services, especially in disadvantaged areas. — Banks’ lobbying activities have considerable impact on policy and are not transparent. — While many banks have signed up to voluntary codes and statements about incorporating social and ethical concerns into lending decisions, they still lend to environmentally and socially destructive projects. — Accounts provided by major banks have facilitated tax avoidance and illicit flows of money from developing countries. — Banks have been associated with tax avoidance—understood as non-payment of tax due and non- compliance with the spirit of the law. — Banks continue to have a role in the debt crisis faced by developing countries. — Investment banks’ speculative trading is a likely factor in recent food and fuel crises. — Banks’ and regulators’ unrealistic assumptions and over-reliance on quantitative risk management techniques very likely led to a widespread failure to apply judgement or to prevent harm. 145 The Ethics of Remuneration: A Guide for Church Investors, Church Investors Group, March 2011. Available at http://www.churchinvestorsgroup.org.uk/documents/ethics-executive-remuneration-guide-christian-investors cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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— There is a lack of awareness of regional issues and an unwillingness to make advances on the basis of personal knowledge of customers’ needs rather than just collateral or computer scoring of credit-worthiness. 9.2. The primary task now is to rebuild a banking system in which society can trust: one that manages risk, is ﬁnancially sound, meets the needs of the public, and recognises the high price that present and future generations will pay if we continue to neglect the Earth’s environmental limits and the harmful outcomes of injustice and inequality. Banks cannot divorce themselves from this context. 9.3. ECCR considers banks have a responsibility and an opportunity to respond positively to current concerns. To the extent that they are seen to use their power and inﬂuence to address such challenges, banks will earn back society’s trust. Accordingly we make a number of recommendations to banks that we consider, if implemented, would enable this to happen. Some banks are already undertaking some of these steps. We hope that the recommendations will be far more fully and widely implemented. 9.4. We fully accept that banks have to respond to regulatory and other external pressures. In that context we endorse the recent Kay report suggesting that quarterly reporting can be harmful and encouraging companies and investors to adopt longer time horizons. Sustainable companies have to have regard to their performance and reputations over decades not months.

10. Recommendations for Regulators We make the following recommendations directed primarily at ﬁnancial service regulators.

10.1. Responsibilities of non-Executive Directors Parliament should consider giving statutory force to some of the wider responsibilities of non-executive directors requiring them to consider the long-term and wider social issues in the company’s decision making.

10.2. Whistleblowing Incentives UK regulators should consider ways to encourage whistleblowers within banks and other companies to come forward. This could include a revival of laws that would allow private citizens to share part of any ﬁnes received by the authorities as a result of their whistle-blowing.

10.3. Remuneration Parliament should consider whether current regulations on remuneration and transparency of remuneration are sufﬁcient to curb excesses and ensure that there is “no reward for failure”.

11. Recommendations for Banks The following recommendations are primarily directed at banks. However we there is a need for Parliament to consider the extent to which it can usefully put mechanisms in place to encourage their adoption.

11.1.Codes ofConduct Every bank should have its own code of conduct. This should state the core principles that guide the bank. It should make it clear that every employee is expected to comply with the code and that non-compliance is a reason to terminate employment. The code should also state explicitly that employees identifying non- compliance should report that non-compliance to an identiﬁed Compliance Ofﬁcer and if the report is upheld will be appropriately rewarded. All employees should receive appropriate training about the Code and in the case of management and lending positions this should include consideration of a series of case studies aimed at helping employees identify the moral issues and the reputational risks for the bank; it is not fair to assume that every employee will recognise the difference between right and wrong in every situation. ECCR suggests such codes should not only comply with regulatory minima and suggestions in the Global Reporting Initiative, The Global Alliance for Banking Values, and UN Guidelines but should contain explicit statements on at least fourteen social, ethical and environmental concerns material to most of the major UK banks146.

11.2. On customer Service, Banks should: — Work to achieve consistently positive customer feedback. — Reduce the proportion of customer complaints upheld by the banking ombudsman. — Strengthen the way they monitor and rectify complaints. — Be more transparent about the different interest rates they offer and charge to customers. 146 ECCR suggests that the areas identified by Bank Track are a good starting place. These include Agriculture, fisheries, forestry, armaments/the military, mining, oil & gas, power generation, biodiversity, corruption, human rights, indigenous peoples, labour rights, operations in conflict zones, taxation and toxic materials. For more information see http://www.banktrack.org/ cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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— Make greater efforts to “know their customers” and use that knowledge in lending rather than rely on centralised, computerised credit-scoring

11.3. On Financial Exclusion, Banks should: — Publish information, and ensure staff follow government guidelines, on alternative identification allowed for new customers opening accounts. — Publicly report the number and percentage of active basic bank accounts they hold and about lending to small businesses in deprived areas. — Be more transparent about penalty charges for unpaid direct debits and cheques. — Train frontline staff in the promotion and use of basic bank accounts. — Commit not to withdraw counter services when they are the last financial institution in a community without an independent social impact assessment showing no adverse effect. — Consider changes to account facilities in consultation with financially excluded customers. — Consider supporting, and when appropriate referring customers to, community financial institutions.

11.4. On Responsible Credit, Banks should: — Publicly report the volume of credit they make available to individuals and businesses and break this down by demographic group and geographical area. — Provide clearly written, not misleading, information on loans and other credit products. — Have clear policies and procedures for fair and respectful treatment of individuals experiencing difﬁculty servicing loans and use home repossessions only as a last resort. — Publicly report complaints or prosecutions upheld against them for unfair lending. — Ensure that remuneration structures for frontline staff incentivise responsible lending.

11.5. On Gender Equity in Employment, Banks should: — Develop an action plan and work towards gender parity at all levels of employment. — Publicly report on the gender balance of employees and at board level. — Carry out regular equal pay audits and report top-level ﬁndings and recommendations.

11.6. On Lobbying, Banks should: — Fully complete the European Commission lobbying register. — Publicly report on all other lobbying and on their representation on high level committees or expert groups likely to inﬂuence government policies.

11.7. On Lending, Financing and Asset Management, Banks should: — Preclude provision of services to socially and environmentally harmful proposals. — Ensure that asset managers take full account of social and environmental considerations. — Publish all social, ethical and environmental policies they apply to lending, ﬁnancing, asset management and provision of other services. — Increase the proportion of renewable energy, energy conservation and other environmental protection projects in their portfolios. — Include social and environmental analysis as a standard component of mergers and acquisitions advice and brokerage reports. — Be transparent about their lending by providing information, on a regional and national basis, about the companies and projects they fund and any social or environmental grounds on which they decline loans.

11.8. On Money Laundering, Banks should: — Confirm the identity of all customers before accepting funds and have systems to identify Politically Exposed Persons (PEPs) and beneficial owners of companies. — Refuse to open accounts for PEPs where precluded by the law of a PEP’s country. — Conduct enhanced due diligence on PEPs and sectors, companies and countries most associated with corruption. — Refuse to handle funds where that is part of an attempt to avoid sanctions or taxation, or the processing of funds derived from illegal operations — Publicly report any prosecutions or fines for the contravention of anti-money-laundering regulations. — Ensure their compliance department has an independent reporting line to the board. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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— Create mechanisms to reward compliance ofﬁcers even when their work leads to business being turned down.

11.9. On Tax Avoidance, Banks should: — Report on a country-by-country basis on all taxes they pay on their own profits. — Ensure that customers are aware of their own tax obligations. — Refuse to provide tax planning that does not serve genuine business transactions. — Not be party to plans to avoid taxation on profits earned within a country, nor to aggressively move profits earned over international activities into tax havens.

11.10. On Developing Country Debt, Banks should: — Publicly report on their exposure to developing country government debt. — Carry out enhanced due diligence before committing to loans to developing country governments to avoid undermining poverty reduction efforts. — Carry out enhanced due diligence before committing to projects or arrangements benefiting from export credit agency support. — Apply social and environmental criteria to lending benefiting from export credit agency support. — Publish non-confidential information about export credit agency arrangements.

11.11. On Commodity Speculation, Banks Should: — Examine the social and environmental consequences of speculative trading — Put limits on speculation where there is a risk of signiﬁcant environmental or social harm. — Ensure that derivatives are traded transparently on regulated exchanges. — Be transparent about any lobbying activities seeking to inﬂuence regulation

11.12. On Risk Management, Banks Should: — Encourage senior level discussion of risk. — Continually evaluate exposure to risk within the ﬁnancial system and the extent to which the bank contributes to such risk. — Apply the precautionary principle to minimise their contribution to systemic risk. — Ensure a responsible attitude to risk throughout the business. — Have an independent risk committee and publish an annual report of its activities. — Ensure a balance between ﬁnancial expertise and other experience among board members, particularly non-executives. Ensure that non-executive directors limit other roles such as trusteeships or directorships so as to be able to play an effective role on the Board.

11.13. On Remuneration, Banks Should: — Take into account the views of external stakeholders when establishing remuneration policies and structures. — Ensure that remuneration structures: do not encourage excessive risk taking; are commensurate with long term performance and shareholder value; include consideration of social, ethical and environmental factors; do not undermine the need to lend responsibly; include indicators of customer service and fair resolution of complaints. — Publish the absolute value of, and ratio between, the remuneration of their highest paid employees and the average salary of the lowest paid 10% of employees and seek to continually reduce this ratio.

11.14. On Human Trafficking, Banks Should: — Establish mechanisms to ensure that they do not employ, directly or through sub-contractors, trafficked people. — Refuse to handle the proceeds of human trafficking or to provide banking facilities to individuals involved in trafficking. — Report to the appropriate authorities any suspicions that clients, suppliers or others with whom they do business are involved in human trafficking.

11.15. On Transparency, Banks Should: — Produce a separate, externally veriﬁed corporate responsibility report that at a minimum follows Global Reporting Initiative guidelines. — Publish all policies on social, ethical and environmental issues. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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— Be transparent about how they are likely to use depositors’ money. — Provide stakeholders with meaningful information on the range of issues covered in reports including the indirect impact of lending activities. 11.16. More information about many of these recommendations can be found in The Banks and Society: Rebuilding Trust. Alternatively an ECCR representative would be very happy to provide more information in person. 19 October 2012

Written evidence from FairPensions Summary — Good corporate governance in banking institutions should promote sustainable wealth creation and effective management of risks, including systemic risks. — Regulation and good corporate governance are complementary; comply or explain is effective if explanations are meaningful and properly scrutinised. There is now some recognition of a need for improvement in this respect. — Debates about the role of shareholders in banks’ corporate governance have tended to focus on the problem of insufficient shareholder engagement. However, the wrong sort of engagement can equally be viewed as a contributing factor to a culture of risk-taking and short-termism. The encouragement of “stewardship” is therefore not just about increasing engagement but about cultivating a responsible, long-termist ownership ethos among institutional investors. — The Stewardship Code has been effective in gathering mainstream industry support for the concept of stewardship, but less so in translating this into meaningful behavioural change. This should be addressed, including through this year’s review of the Code. — As Ferdinand Mount has pointed out, the asset managers who exercise shareholder rights are not themselves the actual owners of companies but are merely another layer of agents. Getting shareholder oversight right therefore means paying attention not just to the relationship between shareholders and managers, but to the relationships between asset managers and asset owners, and between asset owners and their ultimate beneficiaries. — Current problems with this chain of relationships include: — Narrow interpretations of institutional investors’ fiduciary duties to savers, which (a) assume that fiduciaries cannot have regard to anything which is not immediately monetisable, and (b) encourage fiduciaries to “follow the herd”. FairPensions has proposed statutory clarification to create a more flexible and enabling environment in which a broader approach can be taken to beneficiaries’ best interests, including their interest in management of systemic risks. — Inconsistencies in the application of fiduciary duties to investment intermediaries, contributing to inadequate management of conflicts of interest, including in relation to the exercise of shareholder rights. This could be improved through greater oversight from institutional clients and by more consistent application of fiduciary standards by regulators. — Lack of consumer demand due to the disconnect between “ultimate owners” and the stewardship debate. Greater transparency and accountability to beneficiaries could help to generate market pressures for better shareholder oversight. — Disclosure of remuneration in banks should include not just the quantum of pay but also the performance criteria on which variable pay is based. Without this it is difficult to see how shareholders can assess whether incentives are appropriate.

Introduction 1. FairPensions is a registered charity that works to promote active share-ownership by institutional investors in the interests of their beneficiaries and of society as a whole. Our particular focus is on encouraging shareholder engagement with listed companies to ensure effective management of environmental, social and corporate governance (ESG) risks which may affect long-term financial returns. We work collaboratively with investors on issues where there is a strong business case for engagement. We also educate and facilitate individual pension savers to take an interest in their money, and advocate for greater transparency and accountability to beneficiaries about how shareholder rights are exercised on their behalf. 2. We are a member organisation. Our members include bodies representing pension savers, leading UK charities and thousands of individual pension fund members. We are independent of industry and are funded primarily by grants from charitable foundations and trusts. 3. Our experience and research on shareholder engagement applies to all listed companies, but we believe that many of the issues we have encountered are particularly relevant to the banking sector and therefore to the Commission’s remit. This submission draws on our evidence to the Treasury Select Committee’s enquiry on corporate governance and remuneration in financial institutions. It is most relevant to the Commission’s call cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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for evidence on “the role of shareholders, and particularly institutional shareholders” in shaping the culture of UK banking, and how any weaknesses identiﬁed here might be addressed. 4. We are currently undertaking a research project analysing the character and impact of this year’s so-called “Shareholder Spring”. We are using a range of evidence, including voting records and investor responses to government consultations, to assess what has driven shareholders to intervene at particular companies, the extent to which this marks a fundamental shift in shareholder attitudes to engagement, and what further steps policymakers could take to encourage responsible shareholder oversight. We expect to publish a report in October and will share this with the Commission.

Regulation, governance and “comply or explain” 5. Good corporate governance in banking institutions should seek to promote: — sustainable wealth creation (this may not coincide with the maximisation of short-run returns, as the 2008 crisis all too clearly demonstrated); and — effective management of risk, including potential systemic risks posed by the institution’s activities. 6. Both of these objectives serve the long-term interests of shareholders whilst also protecting the public interest in stable and sustainable banks. 7. We regard regulation and good corporate governance as complementary. The 2008 crisis exposed failings in both regulation and corporate governance as mechanisms for ensuring that banks pursued sustainable business models and managed risks effectively. Regulation should set the parameters of acceptable behaviour (external accountability), while good corporate governance should ensure effective strategic decision-making and risk management within those parameters (internal accountability). 8. “Comply or explain” is only as good as the quality of explanations offered for non-compliance by boards, and the degree of critical scrutiny of those explanations by shareholders. Evidence suggests there is much room for improvement in this respect. A 2005 study by the London School of Economics found that ﬁrms who did not comply with the Combined Code of Corporate Governance “often did a very poor job explaining themselves”, with almost one in ﬁve cases of non-compliance not explaining themselves at all. Moreover, the study concluded that “shareholders seem to be indifferent to the quality of explanations”.147 Our recent research suggests this conclusion may still hold (see paragraph 16).

Shareholders and UK banking culture 9. There appears to be a growing consensus that the problems revealed by the 2008 banking crisis and by the recent LIBOR scandal can be traced in part to a flawed banking culture—one of excessive risk-taking, short-term profiteering and unchecked conflicts of interest. In the wake of the banking crisis, questions were asked about why shareholders had not done more to challenge this culture. Analysis of this issue focussed largely on the “absentee landlord” problem, with the Walker Review recommending the introduction of a Stewardship Code to promote greater shareholder engagement. 10. In our view, this is clearly part of the problem, but it is not the whole story. As the recent report of the Kay Review noted, “Shareholder engagement is neither good nor bad in itself: it is the character and quality of that engagement that matters.” Indeed, as Kay observes, many bad corporate decisions of recent years “were supported or even encouraged by a majority of the company’s shareholders”. In our view this is particularly true of the banking sector in the run-up to the financial crisis. Shareholder demands were an active driver of greater leverage and more risky strategies in the pursuit of short-term returns. Only one major asset manager (The Co-operative Asset Management) voted against RBS’ takeover of ABN-AMRO, with only one other (Royal London) abstaining. 11. In asking why this is, it is important to examine the culture of shareholders themselves as well as that of banks. Kay argues that the culture of City investment intermediaries has become too focussed on trading and transactions (exit) and insufficiently focussed on long-term relationships and engagement (voice). Of course, one consequence of this is that shareholders deprioritise engagement. But another important consequence is the measurement of company success (and, by extension, investment success) in terms of short- term share price movements rather than the fundamental value of the business. This means that when investors do engage, it may exacerbate rather than mitigate banks’ cultural problems. 12. Although we would by no means suggest that genuinely long-term engagement is non-existent, our experience broadly accords with Kay’s analysis. Surveys of both directors and investors support this picture of pressure to maximise short-term results, even amongst theoretically long-term investors such as pension funds. In one US study, 78% of financial executives interviewed said they would give up long-term economic value to maintain smooth earnings flows to their investors in the short-term.148 In the recent FRC review of the Stewardship Code, many companies felt that “some shareholders still seemed to focus too much on specific 147 Arcot, Bruno & Grimaud, 2005, “Corporate Governance in the UK: Is the comply-or-explain approach working?” 148 Graham et al, 2005, “The Economic Implications of Corporate Financial Reporting”, http://papers.ssrn.com/sol3/papers.cfm?abstract_id=491627 cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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issues of a short-term nature”.149 In a survey of ten large European pension funds, their ideal time horizon was estimated at 23 years and their actual time horizon at six years. Participants blamed short-term, benchmark- relative remuneration structures for the discrepancy.150 13. Similarly, Ferdinand Mount has argued that the shareholders we rely upon to oversee company managers are in fact part of the same managerial elite, sharing the same culture and the same incentives (ie the short- term maximisation of the share price).151 If true, this is even more so in the case of banks, where the two groups are part of the same industry—and even in some cases, since the Big Bang, part of the same parent company. Moreover, the loss of public trust caused by incidents like the LIBOR scandal has not been confined to banks but has affected the entire finance industry. In the most recent survey by the National Association of Pension Funds, mistrust of industry was the number one reason given by people planning to opt out of enrolling into a pension scheme under the government’s workplace pension reforms.152 The Commission should therefore ask itself what can be done to ensure that investment institutions (a) regain public trust and (b) effectively fulfil their role in the governance of the banks they own.

Impact of the UK Stewardship Code 14. The UK Stewardship Code has been effective in promoting the concept of stewardship (virtually the entire UK asset management industry, by assets under management, has signed up to the Code). What is less clear is its impact on the quality of stewardship in practice. 15. Examples such as the blocking of Prudential’s planned takeover of the Asian arm of AIG in 2010, or the recent wave of rebellions over executive pay, might suggest a step up in shareholder oversight. However, the general picture is much more mixed. In the recent FT/ICSA Business Bellwether survey, 79% of responding FTSE 350 companies reported no increase in engagement since the introduction of the Code, with the remaining 21% reporting only a slight increase.153 Similarly, the FRC’s first review of the Code found that most companies “[had] noticed relatively little change in approach to engagement”.154 16. Our own research155 suggests that the decision to keep the Code high-level and principles-based has not prevented a “tick-box” approach to disclosures, with many asset managers simply repeating the wording of the Code’s Principles. This was particularly the case regarding management of conflicts of interest. Disclosures on investors’ approach to company “explanations” for non-compliance with the Corporate Governance Code were also an area of weakness. For instance, one firm simply stated “We evaluate each deviation on its own merits” without giving any insight into the criteria on which explanations were judged. Such detail was a feature of the better statements we examined, but unfortunately these were the exception rather than the rule.156 The recent attention given to the quality of explanations by the FRC and industry participants is welcome. This issue should continue to be monitored closely. 17. Disclosure of voting records under Principle 6 of the Code also remains poor. One study by PIRC found that just 21% of signatories disclose full records, and over half do not disclose any information at all.157 The government has reserve powers to introduce mandatory voting disclosure if voluntary initiatives do not generate sufficient improvements (under section 1288 of the Companies Act 2006). 18. The FRC’s success in gathering signatories to the Code must now be built on with efforts to raise standards of behaviour and disclosure. The FRC’s present review of the Code offers an important opportunity to do this. However, there is also a need to examine the structural barriers to greater uptake of stewardship behaviour. The remainder of this submission explores what we believe are some key problems, along with possible solutions.

Structural problems—the investment chain 19. It is well established in economic theory that the relationship between shareholders and company managers creates “principal/agent” problems. There is now general consensus that managing these problems requires active shareholder oversight. However, to achieve this there is a need to disaggregate what we mean by the term “shareholder”. Institutional investment is itself a chain of principal/agent relationships: the asset managers who generally exercise shareholder rights are agents acting on behalf of asset owners (such as pension funds), who in turn are agents acting on behalf of individuals (such as pension savers). This “triple 149 See footnote 4 150 Hesse, 2008, “Long-term and sustainable pension investments: A study of leading European pension funds”. See http://bit.ly/uaPQdd 151 Ferdinand Mount, 2012, “The New Few: Or, A Very British Oligarchy”, Simon & Schuster 152 NAPF, 2012, “Workplace pensions survey”, http://www.napf.co.uk/PolicyandResearch/~/media/Policy/Documents/0220_NAPF_ workplace_pensions_survey_-_March_2012.ashx 153 See http://www.ft.com/cms/s/0/9ec5594c-6f8f-11e1-b368–00144feab49a.html 154 FRC, December 2011, “Developments in Corporate Governance 2011: The impact and implementation of the UK Corporate Governance and Stewardship Codes”. Available at http://www.frc.org.uk/images/uploaded/documents/ Developments%20in%20Corporate%20Governance%2020116.pdf 155 See footnote 2 156 FairPensions, 2010, “Stewardship in the Spotlight”, p9, http://www.fairpensions.org.uk/sites/default/ﬁles/uploaded_ﬁles/ whatwedo/StewardshipintheSpotlightReport.pdf 157 See http://www.pirc.co.uk/news/voting-disclosure-revisited cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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agency problem” is the source of many key barriers to better shareholder oversight of banks and other listed companies. 20. For example, as the evidence discussed above shows, there is clearly a misalignment between the inherently long-term financial interests of pension savers and the short-term metrics used both by pension funds to assess fund manager performance, and by fund managers to assess company performance. It is unclear that the post-crisis focus on stewardship has done anything to alleviate this problem—and equally unclear that current norms of shareholder oversight would be effective in preventing a repeat of the 2008 crisis. 21. Fiduciary duties are the main legal mechanism used to deal with principal/agent problems in UK law. Those who act on behalf of others have a fiduciary duty to act in their best interests, and not to use their position to further their own interests or those of third parties. FairPensions has conducted extensive research on interpretations of fiduciary duty. This has helped to inform the Kay Review, whose final report included an extended discussion of fiduciary duty.158 In our view, there are two key problems with the current situation: firstly, confusion over what fiduciary duties require, and secondly, inconsistencies in who is deemed to have fiduciary duties.

Problem 1: Narrow interpretations of fiduciary duty 22. Pension fund trustees’ fiduciary obligations are widely interpreted as a duty to maximise short-term returns and ignore other considerations, even if they might have a material impact on long-term outcomes for beneficiaries. This is a real barrier to stewardship: legal advice given to one large UK pension scheme even suggested that their policy of exercising voting rights could breach their fiduciary duties if they could not demonstrate that the costs incurred were justified by monetisable benefits to that individual scheme. Since the benefits of stewardship almost inevitably accrue to the market as a whole, this contributes to a “free- rider” problem. 23. Institutional investors’ fiduciary duty to invest prudently has also been interpreted by UK and US courts as being relative to the behaviour of other investors.159 This encourages herding behaviour, sometimes characterised as “reckless caution”, and potentially exacerbates systemic risk. For instance, we have been told privately that, before the dot-com bubble burst, some managers who recognised the bubble and avoided tech stocks were sacked by pension fund clients for underperforming their peers in the short-term. 24. In combination, these widely held perceptions of the law contribute to a focus on chasing short-term outperformance (alpha) rather than improving the performance of the market itself (beta) through stewardship activities. This is one driver of the short-term, benchmark-relative remuneration structures which incentivise fund managers to demand that their investee companies prioritise short-term returns. It also has no place for the wider interest of pension fund beneficiaries in the management of systemic risk: market volatility and systemic crises have a far greater impact on pension savers than the degree to which their individual fund outperforms the market, yet current interpretations of the law require their agents to relentlessly prioritise the latter.

Proposed solution 25. FairPensions has proposed statutory clarification to remove these perceived legal barriers to better shareholder oversight. The aim would be to create a more flexible and enabling environment by clarifying that fiduciary investors may consider factors beyond quarterly results, and to encourage a focus on sustainable wealth creation. We have published draft legislation which suggests, among other things, that investors should be explicitly permitted to have regard to “the impact of [their] investment activities on the financial system and the economy”.160 This is intended to help resolve the problems outlined above, and should create space for better shareholder oversight of systemically important financial institutions. The Kay Report essentially endorsed this recommendation, concluding that “there is a need to clarify how these duties should be applied in the context of investment, given the widespread concerns about how these standards are interpreted.”161

Problem 2: Inconsistent application of fiduciary duties 26. One less frequently invoked aspect of fiduciary duty is the duty to avoid conflicts of interest. There is considerable anecdotal evidence that conflicts of interest among fund managers are one barrier to more robust shareholder engagement. For example, one recent paper cites an instance where “the company secretary of a UK manufacturer reminded a fund manager who was intending to vote against the company’s remuneration report that his firm was bidding for an investment mandate from the corporation’s pension plan”.162 In financial conglomerates, conflicts may arise between asset management arms and investment banking arms. When we surveyed asset managers’ disclosures under the Stewardship Code, we found that many gave little or no insight into how these conflicts were managed. The FRC has also identified this as an area for improvement. 158 Final Report of the Kay Review, 2012, Chapter 9 “Fiduciary duty” 159 See FairPensions, 2012, “The Enlightened Shareholder”, p7–8 160 Ibid, Appendix A 161 Final Report of the Kay Review, 2012, para 9.22 162 Wong, S, “How conflicts of interest thwart institutional investor stewardship”, Butterworths Journal of International Banking and Financial Law, Sept 2011. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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Proposed solution

27. Asset owners should be more attentive to how conflicts are managed by their investment agents; greater clarity is also needed about asset managers’ own fiduciary responsibilities. The Law Commission has concluded that asset managers, and indeed anyone engaged in discretionary asset management or investment advice, have fiduciary duties.163 This appears to be accepted by the Investment Management Association, for example in Richard Saunders’ oral evidence to the Treasury Select Committee.164 However, it is unclear that these duties are genuinely accepted or applied by the industry as a whole. The position is even less clear with regard to contract-based pension providers like insurance companies. The Kay Report recommended that regulators “should apply fiduciary standards to all relationships in the investment chain which involve discretion over the investments of others, or advice on investment decisions.”165 FairPensions supports this recommendation (although it is vital that any such measures go hand in hand with steps to clarify the content of fiduciary duties, as discussed above).

Problem 3: Lack of transparency/market pressures

28. An analysis of the chain of principal/agent relationships between saver and company also highlights the absence of market pressures from those whose money is ultimately at stake. Beneﬁciaries have been virtually absent from the stewardship debate: indeed, there is often some intellectual confusion about whether investors’ “stewardship responsibilities” are owed to companies or to savers (in law, it is clearly the latter). Ferdinand Mount, in his book “The New Few”, speaks of a “double disconnect”: shareholders are disconnected from management of the companies they own, but the ultimate owners of shares are equally disconnected from the intermediaries who manage their investments. Most savers have no voice or visibility on decisions made about their money and many do not even realise that it is being invested in stocks and shares.

Proposed solution

29. FairPensions works to change this through consumer engagement—the most recent example being our online tool enabling individual savers to contact their pension fund or stocks-and-shares ISA provider asking about their voting intentions on remuneration. We believe that greater transparency to these “ultimate owners” could help to ensure that demand for stewardship is transmitted along the chain. If the Stewardship Code continues to produce poor levels of voting disclosure (see paragraph 17), consideration should be given to the exercise of reserve powers in the Companies Act 2006 to make disclosure mandatory.

Remuneration

30. In our submission to the Treasury’s recent consultation on bank executive remuneration disclosure, we supported the extension of disclosure to signiﬁcant risk-taking decision-makers below board level. However, we were concerned that the government’s proposed requirements related only to the quantum of remuneration, and did not cover the performance criteria on which variable components were based. It is difﬁcult to see how this meets the government’s stated objective of addressing the problem of “poorly designed remuneration structures [which incentivise] excessive risk taking”,166 since it does not provide information about the behaviours which remuneration is incentivising or disincentivising.

31. We also suggested that a disconnect exists between the role HM Treasury appears to envisage for institutional investors in making use of remuneration disclosures, and the way in which shareholders view their own responsibilities. The key objective of the reforms appears to be to facilitate oversight of systemically important actors. Institutional investors such as pension funds tend to be “universal owners” (ie they have holdings across the economy), and therefore do have an interest in the long-term stability and sustainability of the economy as a whole, which may not coincide with their interest in maximising short-term profits at individual firms (see paragraph 24). In practice however, shareholders appear to evaluate executive pay precisely in the context of the recent performance of the individual firm in question. HM Treasury should work with the FRC in developing the UK Stewardship Code to ensure that it meets this challenge head-on, by encouraging institutional investors who are “universal owners” to engage with systemically important companies in this spirit. 24 August 2012

163 Law Commission, 1992, “Consultation Paper No. 124: Fiduciary Duties and Regulatory Rules” (HMSO), para 2.47 164 19 June 2012, Q163 165 Final Report of the Kay Review, 2012, Recommendation 7 (p69) 166 HMT, 2011, Bank Executive Remuneration Disclosure: Consultation on Draft Regulations, p5 cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

Ev 1008 Parliamentary Commission on Banking Standards: Evidence

Written evidence from James Featherby Summary of thisSubmission 1. The characteristics of modern banking are such that banks have a strong tendency to create poor internal cultures. 2. The structure of banking has not evolved to ameliorate the resultant risks to the economy or society. 3. Structural reform of banks is necessary to realign banking with more economically and socially purposeful activities and to remove a variety of structural opportunities and incentives for poor behaviour. 4. Increased regulation is unlikely to be either sufﬁcient or effective. 5. Structural reform may need to encompass: (a) banks adopting an appropriate degree of public purpose to sit alongside their private purpose; (b) the full separation of investment banking from retail and commercial banking; (c) full reserve rather than fractional reserve banking; (d) limits on the creation of excessive debt; and (e) a reduction in speculative trading, hedging and derivatives unconnected to the needs of the real economy. 6. The culture of banking in the UK is, however, as much a human issue as a structural or technical issue. As a society we need to change the way we analyse problems and construct solutions. It is unrealistic to expect banking to change unless we do. 7. The choice between economic growth and structural reform of banking in the UK is a false dichotomy.

The Particular Cultural Challenges Of Banking 8. Banks have a strong tendency to create cultures that show insufficient concern for the welfare of their customers, for the welfare of the economy and society in which they operate, and for regulatory compliance. 9. There are various reasons as to why this tendency is stronger in the banking sector than in other sectors: (a) Debt has a tendency to centralise wealth on the person to whom debt is owed, and wealth has a tendency to centralise power (see “The dangers of excessive debt” on pages 30 -31 of OMM). The balance sheets of banks have grown significantly in recent years, and the effect has been to centralise power on banks. Power without adequate checks and balances trends to corrupt and desensitise, particularly when it is unconstrained by any responsibility for the public good; (b) The contractual nature of the returns available to banks under debt contracts (see “The disinterest of debt” on page 32 of OMM). Unlike the risk sharing nature of equity, debt contracts do not incentivise banks to be interested in the economic success of borrowers or of the economy or society that supports them because the returns available to banks under debt contracts are not so obviously dependent on such factors; (c) The contractual nature of debt also leads to over-confidence because it enables reliance (whether justified or not) on contracted future cash flows and hedged and secured risks (see “The effect on cultures and behaviours” on pages 50—52 of OMM). In other industries investors and managers accept that their businesses will inevitably be affected by unpredictable events. That leads to a less over-confident approach; (d) The instability of both bank funding under the fractional reserve model (see “Too big to live” on page 36 of OMM) and the value of bank assets due to mark-to-market valuation. This leads to a desire to maximise the externalisation of risk, and that risk can only be externalised to the rest of the economy; (e) The pressure put on senior management by the equity markets because of the asymmetric returns available to shareholders through making investments in banks. Within banks short term profits can be quickly magnified, through increased bank leverage, and if necessary at the expense of good behaviour which tends to pay off only over a longer time frame. From the shareholders’ perspective, significant losses that might otherwise have been incurred by them as a result of such activities can be externalised to others through the combination of limited liability and government support for banks too big to fail. This moral hazard has not been resolved by, and will not be resolved by, even full adoption of the Vickers Commission recommendations or Basle III; (f) Difficulty in distinguishing between activities that are net contributors to real economic growth and those that are merely a zero sum game (where the gain of another must come as a result of a loss to the bank). This leads to a tendency to assume in practice that all banking activities are a zero sum game, and this leads to a tendency in practice to seek to minimise contributions towards the prosperity of others, beyond the minimum needed to make a trade, because of the assumed cost to the bank of doing so; cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 1009

(g) A significant growth in profits in recent years from proprietary trading, which has no identifiable human customer or counter-party and therefore no apparent moral consequences; (h) The nature of investment banking, where banks are often in effective competition with their own customers. This gives rise to an increased occurrence of conflicts of interest between banks and, in particular, their financial services sector customers. In turn, this gives rise to increased opportunities for banks to abuse those conflicts of interest and to act contrary to the interests of their customers; (i) The motivation of large numbers of staff through: (i) high pay rather than job satisfaction obtained through factors such as social contribution, autonomy or physical creativity; (ii) high pay structured by reference to short-term, inward facing financial criteria rather than longer-term, external facing stakeholder criteria; (iii) high pay that is in large measure discretionary, partly to incentivise constant over-achievement and partly to facilitate cost control on downsizing by avoiding the normal employee protection rules on termination pay; and (iv) high pay that is asymmetric in risk as between employer and employee. This can readily lead to individualistic priorities, a lack of loyalty between employer and employee, and therefore a lack of loyalty between employees and the bank’s other stakeholders, aggressive rather than co-operative relationships between staff and others, increased risk taking, and the encouragement of an over-confident, even narcissistic, view of self in a society that increasingly attributes worth to wealth. (j) A combination for large numbers of staff of over-work (demanded by banks in return for high pay) and a lifestyle enabled by high pay that is removed from the demands placed on others. This can readily lead to a lack of connectivity with reality, and therefore to a lack of appreciation of the broader social and economic consequences of decisions.

Structural And Cultural Reform 10. The evidence is clear from the last few years that the culture of banking in the UK can produce signiﬁcant ﬁnancial pollution for the rest of the economy, and result in serious regulatory breaches. It is my view that the combination of challenges listed above may well put banking beyond adequate cultural change absent material structural reform. The objectives of such structural reform would be to: (a) increase the rationale and incentives for positive behaviour; and (b) reduce the opportunities and incentives for poor behaviour.

Structural Reform 11. An appropriate degree of social purpose for banks, to sit alongside their private purpose, would provide the senior management of banks with: (a) the rationale and energy for creating and maintaining more positive cultures. It has been recognised since Aristotle that virtue loses its power if it is not seeking the achievement of a positive destination. A social purpose would provide banks with that destination; (b) greater clarity on the responsibility of banks to: (i) manage their own and systemic risk; (ii) protect and maintain the payment system; (iii) provide only appropriate products to retail customers; (iv) assist retail customers to save and budget as well as borrow; (v) contribute to the growth of the UK economy by supporting SMEs rather than their currently increasing focus on mainly large corporate borrowers; and (c) a degree of protection against short-term equity market pressures, particularly from investors with a short-term perspective. 12. “Private purpose” on pages 18—19 of OMM describes why “enlightened shareholder value” is currently failing to produce more long-term and stakeholder aware decision-making within large companies, including banks. Pages 20—24 of OMM provide suggestions as to how to introduce an appropriate degree of social purpose. 13. A social purpose may or may not affect the proﬁtability of banks. It is not inevitable that it would, and it may even increase their proﬁtability since it is generally the case that businesses that serve the interests of stakeholders prosper more over the longer term. In any event, a social purpose may be seen as a fair price for on-going government support and the privilege of continued limited liability. 14. The Commission may wish to consider whether some or all of the following are also necessary in order to reverse the structural problems within UK banking: (a) the full separation of investment banking from retail and commercial banking; cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

Ev 1010 Parliamentary Commission on Banking Standards: Evidence

(b) the full separation within investment banking of proprietary activities from agency and advisory activities; and (c) full reserve rather than fractional reserve banking. Further details are given in OMM (see from “Debt Engines” to “Kicking the habit” on pages 32–39). 15. Full reserve banking has various advantages, including improved bank safety. Professor Kay, in his Review of Long-Term Decision Making, recommends that ﬁduciary standards should apply to all relationships in the investment chain that involve discretion over the investments of others. The savings accounts of depositors under full reserve banking could similarly be made subject to ﬁduciary standards. This would accord more with the understandable (if currently technically incorrect) assumption made by many retail depositors under our current fractional reserve system that money deposited with banks remains “theirs” and does not belong to the bank. 16. Further rationale for reducing excessive debt, including suggestions for how to do so, is given in “Reducing excessive debt” on pages 25—39 of OMM. Further rationale for leaning against speculative trading, hedging and derivatives unconnected to the needs of the real economy is given in “Taming speculative and claims-based trading” on pages 41—53 of OMM, including suggestions for how to do so on page 49.

Other Reforms 17. Increased regulation aimed at controlling behaviour may not be an effective option. Where people are, or feel themselves to be, under pressure to behave poorly it is generally intrusive, expensive and ineffective to attempt to stop them from doing so through regulation. Indeed, increased regulation often incentivises more perverse behaviour. I therefore suggest that structural reform should be favoured over increased regulation. 18. I would, however, suggest an exception in relation to the sale of loans and other credit facilities to retail borrowers. In this area the principle of “buyer beware” constrained only by rules on misleading advertising appears inadequate. Given that borrowing can affect a person’s financial health as much as saving, it would seem appropriate to apply the same standard of customer appropriateness to the sale of credit as applies to the sale of investments. 19. The banking sector is not short of corporate governance procedures. I see no reason for thinking that increased corporate governance would improve the culture of banking. 20. Requiring bankers to join a professional body may result in some cultural improvements, particularly in retail and commercial banking. Professional bodies, combined with appropriate training and peer-led disciplinary procedures, can be effective tools. Such a process is, however, in my view less likely to be effective in investment banking where the cultural challenges are greater. 21. It is not clear that increased competition would improve the culture of banks. As the Kay Review points out, the financial services sector differs from other sectors in that the quality of its products and services is not readily apparent, either for borrowers or savers. With many banks it is also the case that a significant proportion of their profit comes from proprietary trading where there is effectively no customer for whom competition issues are relevant. 22. I would, however, welcome a significant increase in the number of banks offering services to retail and commercial customers in the UK for other reasons, including the resultant: (a) decrease in power of the current major UK banks; (b) decrease in reliance of the UK economy on so few a number of UK banks; (c) increase in diversity of likely business models; and (d) increase in systemic strength of the UK banking sector. 23. The FSA has stated its desire to regulate the culture of banks. I understand, however, that the FSA is finding it difficult to formulate a basis for doing so. In particular, I understand that the FSA feels reluctant to specify what a “good” culture looks like in the absence of guidance from government. This may also be an issue the Commission wishes to address.

Cultural Reform 24. Material though the structural problems facing banks are, the cultural problems within banks are not primarily technical. They are instead human issues, resulting from intellectual and philosophical mistakes. Some would call them moral mistakes, particularly if by moral one means those motivations and behaviours that are most likely to help an individual, and the society of which he or she forms part and upon which he or she depends, to flourish. 25. Banks are not alone in appearing to have lost their appreciation, familiarity, and dexterity with the concepts and language of morality in the public arena. Many of us have been making the false assumption that the public arena, including business, can and should be a “values free” zone, where the positive side of human nature is assumed, with the negative side of human nature is ignored, where following the rules or the market provides sufficient morality, where financial incentives substitute for common purpose, and where the fear of cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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judgementalism prevents leaders from exercising discernment over those motivations and behaviours most likely to produce desired outcomes. 26. Many of us are analysing issues and constructing solutions on a basis that is individualistic, reductionist, utilitarian, fearful, disparate, arrogant and pragmatic. “Pruning the vine” on pages 5- 12 of OMM describes this in more detail. In part this is because we have come to believe that that is the best way to analyse issues and construct solutions. As a result, many of us are undervaluing the social and economic value of making decisions on a basis that is relational, holistic, neighbourly, adventurous, purposeful, humble and principled. 27. However, the leaders of UK banks do in particular appear to have lost their ability to inspire and embed positive motivations and behaviours within their organisations. The leaders of banks in the UK will need to develop a new skill set; one that permits them to identify, name, communicate and embed positive values throughout their organisations. This is not just a worthy aim. It is the bedrock of creating and maintaining long-term value for their organisations and all of their stakeholders. To do so, the leaders of banks in the UK will need to provide not just mission statements but fully formed, formal and informal, intellectual, social and economic support for positive behaviour. 28. Some have questioned how it has happened that UK banks have developed such poor cultures whilst in general being led by men and women of personal integrity. I believe the issues raised by this submission go some way to answering that question. Personal integrity is no longer enough. The task now is to transpose that integrity into the public arena. If necessary it must lead to changes in the priorities, objectives, products, services, processes, and incentives of banks. It must change the way in which issues are analysed and solutions are found, and it must change the nature of public discourse. Some of this can be achieved through structural reform. Much of it, however, can only be achieved through a fresh understanding of the kind of positive business objectives and practices that lead to the creation of sustainable value. 29. It may be unrealistic to expect the culture of banks operating in the UK to be signiﬁcantly more positive than the general culture operating within the rest of the UK. Nevertheless, it is incumbent on the leaders of all public and private institutions to take responsibility for attempting to inspire and embed a more positive culture. 30. It will be for the members of the Commission to determine the extent and means by which government is able to bring about broader cultural change. It may, however, be helpful for the Commission to express the challenge that exists within banking within this broader and challenging UK cultural context.

Growth Versus Culture 31. Some see the challenge of reforming the culture of banking as a choice between, on the one hand, structural reform and better cultures and, on the other hand, the growth and jobs that arise from an internationally competitive City. That choice is a false dichotomy, not least because those are not the only two policy choices available. In any event, a City that cannot be trusted will not ﬂourish to produce the hoped for growth or jobs. 12 August 2012

Written evidence from FIA European Principal Traders Association High-Frequency Trading Pointof View FIA EPTA appreciates the opportunity to provide its views on High Frequency Trading to the Parliamentary Commission on Banking Standards. Below, we have provided responses to the Commission’s specific questions. In addition, we would lilke to comment on a recent discussion between the Parliamentary Commission on Banking Standards and the CEO of HSBC, Mr. Stuart Gulliver. High Frequency Trading was described as an “ethical and culture free zone” by one of the Commission members, an opinion with which Mr. Gulliver agreed with. FIA EPTA was disappointed to hear this view. We do not quite understand where this perception around High Frequency Trading Firms in the Commission originates from and would be interested to learn more about it. As we will explain in this paper HFT firms only operate on highly regulated, transparent and public exchanges. Their electronic and quotes and trades are based purely on public information and are completely transparent and continuously monitored by regulators and exchanges. This transparency makes any wrongdoing significantly easier to detect than in many of the non-electronic, non-public markets. In addition, the advanced automation of exchange traded markets has significantly reduced the opportunities for collusion. In FIA EPTA’s position paper published last year in relation to MiFID II, we included a section specifically aimed at dispelling a number of these types of popular myths surrounding HFT167. The UK Treasury’s Government Office for Science’s project on the Future of Computer Trading in Financial Markets (commonly referred to as the “Foresight Project”) came to the conclusion that, while HFT activity 167 FIA EPTA MiFID Position Paper [http://www.futuresindustry.org/epta/downloads/FIA-EPTA-MiFID-PositionPaper050412.pdf] cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

Ev 1012 Parliamentary Commission on Banking Standards: Evidence

had surged in recent years,168 the concerns around its impact on market integrity were unfounded. The Project commissioned three separate empirical studies that found no link between HFT and market abuse. One of those studies found that the increase in HFT over the five-year period had actually reduced the likelihood of market manipulation. We would strongly argue that automation is a very effective means of limiting the incidence of market abuse. Electronic trading makes markets more transparent and wrongdoers easier to trace. The recent LIBOR scandal is a case in point. Manipulation by human traders at several banks went undiscovered for years. Had this measure been electronically generated in our opinion it would not have been subject to the same risks of manipulation and it would have made uncovering wrongdoing substantially more straightforward. It should also be noted that the manually determined LIBOR benchmark is where the manipulation took place, not in the electronically traded Eurodollar futures contract, which is a related benchmark. We were also surprised to learn that Mr. Gulliver assumed that the boards of many of these HFT firms would have little knowledge of what was actually going on in their own firms. Nothing could be further from the truth. These firms are most often owner-managed, highly entrepreneurial and innovative partnerships. These firms do not rely on clients or shareholders’ funds (nor taxpayers’ funds) to run their operations and are therefore highly skilled in the area of risk management. Because it is their personal capital that is at stake, the owners and managers have the strongest possible incentive to keep a very close watch on how trading is being conducted and to minimise the risk of any losses. Furthermore, HFT firms are relatively small in the context of the financial industry and as a result there is a very good understanding by the boards of trading firms of the various strategies that are being deployed. More often than not these senior managers are the originators of these same strategies. Lastly, the vast majority of these firms are authorised and regulated by their relevant regulatory authority which means they are required to have adequate systems and controls in place in relation to their trading activities and operations. Given that many HFT firms are UK based the FSA has taken the lead in rendering its supervisory activities with respect to HFT firms more effective. FIA EPTA and many of its UK based members have been working very closely with the FSA in this regard. This cooperation has included from participating in thematic reviews to aid FSA’s understanding of HFT, and informal and formal dialogue following these reviews and in relation to the implementation of the ESMA Guidelines and the on-going review of MiFID.

TheNature of HFT/AT and theExtent to whichBanks areInvolved Despite continued attempts a common definition of HFT is yet to be found. FIA EPTA believes too much commentary and media reporting has focused on supposed “high-frequency trading strategies”. High-frequency trading is simply a new means, or tool, used to implement age-old trading strategies such as arbitrage and market-making.169 The members of FIA EPTA are the electronic versions of the floor-based jobbers, market makers or specialists in the equity markets or “locals” in the futures markets. New technologies such as co- location and high speed data lines are, in some shape or form, used by all actors in the financial industry, including banks, hedge funds, proprietary traders and brokers. The members of FIA EPTA act as electronic liquidity providers and are major source of liquidity on public exchanges, across a variety of asset classes. By providing prices at which other market participants may choose to trade, electronic liquidity providers bridge the time gap at which natural buyers and sellers come to the market. In fact, several exchange-traded markets, such as options, futures and ETFs, would simply cease to exist and other markets such as the equity markets would become severely illiquid if it were not for these participants. We note that the Foresight Report has found that “high frequency traders now provide the bulk of liquidity”.170 Apart from providing liquidity, there are other strategies that can be implemented by means of HFT tools.171 For example, arbitrage ensures that participants can trade at the right price across fragmented markets in the same or related products. For example, a US investor that buys ADRs listed in New York that are economically equivalent to more liquid ordinary shares traded in London wants to pay a price economically equivalent to the ordinary share price. If no market participants provided liquidity in the ADRs through arbitrage between the ADR and the ordinary shares, the US investor would pay a substantially higher price than the price at which ordinary shares are trading.

TheImpact of HFT/AT onLong-TermInvestors The HM Government led Foresight Project has found that “the commonly held negative perceptions surrounding HFT are not supported by the available evidence”.172 The Foresight report came to the conclusion 168 Foresight: The Future of Computer Trading in Financial Markets (2012), Final Project Report, The Government Ofﬁce for Science, London [link] 169 We note that our position is in line with the conclusions reached by ESMA”s Task Force established in February 2011 to consider micro-structural issues in an automated trading environment and which resulted in the publication in December 2011 of Guidelines on systems and controls in an automated trading environment for trading platforms, investment ﬁrms and competent authorities. 170 Foresight Report, p.41 171 Foresight Report, p.41 172 Ibid., p.5 cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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that “computer-based trading has improved liquidity, contributed to falling transaction costs, including specifically those of institutional investors, and has not harmed market efficiency”.173 The biggest impact of AT/HFT has been the decrease of transaction costs for institutional and retail investors. Increased automation in trading technology has enabled many institutions to access the markets through algorithms. Compared to the voice-based brokerage of ten years ago at tariffs of 25–40 basis points, institutions now access the markets through algorithms at rates as low as 1–3 basis points. Data compiled by Oxera shows a decrease of 21% in trading costs between 2006 and 2009.174 These results are supported by some of the largest asset management institutions such as BlackRock and Vanguard, who have publically stated that transaction costs have fallen as a result of automation and high-frequency trading. Vanguard for example calculates that, as a result of lower transactions costs, the average pensioner will have 30% more funds in his or her investment account over a lifetime. In addition, using a methodology commonly known as execution shortfall—which measures the difference between the price of a security before an order is entered and the final price paid by the institution—both ITG and Elkins/McSherry, which track this data for scores of institutional investors around the world, show that costs have dropped over the past decade. Some critics of HFT contend that HFT firms have an unfair advantage over institutional investors because HFT firms have better technology and are faster than these institutions. This notion would only be valid if institutional investors were competing with HFT liquidity providers by pursing a strategy based on the same intra-day time horizon in which many the HFT liquidity providers operate. That is clearly not the case. Instead, institutional investors make trading decisions by meeting company management and conducting research of companies. This information gives these long term investors an insight into fundamental valuations that are not accessible, and also not of relevance, to those market participants pursuing intra-day strategies. It is no more true that these institutional investors have an unfair advantage over HFT firms because HFT firms do not have the same access to company management and broker research, as it is to claim that these HFT firms have an unfair advantage over long-term investors. Because these two types of market participants pursue different trading strategies, on entirely different investment time horizons, they typically do not compete with each other and act as each other’s counterparties as a result.

How Values Consistentwith High Standards can be Embeddedin Automated Systems Exchange traded markets have in a relatively short period of time become increasingly automated. Many participants that used to rely on traders to manually execute orders have now replaced many of these traders with substantially more efficient computers. The benefits of these developments, in terms of increased transparency, less opportunity for collusion and in particular vastly lower transaction costs, are unquestionable. At the same time, regulations have not kept up with these developments. These markets require harmonization of risk controls, high standards of software development and a better understanding of trading parameters. FIA EPTA members purely trade their own capital and are reliant on their own risk controls to preserve this capital. FIA EPTA, therefore, believes that trading venues and market participants should have robust risk controls in place to address risks inherent in electronic markets and is fully supportive of the risk control requirements in the ESMA’s guidelines on systems and controls in an automated trading environment.175 Electronic systems enable the users to implement a wide range of risk management techniques and safeguards. These include, amongst others pre and post-trade checks, maximum exposure thresholds and kill switches. Risk controls are incorporated in algorithms and monitored by traders and risk managers in each firm. The execution of trading strategies is carried out by computers; but the design and monitoring of these strategies remain in human hands. Additionally, FIA EPTA has developed internal best practices to emphasise the importance of the preservation of market integrity.176 These best practices build upon existing European regulation in general and ESMA’s guidelines on systems and controls in an automated trading environment in particular. They act as a set of recommendations from FIA EPTA to trading firms and provide guidance to firms in establishing their internal policies and procedures and/or Codes of Conduct. They reflect the commitment of FIA EPTA members to actively prevent, detect and report market abuse and to manage the risks related to their trading activities.

How HFT and AT can beRegulated andOverseen given itsComplexity andPace ofChange There are many complex questions facing regulators, policy makers and indeed market participants on risk management. It is our collective responsibility to answer these questions in an objective and dispassionate fashion, reaching conclusions based on careful analysis of empirical data. 173 Ibid., p.41 174 “Monitoring prices, Costs and volumes of trading and post-trading services”, Oxera, May 2011 175 ESMA, “ESMA Guidelines on Systems and controls in an automated trading environment for trading platforms, investment ﬁrms and competent authorities”, 22/12/2011, http://www.esma.europa.eu/content/Final-report-Guidelines-systems-and-controls- automated-trading-environment-trading-platforms 176 FIA EPTA Market Intergity Framework; Best Practices to Preserve Market Integrity, July 2012, http://www.futuresindustry.org/ epta/downloads/EPTA-Market-Integrity-Framework_072012.pdf cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

Ev 1014 Parliamentary Commission on Banking Standards: Evidence

FIA EPTA members believe that markets should strive for full transparency. High frequency trading by definition takes place on automated exchanges and MTFs. All quotes and all trades that are sent into these markets are completely transparent. FIA EPTA members base their activities fully on publicly available information and all trades and quotes can be monitored by exchanges and regulators. There is a permanent record of all these orders and trades. FIA EPTA is committed to the minimisation of risk and the optimisation of controls related to the safe operation of electronic systems in today’s financial markets. As noted elsewhere, FIA EPTA fully supports the work of ESMA to establish guidelines relating to these specific areas. Also, to this effect, FIA EPTA has issued a set of recommendations for software development and change management.

AnyLinks between HFT/AT and (a)MarketAbuse and (b)MarketInstability andPeriodic Illiquidity Research conducted for the Foresight project (Capital Markets Cooperative Research Centre (CMCRC) in Sydney) found that while HFT activity had surged in recent years, the concerns around its impact on market integrity were unfounded. The study found that there was a “negative correlation” between HFT and end-of-day price dislocation—meaning the increase in HFT over the five-year period had actually reduced the likelihood of market manipulation. Market abuse is not only morally reprehensible; it also comes with a hefty price tag for the market. A large part of the cost of these practices is borne by those firms that provide liquidity to the screen based markets, ie many of our members. FIA EPTA members depend on fair, orderly and honest markets to enable them to properly value the securities in which they provide liquidity. A Market participant that trades on inside knowledge will more often than not find our members as counterparty to their illicit behavior. It is also for these reasons why we have taken such a firm stance on abusive behavior. Contrary to public opinion HFT is not more susceptible to abusive practices than other types of trading. FIA EPTA is fully supportive of measures proposed to monitor markets more effectively but emphasize the need for these same rules to apply to all market participants. In this regard, FIA EPTA fully supports the proposed changes to MAD designed to provide well-defined and clear regulation to detect, deter and enforce actions to counter fraudulent and manipulative behaviour. Regarding market instability, much academic evidence concludes that HFT either has no effect or reduces volatility.177 The one research report that concludes otherwise178 is linking HFT activity to volatility but fail to provide evidence supporting the causal link between the two. The liquidity provided by HFTs actually counters excessive volatility and helps to bridge short term imbalances between buyers and sellers. They generally do not hold positions for longer periods of time and can therefore not influence longer termed price developments.

Periodic illiquidity The popular notion that the liquidity provided by these firms is fleeting is anecdotal at best and not supported by data. Recent data provided by Eurex and the Tokyo Stock Exchange around severe market dislocations showed that these firms stayed in the market during these very volatile periods. Financial Services Authority- sponsored research on other markets by the University of Sydney has shown precisely the same results. These firms provide much needed liquidity around very volatile periods. The flash crash is often used as the prime example of this fleeting liquidity. It should be noted that even in this cataclysmic event many of these HFT firms continued to trade. The problem was that the demand for liquidity vastly outstripped supply in a very short period of time. High-frequency trading did not cause the Flash Crash and in fact absorbed the initial sell orders according to a report released by the CME as well as the CFTC/SEC report. In contrast to some media references to high-frequency traders exacerbating illiquidity, the CME review of the trading activity during the period of the flash crash found that most high-frequency traders did not leave the futures markets during the market break and continued to provide liquidity under extreme market conditions. “Based on our review, there is no evidence to support the proposition that high-frequency trading exacerbated the volatility in the markets on 6 May.”179 Additionally, the CFTC has found in their market study following the flash crash that “although some HFTs exited the market for reasons similar to other market participants… other HFTs continued to trade actively”.180 It should be noted that HFTs must execute trades in order to make profits. As such they have strong incentives to quote very close to or even at market prices. Trading firms sign-up to market-marker and liquidity programs developed and enforced by the trading venues. These programs provide incentives to market makers and 177 CME Group July 2010; Jarnecic, Snape, June 2010; Hendershott, Rioirdan, Brogaard, 2009; Chaboud, Hjalmarsson, Vega and Chiquoine, October 2009; Hasbrouck, Saar, May 2011; Credit Suisse, April 2010; Frino and Zheng, 2011; UK foresight committee 178 Frank Zhang, Yale University, November 2010. 179 Comments by Bryan Durkin, Managing Director and Chief Operating Officer, CME Group, to CFTC Technology Advisory Committee, July 14, 2010, page 4 [http://www.cmegroup.com/trading/equity-index/files/CFTC_techadvisory_durkin.pdf] 180 CFTC Market Event Findings, p.45 cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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liquidity providers in return for meeting certain obligations, such as providing liquidity at the best bid and offer, assuring successful price formation and market stability.

Lessons from the Flash Crash

High frequency trading did not cause the ﬂash crash according to a joint report by the CFTC and the SEC. The staffs of the two agencies concluded that a large long term investor’s order to quickly sell 75,000 CME S&P 500 mini contracts (with a notional value of over $4 billion) created a “liquidity crisis” in the CME E- Mini futures that caused the price to drop more than 5% in four-and-one-half minutes during the most intense part of the episode. This long term investor’s order resulted in the largest net change in daily position of any participant in the S&P E-Mini contract since the beginning of that year, ie it was exceptionally large. At the same time, this long term investor decided to enter this sell order in an algorithm with no regard to price or time limits. In a market that was already extremely nervous because of the European debt crisis (there were riots in the streets of Greece at the time) this order caused the events witnessed that day. The report carried out by the CFTC found that “this sell pressure was initially absorbed by high frequency traders (‘HFTs’) and other intermediaries in the futures market”.181 The sell-off, however, created high levels of insecurity in the markets as other investors thought they had missed critical information. As a result other market prices started to rapidly drop as well.

The market events of 6th May in the U.S. exposed shortcomings of the current U.S. securities and futures market structure, most notably the absence of circuit breakers. In addition, these events exposed the need for robust risks and controls to be implemented on all algorithms. Had the long term investor used a price limit in the algorithm that they used that day than this event probably would not have taken place. It is important to note that there are meaningful differences between the European and US market structures. For example, European markets are not linked, unlike in the US where the National Market System operates (under Reg NMS). In addition, most European exchanges have circuit breaker type mechanisms in the form of intraday auctions triggered by high volatility and allow market participants to digest information and bring in additional liquidity. FIA EPTA supports robust requirements for regulated markets’ systems resilience, circuit breakers and electronic trading.

TheAdequacy ofControls andRegulation

The members of FIA EPTA are committed to a sound regulatory framework. We welcome, and actively engage with EU and national policy makers regarding, the design and implementation of appropriate regulation which serves to increase transparency on markets and reduce risks.

As outlined above, FIA EPTA fully supports of the risk control requirements in the ESMA’s Guidelines on automated trading and developed the FIA EPTA Market Integrity Framework; Best Practices to Preserve Market Integrity.

Future direction

HFT will continue to develop as an industry and will play an important role over the coming years in asset classes that are currently still largely OTC traded. In accordance with the stated objectives of the G20, high frequency trading ﬁrms will play a key role in enabling this development. In fact this objective can simply not be achieved without the active participation of these ﬁrms.

The increasing amount of experience with automated and high frequency trading will help to improve risk management practices and error prevention systems both within trading firms and exchanges. Mechanisms such as circuit breakers and kill switches have already seen considerable risk reductions. These systems will become more sophisticated over time thereby further improving market stability. Increasing competitive pressure amongst HFT firms will not only see further reductions in trading cost but will also compel firms to implement improved risk management.

Meanwhile regulators and trading venues will continue to upgrade and reﬁne their supervisory systems and processes. This will enable them to monitor market activity more effectively. In the EU it will also be particularly important to improve cross-border co-operation between regulatory authorities as well as with the US where HFT trading has a considerably larger footprint. 28 February 2013

181 CFTC Market Event Findings, p.3 cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

Ev 1016 Parliamentary Commission on Banking Standards: Evidence

Written evidence from Fidelity Worldwide Investment DEVISING A BETTER FRAMEWORK FOR MANAGEMENT INCENTIVISATION WITHIN THE BANKING INDUSTRY A. Background 1. Fidelity Worldwide Investment (“FIL”) manages £102 billion of equity funds under management with approximately £16 billion invested in listed UK equities. Almost all of these funds are under active rather than passive management. We appreciate this opportunity to contribute to your deliberations on standards within the banking industry and have chosen to focus on the very specific issue of management incentivisation. This is an area in which we have extensive experience given our shareholdings in some 1,600 listed UK and European companies, and we would like to share the conclusions we have reached. We have not commented on the many other important areas of your brief as you will doubtless be receiving expert input from others whom are better positioned than us to contribute. 2. FIL has taken a prominent role in the debate about Directors’ remuneration in the United Kingdom. We contributed to the recent Executive Pay Consultation undertaken by the Department of Business, Innovation and Skills, and we have argued publicly in support of the introduction of a binding shareholder vote to govern Directors’ pay. Specifically, we recommended that all annual variable pay should be made subject to prior shareholder approval by a supermajority of the votes cast and with the Chairman of the Remuneration Committee being required to step down if the resolution failed to secure the requisite majority on two consecutive occasions. The decision to introduce a new rule requiring companies to submit a binding vote on pay policy for straight majority shareholder approval at least once every three years does not go as far as we had initially suggested, but we nonetheless welcome this important step towards giving shareholders a greater say on pay. The new regulations should improve the ultimate accountability of shareholders in determining remuneration and diminish the future likelihood of payment for failure. 3. It is widely recognised that misaligned incentives played a part in facilitating excessive risk taking within banks and were a contributory factor to the crisis which engulfed the banking sector in 2008. This situation had arisen over time as a consequence of a number of factors: — A lack of adequate oversight by Boards of Directors and Remuneration Committees. — An inflationary dynamic fuelled by a desire to achieve a second quartile reward profile. — A lack of meaningful input from shareholders. — The introduction of progressively more complex remuneration arrangements encouraged by a new profession of remuneration consultants. 4. These factors combined with the prevailing culture of risk tolerance to produce a situation in which both the quantum and structure of incentive awards were wholly disproportionate to the economic benefit being generated. The resultant cost to the tax payer, destruction of value for shareholders and damage to national well-being have made it essential that practices within banks are brought back into line with the needs of the wider economy.

B. The Importance of Longevity and Duration 1. Considerable work has already been carried out to analyse what went wrong in the financial system in 2008 and to devise measures to prevent a repetition. Management incentives are one of the areas which have been examined and several recommendations have already been made in this regard. However, practice on the ground has been slow to adapt and we would like to see companies make more widespread and faster changes in their approach to this critical area. 2. We would like to draw your attention to one of the conclusions of Sir David Walker in his 2009 review of corporate governance within banks in which he recommended that the LTIPs governing the variable remuneration of senior banking executives should have a minimum vesting period of at least five years for 50% or more of the award. More recently Professor Kay in his Review of UK Equity Markets and Long-Term Decision Making pursued the same theme and recommended that all long term incentive payments should only be made in the form of shares to be held at least until the executive has retired from the business. 3. We fully support the line of thinking expressed by Sir David Walker and Professor Kay and for our own part we have decided to focus on LTIP longevity and duration as key factors upon which Boards of Directors should concentrate. There is no easy way to promote a long-term philosophy within an organisation but, if this can be successfully achieved, the organisational culture will benefit and a whole spectrum of positive behaviour and values should result. By placing LTIP longevity and duration at the centre of our own governance voting guidelines we are giving Boards a clear message and this is also a framework which is straightforward to explain both to our clients and the wider public.

C. Practical Suggestions 1. We have recently changed our proxy voting guidelines such that there must be a minimum period of ﬁve years (up from three years) between the date of grant of an award and the sale of any shares. We are also cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 1017

encouraging companies to make at least a portion of these shares Career Shares with the stipulation that they must be held until termination of employment with the company or retirement. This mirrors our own internal approach to senior management incentivisation. An alternative to Career Shares might be to have ﬁve year+ vesting in conjunction with a further mandatory holding period, potentially in some circumstances extending beyond the departure of an individual from the company. When combined with a meaningful minimum shareholding requirement this would come close to replicating the effect of Career Shares.

2. A further advantage of management building up a sizeable long term holding in companies is that the dividend income arising from these shares should hopefully become an important part of overall remuneration. We regard dividends as an integral part of shareholders’ reward for investing in a business but, in the absence of a sizeable management shareholding, there is always the temptation for management to try and grow the business as an end in itself rather than balance growth with current rewards for existing investors. Sizeable management shareholdings address this problem.

3. Another benefit of long duration LTIP schemes is that they potentially enable a simplification of LTIP schemes more generally which is one of our other paramount objectives. Alignment between the interests of management and shareholders is achieved through the mandatory long-term marriage of their respective economic interests and there is less need to have detailed performance conditionality in determining the number of shares to be vested. Performance conditionality is a major source of complexity in existing LTIP schemes with shareholders having to make highly subjective judgements on whether the performance conditions are sufficiently stretching, and companies themselves are also very sensitive to revealing performance targets for commercial reasons.

4. We would also like to refer you to work which has been carried out by Pricewaterhouse Coopers which shows that recipients of shares under LTIPs place a high value on certainty with highly conditional awards being valued at a material discount. In the case of Career Shares or ex-ante performance vesting, once shares are awarded they really do belong to the recipient and hence it should be possible to achieve the same motivational effect with a lower quantum of shares. This could make a contribution to reining in the overall size of awards which is another area which needs attention.

5. Notwithstanding recent comments by the Bank of England and the FSA that they favour the use of bail- inable senior debt or other more subordinated forms of capital such as CoCos in remuneration arrangements, this is not a practice we would encourage. Debt carries less risk than equity and is less volatile in its value. By awarding management through debt instruments one is implicitly encouraging risk with the debt retaining value (and high coupon payments) even in circumstances where the equity may have been wiped out.

D. Progress to Date

1. There are some grounds for optimism that Boards are starting to recognise the importance of having a long-term framework for their incentive schemes. The HSBC LTIP scheme in particular adopts many of the ideas underlying Career Shares and they would doubtless argue that their approach to remuneration is reﬂective of their philosophy towards their underlying business as a whole. It is notable that HSBC were one of the banks which coped best with the challenges of 2008.

2. We are also aware of a proposal currently being considered by another clearing bank which incorporates ex-ante vesting with the quantum of shares being awarded being determined by the individual’s performance in the year prior to award. There would be no subsequent performance vesting with the alignment between shareholders and management being achieved solely through a demanding share ownership guideline and a long term retention requirement.

E. Conclusion

We believe that the structure of long term incentive programmes can have a major impact on the culture and performance of an organisation. There is much noise surrounding this topic and we believe that some leadership is required to direct the debate and to focus attention on those aspects of remuneration which have the potential to make a real difference in the long term. LTIP longevity and duration are key features which should be encouraged and which, if properly crafted, have the potential to foster a longer term culture in systemically important banks and organisations. 31 October 2012 cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

Ev 1018 Parliamentary Commission on Banking Standards: Evidence

Letter from Natalie Ceeney CBE, Chief Executive and Chief Ombudsman, Financial Ombudsman Service RE: PARLIAMENTARY COMMISSION ON BANKING STANDARDS— REQUEST FOR EVIDENCE In your letter of 23 January, you requested evidence from the ombudsman service about the effectiveness of the current enforcement regime—with some speciﬁc questions about our role, and around some speciﬁc powers. I hope my response below is helpful.

The Enforcement and Redress Regime As you suggest in your letter, the enforcement regime and redress regimes under FSMA need to be considered together when thinking about addressing poor conduct in retail markets. The ombudsman and the FSA/FCA each play a crucial—but different—role. The ombudsman’s role is to resolve individual disputes, and put right things which have gone wrong on a case-by-case basis. The FSA/FCA’s powers include the creation of mass redress schemes (where whole groups of consumers receive compensation for something which has gone wrong), fines, and enforcement of proper conduct. The FCA and the ombudsman can, and should, also work together to use our respective insight from what has gone wrong to prevent future issues occurring. Inevitably, as the ombudsman sees complaints from individual consumers, we are likely to see many of the same issues that will concern the FSA/FCA. Where things have gone wrong, typically three things need to be considered. Firstly, correcting poor conduct so that consumers do not suffer detriment in future. Secondly, providing redress to those consumers who have suffered as a result of past poor conduct (either collectively or individually). And thirdly, providing a visible deterrent to other businesses from carrying out the same poor conduct (and/or whether individuals need to be criticised and their practice curtailed)—for example through fines, public censure or criminal prosecution. All three of these approaches are valid responses to poor conduct. Historically, regulation in financial services has primarily focused more on the first and third of these—with limited powers for delivering proactive collective redress. But more recently and particularly since the revision of s404 of FSMA, regulatory action in financial services has placed increasing weight on collective consumer redress. In practice, consumer redress costs to businesses can be far more material than regulatory fines. PPI provides an extreme illustration of the point. But other regulatory action shows the significance of redress to consumers and businesses. In the particular context of financial services, providing redress only on the basis of relying on proactive action by the consumer has a number of policy disadvantages. Consumers may not be aware that they have a problem, or of its cause in terms of poor conduct by the financial business. They may also lack the confidence or ability to complain. And as we have seen in areas like PPI and mortgage endowments, claims managers may “intermediate” complaints for their own commercial advantage. In contrast, proactive action by the financial business is—if conducted fairly—likely to increase the proportion of consumers compensated and minimise the administrative overheads associated with large-scale complaint environments. It can accordingly provide a powerful incentive for businesses to ensure fair conduct. Our view, therefore, is that any effective enforcement regime needs to consider redress as a powerful tool in its armoury, with the ombudsman and regulator able and ready to play key, different but complementary, roles.

Section 404 You asked specifically for our comments on the section 404 provisions within FSMA. The current FSMA section 404 power was brought into force around two years ago and gives the FSA powers to make a widespread redress scheme, covering groups of consumers. Section 404 also, for the first time, provides that the ombudsman will decide relevant cases according to the redress scheme. We welcomed the strengthening of this power. The ombudsman is set up to consider the individual circumstances of each case, and sometimes—for the reasons expressed above—it is more appropriate and effective to have a more proactive and wide-reaching approach than relying on consumers complaining individually if they believe that there has been detriment. The regulator is inevitably best placed to judge whether there has been widespread and regular failures and, where there has, can intervene decisively to correct the problem. Experience with the use of new s404 powers is still limited. So, it is early days to identify how this will work out in practice. But one of the early challenges for s404’s use is around the transparency of the processes, and, given the scale of its impact, what evidence is taken into account in determining the redress solution. For an industry-wide redress scheme under s404, the legislation requires the FSA to consult publicly on its approach. In contrast, some actions under s404 do not carry an obligation to consult—particularly where a scheme only covers one individual financial services business. The FSA (and new FCA) has said that it wants to ensure that it is not only the perspective of the financial services business (that is considered to have acted unfairly) that is brought to bear on the regulatory decision about the approach to redress, but that consumers’ cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 1019

voices are also heard and understood. This is particularly important given that s404 schemes act to limit the ability of the ombudsman to consider cases under its “fair and reasonable” jurisdiction (where both parties’ evidence is considered in reaching a judgement) instead being tied to the scheme determined under the s404 power. At the same time, public consultation is complex, time-consuming (in that it delays redress), and exposes ﬁnancial services businesses to external scrutiny before a decision to take enforcement action has necessarily been agreed. The FSA is currently considering its approach to transparency for enforcement action, and has also committed to consulting publicly at a future date on how they will operate the business-speciﬁc s404 action going forward.

Super-Complaints As you say in your letter, one new power being introduced into FSMA under the new regulatory structure is the power for named consumer-groups, financial services businesses (in respect of their own failings), and the ombudsman service to raise super-complaints. Again, we believe that the power for consumer groups to raise super-complaints is a helpful one. It’s a power which has existed in relation to general market issues and the OFT for some time, and which has been actively used in the past. Extending this regime across all of financial services seems to us to be sensible. As far as the ombudsman is concerned, we have always maintained that this is a power we hope we will never have to use. The regime envisages a transparent ombudsman service which will be publishing our final decisions—and a regulator which acts early on issues of mass detriment. There should, therefore, be no need for us to ever use a power where we need to flag an issue formally because we believe that the regulator hasn’t taken account of what we are seeing. 1 February 2013

Written evidence from the Financial Reporting Council The Chairman of the Financial Reporting Council (FRC), Baroness Hogg, gave evidence to the Commission on 8 November 2012. Subsequently the Commission182 has requested that FRC responds to the additional specific questions dealt with below. The Commission has also now established a sub-committee to address accounting, audit and taxation. We have been told by Commission staff that we should expect further calls for evidence on these areas, and expect to submit further written and oral evidence to that sub-committee, which is likely to expand and amplify the points made below. While financial reporting should be useful to a range of stakeholders, its core purpose is to communicate with investors on the stewardship and prospects of the company. We are concerned that insufficient attention is currently focussed on the needs of investors as the primary users of financial statements, and therefore on their readiness to provide risk capital. In addressing the financial reporting and audit frameworks for banks, we suggest, the sub-committee has a particular opportunity to contribute to re-establishing the investibility of banks. Financial statements presented by systemically important listed banks are based on International Financial Reporting Standards (IFRS) which are issued by the International Accounting Standards board (IASB), and endorsed for use in the European Union by the EU Accounting Regulatory Committee. The main role the FRC plays in this area is to seek to influence the IASB throughout the standard-setting process, and to influence European authorities when the IASB’s standards come forward for endorsement. We are stressing to the IASB the need to make timely improvements, and to ensure that it re-assesses those decisions, taken in pursuit of US convergence, which in our view do not support a culture of long-term investment. And where the IASB has agreed improvements to accounting standards that we consider important, we have been seeking to secure timely adoption by the European Union. Meanwhile, the FRC can mandate changes or issue persuasive guidance in a number of areas of interest to the Parliamentary Commission. These include: enhancing the narrative reporting and disclosure provided by companies; enhancing and changing the governance requirements applicable to listed companies (including banks); making changes to guidance on directors’ responsibilities; and enhancing audit requirements. We can also seek to drive improvements in these areas through our conduct-related activities: specifically, by our reviews of corporate reporting and audit quality, or by taking disciplinary action with respect to the audit firms or professions within our remit. We have already taken a number of important steps (detailed below) designed to enhance disclosure. It is not, however, the case that more is always better; we are concerned to avoid reporting overload at the behest of competing regulators. Our actions have been driven by the principles of accountability to investors. Although there is likely to be significant overlap between the investors’ needs and those of financial regulators, they do not always coincide. But since financial regulators can and do make extensive use of rights to ask for additional 182 Through various emails from Commission staff cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

Ev 1020 Parliamentary Commission on Banking Standards: Evidence

information, which can be reported privately or publically outside of the ﬁnancial statements, we believe that further disclosure requirements should be added to banks’ accounts only if and where they demonstrably meet the needs of investors. We are happy to enlarge on the answers given below to the Commission’s questions, should the subcommittee (or of course the Commission) require further detail.

Q—What are the problems with IFRS? What is being done to solve them? The background to IFRS — Globally recognised accounting standards help investors to compare companies in different countries. A common reporting language is therefore seen as conducive to global economic growth and financial stability. Hence the call from the G20, amongst others, for both further development of IFRS and their more widespread adoption. The IFRS Foundation recently published a review of the arrangements and evidence as to their effect, most importantly perhaps on the cost of capital.183 — The EU has mandated the use of IFRS for listed groups as the only practical way of achieving reporting comparability across Europe. In 2002 a regulation was passed requiring EU listed groups to prepare their financial statements following IFRS, as “adopted” in the EU, from 2005. The regulation requires the European Commission to endorse each IFRS for application; no additions or amendments can be made to the IFRS, but deletions, or “carve-outs”, are permitted. The adoption process has not proved easy and recent changes made by the IASB in response to the financial crisis remain to be adopted in part because the European Commission is waiting for all changes to be completed. We and others are pressing the European Commission to reconsider this policy, and move ahead faster. — The IASB has struggled to meet three sometimes conflicting aspirations: for standards that are timely, high-quality, and of the widest possible geographical application. These requirements have not always proved compatible. The aspiration for global reach drove the IASB to seek “convergence” between IFRS and US Generally Accepted Accounting Practices (US GAAP)—the standards used in the largest capital market in the world. As the Financial Stability Board (FSB) noted in its report to the G20 Finance ministers at the end of October 2012,184 considerable progress towards convergence has been made. — However, the pursuit of convergence has, in some instances, conflicted with the other objectives of timeliness and quality. Timeliness is inevitably affected by a wider search for compromise; quality may be differently perceived in the US, with its different corporate and legal history. (At the FRC, we would define quality standards as those which are principles-based, evidence-based and pragmatic.) We and many others have therefore for some time been pressing the IASB to emphasise quality over convergence. We are therefore glad to note that the IASB has said that—once the current convergence projects with FASB are concluded—convergence will no longer be a short-term priority. — The IASB has said that it recognises the need to make timely improvements in the case of financial instrument accounting in particular, and exposure drafts on key aspects are expected shortly (see more detail below for standard-specific problems). The IASB and the US Financial Accounting Standards Board (FASB) have agreed to continue to liaise, but to reach their own independent decisions.

The conceptual framework — Some of the criticisms that are made of the reporting by banks pertain to the principles set out in the IASB’s conceptual framework for its own work in standard-setting, of which initial—and, on some issues, controversial—revised chapters were published in 2010. We are concerned that, even though the IASB is now working without the constraint of seeking agreement with the FASB, it does not wish to re-open these issues. Areas of particular concern to us are: (a) The lack of emphasis on prudence and reliability in standard-setting principles. Instead, the IASB has emphasised the need for “faithful representation”. The IASB Chairman recently defended the omission of prudence from the principles in the framework, preferring the concept of neutrality and citing the need to converge with US GAAP. He did, however, qualify this by arguing that “prudence” remains intact and visible throughout basic elements of IFRS. While we accept many such elements remain (and we are also alive to the risk that results may be distorted by excessive caution) we would urge the need for some re-emphasis of prudence and less emphasis on neutrality. (b) The lack of a primary principle articulating the importance of stewardship, or accountability, which we believe would help focus standard-setting on the needs of investors. Stewardship is accorded only a subsidiary role in the initial chapters. There should be a clearly stated objective for ﬁnancial reporting to provide investors with information on how the board of the group has exercised its stewardship of the business. 183 http://www.ifrs.org/Use-around-the-world/Documents/Case-for-Global-Accounting-Standards-Arguments-and-Evidence.pdf 184 The full report can be obtained from the FSB website here https://www.ﬁnancialstabilityboard.org/publications/r_121105.pdf cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 1021

— The IASB expects to issue the remaining chapters of its conceptual framework for discussion in June 2013. We will be encouraging the IASB to set principles to ensure sufﬁcient weight is given to the need to give a clear view of the performance of the business over the year rather than focussing on the end-year position. At the same time we think the IASB should develop principles designed to ensure that any narrative disclosures required are useful to the investor and do not overload the report.

Standard-specific problems — IFRS are not industry-specific, but are frequently instrument or transaction-specific. Standards for financial instruments are clearly of great significance in banks’ accounts and have long caused controversy. Indeed, some of the features of IFRS that have attracted much concern since the financial crisis were only introduced in response to concerns that arose with the Enron scandal. These changes included the extension of “fair value” accounting, together with restrictions on off-balance sheet accounting and general provisioning. While it would not be sensible simply to reverse these changes, there are valid criticisms to be made of current standards for financial instruments. The role of fair value in accounting — An important criticism levelled against “fair value” accounting (required for certain financial instruments under IFRS) is that it generates unrealised profits, which are relied on to support borrowing and/or justify dividends and bonuses. When markets fall, such actions may be revealed to be unsupportable or unsustainable. — “Fair value” is not a new concept. It has been permitted in the UK since the Companies Act 1948, when it was introduced to assist companies to fund post-war reconstruction by borrowing against re-valued property assets.185 — In some instances it clearly remains the most appropriate basis for valuation. For example, the historic cost of a derivative, often zero, is completely irrelevant to its current value. Equally, in other instances historic cost is more appropriate, for example where the asset is held to maturity. In some instances fair value is positively unhelpful, for example in the case of own debt. — The post-Enron financial instrument standard did not give sufficient clarity as to which measurement basis should be used in which circumstances. The IASB is working to ensure that there are clearer principles as to when fair value is appropriate for accounting and when other bases should apply. — Moreover, even when fair value may be the most appropriate basis of accounting, we believe more should be done to ensure financial reporting makes clear that reported performance is measured using values which fluctuate with market movements. — Within the scope of IFRS 9, the IASB is seeking further to amend and simplify the classification and measurement of financial instruments held at fair value, as well as addressing hedge accounting requirements. Exposure drafts of the IASB’s proposals are due out early in 2013. However (as noted above) unless the EU accelerates its endorsement process, it could be a number of years before adoption. The “incurred loss” impairment model — We share the view that the current impairment model, whereby losses may only be accounted for once they have occurred, does not properly allow for economic risk and led to provisions being made unsatisfactorily late. We would not favour a return to general provisioning, which is highly open to the manipulation of results, but have urged the IASB to move ahead rapidly towards the development of “expected loss” standards. While this would oblige companies to take a more forward-looking approach, of greater relevance to their investors, it must of course be noted that the results of such an approach can only be as good as the foresight of those making the “expected loss” judgements. The use of fair value gains to support dividends — Some have raised concerns that fair value accounting led to dividends being paid out of “paper profits” which vanished with falls in the market. However, the Companies Act 2006 (s830), which imposes its own tests, allows such distributions to be made from realised profits only. The real issue of concern here is that this test does permit dividends to be paid out of profits that have subsequently been invested in illiquid assets. The FRC has long been pressing for a fundamental review of the capital maintenance regime (which is determined at the EU level). A solvency-based test for distributions would, we have argued, provide a better form of risk management. — Criticisms have also been made of the link between volatile unrealised profits and bonuses. While the setting of bonus targets is a matter for directors, an approach to reporting that highlighted the unrealised element of profits might also act as a check on bonus distributions, and we are working with the Bank of England to pursue this approach. 185 The UK is currently seeking to ensure that the ability to revalue is retained in the Accounts Directive governing UK GAAP. Businesses and banks have told us that it remains important to facilitate lending and support growth. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

Ev 1022 Parliamentary Commission on Banking Standards: Evidence

Q—Stephen Haddrill recently questioned (in his speech to the E&Y conference on 5 November) whether banks should have separate accounting standards. What are your views on this proposal and what areas should any change in accounting standards focus on? In seeking to change accounting standards for banks, what is the desired outcome? Is it possible to achieve this more simply? — Stephen Haddrill was raising an open question—“Are banks different?”—rather than announcing a concluded view. The FRC has facilitated discussion on this question, and its implications for a number of issues ranging from accounting standards to reporting requirements and governance. — In principle, we do not favour separate accounting standards for banks. It is difficult to ring fence the banking sector. Conducting banking activities is not the sole preserve of traditional banks; others involved include the shadow banking sector, insurance companies (and companies whose primary business is in an entirely different sector). Moreover many companies use financial instruments which are identical to those used by banks, so that attempt could lead to different accounting for similar financial instruments. A better solution is to improve accounting standards for these instruments wherever they are being used. — However, where banks may be different is in the need to improve the flow of relevant information to their investors, thus enhancing their understanding of banks’ performance and hence willingness to invest. This can, of course, be achieved through mechanisms other than accounting standards. — A key area of concern has been the “going concern” process. The FRC asked Lord Sharman to review the guidance to directors on going concern, liquidity and solvency. Certain of his recommendations, on which we will shortly consult, are specifically relevant to banks. The extra disclosures he proposes are narrative in form, and require greater analysis of risks to going concern over a longer period than required by accounting standards. We believe this should encourage a longer-term focus on solvency and liquidity. — We also gave evidence to the Financial Stability Board’s Enhanced Disclosure Taskforce (which included 10 investor groups) as to improvements that could be made in the context of a disclosure framework that provides better and more relevant information for banks’ investors.

Q—What does a “true and fair view” really represent to the market? Is it delivering what it is meant to? How far do you think the FRC’s proposals on disclosure go in terms of bridging the information gap between a bank and its stakeholders, and to what extent will this help present a “true and fair view”? — As we sought to clarify in the FRC’s July 2011 paper, “True and Fair”,186 this concept is not something that should be seen as a separate add-on to accounting standards but as their essence. So, in the vast majority of cases, compliance with accounting standards should result in a true and fair view. Disagreement with a particular standard does not, on its own, provide grounds for departing from it. And, in the past, under UK GAAP, almost all true and fair overrides were of law rather than of a standard. — There are instances, as discussed above, where accounting standards clearly address an issue, but the answer does not seem to accord with common sense. Fuller disclosure can be used to address exceptional examples of this, and indeed has been used to deal with more general issues that arise with standards. For example, many companies have added information on—for example—the effect of stripping out fair value movements on their own debt, an IFRS issue referred to above. — However, it remains the case, clearly stated under IFRS (under IAS 1) that where directors and auditors do not believe that following a particular accounting policy will give a true and fair view they are legally required to adopt a more appropriate policy, even if this requires a departure from the standard. These circumstances are more likely to arise where the precise circumstances are not covered by a relevant standard.

Q—The Sharman Report suggested (paragraph 209) that there might be a need for a more prudent approach to the assessment of asset values in banks. Do you consider there is a need for this and if so, what are your views on how this “more prudent approach” should work? — The FRC will consult shortly on the Sharman recommendations, including: (a) a focus on both solvency and liquidity risks to going concern; (b) “the need for a more prudent approach to the assessment of asset values than the normal accounting basis in assessing solvency risks” (and a particularly prudent approach to the assessment of bank solvency); and (c) the introduction of stress tests in relation to both solvency and liquidity risks, undertaken with an appropriate degree of prudence. — The Panel’s recommendation is very different from simply changing the accounting standards to reintroduce greater prudence in the measurement and recognition of assets and liabilities. However (as noted above) we do believe there should be a greater emphasis on prudence in the IASB’s conceptual framework. 186 The FRC paper “True and Fair” can be obtained from the FRC’s website here http://www.frc.org.uk/FRC-Documents/FRC/ Paper-True-and-Fair.aspx cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 1023

Q—Should the audit framework be enhanced so that auditors can better express views on governance and banking standards? If so, what changes are required? — Since the financial crisis, the FRC has taken several steps to improve the audit framework, and audit reporting. — The initiatives that have been, or that will shortly have been, implemented that are most pertinent to this question include: — The extension of the scope of FRC’s audit quality work to cover all bank and building society audits, and the inclusion of an overview of the findings from inspections of bank audits in the FRC’s annual report; — Changes in connection with the Sharman Review recommendations; — Changes in the Corporate Governance Code, issued at the end of September; and — Regular meetings with the FSA to share information on audit quality. — The FRC is responsible for reviewing audits on a regular basis. The findings of our reviews indicate that improvements still need to be made to improve audit quality, but we hope that the steps we have taken will help to stimulate such improvements. — We are proposing further changes to the framework to implement Lord Sharman’s recommendations (discussed above), notably a requirement on auditors to report if the directors’ going concern assessment is inconsistent with the auditors’ knowledge of the business. — A number of initiatives (further described below) have been, or will shortly have been, implemented for companies that apply the UK Corporate Governance Code. These initiatives have been developed to enhance the auditor’s ability to express views about such matters to the Audit Committee and to ensure, if they believe it is appropriate, that those views are disclosed (either in the annual report or in their auditor’s report). — We believe these changes now need to be given time to take effect before we can assess their impact on the effect of the audit process. — It should however be noted that these initiatives apply to listed UK banks. It is for the FSA to determine whether and to what extent these requirements should be applied to other UK banks. — Moreover, these initiatives are based on the current scope of the audit, which is primarily directed towards obtaining assurance that the financial statements are free from material misstatements, whether due to fraud or error. So we will continue to analyse public policy concerns arising from the crisis, to assess whether any more fundamental changes are needed to align the auditor’s role with public expectations. In doing so, we will consider whether such changes should be implemented through auditing standards or would require regulatory or legislative changes. The Corporate Governance Code — In the 2010 version of the UK Corporate Governance Code (the Code), we introduced the proposition that the company’s business model should be explained and that the company’s board should be responsible for determining the nature and extent of the significant risks it was willing to take. — In the 2012 version boards are requested to confirm that the annual report and accounts taken as a whole are fair, balanced and understandable. This version also calls on boards to include in the annual report a separate section describing the work of the audit committee, including a description of the significant issues the audit committee considered in relation to the financial statements, and how they were addressed. In developing these disclosures, the audit committee is expected to have regard to the matters communicated to it by the auditor. — Changes to the Auditing Standards support these changes to the Code, by expanding the nature and extent of the communications to be provided by auditors to Audit Committees. These changes are intended to refocus the auditor on providing the committee with the insights about the company arising from the audit. — The Auditing Standards have also been revised to require auditors to report if they believe that the board’s statement that the annual report is fair, balanced and understandable is inconsistent with the knowledge acquired by the auditor in the course of performing the audit, and to include any information communicated by the auditor to the audit committee, that has not been, but in the auditor’s judgement should have been, disclosed by the board in the annual report. — These are significant changes that the FRC hopes will stimulate better disclosures by companies (including banks) through the constructive tension that results from giving auditors the responsibility to report publicly if they are not satisfied that the directors have fully met their reporting responsibilities. An important feature of this approach is, in our view, that the directors’ primary responsibility for reporting is not undermined unless they do not fulfil their responsibilities. This also provides the auditor with a much more proportionate and credible sanction than the nuclear option of qualifying the audit report. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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Q—What are your views on the current level of dialogue between bank auditors and supervisors on banking standards and organisational culture? Do you think there is a need for a “safe environment” in which auditors and regulatory authorities can share confidential information and concerns? — We believe that this question would be most appropriately directed towards the FSA since they have actual experience of the dialogue between bank auditors and supervisors. However, our impressions are that the levels of such dialogue have improved. We are not able to comment on the extent to which that dialogue addresses banking standards and organisational culture. However, we do consider that the Code of Practice for auditors and supervisors appropriately addresses the need for such dialogue. — This Code was developed in response to concerns expressed in the joint discussion paper that we issued in 2010 with the FSA to consult on the issues that we each observed from our work with auditors and to determine how to enhance the contribution of auditors to prudential regulation in the future. The Code of Practice was developed by the FSA with our input, alongside the Bank of England, to enhance dialogue between auditors and supervisors. — The Financial Services and Markets Bill already includes arrangements that should enable auditors to share confidential information and concerns with the supervisory authorities. Auditors of a UK bank will have both a right and a duty to disclose matters relevant to the functions of the FSA, and protection where they do so in good faith. — The FRC’s Audit Practice Note 19, which provides guidance to auditors on areas identified by the FSA where particularly close consideration should be given as to whether the duty to report arises. 29 November 2012

Written evidence from the Financial Services Consumer Panel

ExecutiveSummary

1. The Panel feels there is an urgent need to address failures in the UK banking industry. We have witnessed how consumers and smaller businesses have suffered detriment as a result of numerous banking scandals. This has undermined conﬁdence in an industry which fulﬁls an essential role in society.

2. We think this Parliamentary inquiry into the banking sector is long overdue and has the potential to deliver positive change. The inquiry covers a very broad range of topics. In our response we have focused on the UK retail banking sector, as this is the area on which we are best placed to provide comments.

3. It is worth remembering that the FSA took on the conduct regulation of retail deposits in November 2009 when it was apparent that industry self-regulation was not working. At this time, the retail banking sector had problems with maintaining standards and, despite the efforts of the FSA, continues to do so.

4. Since the introduction of the FSA’s regulatory regime, we have seen ﬁrst-hand how the industry has questioned the interpretation of FSA rules and the key principles which underpin them. This suggests retail banks still fail to appreciate their responsibility to their customers and the corporate responsibility of large organisations. Beyond the well publicised mis-selling scandals, there are numerous examples where banks are failing to treat their customers fairly by, for example, failing to meet basic standards designed to protect consumers.

5. The Panel believes this Parliamentary Commission presents a unique opportunity to deliver reform which would ensure banks can provide a systemically important service, in a competitive environment, that meets the needs of their customers. To achieve this, we believe a number of steps should be taken: — All banking executives should be required to meet professional and ethical standards set by a respected professional standards institution. Where standards are not met, there should be a mechanism for imposing appropriate sanctions with individuals held to account. — The Financial Services Bill should do more to increase consumer protection by requiring banks, and other providers, to have a duty of care to their customers. The new Financial Conduct Authority (FCA) should also be empowered to consider the effect of its actions, and the actions of the industry, on consumers’ ability to access ﬁnancial services. — The Government and regulator should address market failures, which prevent effective competition, in order to create a dynamic retail banking sector which delivers good value and truly operates in consumers’ best interests. — This Parliamentary Commission should develop a vision for the future retail banking market, to ensure the technology based services currently being made available function in the best interests of consumers. This is important to avoid repeating today’s failures. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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Q1. To what extent are professional standards in UK banking absent or defective? How does this compare to (a) other leading markets (b) other professions and (c) the historic experience of the UK and its place in global markets? 6. The Panel has long been concerned by apparently low levels of professionalism and poor corporate culture in UK banking institutions. This has been evidenced recently by the LIBOR scandal and the widespread mis- selling of interest rate swaps by a number of banks. 7. The poor professional standards of UK banks are not a new development, but have plagued the industry for some time. The widespread mis-selling of Payment Protection Insurance (PPI) to a large number of consumers is the most striking example. After years of mis-selling these products and challenging the regulators, banks are finally compensating their customers, at huge cost to the industry. According to data from the Financial Services Authority (FSA), in June 2012 £5.4 billion had been paid out in redress since the start of 2011, yet there is still no noticeable reduction in the number of people complaining about the way this product was sold.187 Indeed, we have seen a number of banks increase their provisions to meet the cost of future PPI complaints.188 8. Further evidence of the poor standards of UK banks is that 1.6 million customers had reason to complain to their bank in 2011 (this figure excludes the significant volume of PPI complaints also received by banks).189 In the second half of 2011 65% of these complaints were upheld in the customer’s favour, a rate which is significantly higher than all other financial services sectors. 9. In contrast to the banking industry, the investment advice sector has made a significant commitment to increasing professionalism as part of the Retail Distribution Review (RDR). Like the banking sector, the investment industry has been guilty of mis-selling products. Its commitment to increasing professionalism should, in the longer-term, benefit consumers and increase trust in the industry. 10. The level of professionalism in the banking industry also compares poorly to other sectors, such as the legal and accounting professions. All lawyers and accountants complete years of training and examinations before qualifying. The importance of ethical standards in maintaining trust in the profession is impressed on all trainees. Once qualified, an individual faces significant penalties if they fail to meet the required ethical standards, with the threat of being banned from practicing or sent to prison highlighting the importance attached to maintaining professionalism in these sectors. 11. In contrast, the Chartered Banker Institute is the only remaining banking institute in the UK.190 As an independent professional education body it has a statutory duty to work in the public’s interest and is focused on raising standards across the sector. However, it currently has just 9,000 members, of which 4,000 hold the highest level of qualification. This reflects the fact there is no mandatory qualification requirement for bankers and membership of a professional body is not compulsory. 12. As we have outlined in paragraphs 17 to 21, we believe there should be mandatory professional and ethical standards for bankers who exercise control, leadership or a significant management function within a UK banking institution. This can only be beneficial in improving trust in UK banking and its position in global markets.

Q2. What have been the consequences of the above for (a) consumers, both retail and wholesale, and (b) the economy as a whole? And Q3. What have been the consequences of any problems identiﬁed in question 1 for public trust and in, and expectations of, the banking sector? 13. The Panel is concerned that the apparent low level of professionalism within the banking sector has been costly and damaging for a large number of consumers and destroyed signiﬁcant shareholder value. This is seen most noticeably with the PPI mis-selling scandal we highlighted in our response to question 1, but also in the apparent lack of responsibility when offering sub-prime mortgages. We would be happy to share a fuller list of poor banking practices with the Commission if it would be helpful. 14. The poor practices amongst retail banks have also disadvantaged smaller businesses. This is seen most noticeably with the mis-selling of interest rate swaps where a recent FSA review “found a number of cases of bad practice, including the possible mis-selling”.191 Although a number of the UK’s largest retail banks will 187 Financial Services Authority’s month PPI refund and compensation statistics see http://www.fsa.gov.uk/consumerinformation/ product_news/insurance/payment_protection_insurance_/latest/monthly-ppi-payouts 188 See, for example, Lloyds Banking Group 2012 half-year results—http://www.lloydsbankinggroup.com/media/pdfs/investors/ 2012/2012_LBG_HalfYear_Results.pdf and RBS 2012 half-year results—http://www.investors.rbs.com/download/ announcements/Interim_Results_2012.pdf 189 FSA aggregated complaints statistics 2006–2011 see http://www.fsa.gov.uk/library/other_publications/commentary/aggregate_ com 190 See http://www.charteredbanker.com/home/ 191 Financial Services Authority, Information on interest hedging products, July 2012 see http://www.fsa.gov.uk/library/other_ publications/interest-rate-swaps/interest-rate-products cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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be undertaking a past business review, this mis-selling threatens the survival of some of the UK’s smaller businesses, a key sector for future economic growth.192 15. The Panel feels the seriousness of the detriment experienced by many banking customers should not be underestimated. Holding and operating a bank account has become essential to participating in a modern society. For many consumers this has left them vulnerable to poor practices. Unsurprisingly, the inconvenience and disadvantage felt by many banking customers has led to worryingly low levels of trust in UK banks. This is highlighted by a number of market studies, including a 2011 Accenture survey of nearly 4,000 current account customers which found that only 45% of people trusted their bank.193

And Q5. What can and should be done to address any weaknesses identiﬁed? To what extent are such weaknesses subject to remedial corporate, regulatory or legislative action, domestically or internationally? 16. The Panel believes all the factors set out in question 4 contributed to the poor practices and failures in the UK banking industry. As we outlined in our response to earlier questions, the apparent low level of professional standards and inappropriate culture within UK banking institutions has directly led to consumer detriment in the retail market and undermined conﬁdence in the sector. 17. The Panel believes many of the problems could be tackled by: establishing mandatory professional and ethical standards for senior executives; and enhancing effective competition, particularly within the Personal Current Account (PCA) market.

Establishing mandatory professional and ethical standards for senior banking executives 18. Given the socially important role the banking industry plays in the UK, we believe executives and senior managers that run UK banks should be required to meet mandatory professional and ethical standards. The establishment of professional societies has been the tried and tested way of maintaining professionalism in numerous industries across the world. 192 Barclays, HSBC, Lloyds, RBS, Allied Irish Bank (UK), Bank of Ireland, Clydesdale and Yorkshire banks (part of the National Australia Group (Europe)), Co-operative Bank, Northern Bank and Santander UK will all be reviewing their sales of interest rate swaps. 193 Survey was undertaken in October 2011 see http://www.accenture.com/SiteCollectionDocuments/Local_UK/Accenture- Restoring-The-Relevance-Of-Relationship-Banking.pdf cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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19. Institutions like the General Medical Council, the Law Society and the Institute of Chartered Accountants play a crucial role in establishing and monitoring the professionalism of their members. Key to the success of this model is a statute based, self-contained disciplinary system. Any individual that fails to comply with the requirements set by their professional society can be struck off the register and is unable to fulfil a similar role in the future. Furthermore, where evidence of deliberate abuse of standards or neglect of position has been identified, this is punishable through the criminal justice system. Employing a similar system for UK banking executives will increase personal accountability of senior managers. There is a strong case for all professional bodies in the financial services area being established on a statutory, or quasi-statutory, footing as for doctors or accountants. 20. We recognise that many banks operate in-house training centres for their staff and will feel it is unnecessary and expensive to subscribe to professional examinations. However, as Professor John Kay outlined in the FT in February 2009, there is a big difference between company training programmes and professional education: “Company training reinforces the culture of an organisation: professional education emphasises a historical and social context. The bond salesman asks whether a new product will be profitable for him and his bank: the doctor asks whether a new treatment will be beneficial to his patient. In the most trusted profession, medicine, the quality of education is clearly the responsibility of medical schools rather than medical employers.”194 21. The Panel believes the introduction and maintenance of ethical standards will benefit consumers by ensuring banks are being honest and open with them. Customers will have confidence that a bank will only try to sell a product which truly meets their needs, with any conflicts of interests properly explained so they can make an informed decision. Reward and remuneration structures employed within banks would also be aligned with the best interests of the customer, rather than encouraging product sales at any cost. This will change the dynamic of the UK retail banking industry

Enhance competition, particularly in the PCA market 22. The Panel recognises that, for a bank to be successful, it needs to take appropriate risks. However, the risks currently taken by banks appear to focus on circumventing rules and regulations rather than developing innovative propositions in the interests of their customers that will help the banks be more successful in a competitive market. Furthermore, individuals are incentivised to take excessive and inappropriate risks, with failures seemingly going unpunished. Much of this is caused by poor corporate culture within retail banks, but also by ineffective competition. 23. The Panel has expressed concern about ineffective competition in the UK retail banking market for some time. We have witnessed how this has created stagnation in the PCA market, which in turn has led to a number of poor consumer outcomes. We have set these out in detail in a report published by the Panel in March 2012.195 24. The Panel believes ineffective competition in the UK retail banking market has driven many of the failures identified in our response to earlier questions. The Panel would like to see the Government and regulator take forward five important steps to encourage competition and create a dynamic market which truly operates in consumers’ best interests: — remove opaque charging by requiring transparency on the true cost of different banking services; — empower consumers to shop around much more and switch their bank account provider without any hurdles or delays; — tackle inappropriate cross-subsidisation within retail banking at the expense of financially vulnerable consumers; — bring an end to inappropriate incentive structures which reward one-off sales and short-termism, rather than developing long-term customer relationships; and — make it easier for new competitors to enter the retail banking market in order to increase consumer choice.

Ev 1028 Parliamentary Commission on Banking Standards: Evidence

not sufficiently enhance consumer protection standards as originally intended or tackle failures in the banking sector. 26. Historically, customers could trust their bank managers to act in their best interest. This is no longer the case, with the recent banking scandals damaging consumers’ trust in the industry. Although the Bill requires firms to give consumers an appropriate level of care and provide accurate and timely information, we do not feel these requirements go far enough to truly protect consumers’ interests. Indeed the Bill requires consumers to “take responsibility for their decisions” without placing a corresponding requirement on firms to act in the best interests of their client. 27. The Panel believes the Bill should require banks, and other financial institutions, to have a duty of care to their customers. This would require banks to act honestly, fairly and professionally in the best interests of their customers and to manage any conflicts of interest.196 Both requirements are already included in the FSA’s principles for business, yet consumers have still been subjected to poor practices by banks as these do not have sufficient prominence.197 28. The Panel believes that promoting a duty of care requirement to the face of the Bill will signal a clear message from Parliament that it is no longer acceptable for a bank to unfairly profit at the expense of its customers. Appropriate enforcement of this duty by the FCA, would help rebuild consumer trust. 29. Given that access to retail banking services has become an essential part of participating in a modern society, any inappropriate restrictions on consumer access could have a significant impact on certain groups. The FSA has been unable to look into the Panel’s concerns on restrictions being introduced by some banks to limit access to cash machines for consumers with basic bank accounts, or wider restrictions on consumers’ ability to access transactional services, due to the limitations set by statute. The Panel therefore firmly believes the Bill should empower the FCA to have regard to consumers’ ability to access services and products which are affordable and appropriate to their needs.198

The Government’s banking reform proposals 30. The Panel supports the Government’s intention to protect retail banking services from shocks in the financial system. However, we feel the Government should revisit the Independent Commission on Banking’s (ICB) ring-fencing recommendations in the light of recent banking scandals. It should consider whether greater separation of retail and wholesale/investment banking services, than currently proposed by the Government, would better protect consumers. The Panel feels the disadvantages of full separation identified by the ICB may now be overstated.199 31. The Panel also thinks the Government should be seeking to introduce the proposed banking reforms sooner than the 2019 deadline. We feel it would be prudent to proceed with reforming the UK banking sector as quickly as possible to ensure it is well placed to survive any further shocks in the global financial system.

The regulators 32. We believe the Government’s banking reform proposals underestimate the significant changes which are needed in the retail banking sector to increase competition. For example, the Government has cited the sale of Northern Rock plc to Virgin Money as an “important step forward in encouraging new entrants to the banking sector”.200 In reality, the products offered by the two institutions have been merged and provided under the Virgin Money brand. The Panel does not feel this represents an increase in competition or consumer choice as suggested by the white paper. 33. As we have outlined in paragraphs 22 to 24, we believe the regulator, working with the Government, should urgently take forward five important steps to increase competition in the UK retail banking market. These steps are important to ensure UK retail banks compete fairly for business based on price and service standards, leading to better consumer outcomes. 196 The Panel has proposed a number of amendments in relation to duty of care: Adding two sub-clauses to 3B(1) to read (Clause 5, p.29, line 15): “(g) the principle that, where appropriate, authorised persons should act honestly, fairly and professionally in accordance with the best interests of consumers who are their clients” “(h) the principle that, where appropriate, authorised persons should manage conflicts of interest fairly, both between itself and its clients and between clients” and amending 1C(2) to read (Clause 5 p17 line 2): (e) the general principle that those providing regulated financial services should be expected to provide consumers with a level of care that is appropriate having regard to the degree of risk involved in relation to the investment or other transaction and the capabilities of the consumer in question, having regard to the general duty to provide those services honestly, fairly and professionally in accordance with the best interests of the consumers in question. 197 See the FSA’s principles for business: http://fsahandbook.info/FSA/html/handbook/PRIN/2/1 198 The Panel has proposed the following amendment to the Financial Services Bill: Adding a sub-clause to 1B(5) to read (Clause 5, p.16, line 15): “(c) the ease with which consumers can have access to financial services and products which are affordable and appropriate to their needs”. 199 Independent Commission on Banking, Final report: Recommendations, September 2011 see http://bankingcommission.s3.amazonaws.com/wp-content/uploads/2010/07/ICB-Final-Report.pdf 200 HMT & BIS, Banking reform: Delivering stability and supporting a sustainable economy, June 2012 cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 1029

Q7. What other matters should the Commission take into account? 34. The Panel is aware of a number of technology based banking services which are currently under development, including by firms not typically associated with providing day-to-day banking services. This includes the o2 wallet and PayPal inStore app which appear to replicate the services provided by a PCA.201 The emergence of near-field communications is also changing the way consumers pay for items through the contactless payment systems offered by some banking institutions. 35. These services could be beneficial to consumers, by improving competition and service, but there will also be risks. The Panel believes the Commission should consider how the introduction of technology-based banking services should be regulated, to avoid replicating the current market failures. For example, these services could have an adverse affect on people without access to, or the ability to use, technology-based services. This could lead to an increase in the number of excluded consumers. As the Payments Council cheque debacle has demonstrated, the removal of “traditional” transaction services in favour of new technological developments is not necessarily in the best interests of all consumers.202 36. We also suggest that the Commission considers the role of Credit Unions in the retail banking landscape. Credit Unions offer an alternative banking model which is popular in a number of European countries including Ireland. These Unions typically operate at a local level and many focus on providing a good customer service. Credit Unions have the potential to offer an attractive alternative to the traditional banking model but only if there is effective competition regulation in the UK retail banking market that enables them to compete with established banks.

Annex THE FINANCIAL SERVICES CONSUMER PANEL The Panel is an independent statutory body, set up to represent the interests of consumers in the development of policy for the regulation of financial services. It works to advise and challenge the FSA from the earliest stages of its policy development to ensure the latter takes into account the consumer interest. The Panel also takes a keen interest in broader issues for consumers in financial services where it believes it can help achieve beneficial change/outcomes for consumers. Since the Panel was established in 1998, we believe it has helped deliver significant, positive benefits for consumers. We support the FSA where we believe policies can help consumers and challenge the FSA forcefully when we feel consumers would be disadvantaged. Members of the Panel are recruited through a process of open competition and encompass a broad range of relevant expertise and experience. There are sixteen members of the Consumer Panel, including the Chair Adam Phillips and Vice Chair Kay Blair. Current members have experience of consumer advice, campaigning, communications, market research, journalism, the law, financial services industry, financial inclusion, European issues, financial regulation and compliance and later life issues. Further information is available on the Panel’s website; http://www.fs-cp.org.uk 24 August 2012

Written evidence from Financial Services Practitioner Panel ExecutiveSummary 1. We welcome the Parliamentary Commission on banking standards’ (“Commission”) inquiry and the Practitioner Panel is keen to contribute to transformational change in the sector. However, we think that the central issue is not a lack of professional standards, but rather one of “cultural imbalance” that has arisen in some parts of financial services over time. 2. We see three hypotheses running through the current questioning: (i) is the problem a lack of technical expertise? (ii) are there clearly defined standards of behaviour and ethics in banking? and/or; (iii) are there credible sanctions for failing to adhere to (i) and (ii) above? 3. We argue that there is sufficient technical expertise in banking, that ethical standards are clearly defined and that the sanction regime for non-adherence is strong (and improving). However, we accept that despite this, significant sections of the financial services industry have failed to adhere to these standards. We believe that the issues are cultural. 201 See http://www.o2.co.uk/money/wallet and https://www.paypal-marketing.co.uk/instore/ 202 The intervention of the Treasury Committee and widespread condemnation forced the Payments Council to reverse a decision to withdraw the use of cheques from the UK payments industry see http://www.parliament.uk/business/committees/committees- a-z/commons-select/treasury-committee/inquiries1/parliament-2010/cheques cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

Ev 1030 Parliamentary Commission on Banking Standards: Evidence

4. Specifically, we believe that the issues that have been occurring in the Financial Services sector are the result of some deficiencies in banking culture that have arisen as a result of the imbalanced pressures that have been exerted on the sector in recent years. 5. Successful banking involves balancing the often competing demands of (primarily) customers, shareholders and practitioners over time. Traditionally, these demands have been held in balance, enabling sustainable returns to each. 6. Historically, the “bond” between practitioner and customer was the strongest of the relationships—formed through an era of “face to face” banking and markets, underpinned by personal and human relationships. Technology, the internet and the “big bang” of the 1980s have progressively distanced the practitioner of financial services from the end consumer. This “depersonalisation” has eroded the historical bond and hence weakened the influence of the end consumer in the decision making of large organisations. 7. At the same time that the customer’s voice has become more removed from the decision maker, the pressure of the shareholder has (by default) become greater. This has created an imbalance within the culture of some financial institutions, which some management teams have failed to correct. The cultural imbalance has led to suboptimal outcomes all round in recent years. 8. The solution cannot be to return to face to face banking—most customers do not want this, and it would be unsustainable for banks to attempt to deliver it. Rather, the central challenge is how do we create a culture where people running banks deeply and thoughtfully consider the outcome of their actions on their customers and the broader community, while still delivering an attractive return for shareholders? The specific change is to seek to embed a culture that is highly considerate of the human impact of decisions, in an environment where the customer may be “out of sight”, and hence “out of mind”. 9. It is the belief of the Practitioner Panel that culture can be measured, regulated and steered in a certain direction. We have examples to support this which we would be happy to provide. We believe that regulators and policymakers should seek to incentivise positive cultural change in this specific direction. 10. We feel that this inquiry and further consideration of the issues can provide a real opportunity to improve the reputation of UK practitioners.

Introduction 11. The Financial Services Practitioner Panel (“the Panel”) was set up under the Financial Services and Markets Act to represent the interests of regulated firms in the work of the Financial Services Authority (“FSA”). It consists of approximately 10 members drawn from a cross section of the larger regulated firms. The Chairman of the Smaller Businesses Panel sits on the Practitioner Panel to ensure that the interests of smaller firms are also considered. 12. The Panel very much supports and welcomes this Parliamentary Inquiry into banking standards and, in particular, believes that the Commission has properly set the tone in trying to identify and find solutions to the underlying problems for the banking industry. We feel that this is a refreshing approach to consider the issues, in addition to looking at the technical regulatory solutions to issues in the banking sector. Although the Government and FSA’s proposals are of great importance, we feel that one of the unaddressed central issues is an emerging cultural imbalance that has arisen in some of financial services over time. This inquiry provides a real opportunity for the banking industry and policymakers to address this imbalance.

Questions Q1. To what extent are professional standards in UK banking absent or defective? How does this compare to (a) other leading markets (b) other professions and (c) the historic experience of the UK and its place in global markets? 13. In the Commission’s first question, we see three elements which need to be addressed. The first is one of technical expertise—do we believe that there is a lack of technical expertise, training, skills or understanding among practitioners holding various roles (front line staff to senior management) in UK banks? The second is whether there are clearly defined standards for practitioners—are there clearly defined standards of behaviour and ethics that practitioners are subject to? And third, where there are failings or lack of adherence in relation to either a lack of expertise or standards of behaviour, are there credible sanctions and deterrents in place? 14. We believe that levels of technical expertise in banking are high and that the majority of staff are well trained for their roles, are knowledgeable about their markets and products and have the necessary skills to undertake their jobs. The FSA’s work as part of the Retail Distribution Review (RDR) to improve the level of knowledge, skill and professional standards of retail investment advisers, has been an important step in ensuring that consumers can be sure they are receiving advice from knowledgeable professionals. The RDR has also strengthened the statements of principle in the Approved Persons Regime which now place more emphasise on personal accountability. As well as being trained to take on their positions, practitioners generally undertake ongoing continued professional development and there are a range of courses available for practitioners to keep skills and knowledge up to date. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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15. Generally, we believe that the banking industry is staffed by a large majority of hardworking individuals who bring high levels of professionalism to their work and are well trained for the wide range of roles banking entails in both the retail and wholesale markets. However, there are a number of banking professionals who have failed to meet the expected level of professional ethical standards in their work. 16. UK banks operate under high levels of professional standards and regulatory rules, which set the expectations for the industry. Professional standards exist principally in the form of the FSA’s Principles for Business, set out at PRIN 2.1 in the FSA Handbook. These principles apply to all regulated financial firms and consider strong ethical requirements such as the requirement to act with integrity and to treat customers fairly. These principles are very similar to the well respected professional standards in other professions, such as the 10 principles of good conduct for solicitors contained within the Solicitor’s Regulation Authority’s (SRA) Handbook and the Hippocratic Oath for doctors. Practitioners are also subject to a number of other professional standards including: — Requirements and responsibilities of directors under Part 10 of the Companies Act 2006 (eg, the duty to promote the long term success of the company and to consider the impact of the company’s operations on the community and the environment); — Rules governing the type of person that can be an “approved person” holding a significant influence function (CEO, Director, compliance oversight, etc.) at banks. For large institutions, these are often now subject to an interview process by the FSA to ensure parties have sufficient knowledge and skill to perform their functions and are suitable; — Training standards in the Training and Competence section of the FSA handbook; and — Standards set by professional bodies and organisations within the banking industry (eg, the Lending Standards Board). 17. Banking professionals also have a range of professional bodies which prescribe good practice, ethics and conduct, and offer training and awareness of these standards (eg, the Institute of Financial Services, Chartered Banker). 18. The FSA plays a similar role to the SRA for solicitors or the General Medical Council for doctors in upholding practitioner standards and preventing parties from acting in the profession should their standards slip. We feel that the FSA’s enforcement regime and practice in the years subsequent to the financial crisis have much improved and is a strong deterrent for those parties who fail to adhere to the FSA’s regulatory rules and principles. The FSA has strong enforcement powers to bring action (including criminal prosecutions) for breach of rules and principles, including holding individuals personally responsible for those breaches, and has increasingly sought to rely on breach of principles for enforcement action rather than breach of individual FSA handbook rules. We support a considered use of this approach and hope it will continue as the FSA transitions to the new regulatory bodies, the PRA and FCA. 19. The negative way in which banks are perceived in the news media often, in fact, overplays customers dissatisfaction with the banks and data shows that although complaints against banks are higher than they perhaps should be, this does not set them significantly ahead of other industries. The graph below (figure 1), prepared based on publicly available complaints data, provides an illustrative example of the level of complaints received by some of the larger UK banks compared to major players in other UK industries, such as energy and telecom. It shows bank customer complaints are comparable to insurance companies in terms of complaints, being generally lower than those against utility companies, but higher than telecom companies. 20. However, we concede that despite high levels of technical expertise, standards and strong regulatory enforcement, significant sections of the Financial Services industry have failed to adhere to proper professional standards. It is the view of the Panel that the reasons for this are cultural. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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Figure 1 RECORDED COMPLAINTS IN VARIOUS INDUSTRIES PER 1000 CUSTOMERS/ACCOUNTS

20 18.45 s

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e y y y y y y y y y k k k i e n n n n n n n n n n n n n n i a a a a a a a a a l a a a a r p p p p p p p p p i p B B B A m m m m m m m m m m o o o o o o o o o o c c c c c c C C C

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Complaints per 1,000 customers/ Industry Speciﬁc example1 accounts 1 Energy Company 1 2011 Npower reported complaints 18.45 2 Energy Company 2 2011 British Gas reported complaints 12.37 3 Energy Company 3 2011 E.ON Energy reported complaints 12.16 4 Water Companies 2009–10 OFWAT industry complaints per 6.4 1000 connections 5 Insurance company Tesco GI & Pure Protection insurance, 1 3.5 1 March 2011 to 31 August 2011 6 Insurance company Admiral Car insurance number of 3.04 2 complaints opened H1 2011 7 Bank 1 RBS H1 2011 complaints 3 8 Bank 2 HSBC H1 2011 complaints 2.8 9 Bank 3 Lloyd’s banking group H1 2011 complaints 1.7 10 Airline 1 Ryanair complaints in 2012 0.7 11 Broadband OFCOM complaints about TalkTalk (Oct— 0.61 company 1 Dec 2011) 12 Broadband OFCOM complaints about Sky Broadband 0.17 company 2 (Oct—Dec 2011) 13 Mobile Phones OFCOM complaints about Orange Mobile 0.17 company 1 (Oct—Dec 2011) 14 Mobile Phones OFCOM complaints about 3UK (Oct—Dec 0.15 company 2 2011) cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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Q4. What caused any problems in banking standards identified in question 1? 21. The Panel believes that the incidents of bad practice in the Financial Services sector are the result of the imbalanced pressures that have been exerted on the industry in recent years and the failure in some quarters to compensate for these changing pressures appropriately. Practitioners are subject to a number of influences, including: — Shareholders pressure for good returns on their equity investments on a consistent basis; — Customers seek good service, a wide range of conveniently delivered products and fair and competitive interest rates. — Practitioners are frequently incentivised at senior levels with reward closely allied to shareholder return—which further increases the shareholder pressure. — Politicians and media have recently exerted significant pressure on banks to make decisions that conflict with the pressure from shareholders (eg, agreeing to lending that they would not otherwise do) and — Regulators have lately been exerting pressure on banks which may also conflict with pressures of shareholders. (eg increasingly capital and tightening liquidity standards at a very rapid rate). 22. Successful banking involves balancing these competing interests. In the ideal scenario, engaged Practitioners meet the needs of their customers. The customers reward them with their loyalty. This loyalty results in strong profitable returns to the shareholder. In meeting the customers’ needs, the bank is also fulfilling its duty to the community that it also exists to serve. It is recognised that this balance is hard to find and that the interests of shareholders and customers can compete in the short term.

Figure 2 THE BALANCED INFLUENCES OF PRACTITIONERS

23. Historically, the bond between practitioners and customers was the strongest of the relationships. This resulted in part from practitioners’ face to face contact with those customers which led to the forming of personal and human relationships. This is often typiﬁed by the notion of the “golden age of banking”, with examples of the caring and friendly local bank managers who maintained long term relationships with customers. In the common notion of this set up, such managers got to know the personal circumstances of their customers and were able to exercise a large amount of discretion in making loans and extending credit. Such a personal service created the perception of care, which many people using the service valued highly. 24. Although we agree that this level of personal service was good for the customer, we believe these arrangements no longer meet the majority of customers needs, nor are cost effective to operate today. It is also questioned how conﬁdent we can be about the fairness or consistency of the personal discretion bank managers exercised in previous eras for all customers. It is possible that past banking relationships may be considered cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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unfair and inconsistent by today’s standards. The customer outcome may have depended more on the strength of the personal relationship, than the merits of the customer’s circumstances. 25. However, various factors have progressively distanced practitioners of ﬁnancial services from the end customer and have eroded the bond of trust between practitioner and customer. Customers inﬂuence over the decision making in (particularly) large organisations has been weakened as explained below.

Figure 3 THE IMBALANCED INFLUENCES OF PRACTITIONERS

26. The Panel feels that one of the key causes of this “depersonalisation” in the retail market has been the decline in human contact between bank practitioners and their customers through attendance at bank branches and personal telephone contact. Instead of meetings with bank managers and bank counter staff, customers are increasingly utilising communication technology to access bank services. Figure 4 (below) shows that between 2002 and 2009 we saw a marked jump in the preferred use of online banking, from around 10% use in 2002 to around 40% use in 2009. At the same time, we saw a 10% drop in the preference for face to face contact with banks at branches. Figure 5 (below) shows that industry experts expect this trend to continue in coming years, particularly with improvements in online banking and, for example, access to services using mobile phones. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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Figure 4 SURVEY OF CUSTOMERS PREFERRED METHOD FOR CONTACTING BANKS

Source: Monitise/The Future Foundation/nVision Research Base: 1,000 respondents aged 18+ UK

Figure 5 PERCENTAGE OF PEOPLE WHO DO AT LEAST PART OF THEIR BANKING VIA THE INTERNET— NVISION FORECAST, SUMMER 2010-BASED PROJECTION 100% Internet users (those using it at least once a 90% week) - forecast e-banking forecast 80% 70% e-banking - actual 60%

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27. While this data shows less personal contact in the retail banking market, we believe that a similar paradigm exists in the wholesale banking market. The so-called “big bang” in wholesale market trading of banks and investment firms of the 1980s took away the physical trading floors that relied on personal contact and relationships between the parties and introduced electronic exchanges and trading platforms. Interbank trades now take place almost anonymously via computer trading servers. Customers, who include institutional investors such as pension funds and insurers, are also increasingly able to take part in computerised trading in a number of markets. They are able to use bank trading interfaces available over the internet to place trades and take positions in the market. In the wholesale markets generally, a large proportion of trades are now placed via computer algorithm, instead of being placed over the telephone with a broker known to the customer. What was once the basic tenant of the London stock exchange “my word is my bond” is no longer given credence. As practitioners and customers no longer exchange so many words, fewer bonds can be created. 28. In both retail and wholesale markets, depersonalised, remote contact with banks has been affected for sound reasons and provides much greater efficiency and corresponds more closely to the majority of customers needs. Benefits such as 24/7 access to current account services, for example, are highly valued by customers who use these services. Consequently though, customers being “out of sight” will inevitably result in them to some extent being “out of mind”, especially when directors of large banking institutions are making decisions at the strategic level. 29. The weakened practitioner-customer bond has distanced the customer’s voice from decision making and the pressure of shareholders has by default become greater. The relationship of trust has also broken down on the customers’ side, which particularly became clear during the financial crisis. Prior to 2007, some banks made significant numbers of loans to customers beyond that which was prudent and which customers would be feasibly able to pay off (not understanding their customers’ circumstances). 30. Likewise, the increasingly remote relationship between customer and Practitioner has led some customers to act less responsibly in dealing with their financial services providers. For example, some customers took advantage of cheap credit and borrowed in excess of their ability to repay loans and mortgages while banks offered these. More recently, we have seen examples of some customers being encouraged to make claims (eg PPI or personal accident) against banks and insurers without regard to the full validity of their claims. 31. Some practitioners have managed to keep customers front of mind, and continue to deliver both solid returns and good customer outcomes despite these pressures. However, other management teams have failed to redress the imbalance within their organisations. The cultural imbalances in some banks have led to suboptimal outcomes for all parties and have resulted in forms of bad practice that are currently damaging the reputation of all UK banks and weakening the economy.

Q5. What can and should be done to address any weaknesses identified? 32. It is clear that the solution to the banking cultural imbalance is not to attempt to turn back the clock to purely face to face banking, or manually operated markets. Although some customers still find it useful or desirable to attend bank branches or speak to practitioners on the phone, a large and increasing number of customers place significant value in remote banking services. Further, attempts to re-instate personal bank managers for every customer would not be economically sustainable for banks. Likewise, Markets would not be viable if not operated by computer. 33. Rather, we believe the central challenge for the industry, regulators and policymakers is to consider how we create a culture where those people making decisions in financial institutions are deeply and thoughtfully considering the outcomes of their actions for customers and the broader community, while still delivering attractive returns for shareholders. We are convinced that if Financial Service Practitioners meet their customer needs, this will lead to superior economic returns over the long term. We do not see a conflict between these two pressures in the long term. 34. The Government and FSA have spent significant time since the 2007 financial crisis addressing many of the issues that contributed to the crisis. However, almost all the focus thus far has been on technical standards, rules and sanctions. For example, we note that in the HM Treasury June 2012 “Banking Reform” paper, which consults on the recommendations of the Independent Commission on Banking, there are 109 references to bank “capital”, yet only seven references to “behaviour” and one reference to “culture”. Policymakers must now further seek to address cultural imbalances. It is the belief of the Panel that culture can be measured, overseen and steered in a certain direction. We are aware of practice at some financial institutions where the culture of staff is measured and actively steered. It is possible to record and understand the degree to which people are considering the human impact of decisions as well as the profit impact. 35. We are happy to provide examples of how some organisations are defining, measuring and influencing their culture to deliver superior outcomes. 36. The FSA has attempted to make in-roads into the issue of culture in recent years, for example, as part of the “Treating Customers Fairly” (TCF) regime. While some believe that these efforts were not entirely successful, it is our belief that perhaps the FSA has further to go in seeking to address issues of culture. We believe that Regulators should consider how best to incentivise positive cultural change in banks. This must start by firms considering where they are currently imbalanced and progressing to a situation where all levels cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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of practitioners in a bank consider the human consequences in all of their decisions. The regulator faces particular challenge in incentivising this in a way that goes beyond mere “box ticking”, to become a thoughtful consideration of outcomes by staff at every step in decision making processes. One proactive step the FSA may take is to seek out good examples of culture and publicise and promote these as examples to other banks and regulated firms. 37. We also believe that the “tone from the top” is extremely important within any organisation. This is because culture inevitably reflects the ethos or philosophy of the leader to a degree. Hence, the character of leadership is particularly important in ensuring good cultural values are permeated throughout financial services firms. 38. We feel that this inquiry and further consideration of culture issues can provide a real opportunity to recover the reputation of UK banking practitioners, as well as improve the outcome for practitioners, shareholders, customers and the economy as a whole. The Panel stands ready to contribute to this important debate and assist the Commission is seeking workable solutions. 24 August 2012

References 1–3—http://www.dailymail.co.uk/news/article-2084919/Energy-bills-Millions-complain-charging-errors- inaccurate-meter-readings.html 4—http://www.ofwat.gov.uk/regulating/reporting/rpt_los_2009–10supinfo.pdf 5—http://www.tescobank.com/help/complaints-reporting.html 6—http://www.admiral.com/car-insurance/your-policy/complaint-performance.php 7—http://www.rbs.com/customers/complaints-data/the-royal-bank-of-scotland.html 8—http://www.hsbc.co.uk/1/2/personal/contact/complaints-and-compliments/complaints-data 9—http://www.lloydsbankinggroup.com/customers/complaints_H1_2011.asp 10—http://www.ryanair.com/en/news/ryanair-no-1-customer-service-stats-april-2012 11–14—http://consumers.ofcom.org.uk/2012/03/ofcom-publishes-latest-telecoms-complaints-data-3/

Written evidence from the Financial Services Authority 1. The establishment of the Parliamentary Commission on Banking Standards is a welcome opportunity to consider the full range of factors which have undermined trust in the UK banking system and to assess the measures that can be taken to improve standards and restore trust. We welcome this opportunity to submit this Memorandum which addresses several of the issues raised in the Parliamentary Commission’s Terms of Reference. We summarise here the key points from our Memorandum.

Declining trust andUnderlyingCharacteristics of theBankingSystem 2. We believe there are three reasons why trust in the UK banking system has declined: — First, the 2008 financial crisis has led to macroeconomic recession, unemployment and loss of income and wealth. As a result, people have come to doubt bankers’ competence and sense of responsibility. — Second, people have come to doubt bankers’ values and the recent LIBOR scandal has greatly reinforced this view. — Third, exploitative product sales, such as interest rate hedging products, have led many customers to doubt whether banks have their interests at heart. 3. In order to design effective policies to address these problems and restore trust, it is useful to recognise the three underlying characteristics of banking that differentiates it from other sectors: — The failure of banks can have consequences for the wider economy. — There is greater potential for customers to be exploited in financial services than in other sectors. — The inherent character of wholesale financial trading and sales activity often makes it very difficult to observe malpractice and therefore creates opportunities for it.

Measures inHandWhichWillHelpAddress theProblems 4. There are a series of measures that are already in hand that will help address these problems directly. Firstly, better prudential regulation and supervision will reduce the probability of bank failure and resulting macroeconomic harm. Second, the structural changes proposed by the Independent Commission on Banking (ICB) will both improve prudential soundness and create the potential for a change in culture and style which cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

Ev 1038 Parliamentary Commission on Banking Standards: Evidence

will help restore trust. Third, more effective conduct regulation and supervision, in both the retail and wholesale arenas, will seek to achieve earlier identiﬁcation of emerging problems, thus reducing both the likelihood and severity of mis-selling problems. The incentives based culture in banking, which has been an important factor in driving conduct failings, will be a key area of focus and robust enforcement action will also remain at the centre of our supervisory approach.

Addressing issues of personal accountability, responsibility and culture 5. Rebuilding trust in UK banking will also crucially depend on changes in culture and improvements in values. The leadership of banks have a vital role to play in addressing this by setting the tone from the top. However, given the consequences bank failure can have on the wider economy, there are strong arguments for ensuring that bank directors face different personal risk return trade-offs than those which apply to other sectors of the economy. These issues are considered in the Government’s July 2012 consultation paper on “Sanctions for the directors of failed banks”. The full range of options considered in this paper will no doubt form an important part of the Commission’s deliberations. We welcome the “rebuttable presumption” proposal that a director of a failed bank is not fit to hold another senior executive or Board position at another bank. The Commission may also wish to consider whether any further reform of senior level remuneration structures has a role to play in improving standards and restoring trust. 6. Effective supervision is also important in encouraging an appropriate culture in banks that is filtered from the top downwards. Drawing on the lessons set out in our RBS Report on board effectiveness, the Prudential Regulation Authority (PRA) will expect senior management and boards to have a strong focus on the safety and soundness of a firm, expecting the firm to have sufficient controls and appropriate incentives in place to minimise the dangers of excessive risk taking. Likewise, the Financial Conduct Authority (FCA) will consider whether firms’ governance arrangements are adequate to enable the firm to identify and manage conducts risks in both the retail and wholesale markets. It needs to be recognised, however, that a supervisor’s ability to assess true commitment to appropriate values is highly imperfect. The Commission may therefore wish to debate whether other levers, such as professional or ethical codes of conduct in banking for instance, are available to improve standards.

Achieving better outcomes through effective competition 7. Competition is less effective in financial services than in other sectors; that creates the rationale for regulation and influence. Asymmetries of information and knowledge between consumers and providers and the fact that infrequent purchases and barriers to switching reduce the ability of customers to exercise market discipline via consumer choice. It is, therefore, vital that public policy seeks to make competition and customer choice as effective as possible. One of the FCA’s new objectives will be to promote effective competition that benefits consumers. This means it will step in when uncompetitive practices result in consumers getting a poor deal. This new supervisory approach could involve, for example, requirements for easier transfer between providers. A toolkit of clearly defined competition powers is required to underpin this approach and we support the recommendation put forward by the Joint Committee on the draft Financial Services Bill that the FCA be given market investigation reference powers203. 8. These issues are explored in more detail in our full memorandum.

PARLIAMENTARY COMMISSION ON BANKING STANDARDS MEMORANDUM FROM THE FINANCIAL SERVICES AUTHORITY (FSA) 1. The establishment of the Parliamentary Commission on Banking Standards is a welcome opportunity to consider the full range of factors which have undermined trust in the UK banking system and to assess, in an integrated fashion, the measures which could be taken to improve standards and restore trust. We welcome the opportunity to submit this Memorandum which addresses several of the issues raised in the Parliamentary Commission’s Terms of Reference. We cover in turn: (a) The reasons why trust has declined; and the underlying characteristics of the banking system which have contributed to that decline. (b) Measures already in hand, in both prudential and conduct regulation and supervision, and via structural reform, which will help address the problems. We also identify here some speciﬁc cultural changes to the regulatory regime which will further enhance its effectiveness. (c) Issues of personal accountability, responsibility and culture, alongside public policy initiatives in this area. (d) Achieving better outcomes through effective competition.

(a) Declining trust and underlying characteristics of the banking system 2. The UK banking system plays a crucial role within our overall ﬁnancial system and within the economy. Cost effective provision of high quality payment, deposit taking, insurance and credit products and services to 203 Draft Financial Services Bill Joint Committee—First Report, paragraph 279 cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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household and business sectors is essential for a flourishing domestic economy. In addition, banking forms part of a UK wholesale financial services industry which provides services to the rest of the world, and which, as a result, creates income and employment in the UK. Many of the products and services sold are of high quality and there are many people working the industry who maintain high standards of integrity and professionalism. 3. It is clear, however, that trust in the banking system—in both its retail and wholesale aspects—has eroded and is now extremely low. We think it useful to distinguish three separate drivers of declining trust. 4. First, the financial and banking crisis of 2008 has led to macroeconomic recession, loss of income, wealth and unemployment. As a result, people have come to doubt bankers’ competence and sense of responsibility, and the economic benefits of increasing financial intensity and innovation. Before the crisis, people were told that many bankers merited very high pay because they were performing complex and important activities which contributed to increasing wealth. Now, and in many cases with good reason, they doubt that proposition. Part of the solution to restoring the trust must therefore be: — Policies that ensure that banking (and the wider financial system) do not induce instability, crisis and macroeconomic harm. — Policies which ensure that finance in future is focused on its valuable and essential activities, not on excessive risk taking or over complex product structuring of no value to society at large. 5. A second driver for declining trust is that people have come to doubt bankers’ values. The recent LIBOR scandal has greatly reinforced this view. While there is nothing new about dealing room culture, nor about market manipulation or insider dealing, what is new is that the sheer scale of financial activity has increased. Its share within the economy is much larger, and as a result, the potential size of corporate and personal benefit from malpractice has grown. 6. Third, direct household and SME experience of exploitative product sales, such as payment protection insurance (PPI) and interest rate hedging rate products, has led many customers to doubt whether banks have their interests at heart. 7. Policies to restore trust and raise standards need to address each of these three different dimensions. To design these policies effectively, it is useful also to identify the underlying characteristics of banking which create the potential for problems. Across all sectors of the economy, there could be opportunities for unethical or poor practice, for inferior quality product sales and for excessively high profit margins. But, in most sectors, we are able to rely on a combination of minimal regulation (eg. of product safety) plus the power of competitive forces, to limit any customer detriment. Financial services, but in particular banking, are different in three respects. 8. First, the failure of banks can have consequences for the wider economy which do no exist when a non- bank, such as a retailer or manufacturer, fails. This feature derives, in particular, from the role of banks as providers of credit and is to a significant extent specific to banks rather than financial institutions in general (though it also applies to some categories of shadow banking activity). As a result, as we argued in the FSA’s December 2011 report on the failure of RBS, society has an interest in ensuring that the executives and directors of banks make different decisions about the balance between risk and return than would be appropriate in other sectors of the economy204. This has implications both for: — appropriate prudential regulation and supervision (considered in section B below); and — incentives and sanctions which should apply to directors and executives of banks (considered in section C). 9. Second, there is greater potential for customers (in particular, but not exclusively, retail customers) to be exploited in financial services than in other sectors of the economy. This reflects (i) the asymmetry of information and sophistication between producers and consumers; (ii) the infrequency of purchase and the long lasting nature of some financial products; and, (iii) the barriers of inertia and of operational complexity which constrain customer switching between providers. Because of these features, customers are less well equipped to discipline providers through competitive choice than they are in other sectors of the economy. Furthermore, producers have greater potential to make excess profit through mis-selling, and greater temptation to develop business models designed to exploit those information asymmetries and switching costs. To overcome these problems requires some combination of: — Regulation and supervision to prevent the inappropriate design or sale of products. — Enforcement sanctions against exploitative mis-selling. — Culture change within banks so that boards and executives themselves voluntarily eschew opportunities for exploitation. — Reforms to make competitive forces and customer choice more effective. 204 Our Chairman’s foreword to the FSA Board Report into the Failure of RBS (2011) stated that: RBS management and Board undoubtedly made many decisions which, at least in retrospect were poor. They took risks which ultimately led to failure. But if they had taken similar risks in a non-bank company, the question of whether regulatory sanctions were applicable would not have arisen. That is because in non-bank companies the downside of poor decisions falls primarily on capital providers and in some cases on the workforce, and to a much less extent on the wider society. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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10. Each of these four dimensions of policy is likely to be important; the crucial issue is the balance between them. 11. Third, the inherent character of wholesale financial trading and sales activity—in which profits are earned as a result of very small margins applied to massive volumes—makes it often very difficult to observe malpractice; and therefore creates opportunities for it. The “swaps dealer” element of the LIBOR scandal illustrates both the temptation and the challenge for effective policy response. Minute manipulations of LIBOR submissions by single basis points—which would be almost impossible to spot on the basis of market data analysis—have the potential when applied to enormous derivative positions to deliver large potential profits for individual traders. This problem is, however, not specific to LIBOR, but generic to much wholesale trading and sales activity. Insider dealing and market manipulation are notoriously difficult to prevent or observe—the victims are dispersed and unaware they are exploited, and the ability to spot the manipulation from market observation is imperfect. Policies to overcome these challenges need to combine: — Supervision and market scrutiny processes which, as best possible, identify problems, while recognising a trade-off between cost of supervision and effectiveness. — Supervision focused on ensuring that banks have in place effective internal compliance functions, which will themselves spot and constrain abuse. — Forceful punishment of offenders, with exemplary sanctions seeking to compensate for low identification and conviction rates. — Fostering corporate cultures which impose ethical constraints on behaviour even if supervision and enforcement is inherently imperfect. 12. In the sections below, we consider some of the actions already in hand and those which could be considered in future, to overcome these problems.

(b) Measures already in hand or planned 13. Much of the responsibility for improving standards and restoring trust lies with the leadership of banks, and we address in section C issues relating to the incentives which directors and top executives face, to culture and professional standards, and to the supervision of culture and governance. But changes to regulation and supervision which address the problems directly (rather than through inﬂuence on culture and incentives) will also play a crucial role. In particular: — Better prudential regulation and supervision will reduce the probability of bank failure and of resulting macroeconomic harm. — The structural changes proposed by the Independent Commission on Banking (ICB) will both improve prudential soundness and create the potential for a change in culture and style which helps restore trust. — More effective conduct regulation and supervision, in both the retail and wholesale arenas, will seek to achieve earlier identiﬁcation of emerging problems, thus reducing the combined likelihood/severity of mis-selling problems.

Better prudential regulation and supervision 14. Effective prudential rules are an essential component of the regulatory structure. Ahead of the crisis, a flawed regulatory approach was marked across three areas: inadequate rules on bank capital and liquidity; failure to identify that credit and asset prices can be key drivers of instability; and institutional underlap between the Bank of England and the FSA. To a large extent, this has been rectified through the Basel III capital and liquidity standards; measures to ensure that all banks are resolvable; and the creation of the Financial Policy Committee (FPC), which will be responsible for deploying macro-prudential levers which can lean against excessive cycles in credit provision. 15. Crucially, this work will be supported by the supervisory approach of the Prudential Regulation Authority (PRA), which will build on the major reforms already introduced in the FSA over the last four years. Aligned with its safety and soundness objectives, the PRA role will be to make sure that firms are prudentially robust. The PRA will be forward-looking and judgement based, and will focus on those institutions and issues with the greatest potential impact on the stability of the UK financial system. Supervisors will intervene at an earlier stage, making judgements about current and future risks to a firm’s safety and soundness and about the action it should take to address these risks. Supervision will also be tailored to different firms and sectors; it will not be driven by a homogeneous approach but will vary according to risk. 16. Throughout the supervisory process, the PRA will engage with banks at a senior level, having conversations of a strategic nature, and holding information-gathering meetings, discussing analytical work and issuing detailed requests at a working level. 17. These changes to our prudential regulation and supervision framework aim to deliver a more stable system that people can trust by mitigating risk to our financial system at an earlier stage. However, this approach will need to be reinforced by changes in incentives and culture, which we will explore in section C. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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Structural change through ring-fencing 18. Structural reforms, such as those recommended by the ICB, will also play an important role in delivering a more stable system and may provide an opportunity to rebuild customer trust. 19. Requiring critical banking functions to be ring-fenced from other banking services will help to ensure the continuity of these functions, whilst reducing the extent to which the government will be forced to bail out universal banks in their entirety in the future. This should help minimise excessive risk-taking by reducing the implicit government subsidy and ensuring that funding costs more accurately reﬂect different risks on each side of the fence. 20. Increasing the loss absorbing capacity of ring-fenced banks (RFBs) should help to mitigate the risks of loss that these banks run. Ensuring that creditors can be bailed-in to bear losses in both RFBs and non- RFBs should also help impose greater market discipline on the banking sector and ensure that risk-taking is not excessive.

21. In addition to these concrete prudential impacts of the ICB reforms, it is also worth highlighting that the emergence of ring-fenced banks may itself offer a major opportunity to rebuild customer trust; signalling a strong focus on the high quality provision of basic retail and commercial banking products. Grasping this opportunity, however, is likely to depend on a commitment by the banks to meet not just the letter but also the spirit of the ICB’s proposals. If this is successful, it may address the problems created by the coexistence of investment and commercial banking cultures under one roof. This may have implications for the appropriate governance of ring-fenced entities, which the Parliamentary Commission may wish to consider.

More intense and effective conduct regulation 22. Since 2008, the FSA has strengthened its supervisory approach, seeking to identify emerging threats at an earlier stage. In respect to conduct issues, the Financial Conduct Authority (FCA) will build on and further develop this approach in at least five ways. — Earlier intervention to prevent the mis-selling of unsuitable products to retail consumers. — Continued and enhanced use of our “Approved Persons’ Regime” to ensure high standards of both competence and integrity. — A strong focus on the impact of sales incentives on behaviour and culture. — An increased focus on conduct in wholesale markets, where in the past the FSA did tend towards a “caveat emptor” approach. — Continued robust enforcement action. 23. Earlier intervention and consumer redress. The FCA will build on this approach and will make greater use of our existing and new powers to intervene earlier to prevent the mis-selling of unsuitable products, such as PPI. It will also place more emphasis, at an earlier stage, on securing redress where consumers have suffered harm. The FCA’s approach will be underpinned by a new framework for supervision which will focus much more clearly on the main drivers of conduct risk at the firm and include both firm-based assessments and comprehensive market, sectoral and product chain analysis. The intensity of the application of the framework will depend on the FCA’s categorisation of the regulated firms. 24. Approved Persons, competence and integrity. The supervisory framework will be reinforced by our Approved Persons’ Regime, which will continue to take a risk based approach to pre-approving individuals to “controlled functions”. These “controlled functions” are those which involve persons exercising significant influence on the conduct of a firm’s affairs or those dealing directly with a firm’s customers. We set out through our Statements of Principle and Code of Conduct for Approved Persons (APER)205, standards of conduct with which approved persons must comply. Many employees, from main board directors to retail investment advisers, are already caught by this regime. In the future, both the PRA and the FCA will have the power to specify significant influence functions. In addition, the FCA will be able to specify customer functions. 25. The justification for requiring prior approval of certain individuals is that they are in a position, should they lack skill or integrity, to do serious damage to either the interests of customers and/or to the firm itself. Whilst the existing list of functions is broad, we expect that both the PRA and FCA may wish to review these over time, and to review their codes of conduct and standards, not least to take account of the findings of this Parliamentary Commission. An example of this could be those who submit information which is used to calculate LIBOR. Such individuals are not engaging in “regulated activity” and are therefore outside of the existing Approved Persons’ Regime. The Wheatley Review206 is currently considering whether and how the regime ought to be brought to bear on LIBOR related activities. 26. Sales force incentives, behaviour and culture. A further area of ongoing focus for the FSA, which will carry on into the FCA, is the incentives based culture in banking. This has been an important factor in driving conduct failings. We recently carried out thematic work on financial incentives of in-house sales forces across a sample of firms and sectors, including a number of high street banks. We assessed whether the financial 205 http://fsahandbook.info/FSA/html/handbook/APER 206 http://hm-treasury.gov.uk/wheatley_review.htm cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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incentives increased the risk of inappropriate selling and whether these risks were adequately controlled. At an individual firm level we found a number of incentive schemes that significantly increased the level of risk, which was not being adequately mitigated. 27. We are now working on the next steps, including taking action against firms where appropriate. We are also considering if new rules or guidance are needed to prevent high risk incentives structures. While the focus of our thematic work to date has been on the risks associated with financial incentives, we recognise that sales staff will also be influenced by the broader culture of the firm and how senior management define what is expected of them through, for example, targets and performance management. We have taken enforcement action against several firms where their approach to performance management contributed towards consumer detriment. 28. Increased focus on wholesale market conduct. One area where we expect the FCA to have greater focus is the conduct in wholesale markets between wholesale participants. It will give more weight to the fact that in many wholesale relationships there is likely to be a retail consumer at the end of the transaction chain and therefore recognise that what are, at first glance, activities involving wholesale participants often do matter to retail consumers. The FCA approach will recognise that poor wholesale conduct is not a victimless act simply because it takes place between sophisticated market participants. Neither is it limited to criminal behaviour like fraud or market abuse. It also captures a wide range of activities which exploit differences in expertise or market power to undermine trust in the integrity of markets or cause retail consumer detriment. An example is asset management where, through a range of intermediaries, many funds are managed for the ultimate benefit of retail customers. 29. Overall, wholesale markets can have a much wider impact on the integrity of, and trust in, markets than a narrow interpretation of the principle of “caveat emptor”207 may suggest. The FCA approach document, to be published in the autumn, will discuss some of the options to address poor wholesale market conduct in the context of how such behaviour might reveal some risk to the market. 30. Continued robust enforcement action. Over the last 6 years the FSA has greatly enhanced the effectiveness of its enforcement action using enforcement powers more robustly to address a wider range of conduct malpractice, and imposing more significant penalties. The PRA and FCA’s new approach to prudential and conduct regulation will require our enforcement team to work much more closely with supervisory and other colleagues in order to identify potential problems, and to enable us to use all of our tools promptly and effectively. Whilst our enforcement powers are largely effective, the Commission may wish to consider the case for further refinement across certain areas. This could include the following changes: — the ability to take disciplinary action against employees outside the scope of our approved persons regime; — the extension of the limitation period for taking action against approved persons; and — a power to prohibit an individual from performing a controlled function on an interim basis. 31. The case for possible change along these lines is set out in the Appendix. 32. Through these and other mechanisms, the FCA can seek to ensure that regulation and supervision play a strong role in constraining inappropriate behaviour and thus in requiring higher standards. But it is important also to note the limits of what regulation and supervision, in themselves, can achieve. It would be impossible for instance, to prevent all retail and wholesale malpractice in advance, without a massive increase in the scale of supervisory resource placing a disproportionate cost on the industry and as a result on the consumer. Rebuilding trust in UK banking will therefore also crucially depend on changes in culture and improvements in values, which in turn depend on the tone set by top management. We therefore consider in the next section what levers and incentives can encourage appropriate top management focus and tone.

33. The top management and boards of UK banks have a crucial role to play in improving standards and rebuilding trust. On the prudential side, the approach that they take to the balance between risk and return will have a major influence on the stability of the system. On the conduct side, the tone that they set and the priorities that they signal, will have a major influence on culture and behaviour throughout the organisation. This section therefore considers: — Measures to ensure that the directors of banks pay appropriate attention to downside risks of bank failure, or to other major prudential or conduct risks. — The importance of appropriate culture and the extent to which regulators can assess and influence it. — Whether there is a role for codes of conduct to encourage improvements in professional standards. 207 ‘Caveat emptor’ in used in this context to describe the extent to which sophisticated market participants can be expected to safeguard their own interests. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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Addressing the risk return trade-off for directors of banks 34. In most sectors of the economy, a company failure is primarily a problem for shareholders and other private stakeholders (eg. suppliers and employees) but not for the overall macro economy. In contrast, a bank failure can have major adverse consequences for the whole economy. We therefore argued in our report into the failure of RBS that there are strong arguments for ensuring that bank directors face different personal risk return trade-offs than those which are appropriate in other sectors of the economy. We also explained in that report that there is neither in the relevant law nor FSA rules any concept of strict liability: the fact that a bank failed does not make its management or board automatically liable to sanctions. A successful enforcement case related to bank failure would therefore need to be based on clear evidence of specific actions by particular people that were incompetent, dishonest or demonstrated a lack of integrity. 35. In response to the FSA report on RBS, the Government issued in July 2012 a consultation document on “Sanctions for the directors of failed banks”. This considered the pros and cons of both: — A series of changes to regulatory rules which might better align risk and reward. It proposed in particular the introduction of a “rebuttable presumption” that a director of a failed bank is not fit to hold another senior executive or Board position at another bank. — The introduction of criminal sanctions for some categories of behaviour, based either on a concept of “strict liability” for bank failure, or on the proof of negligence, incompetence or recklessness. The consultation document was sceptical of the idea that a strict liability approach was appropriate, and noted significant complexities and difficulties in introducing criminal sanctions focussed on negligence or incompetence, but considered that recklessness might be an appropriate basis for a criminal offence of misconduct in bank management. 36. The FSA believes that the consultation paper is a useful starting point for the consideration of the different options, and we welcome the “rebuttable presumption” proposal. If this proposal were included in the current Financial Services Bill, it could send a clear message that bank senior executives and boards have a responsibility to ensure there is strong focus on downside risks. Clearly the consultation paper’s discussion of the full range of options will form an important input to the Parliamentary Commission’s deliberations. 37. One policy option not included in the Government’s consultation paper would be to adjust the reward structure of senior management and non-executive board members in order to encourage longer term focus and to ensure that senior executives and non-executive board members face personal consequences as a result of losses resulting from excessive risk taking. Considerable progress has already been made in the reform of incentive structures for top executive management, and the FSA is now enforcing the new remuneration rules introduced by the Capital Requirements Directive 3 (CRD3), which reflect principles established by the Financial Stability Board. It would be possible, however, to introduce still stronger rules in relation to executive management (eg. to lengthen the deferral periods) and/or to consider the extension of these principles to the remuneration of non-executive board members (eg. with fees deferred for several years and forfeited in the event of bank failure). The Parliamentary Commission may wish to consider whether any further reform of senior executive or non-executive remuneration structures has a role to play in improving standards and restoring trust. 38. Appropriate supervision can also play an important role in encouraging greater focus on downside risks. The PRA will therefore continue to assess board effectiveness on prudential issues, drawing on the lessons relating to board effectiveness set out in our RBS Report. It will engage with banks at a senior level throughout the supervisory process, having conversations of a strategic nature, and holding information-gathering meetings, discussing analytical work and issuing detailed requests at a working level. The PRA will also expect top management and boards to have a strong focus on prudential safety and soundness, and will expect that they will seek to satisfy the spirit as well as the letter of prudential regulations rather than game the rules for maximum short term advantage. It will expect a strong focus on ensuring that there is an appropriate culture, alongside sufficient controls and appropriate incentives in place to minimise the dangers of excessive risk taking throughout the organisation.

Supervision of culture and governance 39. Banks are only likely to earn the trust of customers if there is a clear message from the top that there may be business activities which are profitable but which the firm will not do because they go against its values, even if there were only limited risks that the regulatory authority would identify the problem and require redress and/or enforce sanction. For instance, if the top management and/or board of a retail bank observe very large profit margins being earned on a particular product line, they should be prepared to ask questions about whether the product is truly in their customers’ interest, rather than simply congratulate the relevant division and increase the sales targets. 40. Like the PRA, the FCA will therefore seek, as best possible, to ensure that firms’ top management and boards are acting in this way and that they are taking responsibility for establishing and maintaining an appropriate culture throughout the organisation. The FCA will therefore consider whether firms’ governance arrangements are adequate to enable the firm to identify and manage conduct risks in both the retail and wholesale markets. Where arrangements appear inadequate, the FCA may increase the scope of its firm assessment, undertake a deeper review of a particular area, or require the firm to strengthen systems and cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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controls. It will also seek to assess whether candidates for signiﬁcant inﬂuence functions have appropriate values, and have track records which illustrate appropriate focus on fair treatment of customers in past roles. 41. It needs to be recognised, however, that a supervisor’s ability to assess true commitment to appropriate values (as against the ability to say the right words) is highly imperfect. The Parliamentary Commission may therefore wish to debate how much reliance can be placed on externally imposed supervision in respect of the vital but somewhat “soft” issue of appropriate culture, and whether other levers are available to improve standards.

Culture and professional standards

42. In some sectors of the economy (eg. the provision of medical or legal services) society assumes that appropriate individual behaviour and organisational culture can be fostered through a commitment to “professional standards and ethics” which are to different degree defined and codified. All individuals who work in an authorised firm are required by the FSA to have the skills, knowledge and expertise necessary for the discharge of the responsibilities allocated to them. Individuals who carry out certain regulated activities for retail clients are also subject to detailed requirements in the FSA’s Training and Competence (TC) handbook. However professional competence does not in itself guarantee that those who possess it will use it in an ethical fashion and/or for the benefit of customers. The Commission might therefore wish to consider whether there could be a role for professional or ethical codes of conduct in banking, similar to those that exist in some other areas.

(d) Achieving better outcomes through effective competition

43. As mentioned in section A, competitive forces are less effective at disciplining firm and individual behaviour in financial services than in most other sectors of the economy. This reflects the asymmetries of information and knowledge between providers and customers, and the fact that infrequent purchases and barriers to switching reduce the ability of customers to exercise market discipline via consumer choice. To a degree, therefore, some combination of regulation and supervision, and of producer responsibility and ethical values, has to compensate for the ineffectiveness of markets.

44. Clearly, it is essential that public policy seeks to make competition and customer choice as effective as possible. One of the FCA’s new objectives will be to promote effective competition that benefits consumers. This means that it will step in when uncompetitive practices result in consumers getting a poor deal. Our regulation will try and encourage a market where the price offered is efficient and where firms’ entry and exit from the market is driven by consumers switching to those that offer the best combination of price, quality and variety. This new supervisory approach could involve, for example, requirements for easier transfer between providers.

45. To improve the effectiveness of regulation in this area, we believe the FCA needs a toolkit of clearly deﬁned competition powers. We therefore support the recommendations put forward by the Joint Committee on the draft Financial Services Bill that the FCA be given market investigation reference powers, similar to those currently available to the Ofﬁce of Fair Trading (OFT).

46. The current approach in the Financial Services Bill, which requires the FCA to make a public request to the OFT to consider using its market investigation reference powers, may lead to a disconnect between the FCA’s powers and expectations. It also risks leaving the FCA and the OFT with an overlapping remit on competition. This could lead to uncertainty and delay in challenging poor behaviour and securing better consumer outcomes. While we remain of the view that the FCA should not be responsible for dealing with breaches of the Competition Act 1998208, we continue to believe that the FCA should have the full suite of market investigation reference powers, including the power to agree to undertakings in lieu of reference.

47. We look forward to engaging further with the Commission on the issues raised in our submission.

APPENDIX

ENFORCEMENT POWERS

1. In section B we explain that whilst our enforcement powers are largely effective, the Commission may wish to consider whether these need further reﬁnement. In this appendix, we consider the case for possible change in three areas: — The ability to take disciplinary action against employees outside the scope of our approved persons’ regime. — The extension of the limitation period for taking action against approved persons. — A power to prohibit an individual from performing a controlled function on an interim basis. 208 For example, anti-competitive agreements by UK ﬁrms and abuse of dominant market position. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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The ability to take disciplinary action against employees outside the scope of our approved persons’ regime 2. It is worth noting that we have limited powers against individuals who are not approved. Whilst systems and controls and “tone from the top” are clearly key, it is obvious that a banking sector which functions well for consumers and the economy as a whole cannot be achieved unless employees below the level of senior management also act with honesty and integrity. Therefore, having the power to take action against individuals that commit misconduct, yet fall outside of the approved persons’ regime, could enable us to address existing limitations in this area. 3. We have also considered whether there might be any amendments to the provisions relating to official listings that could drive better behaviours across the financial services industry. At present, we can only take action against a director of a listed company if they were knowingly concerned about a contravention of the listing rules by the firm itself. Our experience suggests that the current definition of knowingly concerned209 is too narrow and positively disincentives directors from making enquiries to discover whether the listing rules are being complied with. We therefore suggest that the definition be amended so that enforcement action can be taken where a director “knew, or should have known” of the contravention.

The extension of the limitation period for taking action against approved persons 4. We believe there is a strong case for reviewing the time limitation period for taking action against approved persons. The period within which the FSA must issue a warning notice against approved persons currently stands at three years.210 This runs from the date that the FSA becomes aware of the offence, rather than the start of our investigation. There is an inconsistency between the treatment of individuals and regulated firms as there is no limitation period for breaches of the regulator’s rules by regulated firms. There is also no time limit for market abuse cases. 5. Our experience has been that three years is likely to be insufficient time for the PRA or FCA to determine whether there is a case to answer in complex cases, some of which may require information from overseas. This can include action taken against senior managers of large firms where the regulators will need to establish personal culpability on the part of those managers for their actions or omissions. Such cases often lead to the regulators having to obtain and process significant volumes of information, which can take a great deal of time. 6. The time limit can mean that the investigation into the individual’s conduct is truncated, making it more difficult for the regulator to pursue its case. In extreme circumstances, this can mean that if the regulator is not in a position to issue a warning notice within the three year time period then no action can be taken against the individual concerned. We would therefore urge the Parliamentary Commission to consider recommending the extension of the limitation period for taking action against approved persons.

A power to prohibit an individual from performing a controlled function on an interim basis 7. We also believe that a regulatory power to prohibit an individual on an interim basis from performing controlled functions would enable the FCA or the PRA temporarily to remove incumbent senior managers where they continue to pose a risk to the regulators’ objectives whilst the action against them is ongoing. We accept that this power would be a signiﬁcant extension to our current powers, and that appropriate safeguards would need to be considered.211 However, this power would be a signiﬁcant tool which would allow the regulators to act swiftly to counter any threat to their objectives by an approved person remaining in position pending an appeal. 6 September 2012

Written evidence from the Financial Services Authority 1. The FSA welcomes the opportunity to supply to the Parliamentary Commission on Banking Standards information relating to the FSA’s dealings with UBS in connection with LIBOR. In this memorandum we set out a narrative account of the FSA’s dealings with UBS in relation to LIBOR and other relevant information, in response to the Commission’s request on 2 January. Our memo includes: — executive summary; — background to LIBOR; — background to the FSA supervision of UBS in the UK; — FSA supervision of UBS in relation to LIBOR; — investigation into UBS’ LIBOR submissions; — current position re LIBOR submissions and UBS; — review by FSA Internal Audit; and 209 Currently contained in section 91(2) of FSMA 210 This was increased by the Financial Services Act 2010 from two to three years. 211 These safeguards might include: an appropriate threshold on the face of FSMA for the exercise of the power; the right for the individual to make representations to the regulator concerned; an immediate right to refer the matter to the Tribunal; and the power for the Tribunal to suspend the effect of the decision pending its determination of the reference. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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— conclusion. 2. This response has been prepared in the short period of time made available to the FSA to enable the Commission to meet its intended timetable for parliamentary hearings. As a result, you should be aware that this note has been prepared on a “best efforts” basis and has not been subject to a detailed review process or audit for factual accuracy. We have relied predominantly on our written records from the period in question, supplemented by the recollection of FSA staff connected to the events where available, but have not had time to interview former staff, review email records or systematically review our ﬁles to challenge the narrative presented in this note.

ExecutiveSummary 3. Concerns were raised about LIBOR submissions generally as a result of media articles in the US and an ongoing series of requests for assistance from the CFTC, starting in 2008. The FSA worked closely with the CFTC, exercising its statutory powers under FSMA to gather information about UBS’ (and other firms’) LIBOR submissions. The focus of these initial enquiries was on lowballing as opposed to trader manipulation. 4. UBS delivered information to the FSA in May 2009. Following this, in 2010 the firm commissioned an internal investigation of its LIBOR processes which resulted in UBS reporting in late 2010 that it had discovered indicators of substantial misconduct by traders and submitters in relation to its LIBOR submissions. 5. UBS gave a presentation to the FSA in March 2011 setting out its findings, which led to the firm being referred to the enforcement division very soon after, in April 2011. 6. From this point onwards, the LIBOR issues were mainly handled as an Enforcement issue. Supervisory activities in this period had some bearing on LIBOR given their focus on systems and controls, but were otherwise centred on the series of issues that impacted the firm’s ability to survive the financial crisis, and the need to respond to the underlying causes of these issues. 7. During the period in question, there has also been considerable supervisory focus on the firm’s legal entity structure in the UK and the risks that this presented to UK financial stability if the firm was to fail. This is now part of a wider regulatory effort to improve the resolvability of major firms operating in the UK. 8. Although these have been, and to some degree remain, the supervisory focus for the FSA, we have ensured that the firm has reviewed its systems and controls in relation to LIBOR submissions, and attested to the FSA that any necessary enhancements have been implemented. 9. This issue has been addressed by the recommendations of the Wheatley Review which includes introducing a new regulatory structure for LIBOR, accompanied by criminal sanctions for those who attempt to manipulate it. 10. LIBOR is an industry benchmark outside the regulatory framework and supervised by the British Bankers Association. During the period in question (the “Relevant Period” for the purposes of the FSA’s enforcement action ran from 1 January 2005 to 31 December 2010), whilst there were concerns shared by some market participants that LIBOR was no longer an accurate reflection of the funding costs of banks, it was not considered a high risk that LIBOR was open to manipulation or even likely to be the target of attempts at manipulation or collusion by traders seeking to improve the profitability of their swap books.

Background to LIBOR 11. LIBOR submission is not included within the scope of regulated activities covered by the Financial Services and Markets Act 2000 (“FSMA”). LIBOR itself is an industry developed benchmark rate. It is produced under the auspices of the British Bankers Association (“BBA”) and described by them as “the primary benchmark for short term interest rates globally and is used as the basis for settlement of interest rate contracts on many futures and options exchanges. It is used in many loan agreements throughout global markets, including mortgage agreements; and is also considered a barometer to measure the health of ﬁnancial money markets.” 212 12. The BBA is a trade association which is not authorised or regulated by the FSA (or any other body). 13. The BBA goes on to describe LIBOR as being used as: “… the basis for a range of ﬁnancial instruments. Derivatives based on LIBOR are now traded on exchanges such as LIFFE and the Chicago Mercantile Exchange (CME) as well as over-the-counter. LIBOR is also used as the basis for many types of lending, from syndicated and commercial lending to residential mortgages.”213 14. The submissions are compiled and monitored by Thompson Reuters which is the “Designated Distributor” of BBA LIBOR. Guidance on the submitting process and on what information should be taken into account by the person making submissions is issued by the BBA. Contributing panel banks are also 212 http://www.bbalibor.com/bbalibor-explained/faqs 213 http://www.bbalibor.com/bbalibor-explained/faqs cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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required to undertake to the BBA that various systems and controls are in place, such as audits of their internal processes and to allow visits from the BBA LIBOR secretariat. 15. The submissions are made by between six and 18 banks for each currency. The individual banks are selected based upon three criteria: — scale of market activity; — reputation; and — perceived expertise in the currency concerned. 16. The submission process is not a regulated activity and is simply ancillary to the firms’ regulated activities. There is no explicit requirement from the BBA for the submitting bank to have a corporate entity in London (although this is likely given the criteria for selection as a panel bank set out above) or that the people making submissions on behalf of the submitting entity are based in London or the UK. Equally, there is no requirement that the submitter is approved by the FSA in any capacity or even working for an FSA regulated entity. 17. In April 2008, the BBA commenced a review of the LIBOR fixing process. The review specifically considered suggestions of inaccuracies regarding submissions in US Dollar (“USD”) LIBOR and a perceived disparity between the published LIBOR rate and the level at which firms could actually borrow. 18. The BBA published its initial consultation document on 10 June 2008. A number of proposals were made in the BBA’s draft consultation including: public communications; broadening or altering the definition of LIBOR; creating a credible oversight body; or ejecting certain panel members. The latter was deemed to have significant challenges especially around reputational risk during a period of intense media speculation. The BBA’s committee opted to “strengthen the oversight of BBA LIBOR”. The FSA’s Markets division (with Banking Sector involvement) discussed the first draft with them, highlighting three areas for attention: — the behaviour of banks in posting LIBOR fixings (ie accuracy of postings); — the process and timeliness of the annual review; and — ongoing monitoring to ensure LIBOR fixings are credible. 19. The FSA recommended explicitly to the BBA that they should look to “utilise mechanisms which will detect several banks collectively (ie as a pack) submitting off-market quotes.” The FSA suggested that these mechanisms could include taking a daily feed of all interbank cash deals traded through the brokers and monitoring in real time the FX swapped rate achievable between the major currencies. 20. The FSA continued to engage with the BBA in its further work on the LIBOR fixing process, particularly on governance and scrutiny. The BBA published a feedback statement on 5 August 2008 and a final paper on governance and scrutiny on 17 December 2008. 21. The FSA considered the BBA’s final paper on governance to have addressed a number of the FSA’s concerns over the governance and scrutiny of LIBOR. The next significant change to the LIBOR process will be the legislative and regulatory changes resulting from the Wheatley Review whose key points include: — statutory regulation of the administration of, and submission to, LIBOR; — a clear set of FCA rules for submitters and administrators of LIBOR, setting systems and controls expectations, conflicts of interest management, record keeping and regular external audits of submitters; — requiring panel banks to submit to LIBOR using an effective methodology with objective criteria and relevant information, in particular supported by transactions in the underlying market wherever possible; — a new code of conduct, developed by the administrator and providing clear guidance to submitters about complying with the FCA’s rules. In particular, it will guide panel banks on transactions that should take into account when making submissions; and — publication of individual LIBOR submission after three months rather than daily.

Background to theFSASupervisionof UBS in theUK 22. UBS operates in the UK predominantly through a branch of the main Swiss bank in the group, UBS AG. This branch provides a broad range of services including investment banking, asset management and wealth management. 23. In addition, the group has a number of subsidiaries incorporated in the UK and authorised to carry on ﬁnancial services activities in the UK. This includes a series of asset management entities under the ownership of UBS Global Asset Management Holdings Ltd (see diagram below) as well as UBS Securities Limited (“UBSL”). 24. UBSL primarily provides investment banking services. Its main value to the wider group is that, as a UK authorised entity, it is able to take advantage of EEA directives to passport around the EEA providing services in these locations. UBS AG is not able to use these directives as it is incorporated in Switzerland, ie outside the EEA. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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Simpliﬁed organisation chart for principal UK entities of the UBS group214

UBS AG (Switzerland)

UBS AG London Branch

UBS Limited UBS Global Asset Management Holdings

UBS Global Asset Management Holding Ltd UBS Global Asset Management Client Services Ltd

UBS Global Asset Management Life Ltd

UBS Global Asset Management Funds Ltd

UBS Global Asset Management (UK) Ltd

25. The consequences of this structure are: — On prudential issues, the prudential standards in the FSA Handbook do not generally apply to the business of UBS AG (Switzerland), other than with respect to liquidity risk in the UBS AG London branch. Instead, the FSA relies upon the prudential oversight carried out by the domestic regulator of UBS AG (Switzerland), the Swiss Financial Market Authority (“FINMA”). — On conduct issues, the London branch of UBS AG is subject to FSA Handbook systems and controls requirements. Conduct of business requirements in relation to the UK branch apply in full, ie these broadly replicate the requirements applying to UK incorporated banks. — UBSL (the UK subsidiary) is subject to full prudential and conduct regulation in the UK, although inevitably there is a degree of reliance on group-wide systems and controls that are monitored by the ﬁrm’s home regulator, FINMA. However, because this is a subsidiary any risk is carried in the branch.

General Supervisory Activity 2004-present215 26. Our supervisory activity can be broken down into three distinct periods: — Pre-2007: Prior to 2007 the FSA’s supervisors considered UBS to have adequate systems and controls in relation to those matters of which they had oversight and in relation to the risks they were considering. Reviews in this period highlighted potential enhancements to governance, systems and controls, but UBS was not identified as a high risk bank in either a prudential or conduct context. — 2007–2009: In this period, the firm experienced losses of approximately USD 50 billion arising from the subprime crisis, which raised concerns about the firm’s ability to continue business. The focus of the FSA in this period was almost exclusively prudential in nature, with daily liquidity calls taking place with the firm, continuous monitoring of risk positions and capital, and constant dialogue about the changes to governance, strategy and controls required to stabilise the firm and return it to a sustainable path. There was also extensive liaison with overseas regulators given the potential consequences in a number of jurisdictions if the firm was to fail.

214 The chart above includes the principal regulated entities of the UBS group operating in the UK. All of the entities are regulated by the FSA other than the two asset management holding companies shown. 215 This section is intended to answer Q6—supervisory steps taken by FSA in relation to UBS in response to information about UBS conduct in relation to LIBOR cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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— 2010 onwards: The supervisory agenda continued to be heavily focussed on prudential issues but there was also an increasing focus on conduct issues. Supervisory concerns, on both the prudential and conduct sides, were increasing over this period as was the force with which they were expressed to the firm. Prudential regulation continued to focus on the pressing need to improve systems and controls around prudential matters but the FSA also articulated concerns regarding a need for better controls as conduct issues began to appear, such as the USD 2.3 billion unauthorised trading incident in 2011. A number of these issues, including LIBOR, resulted in referrals to Enforcement. The firm has subsequently undertaken a major review of its operations in the UK and is in the process of downsizing of its fixed income business. 27. A key part of the FSA’s supervisory approach at the time was the Advanced Risk Responsive Operating framework (ARROW) risk assessments which were undertaken during the period (although supervisors did also undertake other work outside of formal risk assessments including in the case of UBS and other banks significant contingency planning in the event the bank failed, and various section 166 reports. The FSA sent letters to UBS after ARROW assessments on 13 January 2005, 4 April 2006, 26 February 2007, 22 June 2010, 14 August 2012 (Prudential Business Unit of the FSA) and 10 September 2012 (Conduct Business Unit of the FSA). In addition’ joint feedback letters were sent following colleges with other regulators. These made a number of recommendations for improvements to systems and controls and corporate governance (with increasing degrees of concern being expressed) but did not make any recommendations regarding LIBOR. The letters have not been included as the information in them is confidential as defined by section 348 of FSMA. 28. The only references to LIBOR in ARROW letters were in the 2010 ARROW letter which made a reference to derivatives priced according to LIBOR (but which does not refer to any manipulation in the LIBOR rate) and the 2012 ARROW letter which was written following the beginning of the enforcement investigation. In a similar fashion, the correspondence between the enforcement team and UBS during the course of the investigation makes numerous references to LIBOR. We have not identified any section 166 reports that refer to LIBOR.216 29. There was a discussion between UBS and the FSA about the appropriateness of UBS’ LIBOR submissions. This was an email record of a daily liquidity update telephone call with UBS on 27 May 2008, during which a media article of the same date was discussed.

FSASupervision of UBSinRelationto LIBOR 30. The FSA was, at the relevant time, an integrated supervisor responsible for both prudential and conduct supervision (subject to the limitations described above in relation to a non-UK firm). 31. The approach of regulators to prudential and conduct supervision differs. Prudential supervisors consider material within the firm such as its balance sheet and business model to make judgements about its sustainability and future prospects. They also set, often within the context of international requirements or agreements, rules relating to capital and liquidity. As we have previously set out we believe that many of those approaches were, during the relevant period, flawed. 32. The role of a conduct regulator is different. It is not possible for a conduct supervisor to carry out detailed day to day monitoring intended to identify, on a real time basis, inappropriate behaviour of single individuals or a group of individuals within a firm (particularly where some of those may be overseas). Supervisors will, instead, seek to check that there is a reasonable oversight mechanism run by the firm itself, to assess the firm’s overall culture and approach and to undertake review work, whether on a thematic cross firm basis or into an individual risk identified at a specific firm, to look in detail at a particular issue. This is resource intensive and therefore has to be targeted based on the assessment of risks by the supervisor, the firm and/or by issues identified through monitoring of, for example, trade data relating to equities trading in regulated markets. This is dependent on a mechanism for challenging the firm’s oversight processes and a robust enforcement process. 33. As set out above, the priority for FSA supervisors was to engage with the firm to ensure that governance and controls were appropriate and that prudential issues did not lead to large scale failures in relation to regulated business areas. The supervision team covering UBS throughout this period varied in size based on staff turnover and other factors. At its low point, it was around three people, but it generally averaged around four. It is currently staffed with five people within the prudential business unit and two people in the conduct business unit. These figures inevitably created some constraint on the focus that the FSA could put on LIBOR related matters in the period in question. 34. The FSA had no direct remit over the LIBOR process or over the BBA. A distinction can be seen between areas such as markets abuse, where the market itself is regulated by the FSA and the participants— including exchanges and authorised firms—have a duty to report misconduct, and where the FSA and exchanges invest heavily in monitoring the markets and the typical market for products tied to LIBOR which are usually wholesale products. They are often over-the-counter (“OTC”) products and there is no requirement that trading in them is reported to the FSA. 216 Answer to Q7 and Q9—references to LIBOR in FSA correspondence with UBS on ARROW or Risk Mitigation Programmes or s.166 reports cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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35. Where the FSA has a mandate, for example in the area of market abuse, it establishes a strategy for tackling issues, ranging from thematic work by supervisors to full use of enforcement powers. However, the mandate of the FSA to deal with LIBOR is currently much less direct as it is not a regulated activity and is only within the FSA’s scope by virtue of it being an activity conducted by regulated firms which is ancillary to their regulated activities. The recommendations of the Wheatley review, which are in the process of being implemented, will change this. 36. Once the FSA became aware that there were significant issues with firms’ LIBOR submission process it implemented a series of steps across all panel banks, including UBS. 37. In Autumn 2010, as a result of the information that was being discovered during the Barclays investigation it became apparent that there was a possibility that misconduct may have occurred in relation to broader areas—including currencies other than USD and for reasons other than lowballing (the initial enquiries had been focussed on this issue). As a result, in late 2010 the FSA decided to engage an external firm to undertake an analysis on behalf of the FSA of the submission data in 2007 and 2008 for all panel banks in USD, JPY and Sterling (“GBP”). 38. The purpose of the analysis was to seek to focus further enquiries (bearing in mind that there are many hundreds of LIBOR submissions made every single day) by identifying submissions which may have been inconsistent with other submissions made by the bank or other panel members. The most inconsistent submissions would then be referred to banks with a request for them to explain how the submission had been determined. In January 2011, following a tendering process, Ernst & Young (“E&Y”) were engaged and began the work. This was in parallel to work being undertaken by the firms, using external legal counsel, to review internal communications relating to LIBOR. 39. For UBS 56 submissions (36 JPY, 16 USD and 4 GBP) were identified which appeared anomalous and would have required explanation. However, as UBS had at this stage begun to disclose to the FSA its own evidence of wrongdoing and was being considered for a referral to the FSA’s enforcement division for investigation, a separate explanation was not required but the issues were considered in the context of that investigation. 40. At the same time, whilst the E&Y analysis was being used as an indicator as to which firms might have been involved in inappropriate behaviour in the past, the FSA was concerned to ensure that any misconduct which might have taken place had stopped and would in future be prevented or detected. 41. To that end, UBS (and all other LIBOR panel banks) were requested in February 2011 to attest to the adequacy of their (then) current systems and controls for the determination and agreement of their LIBOR submissions. UBS provided a positive attestation on 31 March 2011.

Investigation into UBS’ LIBORSubmissions 42. In the second quarter of 2008, a number of media articles were circulated within the FSA which suggested that LIBOR contributor banks including UBS were submitting inappropriate LIBOR fixings. Certain of those articles were summarised in Market Update emails circulated by the Bank of England to its own and FSA staff. 217 43. It is not uncommon where multiple regulators have an interest for one to take the lead initially. There were a number of communications between the FSA and CFTC in relation to LIBOR during 2008 and in October 2008, following those media articles expressing doubts about the accuracy of LIBOR submissions, the CFTC wrote to a number of firms (including UBS) asking them to provide information about their submission process. Because the majority of information was held at the banks’ London branches, on 3 December 2008 the CFTC asked the FSA to gather information to assist regarding firm’s LIBOR submissions. In addition, the FSA wrote to the BBA asking for information about LIBOR. 44. The FSA contacted a number of firms including UBS, requesting that they produce information to the FSA. At that stage the requests were focussed on USD only—and were in fact only sent to firms on the USD panel—and although they covered all LIBOR reporting the principle focus at that time was on “lowballing”— the suggestion that firms might have been making artificially low submissions in order to protect their reputations during the financial crisis. 45. The request to UBS specifically was issued on 11 December 2008.218 A second request was sent by the FSA to UBS on 5 March 2009. The requests comprised schedules of information that the firm was requested to produce and in response to which UBS delivered a very substantial amount of information to the FSA on 22 May 2009.219 46. Throughout 2008 and 2009 the enquiries were primarily focused on gathering and reviewing data and information. The FSA worked closely with the CFTC on these requests and was involved with them in reviewing material. 217 Answer to Q7, 8 and 9—references to LIBOR in correspondence with UBS 218 Answer to Q3—steps taken by FSA in response to communications from CFTC about UBS conduct in relation to LIBOR; plus see following paragraphs 219 Answer to Q2—information provided to the FSA about UBS’ conduct; plus see following paragraphs cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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47. In April 2010, the CFTC requested that UBS, along with other banks, conduct an internal investigation relating to its USD LIBOR practices. During the course of this review UBS discovered indicators of serious misconduct in broader areas than those already under review. This caused the firm to widen the scope of its investigation and to look specifically for wider examples of misconduct and in further currencies. 48. UBS later notified the FSA that it had discovered evidence of more extensive wrongdoing. The firm also notified the FSA that it was making leniency applications to various competition authorities around the world, including the OFT, since the wrongdoing appeared to indicate breaches of various competition laws. Various discussions then ensued between the FSA and competition agencies (such as the OFT and DoJ) and between the firm and the FSA about restrictions imposed on the firm discussing its findings more widely as a condition of its leniency applications. 49. These led to the firm giving the FSA a presentation as to what it had found in shortly before UBS was referred to Enforcement. The investigation began with a scoping meeting on 9 May 2011 which explained to the firm the areas under investigation and how the investigation would proceed.220 50. The FSA Board was informed of the FSA’s investigation into Barclays, and the CFTC and SEC LIBOR investigations, in January 2011. The Board were told that the FSA’s investigations into other firms would take place in stages, with investigation of higher risk firms prioritised. 51. The Board were also told of the decision to engage an external firm to conduct an analysis of LIBOR submissions made between 2007 and 2008, and were told of the plan to require firms to make an attestation over LIBOR controls.

CurrentPosition re LIBORSubmissions and UBS 52. Part of the failings set out in the FSA Final Notice relates to UBS’ failure to implement proper systems and controls, despite a number of internal and external reviews. In particular, reference is made to the fact that UBS Internal Audit reviewed the relevant parts of the ﬁrm on a number of occasions and did not recognise the problems which existed. 53. UBS has taken a number of steps to update its processes as set out in the Final Notice. It has also given a series of undertakings to the CFTC regarding future actions in this area. 54. The FSA Board was, in the normal course, kept updated about the overall issues surrounding LIBOR submissions. On 28 April 2011, the Board was provided with an update on the Barclays investigation and told that a formal UBS investigation had begun. A further update on Barclays and UBS was provided in July 2011. UBS has since only been discussed speciﬁcally post the referral of UBS to Enforcement, when the Board has been updated periodically on the progress of the investigation.221

Review by FSA Internal Audit 55. As Lord Turner explained in his letter to Andrew Tyrie of 24 July 2012, the FSA’s Internal Audit team has been reviewing the FSA’s records to set out the facts relating to contacts with the FSA or awareness within the FSA on the subject of LIBOR manipulation during the period 2007 to 2008. The period covered by Internal Audit’s review is 1 January 2007 to 31 May 2009 and the focus is on lowballing rather than on the manipulation of LIBOR submissions by traders. Within that period, however, Internal Audit has not found any communications to suggest that the FSA was aware of the manipulation of LIBOR submissions by traders. 56. Internal Audit is currently drafting the report which will be reviewed by the Audit Committee of the FSA Board and will go through a “Maxwellisation” process with key internal and external stakeholders. We aim to provide the final report to the Treasury Select Committee by the end of March 2013. 57. The review does have some overlap with the questions raised in the Parliamentary Commission’s information request in relation to contacts with the FSA from firms (including UBS) and other parties. While the Internal Audit review is not finalised we have, taken into account in preparing this response relevant material arising out of Internal Audit’s review.

Conclusion 58. During the relevant period, the FSA’s supervisory priorities and focus was on matters other than LIBOR given the fact that LIBOR was outside the regulatory framework. Once issues had been identified in relation to LIBOR at UBS, this was handled primarily as an Enforcement matter, whilst supervision remained focused on the ongoing issues with the firm’s business model, strategy, systems and controls, and legal entity structure in the UK. 59. The FSA investigation into UBS’ misconduct revealed serious wrongdoing and we have imposed a very substantial penalty—more than double that of Barclays which was itself nearly double the previously highest penalty. In addition, the FSA is assisting the Serious Fraud Office which has recently commenced criminal investigations into LIBOR related matters (having been previously keeping a “watching brief” following the 220 Answer to Q5—date on which enforcement action began 221 Answer to Q10—FSA board papers that refer to UBS conduct in relation to LIBOR cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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FSA notifying it of issues relating to LIBOR) and has recently arrested a number of people in connection with those investigations. 60. In light of concerns that now exist regarding the integrity of LIBOR, a review of LIBOR was undertaken by FSA Managing Director Martin Wheatley at the request of the Chancellor. The Wheatley Review’s ﬁnal report in September 2012 outlined a plan to comprehensively reform the setting and governance of LIBOR. A key recommendation was bringing LIBOR-related activity within the regulatory perimeter. As a result, the Government has inserted the appropriate clauses in the Financial Services Act 2012 and respective secondary legislation to create two new regulated activities: “providing information in relation to a regulated benchmark” and “administering a regulated benchmark”. In the ﬁrst instance, the only regulated benchmark will be LIBOR, but an IOSCO report—co-chaired by Martin Wheatley and Gary Gensler of the CFTC is also considering other important benchmarks. 7 January 2013

Written evidence from the Financial Services Authority This memorandum is prepared in response to the requests directed to Tracey McDermott from the Parliamentary Commission on Banking Standards (“the Commission”) during the oral evidence taken on 10 January 2013 from Sir Hector Sants, Tracey McDermott and Dr Thomas Huertas. The Commission’s requests were subsequently clariﬁed by Mr John Sutherland on 21 January 2013 and are set out below with the FSA’s responses:

The Differences in the FSA’s Financial Penalty Regimes 1.1. Details of the penalty policies that applied in connection with misconduct that took place before 5 March 2010 (“the Old Policy”) and on or after 6 March 2010 (“the New Policy”) have been previously provided as Annexes A and B in our response of 18 January to the Commission’s questionnaire on sanctions and the approved persons regime (“the 18 January Response”).222

Why the fine levied by the CFTC was larger than the FSA’s fine? 2.1. The US and UK authorities operate different penalty regimes. Under the Financial Services and Markets Act 2000, the FSA is required to publish its policy on how it sets penalties (as set out in more detail in the 18 January Response and its accompanying annexes). The CFTC’s financial penalty regime is prescribed by the Commodity Exchange Act (“the CEA”). As a result, the basis for imposing penalties is different. 2.2. In considering the level of the financial penalty to be applied in the UBS case, the Old Policy applied because the majority of the relevant misconduct occurred before that date. 2.3. The Old Policy provides that the level of financial penalty (if any) that is appropriate for the misconduct is determined after consideration of all of the relevant circumstances of the case. The non-exhaustive list of factors (as detailed in Annex B to the 18 January Response) include deterrence, the seriousness of the breach, the extent to which the breach was deliberate or reckless, the amount of benefit gained or loss avoided, the size and financial resources and other circumstances of the firm, the conduct following the breach and other action taken by the FSA. There is no formal weighting of any of the factors; rather it is an assessment in the round.223 2.4. The Old Policy also requires penalties in other comparable cases to be considered. Plainly, the FSA’s action against Barclays in relation to breaches of a similar nature was a directly comparable case and one to which the Old Policy had also applied. In determining the penalties of UBS and Barclays, the FSA also assessed the apparent LIBOR misconduct of other firms that were at earlier stages of the FSA’s enforcement processes. The FSA also considered the LIBOR misconduct by reference to other previous disciplinary cases. Our conclusion was that the misconduct in connection with LIBOR was significantly more serious than any previous case and therefore penalties significantly exceeding any previous penalties were appropriate. 2.5. Comparing the UBS case to Barclays, a penalty of £200m was considered appropriate and proportionate. Because UBS did not settle until the second phase of the settlement discount scheme,224 UBS received a reduced discount of 20%, ie a financial penalty of £160 million. 2.6. As with UBS, in determining the Barclays’ penalty, the factors outlined under the Old Policy were considered. As to comparable cases, it should be noted that the Barclays penalty was approximately double the previous highest penalty that the FSA had imposed on a firm.225 222 Sent by email to Oonagh Harrison on 18 January 2013. 223 The FSA’s assessment of each of these factors in the UBS matter was set out in paragraphs 183 to 193 of the Final Notice of 19 December 2012. 224 Details of the FSA’s settlement discount scheme are set out in pages 21 and 22 of the 18 January Response and in the accompanying Annex A (DEPP 6.7). 225 In May 2010, JP Morgan fined £33.32m after the 30% Stage One settlement discount (were it not for this discount the penalty would have been £47.6m) http://www.fsa.gov.uk/library/communication/pr/2010/089.shtml cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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2.7. Finally, although only a few penalties have been imposed under the New Policy (because it applies to misconduct which took place after 6 March 2010 and many ongoing cases still relate to misconduct that took place before that date), one of the FSA’s intentions in setting the New Policy was that financial penalties will significantly increase, particularly on larger firms (and higher earning individuals) doubling or trebling penalties that would otherwise have been imposed under the Old Policy.226 As we deal with more cases which apply the New Policy, the FSA and the FCA will keep under review how well the policy operates in practice and whether or not it needs further amendment.

2.8. In contrast, the CFTC calculates the maximum civil monetary available to it under its governing legislation the CEA, which prescribes a different approach from the FSA to the calculation of penalty: 2.8.1. The CEA applies a tariff to each “violation” (as deﬁned under the CEA), which is either: (a) a set amount multiplied by the number of violations; or (b) triple the monetary gain.

2.9. The set amount depends on the nature of the violation and whether or not the violations occurred before or after certain dates. Brieﬂy and in summary, the violations attract a tariff of $140,000 each or a maximum of $1m depending on when the violations occurred.

2.10. In determining the amount of the penalty, the CFTC then considers the appropriateness of the penalty by reference to the gravity of the violation according to the particular facts and circumstances of the case227.

Had the CFTC UBS investigation started before the FSA’s investigation?

3.1. As explained by Sir Hector Sants when giving evidence to the Commission on 11 January 2013, the FSA and the CFTC were in discussions about LIBOR submissions in April 2008. The initial contact was made by the CFTC to the FSA following the publication of a number of articles in the press at that time.

3.2. In her evidence, Ms McDermott provided further detail, explaining how that initial contact was followed in June 2008 with the FSA arranging a three way conference call with the BBA and how, thereafter, data was requested from a number of banks, including UBS.

3.3. As outlined in the FSA’s written response to the Commission of 18 January 2013: 3.3.1. During 2008 there were a number of communications between the FSA and the CFTC in relation to the review of banks’ LIBOR submissions; 3.3.2. In October 2008, the CFTC wrote to a number of banks (including UBS) seeking information about their submission process; 3.3.3. In December 2008, the FSA wrote to a number of banks (including UBS) to obtain information, as part of the ongoing enquiries into and review of banks’ (including UBS’) LIBOR submissions; 3.3.4. UBS responded to the FSA’s requests on 22 May 2009. The FSA passed this material on to the CFTC. At this time, the main focus was on concerns about “lowballing” of USD submissions. During 2009, extensive work was undertaken by Barclays (including email and telephone call reviews) and evidence of lowballing emerged in late 2009 and trader manipulation in the early part of 2010, which led to the formal referral of Barclays to Enforcement in May 2010. The first LIBOR related interviews were undertaken in November 2010, and were conducted jointly with other agencies; 3.3.5. In April 2010, the CFTC requested that UBS (along with a number of other banks) undertake internal investigations in connection with USD LIBOR submissions, the results of which were monitored by the FSA; 3.3.6. The FSA also initiated additional investigations, which were led by Supervision. In late 2010, the FSA decided to engage an external firm to undertake an analysis on behalf of the FSA of the submission data in 2007 and 2008 for all panel banks in USD, JPY and GBP. This analysis was to identify anomalous submissions. In January 2011 (following a tender process), Ernst & Young were engaged by the FSA to undertake this analysis. Follow up work was undertaken with a number of firms in July 2011, by which time UBS had been referred to Enforcement; 3.3.7. In late 2010, UBS also reported evidence of potential wider misconduct to the FSA, the CFTC and other authorities; and 3.3.8. Following a presentation by UBS in March 2011, investigators were formally appointed by the FSA in April 2011.

3.4. Therefore, the enquiries and review into the LIBOR submissions of UBS (and other banks) were conducted in parallel with the CFTC, and done so with a view to minimising unnecessary duplication of efforts. As acknowledged by Sir Hector in his oral evidence however, it is correct that it was the CFTC that initiated the ﬁrst contact with the FSA. 226 http://www.fsa.gov.uk/pubs/cp/cp09_19.pdf—paragraph 2.21. 227 The CFTC has not commented publicly about the basis of the penalty calculations for Barclays and UBS because such information was not included in the public orders issued by the CFTC. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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It is hoped that this paper provides the information sought by the Commission, with the appropriate level of detail. If the Commission does have any further questions or requires any further information, then the FSA would welcome the opportunity to provide such assistance. 29 January 2013

Letter from Andrew Bailey, Managing Director, Prudential Business Unit, Financial Services Authority Thank you for your letter setting out concerns on the implementation of Solvency II (SII). I should say that I am pleased this issue has come to the surface because, while it is not a banking issue, it is a major point that we are dealing with as we move from the FSA to the PRA. I would like to deal with two charges that are levelled at the implementation of SII, namely: first, that it is lost in detail and vastly expensive; and second, drawing on the lessons from HBOS and the implementation of Basel II, that it is dangerously distracting from the application of prudential supervision today. In these points, I would like to set out some background on SII. SII introduces a new, EU-wide, insurance regulatory regime that replaces previous EU regimes. The stated aim of SII is to strengthen the prudential regulation of the insurance sector and ensure policyholder protection. It does this by setting out strengthened requirements on capital adequacy and risk management. It introduces requirements to value assets and liabilities at market value and risk-based capital requirements based on internal models. The EU introduced Solvency I as a “minimum harmonizing” directive in 2002, imposing minimum standards but allowing individual member states to impose higher standards if they wished. In practice this has proved a relatively weak constraint and national supervisors within the EU have pursued quite different approaches. The UK introduced its Individual Capital Assessment (ICAS) regime for insurers in 2004. The key features of this regime are the requirement to value assets and liabilities at close to market value, and a risk-based capital requirement that relies upon some internal models. SII is therefore an evolution of the current UK framework, but it represents a major change for Germany, France and Italy, where support for SII appears to have diminished. In particular, it is unclear to us that the French authorities will now be able to agree to any directive that we consider prudentially acceptable. Germany in contrast has long been supportive of a relatively prudent agreement on SII but needs a long transitional arrangement (eg 10 years or more) to allow its domestic industry to adjust. A particular issue for German industry is a large “back book” of guarantees, many issued in conjunction with the Government, which have been rendered difficult to support by the low interest-rate environment. These concerns mean that, as has been the case on many previous EU directives, SII has been substantially delayed. It is, however, politically highly unlikely that the EU would operate long term without harmonised standards for insurance so the issue is really what sort of Directive is eventually agreed. The FSA’s longstanding approach to SII has therefore been to assume that a final version of the Directive will eventually be agreed, and to seek to maximise influence on the policy content. The process to finalise SII in the EU has ground to a halt in the face of these different national interests. I have three major concerns with what could emerge eventually. First, SII is a “maximum harmonised” directive (as will be large parts of the Basel 3 implementation for banks), so there will be a more limited ability for national supervisory authorities to impose sensible treatments to deal with more idiosyncratic risks. There is a risk that this whole area of maximum harmonisation will be a battleground of the future as the judgmented approach of the PRA comes up against narrow interpretations of EU law. Second, SII envisages that firms may calculate their risk sensitive capital requirements by using a bespoke internal mode. This is an option that most of the larger firms in the UK are taking up. There are good reasons for this because the UK has two large sections of its insurance industry whose business does not fit well into the standardised approach of SII, namely the London Market including Lloyd’s with its global focus, and the With Profits business of life insurers. That said, as with banks, there is a risk of over-reliance on complex models and of models being used to pare capital requirements. Moreover, there is a risk that SII overloads supervisors with very detailed model approval requirements. Such an approach is not consistent with the PRA’s proposed approach to supervision. To mitigate this risk, we plan to use “early warning indicators” in our supervisory work. These are designed to be simple measures which are exogenous to the model and alert supervisors as to potential threats to solvency from models being used to pare capital requirements, triggering immediate supervisory action. The analogy here is with the Basel leverage backstop. We believe we can implement these Early Warning Indicators in the UK within the SII framework but in any event we would pursue this approach and accept the risk of EU challenge. Third, SII is designed to set standards for the equivalence (to SII) of insurance supervision in the rest of the world. If the EU determines the insurance regime of a country outside the EU to be not equivalent to SII, EU firms operating in those jurisdictions will be required to hold additional capital, potentially making them uncompetitive in those markets. This is a big issue, and one where we will need if necessary to resist narrow interpretations, bearing in mind the UK’s large presence in the global insurance industry. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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Since there is no timetable for the implementation of SII, I have been very concerned about the implications for costs, which have been, frankly, staggering. In my view it is not wise to take an incremental view of the slippage in the timetable and go on spending money on implementation as if the process was moving when in fact it is not the case. As a consequence, we have told firms that we do not expect implementation until at least 2016, and we have to plan as such rather than let the thing slip in small increments. We have scaled back plans for future work to implement SII. We rejected the option of stopping project work altogether; that would not be the preference of either the firms or us. We are all of the view that there are some useful elements of the work done to date, and we want to bring them into effect. The work to date will therefore be used where possible to introduce an enhanced domestic insurance capital adequacy standard. The scaling back of plans has resulted in a substantial future cost-saving for the industry which, in addition to funding its own internal model development, was being levied to pay for the FSA’s preparatory work to approve those models. In 2009 the FSA Board approved a total spend by the FSA on preparation for the implementation of SII (primarily approving SII models) of between £100 and £150mn. This was to be financed by a levy on the insurance industry. The total expenditure set against the special levy to fund SII is currently just over £63mn. Our re-plan has reduced the estimate of total expenditure to £88mn. This has been warmly received by the Chairmen and CEOs of the major insurance companies. I have to say that I find the history of the EU process on SII shocking. I have attached a copy of a lecture that I gave last week in which I made this point. It would be a help if Parliament could cast light on a process which has gone on for the best part of ten years, and in which the EU process has assumed that firms and regulators will spend very large amounts of money to prepare for something that carries no promise in terms of when, or in what form, it will be implemented. We have taken action since last summer to deal with this as best we can, and I think the outcome is sensible and pragmatic, but it does not cancel the nature and scale of the issue that the PRA inherits caused by an EU process that makes no allowance for value for money. Apologies for the length of the answer, but I hope this casts light on the first concern, namely that SII is lost in detail and vastly expensive. The obvious answer is yes to both of these charges. We are putting in place an approach which I hope will mitigate these risks, but it does not I admit deal with the root cause, which lies in the EU process. The second charge is that SII preparations have crowded out prudential supervision of insurers, the HBOS risk. Ironically, the cost of SII preparation points against this risk, because the FSA in effect set up a second supervision operation while continuing to apply the ICAS regime. We will have to watch this in the future as we seek to economise on spending, but I am content at present that we are alert to this risk, and have scaled the SII work back rather than have it compete with current supervision. I hope this rather long explanation helps. 14 February 2013

Written evidence from the Financial Services Authority 1. We are submitting this memorandum as a follow-up to the oral evidence given by Tracey McDermott, Director of Enforcement and Financial Crime, on 29 January 2013. 2. The Commission requested that we provide any further thoughts on how we could improve the likelihood of being able to hold senior management, particularly in large institutions, to account for failures to meet regulatory requirements (whether prudential or conduct). As discussed during that hearing, this is not an area where there are simple solutions but we set out below some thoughts on changes that could be made together with some of the pros and cons of each which the Commission may want to deliberate on further. This memorandum focuses on the investigation and disciplinary process rather than the wider operation of the Approved Persons Regime. 3. The Commission will, of course be aware that the FCA Board has not yet been established. The approach to this very important issue is a matter that we expect the Board to consider in the early days of the FCA.

Background 4. Personal accountability is an important part of an effective regulatory regime and of maintaining public confidence in both the system and its regulator. This has been recognised since the beginning of the FSA. Our approach has been to set out in our rules the conduct we expect of approved persons, and to take action if they breach those rules. Typically, for example, this would mean that we might take action for a failure to act with integrity or a failure to take reasonable care in the performance of a controlled function. This will normally mean that we must establish some fault or culpability before we can impose any disciplinary sanction. However, to date, it has proved difficult to bring such cases against senior individuals in large organisations. The reasons for this include: (a) The individual did not, in fact, do anything wrong, in the sense of being in breach of our rules. They made judgements which were not clearly unreasonable at the time even though some of those may have proved, with the benefit of hindsight, to be disastrously wrong. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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(b) The individual did not act alone. Decisions were made by properly constituted boards or committees. Such decision making is a standard feature of corporate structures and is normally expected to produce better decisions by allowing for challenge (particularly by non-executives). While the fact a decision was made by a group of people is not a complete defence, it does make it more difficult to establish that the conduct of any single individual (or the group) fell below the relevant standard— put simply the defence is “we cannot all have been acting outside the bounds of what was reasonable”. This is a more acute version of what in civil litigation might be referred to as the “battle of the experts”. One professional says X and another says Y and the Tribunal is left to decide between them. In disciplinary cases the Tribunal will not only be faced with the independent experts on both sides but also with a series of other individuals involved in the decision making all of whom also bring some expertise to bear and who will, almost inevitably, be ranged against the regulator. (c) The responsibility for a particular area may have changed over the relevant period so that no single person is responsible for the entirety of the misconduct. (d) Decisions were made further down the chain of command. If the delegation was appropriate (ie to an appropriately qualified person with suitable resources etc) the more senior individual will not be at fault. In conduct cases (although perhaps less so in prudential matters) the decisions which are made which impact adversely on customers may sometimes be made a long way from the top of the organisation and the senior management and/or board currently have relatively little visibility of them. (e) It is unclear who was responsible for a decision (or series of decisions) because lines of accountability are unclear or confused, or because they pass, at some point, through people who are not approved (and are not required to be). (f) Even in cases where there is a strong suspicion that more senior management “must” have known what was going on, it is difficult to find the evidence to substantiate that suspicion. 5. Any solutions that are sought to the problem of personal accountability therefore need to consider which of these issues they are seeking to address. Some of the challenges are concerned with securing the necessary evidence to establish whether individuals are genuinely responsible for particular decisions or actions and their consequences. But there is a more fundamental question about whether some form of wrongdoing or culpability should be a pre-condition for imposing punitive sanctions. In this context, it is worth noting that typically a CEO would not be held personally responsible for a breach lower down the organisation eg if employment laws were broken. 6. However, in any organisation, staff lower down the hierarchy (and indeed sometimes the non-executives) will, typically, act in a way which they believe reflects the culture and approach of the organisation. That culture will manifest itself in many ways: — what senior management say and, more importantly, what they do; — the incentives and reward structure in place; and — the qualities and characteristics of those who are promoted or otherwise recognised. 7. Large organisations will also establish systems to ensure consistency of approach, to manage legal, regulatory and reputational risk, and to monitor and measure performance and profitability. These structures will be approved by senior management and operated under their delegated authority. 8. So, although direct involvement in misconduct may be limited, senior management ultimately have the tools at their disposal to control or limit it. This combined with the sheer number and extent of the issues in the financial services industry over recent years, which in itself reflects deep seated issues within the culture of certain parts of the sector, justifies a different approach to the liability of senior management within the financial services sector.

Who should be Subject to Disciplinary Sanctions 9. As referred to in our submission of 18 January 2013 (and discussed during the hearing on 29 January 2013) we think it is important, to ensure proper accountability, that we are able to take disciplinary action against individuals who are not Approved Persons.

Culpability vs Accountability 10. If the intention is simply to ensure that, where things do go wrong, an individual is seen to bear the consequences, the simplest way to achieve that would be to impose a strict liability regime and dispense with any notion of fault (other than by the ﬁrm) being required. This would, on the face of it, be quick and simple. It would be likely to have some desirable consequences in that it may encourage more risk averse behaviour by management. It would also enable the regulator to demonstrate that something is being done. It does however have signiﬁcant downsides. The potential issues include: (a) Identifying what event or action should give rise to the automatic sanction For example, one might say that being a director of a bank at the time of its “failure”, in the sense of it going into administration or receiving emergency public funding, should of itself be a cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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justification for the imposition of a sanction. For actions adversely impacting on consumers, one would need to define the facts or circumstances that should be the trigger for disciplinary action. These would need to be defined with sufficient clarity to avoid the sort of arguments and uncertainty we currently face in pursuing disciplinary action. (b) If the aim is to encourage better behaviour then introducing a system where the sanction is the same however well or badly you have done your job may not achieve that. There would be no reward for doing the best possible—only for perfection. (c) Part of the deterrent effect of a sanction is the stigma that goes with it. If it is perceived that the sanction comes without any “blame” attached it may have little, or no, deterrent effect. People, for instance, regularly break the speed limit despite the risk this might result in sanction. (d) The imposition of a sanction—in the absence of establishing culpability—might be perceived as unfair. This perception would be magnified the greater the sanctions imposed (or available). If an individual faced, for instance, being barred from the industry it is likely that this would engage protections under human rights legislation and a strict liability approach may not be upheld by judicial authorities here or in Europe. That risk could be mitigated, to some degree, by imposing lesser sanctions. However, they may not have the desired deterrent effect and may be perceived by society as equally as inadequate as the current position. (e) The reality of the financial crisis has been that many senior management in large firms have lost their jobs and often considerable sums of money. It is difficult to imagine that they may have behaved differently, in a prudential sense, because of the threat of a small sanction imposed through strict liability given that they did not think, at the time, that their conduct was wrong.. It is however fair to say that in the conduct context the impact of past failings may not have been quite so keenly felt at the most senior levels. Therefore, a strict liability approach may have a greater impact in that area not least in ensuring that senior management take greater interest in, and have greater awareness of what might expose them to liability.

11. One way of addressing concerns about the efficacy of the sanctions available under a strict liability regime could be to adopt an approach equivalent to points on a driving licence eg to provide that an individual who had received more than, say, 3 strict liability sanctions would be presumed to be no longer fit to perform their role or would be liable for some other more severe sanction. This might be particularly effective if combined with a time limited approval for certain roles in certain firms eg if there were a 5 year appointment then, on renewal, the regulator could consider whether the number of sanctions accumulated meant any new application should be refused. However, identifying sensible “trigger points” for the imposition of staged sanctions would be critical to the viability of such an approach and to the perception of its fairness.

Rebuttable Presumption

12. If the intention is not to hold people to account simply because something happened on their watch but instead to distinguish between the good and the bad then an option may be to make it easier to establish a case.

13. We currently state that we will not discipline someone simply because something went wrong in an area for which they were directly or indirectly responsible. We could look to reverse that position by introducing a rebuttable presumption that, in certain circumstances and for particular types of misconduct, where something goes wrong in your area you are responsible unless you can demonstrate that you took all reasonable steps to avoid the misconduct and/or that there were no other reasonable steps that could practically have been taken.

14. This would be more targeted than a strict liability regime as it would ensure that an individual who could show they had taken all reasonable steps would have a defence to discipline.

15. It would be helpful for the regulator in that the starting point would be that the relevant person would have to establish why the steps taken met the standards and respond to any areas of challenge where the regulator identified that other steps could have been taken. This would shift, in a significant way, the nature of the investigation and would in itself have an important signalling effect. It would however not be a panacea: — In order to meet requirements of fairness it would be necessary to ensure that the presumption could actually be rebutted. — Although it should enable investigations to be more focussed and limit the areas on which expert evidence is required it would not avoid the need for detailed and complex consideration of the steps taken by the relevant individuals.228 — This option is likely to require legislative change to give the regulators a clear foundation on which to impose “evidential burdens” on those potentially subject to disciplinary action. 228 The recent Tribunal decision in Sime highlights that even in Authorisations cases, where the burden is on the applicant for approval to satisfy the regulator of his fitness, that does not mean the regulator can simply rely on unproved and unresolved allegations. The Tribunal stated in that case that it considered to be its duty to reach conclusions on the allegations and if on examination they are not substantiated, they should disregard them. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

Ev 1058 Parliamentary Commission on Banking Standards: Evidence

Other Approaches 16. As mentioned at the hearing we are also exploring practical ways to try and address some of these issues (particularly around clarity of responsibility and delegation) eg through conducting audits of the responsibilities of Signiﬁcant Inﬂuence Functions (“SIFs”). In addition to those matters which are in train, we set out, for completeness, other areas we are considering.

Changes in Regulatory Approach 17. Expanding the Statements of Principle which we issue under our approved persons regime to impose wider duties on senior management eg to require them to operate their business in a way which puts customers first or reflects a long term view or a duty to society. To make such a provision effective would require very careful thought to be given to the drafting both to ensure that it supported the right outcome and also to manage any potential conflict with other duties (whether regulatory or otherwise) eg putting a customer first could mean turning a blind eye to money laundering or market abuse. Such a provision would, however, have an important signalling effect and may also provide additional support for those within firms who are trying to do the right thing. A change of this nature would require consultation and could be expected to be met with significant resistance from the industry. 18. Amending our Handbook to allow us to ensure we can identify a SIF within a firm who is responsible for ensuring clear lines of accountability. This would enable us, in cases where the relevant person responsible for the decisions leading to misconduct cannot be identified, to take action instead for a failure to apportion responsibility properly. 19. Making other handbook changes. For instance we currently state in our Handbook that “principal responsibility for compliance is with the firm”. That statement could be reversed to make it clear that we regard primary responsibility for compliance as being with individuals.

Addressing the Accountability Gap 20. Another option to address the “accountability gap” would be to consider ways in which those lower down the hierarchy within a large company could hold those higher up to account. Currently we have tended not to pursue middle management or compliance ofﬁcers in most cases. This has been driven by the view that they are often a convenient scapegoat but lack the real power to change things so we are targeting the wrong people. Further, in the case of compliance in particular, we are penalising the person who should be a regulatory ally and reinforcing the view that meeting regulatory requirements is the job of compliance not of the business. 21. We could change this approach and adopt an approach that said, in each case, we would take action against the most senior person we could identify even if they were comparatively junior. This would have the effect of bringing home to those individuals their own responsibility. It may thus incentivise different behaviours, ie better escalation of issues, more forceful demands for resource, a better audit trail of who knew what when etc. Over time this may provide us with the evidence to pursue more senior individuals

Whistleblowing/Notifying the Regulator of Issues 22. We could also focus more on taking disciplinary action for breaches of Principle 4 of our Statement of Principles for Approved Persons where someone fails to report wrong doing to us. The potential implications of this could be significant if we ended up punishing the innocent, but silent, bystander rather than the wrongdoer (albeit the two are not mutually exclusive). This may require changes to the current FSA guidance particularly if we wished to make it clearer that individuals should notify us of issues outside their own firm. 23. For the reasons set out in our submission of 11 December 2012 we are currently unpersuaded of the benefits of financial incentives to whistleblowers. One area which may merit further consideration however is the consequences to individuals in the industry of notifying us of misconduct. Where there is no suggestion that there has been any involvement in the misconduct then, while there are obvious risks to whistleblowers of being stigmatised etc, these are largely the same as in other industries. 24. Where an individual has been involved in misconduct however the position is different. If someone provides us with information which indicates that their fitness and propriety is in question then we have taken the view that we cannot, as the regulator, ignore that. So the consequences may be that an individual who comes forward is prohibited from working in the industry as we cannot be satisfied they are fit and proper. This acts as a further disincentive to report misbehaviour. 25. We could consider whether or not we could operate a scheme similar to that used in cartel enforcement or the leniency provisions which we have adopted in connection with insider dealing. This would mean adopting a more lenient approach to those who are the first movers in bringing misconduct to our attention eg by agreeing not to prohibit them or imposing a more limited prohibition. 26. This is an approach is used routinely by US criminal prosecutors but is much less frequent in the UK. This is partly because the consequences (in terms of length of sentence) are typically greater in the US but also because it is something UK jurisprudence has historically been suspicious of. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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27. Clearly if we in our role (as regulator rather than prosecutor) were to adopt such an approach we would also need to be able to impose suitable supervision requirements on the individual to ensure that they did not put other market users or customers at risk. 13 February 2013

Written evidence from the Financial Services Authority WHISTLEBLOWING 1. This memorandum addresses the Parliamentary Commission on Banking Standards further questions arising from our submission on 11 December. This includes: — possible information we could provide to employment tribunals to support whistleblowers; and — the FSA’s approach to the guidance in our Handbook on disclosures covered by the Public Interest Disclosure Act, and in particular, SYSC 18.2.3 G.

Information toEmploymentTribunals 2. The FSA’s whistleblower unit seeks to offer impartial guidance and support to whistleblowers concerned at the consequences of making a disclosure. This will include advising them of the existence of organisations such as Public Concern at Work which may be able to provide them with advice and assistance. Our procedures are designed to prevent the whistleblower’s identity being known beyond the FSA’s whistleblowing unit without their permission. However, there is a risk that the whistleblower may nonetheless be identified by their employer, and could suffer disadvantage as a result. In the event this led to an employment tribunal, a whistleblower may ask us to provide evidence in their support. 3. We receive infrequent requests to appear before employment tribunals, which we consider on a case-by- case basis. The factors we take into account include the impact of the confidentiality constraints in the Financial Services and Markets Act 2000 (FSMA) on what we can disclose. We also consider the contribution the information we are able to disclose would be likely to make to the fair disposal of the case. Depending on the timing of the employment tribunal, there may be little scope for us to provide an analysis of the validity of the whistleblower’s concerns to the tribunal. This is because of the confidentiality restrictions on what information we could share with the tribunal on the steps we took following their disclosure, and the outcome of these measures. There are situations where we would have greater freedom to comment on the whistleblower’s submission. For example, where enforcement action has been taken following the whistleblower’s submission, and we have put the facts of that case into the public domain in a formal Final Notice, we may have more flexibility about describing the role of the whistleblower. The problem here is one of timing—the published outcome of the enforcement action may happen too late to be included in a tribunal case. 4. The FSA is also provided advance notification by HM Courts and Tribunal Service of cases when a protected disclosure under the Employment Rights Act 1996 has been made and where the claimant has given their consent for it to be sent to the relevant regulator. We review these tribunal notices relating to whistleblowers and will consider whether there is scope within the confidentiality restrictions imposed by FSMA to provide evidence to the tribunal. 5. Broader material about the support we offer to whistleblowers can be found in our previous submission dated 8 February to the Commission.

FSARulesAboutWhistleblowing 6. The FSA’s Senior Management Arrangements, Systems and Controls (SYSC) Sourcebook provides guidance on the FSA’s approach to disclosures covered by the Public Interest Disclosure Act.229 7. We would take seriously the suggestion that an FSA-regulated firm breached the requirements of the Public Interest Disclosure Act by penalising a member of staff who had made a protected disclosure. 8. We believe the best method for us to learn of such breaches is to rely on whistleblowers who made disclosures to us to draw our attention to any detriment they believe they have suffered as a consequence. Employment tribunals do sometimes make us aware that a firm we regulate is contesting a claim. We do not believe that active monitoring of the judgements of employment tribunals would be a cost-effective means of us discovering misconduct by the firms we regulate because thousands of tribunals take place every week: according to Ministry of Justice statistics,230 employment tribunals accepted 186,300 claims in 2011–12, for example. 229 SYSC 18.2.3 G—“The FSA would regard as a serious matter any evidence that a firm had acted to the detriment of a worker because he had made a protected disclosure (see SYSC 18.2.1G (2)) about matters which are relevant to the functions of the FSA. Such evidence could call into question the fitness and propriety of the firm or relevant members of its staff, and could therefore, if relevant, affect the firm’s continuing satisfaction of threshold condition 5 (Suitability) or, for an approved person, his status as such.” 230 See: http://www.justice.gov.uk/statistics/tribunals/employment-tribunal-and-eat-statistics-gb cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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9. There have been cases where whistleblowers have informed us that they believe their employer acted in a manner that led to the whistleblower suffering detriment as a consequence of making a protected disclosure. 10. After a whistleblower has contacted us alleging mistreatment by their employer, our procedure is for the whistleblowing unit to inform the supervisory staff responsible for managing the FSA’s relationship with that firm and discuss the case with them. Internal legal advice may also be sought at this stage. The supervisory staff would consider what action would be appropriate: Enforcement action would be one option, as would other measures such as requiring remedial measures to be taken by the firm. 11. To date, we have not undertaken detailed investigatory work or enforcement action against firms we regulate as a consequence of receiving accusations they mistreated a whistleblower. 12. We will continue to monitor and keep under review the Financial Conduct Authority’s approach to whistleblowing, and implement any changes that will improve the regime, as appropriate. 19 March 2013

Written evidence from the Financial Services Authority FOLLOW UP INFORMATION ON FCA’S ROLE ON CONSUMER ACCESS This memorandum is prepared in response to the request directed to Martin Wheatley from the Parliamentary Commission on Banking Standards (“the Commission”) during the oral evidence taken on 27 February 2013 from Lord Turner and Martin Wheatley. This request was for a note outlining our initial thoughts on how the FCA will take forward its role relating to consumer access to financial products and services. The Financial Service Act 2012 gives the FCA an objective to promote effective competition in the interests of consumers. As part of this objective, the FCA “may have regard” to a number of factors when considering the effectiveness of competition, including “the ease with which consumers who may wish to use those services, including consumers in areas affected by social or economic deprivation, can access them”. This “consumer access consideration” is not an objective or a duty on its own, but something that we may have regard to as we take forward our competition objective. Our approach to consumer access issues will be shaped by this underlying legal framework—the focus of our role will be on how we can enhance ease of access through measures to promote effective competition. It is the FCA’s view that substantial policy interventions that have a sole focus on enhancing access, and which require significant economic and social policy trade-offs to be made, remain the role of the Government rather than the FCA. This includes actions that would require firms to offer products or services where it would not be their commercial choice to do so. We consider that Parliament reflected this intention in the debate on the consumer access consideration231 and by not making enhancing access a specific FCA objective of its own, but a consideration of our competition objective. The focus of our actions will be on making markets work efficiently, but not directing firms to participate in the market. “Financial exclusion” (not being able to access financial products and services) can create real disadvantages for those consumers affected. Not being able to access contents insurance, for example, could mean that consumers face total losses if they are burgled. Not having access to a bank account can mean missing out on discounts for making payments by direct debits. Not having access to lending reduces consumers’ ability to smooth expenditure over time. Depending on the precise circumstances, this can also prevent individuals from accessing funding for business opportunities. There are multiple aspects to the financial exclusion problem, such as a lack of products in the market that consumers can afford or are eligible for, a lack of products that are suitable, or where products are too complex or not explained in a way that the average consumer can comprehend. Actions that the FCA will take to promote competition have the potential to increase consumers’ access to products and services. For example, where we are able to reduce regulatory barriers for firms entering a market, this may facilitate the emergence of firms who are willing to provide services to particular consumer groups. Where competition is increased between firms in a market, there may be greater incentives for firms to design innovative products that are tailored to the needs of specific consumers. Prices might also be driven down by competition, which would also increase the affordability of products for consumers. The FCA will also continue to consider the impact that our interventions might have on the ability of consumers to access services. Our duty to act in a way which promotes competition strengthens the requirements upon us to do this. Where possible interventions might unnecessarily restrict access, we will weigh up the pros and cons and also consider alternative approaches. In doing this, the quality of the products that consumers might access will be important to us though—in some cases the risks to consumers from accessing “toxic” products will far outweigh any benefits and we will intervene to prevent consumers suffering detriment. We look forward to working with Government, and other agencies with an interest in reducing financial exclusion, as we take forward the consumer access consideration. In order to give full effect to our enhanced 231 House of Lords debate on Financial Services Bill, 12 November 2012, Hansard Columns 1320–1324. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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role, we will be seeking to increase our capability and knowledge base in respect of consumer access issues. This includes engagement with consumer organisations and other experts on ﬁnancial exclusion and increased use of data relating to access. We are still at an early stage in deciding how we will take forward the consumer access consideration and are actively engaging with relevant stakeholders to understand the key issues in this area. Following this engagement, we would expect to publish a wider statement on our policy on access later this year. We hope that this paper provides the information sought by the Commission, with the appropriate level of detail. Do let us know if the Commission has any further questions or requires any further information. 14 March 2013

Written evidence from the Financial Services Authority 1. In our previous memoranda to the Commission, the Financial Services Authority set out some of the key conduct issues together with recommendations we believe the Commission could make to enhance the regulatory regime and improve the professional standards and culture within the banking sector. We have consolidated those recommendations in this memorandum and summarise for the Commission our views on the following: — Strengthening and extending the approved persons regime. — The FCA’s competition powers.

Strengthening andExtending theApprovedPersonsRegime 2. We believe that although our powers are largely effective, the challenge of improving standards and culture remains. The Commission may wish to consider the following suggestions: — The extension of the limitation period for taking action against approved persons. — A power to prohibit an individual from performing a controlled function on an interim basis. — The extension of the approved persons regime to employees outside the scope. — Our views on the establishment of a professional body.

The extension of the limitation period for taking action against approved persons 3. There is a strong case for reviewing the time limitation period for taking action against approved persons. When taking disciplinary proceedings against an approved person (eg a censure, fine or suspension/limitation), the FSA must commence proceedings within three years of the first day on which it knew of the misconduct.232 Our experience has been that three years is likely to be insufficient time for the FCA to determine whether there is a case to answer in complex investigations, which is often the case when bringing an action against a senior manager of a large firm. 4. By comparison, there is no time limit when we take action for market abuse which applies to any individual and not just to approved persons. In addition, no time limit applies when we are taking disciplinary action against authorised firms. We are aware of the impact that regulatory enforcement action has on individuals and we agree that regulators should progress their investigations efficiently and without undue delay. However, given that senior managers are responsible for the conduct of their firms it is not clear why they should benefit from a limitation period for action particularly when cases are often more difficult to bring against individuals than they are to bring against firms. 5. We therefore urge the Commission to consider recommending the extension of the limitation period for taking disciplinary action against approved persons or alternatively by moving the commencement of the period to a later stage (eg the appointment of investigators).

A power to prohibit an individual from performing a controlled function on an interim basis 6. Currently, when the FSA takes action against an individual on the grounds of a lack of fitness and propriety (ie to withdraw his approval or prohibit him), we have no direct power to remove him from his position until determination of the action against him by the RDC or Upper Tribunal. In complex cases, this can take many years. 7. We urge the Commission to recommend a regulatory power to prohibit an individual on an interim basis from performing functions at an authorised firm (either controlled functions or any functions). This would enable the FCA temporarily to remove incumbent senior managers where they continue to pose a risk to the regulators’ objectives whilst action against them is ongoing. This power would be a significant tool which would allow the regulators to act swiftly to counter any threat to their objectives by an individual remaining in position pending a final determination by the tribunal. 232 This was increased by the Financial Services Act 2010 from two to three years. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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8. We recognise that this power would be a signiﬁcant extension to our current powers and should only be used in cases where there is strong evidence of a need to remove an individual immediately on the grounds of a lack of ﬁtness and propriety. Appropriate safeguards would need to be established to ensure that the power is properly used, as referred to in points 11–14 in our previous memorandum to the Commission on sanctions and the approved persons regime on 18 January 2013.

Extension of the approved persons regime

9. We urge the Commission to recommend a power to allow regulators the ability to take disciplinary action against employees who are outside the scope of our approved persons regime.

10. We have limited powers against individuals who are not approved. Whilst systems and controls and “tone from the top” are clearly key, it is obvious that a banking sector which functions well for consumers and the economy as a whole cannot be achieved unless employees below the level of senior management also act with honesty and integrity and competence and capability.

11. The current way that our approved persons regime applies to individuals means those approved by the FSA are liable to pay ﬁnancial penalties for misconduct. Others who might commit the same misconduct but do not require approval because they are performing roles that fall outside of the scope of the regime are not liable. However, it is not necessarily the case that those who are liable are more senior or will fall within the scope of the approved persons regime. For example, whilst a number of relatively junior individuals may be approved to perform the customer function as their role requires them to engage directly with customers, the line management above them may not fall within the scope of the current regime and as such do not need to be approved and are, therefore, not liable.

12. Whilst it is desirable to apply the full regime to senior management and other defined groups where there is a particular risk of significant consumer detriment should misconduct occur, it has until now been considered disproportionate to apply this to all bank employees. However, while the risks arising from conduct by those outside the approved persons group are lesser they are not negligible, and it may be that these could be addressed by a modified approach which included some, but not all, of the components of the approved persons regime.

Professional body

13. A number of respondents to the Commission have proposed the establishment of an independent statutory professional body, or “Banking Standards Board”, as a way of raising standards within the industry. The proposal is that such a body would license individuals working within the industry, and would have powers to take disciplinary action against them, including removing their license, which would amount to a prohibition to work in the industry. In taking over the role of regulation of individuals from regulators, we have some concerns about the establishment of such a body as it would appear to duplicate or overlap with functions that are already provided for in the existing regulatory framework. This could lead to confusion of responsibilities and an increase in regulatory costs.

14. We believe it would be possible to deliver any benefit that might be sought from the establishment of a Banking Standards Board, and to avoid any of the difficulties that might arise, by strengthening and extending the approved persons regime. The possible ways of doing this have been raised briefly in this submission and in more detail in point 21 of our submission of 18 January on sanctions and the approved persons regime. We would welcome any initiative that seeks to raise professional standards within the industry. However, the key will be that any initiative adds value rather than duplicates or overlaps with functions that are already provided for in the existing regulatory framework.

FCA Competition Powers

15. One of the FCA’s new objectives will be to promote effective competition that beneﬁts consumers. This means we will be expected to step in when market features or conduct lead to consumers getting a poor deal. We are now gearing up to deliver on this remit.

16. A toolkit of clearly deﬁned competition powers is required to underpin a fully effective approach. The current approach in the Financial Services Act allows us to use our existing regulatory powers to fulﬁl the competition objective. We believe that this will give the FCA a strong set of tools. We will also expect to work closely with the OFT and in due course the CMA. However, one aspect of the Financial Services Act 2012 is that it gives the FCA the ability to make a public request to the OFT to consider using its market investigation reference powers rather than being able to refer directly to the Competition Commission. Whilst in practice we will work in co-ordination with the OFT, this may lead to a potential disconnect because resources may not be available to pursue issues raised by the FCA. This could lead to uncertainty and delay in tackling features of market structure that harm competition, and hence in securing better consumer outcomes. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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17. We therefore continue to support the recommendation previously put forward by the Joint Committee on the draft Financial Services Bill that the FCA be given market investigation reference powers. 22 February 2013

The extension of the limitation period for taking action against approved persons 3. There is a strong case for reviewing the time limitation period for taking action against approved persons. When taking disciplinary proceedings against an approved person (eg a censure, fine or suspension/limitation), the FSA must commence proceedings within three years of the first day on which it knew of the misconduct.233 Our experience has been that three years is likely to be insufficient time for the FCA to determine whether there is a case to answer in complex investigations, which is often the case when bringing an action against a senior manager of a large firm. 4. By comparison, there is no time limit when we take action for market abuse which applies to any individual and not just to approved persons In addition, no time limit applies when we are taking disciplinary action against authorised firms. We are aware of the impact that regulatory enforcement action has on individuals and we agree that regulators should progress their investigations efficiently and without undue delay. However, given that senior managers are responsible for the conduct of their firms it is not clear why they should benefit from a limitation period for action particularly when cases are often more difficult to bring against individuals than they are to bring against firms. 5. We therefore urge the Commission to consider recommending the extension of the limitation period for taking disciplinary action against approved persons or alternatively by moving the commencement of the period to a later stage (eg the appointment of investigators).

A power to prohibit an individual from performing a controlled function on an interim basis 6. Currently, when the FSA takes action against an individual on the grounds of a lack of fitness and propriety (ie to withdraw his approval or prohibit him), we have no direct power to remove him from his position until determination of the action against him by the RDC or Upper Tribunal. In complex cases, this can take many years. 7. We urge the Commission to recommend a regulatory power to prohibit an individual on an interim basis from performing functions at an authorised firm (either controlled functions or any functions). This would enable the FCA temporarily to remove incumbent senior managers where they continue to pose a risk to the regulators’ objectives whilst action against them is ongoing. This power would be a significant tool which would allow the regulators to act swiftly to counter any threat to their objectives by an individual remaining in position pending a final determination by the tribunal. 8. We recognise that this power would be a significant extension to our current powers and should only be used in cases where there is strong evidence of a need to remove an individual immediately on the grounds of a lack of fitness and propriety. Appropriate safeguards would need to be established to ensure that the power is properly used, as referred to in points 11–14 in our previous memorandum to the Commission on sanctions and the approved persons regime on 18 January 2013. 233 This was increased by the Financial Services Act 2010 from two to three years. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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Extension of the approved persons regime

9. We urge the Commission to recommend a power to allow regulators the ability to take disciplinary action against employees who are outside the scope of our approved persons regime.

Professional body

FCA Competition Powers

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Written evidence from the Financial Services Authority FOLLOW UP INFORMATION IN CONNECTION WITH PENALTIES AND TIMING OF INVESTIGATION 1. This memorandum is prepared in response to the Parliamentary Commission on Banking Standards’ questions following the FSA’s enforcement action against RBS in relation to LIBOR.

Further Explanationof Financial Penalties Levied 2. The misconduct in the UBS and Barclays cases was similar in some ways to the misconduct described in the RBS Final Notice. Each case, however, had unique features which ultimately led to the imposition of different ﬁnancial penalties.

Why was the RBS fine £40 million more than Barclays and £75 million less than UBS? 3. The LIBOR misconduct at Barclays involved: (a) a similar number of individuals as in RBS; (b) more (and more senior) managers than RBS; (c) involved more serious USD misconduct than in RBS, including submitters acting on derivatives traders requests on numerous occasions; (d) concerned the additional issue of inappropriate submissions to avoid negative media comment (“low balling”) whereas RBS did not; and (e) collusive behaviour with other panel banks of a similar degree to RBS. 4. The Barclays penalty also took into account the firm’s extremely good cooperation which led to an early outcome to the investigation. This resulted in a significant reduction to the financial penalty levied. 5. RBS featured issues not seen in other cases. Specifically: (a) derivatives traders acting as substitute submitters; (b) the creation of the STM desk which sat submitters in close proximity to derivatives traders and encouraged unrestricted communication between the two groups (this resulted in an unquantifiable number of in-person requests); (c) money market traders taking into account the profitability of forthcoming transactions as a factor when making (or directing others to make) LIBOR submissions; (d) derivative trader requests continuing to a later date (until November 2010, compared to June 2009 for Barclays); (e) significant collusion with other institutions. In contrast to Barclays, RBS’s collusive behaviour involved brokers; (f) the use of, and failure to identify, wash trades to build relationships with traders which were then used to facilitate LIBOR manipulation; and (g) RBS provided an attestation to the FSA that its systems and controls were adequate when they were not. 6. The FSA considered the above-referenced factors in the context of the FSA’s overall approach to the determination of financial penalties (as mentioned in our 29 January 2013 follow up memorandum to the PCBS (the “29 January Memorandum”)) to determine the appropriate financial penalty in the RBS case. As noted in the 29 January Memorandum, there is no formal weighting of any factors; rather the FSA’s determination is made after an assessment in the round. However, the FSA viewed the flawed attestation, RBS’s failure to identify and manage the risks of biased submissions, the fact that the misconduct continued well into 2010 (even after RBS had commenced an internal investigation into LIBOR-related misconduct), the “wash trade” misconduct, and the absence of extremely good cooperation, as key factors which led to the imposition of a higher financial penalty on RBS than on Barclays. 7. In contrast to the misconduct described in the RBS notice, the LIBOR misconduct at UBS involved: (a) many more individuals (ie, 40 in UBS versus 21 in RBS); (b) more LIBOR currencies (five in UBS versus three in RBS); (c) much more extensive (in terms of duration, breadth, scale and openness) abuse than RBS; (d) an arrangement whereby, for a number of years, derivatives traders were also submitters (the “trader-submitter conflict”); (e) knowledge of manipulation (as well as the risks arising from the trader-submitter conflict) by senior managers to a much greater extent than RBS; and (f) a significantly greater volume of documented collusive requests than RBS, including through brokers and other panel banks. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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8. In contrast to RBS and Barclays, UBS did not qualify for a Stage 1 discount of 30% (it received a Stage 2 discount of 20%). 9. These factors led to the penalty imposed on UBS being higher than that on either Barclays or RBS.

CommunicationsReferenced in Final Notice and6 February Memo to the PCBS 10. Disclosure of certain documents referenced in the Final Notice has been requested. We attach: (a) Letter dated 10 February 2011 from FSA to RBS requesting that RBS attest to the adequacy of its systems and controls for LIBOR submissions (Final Notice reference paragraph 93). (b) Attestation from RBS dated 21 March 2011 regarding the adequacy of its systems and controls for LIBOR submissions (Final Notice reference paragraph 96). 11. The other documents requested are subject to statutory conﬁdentiality restrictions on disclosure, as they are conﬁdential documents within the meaning of section 348 of the Financial Services and Markets Act 2000. This means the FSA cannot disclose them without the consent of the person from whom the FSA obtained the information and the person to whom the information relates.

DetailsRegardingApprovedStatus of 21IndividualsImplicated 12. Of the 21 individuals implicated in the misconduct, 15 were approved during the Relevant Period and six are currently approved. Of the six, one is approved at another ﬁrm and the rest are approved at RBS entities. It should be noted that while many of the individuals were approved during the Relevant Period, their conduct in relation to LIBOR fell outside the scope of their controlled functions. 7 February 2013

Written evidence from the Financial Services Authority RBS FINE FOR SIGNIFICANT FAILINGS IN RELATION TO LIBOR 1. The Parliamentary Commission on Banking Standards (“PCBS”) will be aware that on 6 February 2013 the FSA together with the US Commodities Futures Trading Commission (“CFTC”) and US Department of Justice (“DoJ”) announced the outcome of its investigation into LIBOR related failings at RBS. In anticipation of the PCBS’s likely interest in this matter, in this memorandum we set out a narrative account of the FSA’s dealings with RBS in relation to LIBOR and other relevant information. We also enclose a copy of the FSA’s Final Notice.

Executive Summary 2. Concerns surfaced in 2008 about LIBOR submissions generally as a result of media articles in the US, and the FSA has had ongoing communications with the CFTC regarding LIBOR since that time. The FSA made initial requests of certain LIBOR panel banks for information relating to the potential suppression of US dollar (“USD”) LIBOR in December 2008. The FSA did not request LIBOR-related information from RBS at this time. 3. Between 2009 and 2010, the FSA examined a large amount of data relevant to certain panel banks’ LIBOR submissions. This data suggested to the FSA that the misconduct in relation to LIBOR took a number of forms and involved a number of banks. From July 2010, the FSA and CFTC began requesting that RBS provide information relating to its LIBOR submissions. Further, between January and June 2011, the FSA commissioned an analysis of the LIBOR submission data in 2007 and 2008 for RBS (and all panel banks) in relation to USD, JPY and GBP (the “Analysis”). The purpose of the Analysis was to identify anomalous submissions made by RBS or other panel banks in order to focus our enquiries. Certain anomalous submissions by RBS were identiﬁed by the Analysis and these were followed up by the FSA. In parallel, as a result of work RBS had been doing following requests commencing in July 2010, RBS reported potential misconduct to the FSA between March 2011 and September 2011. 4. RBS was referred to Enforcement for formal investigation on 20 September 2011 and a scoping meeting was held with RBS on 13 October 2011.

Background to LIBOR and the FSA’sSupervision of RBS 5. The FSA refers the PCBS to (i) the UBS memorandum of 7 January which discusses in detail the background to LIBOR and (ii) the FSA’s December 2011 report on the failure of RBS available at www.fsa.gov.uk/static/pubs/other/rbs.pdf (the “RBS Report”) which thoroughly describes the FSA’s supervision of RBS between 2005 and 2008. 6. Since 2009, signiﬁcant changes have been made to the FSA’s approach to supervision, especially with reference to high impact ﬁrms like RBS. The team supervising RBS has increased in number and is organised around the RBS Group structure to provide intensive and intrusive coverage of prudential risks globally and cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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conduct risks within the UK. At the time of RBS requiring Government support FSA Supervision had seven full time equivalent (“FTE”) resources (managers and associates) dedicated to the supervision of RBS. Today, the number stands at 23 FTEs (with 14 on the prudential side and nine on the conduct side). 7. From 2009, the FSA has delivered supervision of RBS through a combination of Advanced Risk Responsive Operating framework (ARROW) risk assessments; core programme reviews (eg on capital, risk management, liquidity and governance); and ad-hoc or reactive pieces, including section 166 reports. The focus has been mainly on prudential risks that could lead to ﬁrm failure. As part of this framework the FSA issued two ARROW letters, one in 2009 and one in 2011 (neither made reference to LIBOR). Over the period, the heavy focus on prudential issues was increasingly accompanied by ampliﬁed focus on conduct issues (both potential and crystallised risks) such as PPI. 8. During the period between March and September 2011 (when a referral on LIBOR was made to Enforcement), a number of verbal updates were given to FSA Supervision by RBS and its counsel regarding the progress the bank was making in relation to its own LIBOR investigation. RBS also updated FSA Supervision on evidence uncovered relating to the conduct of, and action being taken against, certain individuals. 9. In April 2012, the FSA split its supervision between conduct and prudential supervision in preparation for the legal cutover to the new regulatory regime that will see the Financial Conduct Authority (“FCA”) and the Prudential Regulation Authority (“PRA”) replace the FSA in April 2013.

EarlyCommentRegarding LIBOR 10. From 2007, there were a number of instances where RBS expressed the view in communications with the FSA that LIBOR ﬁxings (but not RBS’s LIBOR submissions) were not representative of actual market activity. These comments were provided in the context of liquidity and market updates. 11. In the second quarter of 2008, a number of media articles were circulated within the FSA which suggested that LIBOR contributors were submitting inappropriate LIBOR ﬁxings (these articles were mainly focussed on “low balling”), including one article which named RBS. Certain of those articles were summarised in Market Update emails circulated by the Bank of England to its own and FSA staff. It should be noted that the investigation has not found evidence of low balling by RBS.

FSA Investigation into RBS’s LIBOR Submissions 12. As noted in paragraph 2, in December 2008, the FSA made requests of certain LIBOR panel banks for information relating to the potential suppression of US dollar (“USD”) LIBOR. The FSA did not request LIBOR-related information from RBS at that time and was not aware of any enquiries by other regulators of RBS at that time. 13. Between 2009 and 2010, the FSA examined a large amount of data relevant to certain panel banks’ LIBOR submissions. This data suggested to the FSA that the misconduct in relation to LIBOR took a number of forms and involved a number of banks. The FSA, as noted in paragraph 3, first sought information (in conjunction with CFTC) from RBS in July 2010. By that point, RBS had commenced an internal investigation which was initially focussed on USD. 14. RBS delivered information to the FSA in a number of instalments during 2010 and beyond. 15. In February 2011, FSA Supervision requested that RBS (and other panel banks) attest to the adequacy of its (then) current systems and controls for the determination and agreement of its LIBOR submissions. RBS provided a positive attestation on 21 March 2011 (discussed in more detail below). 16. Also, between January and June 2011, the FSA commissioned an analysis of the LIBOR submission data in 2007 and 2008 for RBS (and all panel banks) in relation to USD, JPY and GBP (previously defined as the “Analysis”). The results of the Analysis identified 52 anomalous submissions made by RBS. FSA Supervision contacted RBS in June 2011 regarding the anomalous submissions and, in early August 2011, RBS provided a response to the FSA regarding these submissions. In parallel, between March 2011 and early September 2011, RBS reported potential misconduct it was identifying in relation to its JPY, CHF and USD LIBOR submissions. 17. RBS was referred to Enforcement on 20 September 2011 and a scoping meeting was held with RBS on 13 October 2011. 18. The FSA Board was informed of the FSA’s investigation into Barclays in January 2011. The Board were told that the FSA’s investigations into other firms would take place in stages, with investigation of higher risk firms prioritised. The Board was also told of the decision to conduct an analysis of LIBOR submissions made between 2007 and 2008, and were told of the plan to require firms to make an attestation over LIBOR controls. From that point, the FSA Board was, in the normal course of business, kept updated about the overall issues surrounding LIBOR submissions. LIBOR related issues at RBS were only discussed specifically post RBS’s referral to Enforcement during the course of periodic Board updates. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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CurrentPositionRegarding RBS’s LIBORSubmissions 19. Part of the failings set out in the FSA Final Notice relate to RBS’s failure to implement proper systems and controls. In particular, reference is made to the fact that RBS was slow to implement adequate systems and controls in part because it failed to identify risks. The FSA found that RBS’s 21 March 2011 attestation was flawed because RBS’s LIBOR-related systems and controls were not adequate at that time. The FSA did not conclude that RBS deliberately misled the FSA with respect to its attestation. However, RBS’s systems and controls were not adequate at the time of the attestation because they did not address the risk that Derivatives Traders would make requests to Primary Submitters. 20. RBS implemented systems and controls in June 2011 that addressed the risk of inappropriate Derivatives Trader influence. However, the less obvious but significant risk that Primary Submitters would consider the impact of LIBOR and RBS’s LIBOR submissions on the profitability of transactions in their money market trading books as a factor in determining RBS’s LIBOR submission, was not addressed until March 2012. 21. RBS has now taken a number of steps to update its processes in relation to its LIBOR-related systems and controls and FSA Supervision continues to monitor the firm to ensure its systems and controls around LIBOR are adequate.

22. In September 2012, FSA Supervision requested and received from RBS a review by its Group Internal Audit of its LIBOR controls. Further, in November 2012, FSA Supervision had further discussions with RBS to ascertain the status of RBS’ governance framework on rate setting and ﬁxing for LIBOR and analogous processes.

23. The FSA imposed a ﬁnancial penalty of £87.5 million on RBS in connection with its breaches of Principles 3 and 5 of the FSA’s Principles for Businesses. We refer the PCBS to the FSA’s memorandum of 29 January 2013 which details how the FSA determines ﬁnancial penalties.

Review by FSA Internal Audit 24. As discussed in greater detail in the UBS memorandum, the FSA’s Internal Audit team has been reviewing the FSA’s records to set out the facts relating to contacts with the FSA or awareness within the FSA on the subject of LIBOR manipulation during the period 2007 to 2008. Internal Audit has not found any communications to suggest that the FSA was aware of the manipulation of LIBOR submissions by traders. Internal Audit aims to provide the report to the Treasury Select Committee by the end of March 2013.

25. While the Internal Audit review is not ﬁnalised, the FSA has used relevant material arising out of Internal Audit’s review in preparing this memorandum. 6 February 2013

Letter from the Financial Services Authority to Royal Bank of Scotland Group

SYSTEMS AND CONTROLS FOR LIBOR SUBMISSIONS

We are writing to you as one of the contributors to the British Bankers’ Association (BBA) London Inter- Bank Offered Rate (LIBOR) setting process.

As you will be aware, there has been much analysis and commentary regarding LIBOR since the start of the ﬁnancial crisis. This is, in part, due to LIBOR displaying volatility during this time and as a consequence becoming a widely used barometer for the health of the ﬁnancial sector. More importantly, LIBOR continues to be a fundamental benchmark for interest rates globally and is widely used a basis for settlement: the integrity of LIBOR therefore remains paramount.

Given the importance of LIBOR, we wish to gain assurance that the arrangements in place for banks’ submissions are adequate. As such, we are asking each bank in the LIBOR setting process to provide an attestation as to the adequacy of the systems and controls arrangements currently in place for the determination and agreement of their LIBOR submissions. This is in the context of the deﬁnition of LIBOR and the wider guidance provided by the BBA.

We therefore request that you provide the attestation to us, as described above, for the submissions made by the Royal Bank of Scotland plc. In providing your response, it is not a requirement at this stage to provide details of any assessment or review which may have been undertaken, either as a result of this request or previously, nor any evidence which has supported senior management in reaching their view. We may, however, request this information at a later stage. Should the current arrangements not be considered wholly adequate, please provide reasons for this and what plans are in place in order to address the identiﬁed issues. We wish to receive your response by 18 March 2011.

If you have any questions regarding this letter please contact me. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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Letter from the Royal Bank of Scotland Group to Financial Services Authority SYSTEMS AND CONTROLS FOR LIBOR SUBMISSIONS I refer to your letter of 10 February 2011. The Royal Bank of Scotland appreciates the importance of LIBOR and our responsibilities as one of the contributors to the British Bankers’ Association LIBOR setting process. As set forth in a Draft Internal Audit Report dated March 2011, Group Internal Audit has conducted a review of the LIBOR setting process and the issues raised are being addressed to their satisfaction. Thus, on that basis I conﬁrm that RBS has in place adequate systems and controls for the determination and submission of its LIBOR rates. Should you have any further queries, please let us know. February 2013

Written evidence from the Financial Services Consumer Panel Summary The Panel welcomes the opportunity to provide further comment on potential changes to the sanctions regime for directors of failed banks. We have already provided input in this area through our response to the Commission’s earlier request for information,234 in the oral evidence given by Panel member Mike Dailly to the Commission on 26 September 2012235 and in our response to HM Treasury’s consultation paper on Sanctions for Directors of Failed Banks.236 We agree that directors of financial institutions, including banks, should take responsibility for the risks taken as a result of the business’ strategy and operations, as well as enjoy financial reward when the business produces profits and growth. The recent history of bank failures has served to emphasise the price paid by customers and taxpayers for directors’ bad decisions and those same directors’ ability to side step any real individual responsibility for their actions.

Ethical Code We believe that, as minimum, all banking directors should be required to comply with an Ethical Code for Directors of UK Banks set by a respected professional standards institution, and for such a code to be incorporated in the Code of Practice for Approved Persons (APER) speciﬁcally to apply to all directors of UK banks. The Ethical Code should impose robust standards of behaviour and, in particular, address reckless misconduct. We would also see a strong case for applying this more widely to senior executives other than directors.

CriminalSanctions We strongly support tougher and more effective criminal sanctions for directors of UK banks—and of other financial institutions—in appropriately defined circumstances. In particular, we suggest that primary legislation requires that specific breaches of the proposed Ethical Code give rise to the possibility of criminal sanction, whether as a fine or indeed in the most extreme and serious of cases, a custodial sentence, in order to create a more credible deterrence.

RebuttablePresumption However, we do not support the introduction of a “rebuttable presumption” which could well have a perverse effect, discouraging the far-sighted and diligent from accepting key management positions.

Use ofExistingSanctions We suggest that in addition, regulators should exercise more vigorously the sanctions already available to them to keep individuals without the necessary levels of fitness, propriety and competence from taking up or retaining positions of significant influence within the financial sector.

Questions 1. What are your views on extending criminal sanctions to cover managerial misconduct by bank directors? The Panel strongly supports tougher and more effective criminal sanctions for directors of UK banks—and of other ﬁnancial institutions—in appropriately deﬁned circumstances. 234 http://www.fs-cp.org.uk/publications/pdf/cp-response-parliamentary-commission-on-banking20120924.pdf 235 http://www.publications.parliament.uk/pa/jt201213/jtselect/jtpcbs/c619-i/c61901.htm 236 http://www.fs-cp.org.uk/publications/pdf/sanctions-consult20120928.pdf cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

Ev 1070 Parliamentary Commission on Banking Standards: Evidence

We believe that all banking executives should be required to meet an Ethical Code for Directors of UK Banks set by a respected professional standards institution. Such a code should be incorporated in the Code of Practice for Approved Persons (APER) specifically to apply to all directors of UK banks, and arguably to other senior executives. Specific breaches should give rise to the possibility of criminal sanction, whether as a fine or indeed in the most extreme and serious of cases, a custodial sentence.

2. What are your views on the possible formulations of a criminal offence based on options (i) to (iv)? The Panel’s thinking on this has been evolving, and we have considered a number of options. Our philosophy has not changed, rather, our thinking on how best to deliver it has been refined. Option i), the possibility of a strict liability offence, has been used successfully in non-financial services retail markets for many years and has the benefit of attaching to the point at which the fault lies. More recently the Unfair Commercial Practices Directive—through part 3 of the Consumer Protection from Unfair Trading Regulations 2008—created a number of strict liability offences. Clearly any new measures would have to incorporate a clear and careful definition of the offence and a short list of “defences”, such as a director joining a bank board after it had failed, to assist with run-down. In relation to option iv), one possibility could be the establishment of an independent professional body, mandatory membership of which should be debated, with its own civil and possibly criminal prosecution powers based on the concept of recklessness or wilful recklessness. Another possibility could be a more traditional offence with the two part test of actus reus and mens rea. Under Scottish law, the mens rea test of something done recklessly is sufficient to establish intent at common law, so this would be consistent with both current Scottish practice and one of the early basic principles of English common law. On balance, however, we believe the best solution to be the Ethical Code incorporated into APER as stated in our answer to question 1.

3. Do you think that an offence based on one of those options would be likely to discourage those considering positions of leadership within banks? We do not believe that this would be the case, unlike the proposals for a rebuttable presumption that the director of a failed bank is not suitable to be approved by the regulator to hold a position as a senior executive in a bank (see response to q’s 7,8 and 9).

4. Will the possibility of criminalising behaviour which can already be sanctioned under Financial Services and Markets Act 2000 (FSMA) act as a greater deterrent? Criminalisation of specific breaches of a new Ethical Code for bank directors sends a signal as to the seriousness with which certain duties are regarded, as a matter of public policy, and gives the FCA backstop powers. It may allow the FCA to graduate its enforcement activity, ratcheting up the intensity of intervention, depending on the issue at hand. There is a need to strengthen the suite of enforcement powers more generally. Private enforcement, for example, is limited in the UK as compared to, for example, private enforcement in the US, where a general anti-fraud rule is used vigorously to proceed against firms. Cross-jurisdictional comparisons should be undertaken with caution, given the range of local factors which shape the compliance and enforcement climate. Nonetheless, there is a need to expand the enforcement ‘tool-box” and to send a strong signal as to seriousness of certain core duties. Criminalisation also sends a very strong signal that “banks are different” because of the inherent public subsidy. The public interest must be seen, in a very clear way, to trump any potentially conflicting short term shareholder interests. A carefully designed Ethical Code has the potential to capture the fundamental public policy interest at stake, while criminalisation sends a signal as to the importance of that public interest.

5. Do you think that it is likely that the threat of criminal action will stifle perfectly legitimate activity and ultimately deter growth in the banking sector? No. We believe the potential for criminal sanctions tied to specific breaches of a carefully designed and reasonable Ethical Code would not be a deterrent to legitimate activity. Such sanctions are applied in other sectors such as the legal and accounting professions. All lawyers and accountants complete years of training and examinations before qualifying in which the importance of ethical standards in maintaining trust in the profession is impressed on all trainees. Once qualified, an individual faces significant penalties if they fail to meet the required ethical standards, with the threat of being banned from practicing or sent to prison highlighting the importance attached to maintaining professionalism in these sectors. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 1071

No comment.

Civil and Regulatory Sanctions

7. What are your views on the proposal to introduce a rebuttable presumption that the directors of failed banks are not suitable to hold senior executive positions in other ﬁnancial institutions? and 8. Does the rebuttable presumption go any further than the current regulatory regime? and 9. Do you think that the introduction of the “rebuttable presumption” could discourage skilled individuals from accepting key management positions?

We do not support the introduction of a rebuttable presumption which, to the extent that it had traction, could well have a perverse effect, discouraging the far-sighted and diligent from accepting key management positions. The presumption of guilt rather than innocence of directors of failed banks also offends notions of natural justice and due process.

Innocent individuals would face an almost impossible legal hurdle to demonstrate that their actions did not directly contribute to a corporate failure and/or significant detriment. Such an introduction could mean that careful and far-sighted individuals may be deterred from accepting a significant management role, fearing the possibility of a lifetime ban should the bank fail through no fault of their own. By contrast, buccaneering and over-confident individuals who valued instant reward over long-term commitment would be unlikely to be deterred by what they would regard as an improbable set of circumstances and sanction. If it had any effect, a rebuttable presumption could perversely discourage the longsighted and diligent from accepting positions of influence, while failing to weed out the short-sighted risk-seeker: an outcome the precise reverse of that desired. The rebuttable presumption sanction would be of no help to consumers or to anyone else.

10. Do you think introducing the presumption would send a clear message that bank senior executives and boards have a responsibility to ensure there is a strong focus on downside risks?

No, in fact we believe it would have the opposite effect (see answer to 7, 8, 9 above).

11. What are your views on the possible supporting measures aimed at clarifying management responsibilities and changing the regulatory duties of bank directors?

No comment.

Existing Regulatory Sanctions

12. Despite the range of enforcement powers currently available to the FSA, are additional powers necessary? If so, what would those powers be?

As in our answer to question 4, criminalising a breach of an Ethical Code gives the FCA backstop powers, adding to its “regulatory toolkit” and allowing a graduated approach to intervention.

In its efforts to deal with behaviour which resulted in the recent ﬁnancial crisis the FSA, (as Lord Turner noted in his foreword to the FSA report on RBS237) was faced with the problem that reckless managerial misconduct by banking directors was not of itself a criminal offence in the UK. Therefore it was very difﬁcult under the current legal regime to “pin” any one senior banking director down as being responsible in relation to prosecution or individual liability under any other provisions.

The use of an Ethical Code as proposed by the Panel, would mean that, in the event of another crisis, one would only have to prove they were a director subject to the Code and that they had breached that code (using evidence of a systemic banking crisis and insolvency).

13. What are your views on amending FSMA to include a power to prohibit an individual from performing a controlled function on an interim basis?

No comment. 237 http://www.fsa.gov.uk/pubs/other/rbs.pdf cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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As noted above, Lord Turner, in his foreword to the FSA’s report on RBS, stated that “there is neither in the relevant law nor FSA rules a concept of “strict liability”: the fact that a bank failed does not make its management or Board automatically liable to sanctions. A successful case needs clear evidence of actions by particular people that were incompetent, dishonest or demonstrated a lack of integrity”. An Ethical Code, in conjunction with the APER Code, would address this issue.

However, such a Code must be combined with a willingness to act. In its 2012 Review of the FSA’s Conduct Regime,238 the Panel identified a number of areas where the regulator could have taken action earlier, been more forward looking, or taken action to address the underlying causes of issues. In future, the FCA’s action must deter poor conduct behaviour in the firms it regulates. In the last couple of years the FSA has been taking forward more high profile enforcement action, including holding individuals in Significant Influence Functions to account. The Panel applauds this approach and believes the FCA must build on this.

15. What are your views on extending the limitation period for taking action against approved persons?

No comment.

Legislation versus Regulation

16. In order to make bank directors more accountable (due to the adverse impact a large failed bank can have on the wider economy), what are your views on amending the approved persons’ regime under FSMA rather than the Companies Act 2006 and the Insolvency Act 1986. To the extent you consider changes should be made to the legal framework, please articulate how you think this could be achieved given the legislation would apply to all company directors.

As outlined above, an Ethical Code for Directors of UK Banks should be written into the Code of Practice for Approved Persons (APER) speciﬁcally to apply to all directors of UK banks.

Speciﬁc breaches of the proposed Ethical Code should give rise to the possibility of criminal sanction, whether as a ﬁne or indeed in the most extreme and serious of cases, a custodial sentence, in order to create a more credible deterrence. This would require primary legislation.

The Approved Persons’ Regime (APER)

17. The Upper Tribunal ruling in John Pottage v The FSA (FS/2010/0033) highlighted that enforcement action against senior managers is only likely to be successful where there is evidence of actual wrongdoing by the executive concerned. In your opinion, what changes could be made to some of the statements in APER about the standard of conduct expected of directors in order to make it easier to bring enforcement?

No comment.

20. Do you see merit in requiring the regulator to re-appraise SIF individuals at set intervals and on other occasions if it believes that circumstances justify it

No comment. 238 http://www.fs-cp.org.uk/publications/pdf/review-conduct-reg-20120730.pdf cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 1073

21. What are your views on extending APER so that it applies to all bank employees in order to enable the regulator to take disciplinary action against employees who are currently outside the scope of APER? and 22. Do you see merit in the establishment of an independent professional body with mandatory membership which has the power to impose civil and possibly criminal sanctions? In your view, could such a body provide a solution for the issue of global matrix management structures that can exist within universal banks? A mandatory Ethical Code, set by a respected professional standards institution, should apply to bankers who exercise control, leadership or a significant management function within a UK banking institution. The introduction and maintenance of ethical standards will benefit consumers by ensuring banks are being honest and open with them. Customers will have confidence that a bank will only try to sell a product which truly meets their needs, with any conflicts of interests properly explained so they can make an informed decision. Reward and remuneration structures employed within banks would also be aligned with the best interests of the customer, rather than encouraging product sales at any cost. This will change the dynamic of the UK retail banking industry.

International 24. Do you think introducing additional criminal, civil or regulatory sanctions would have an impact on the international competitiveness of UK banks? No comment.

25. In your opinion, are there other legal or regulatory regimes that the Commission should be considering? Please provide your reasons for suggesting the applicable regime No comment.

27. What are your views on applying different sanctions for different types of directors—for example, non- executive directors? No comment.

28. Are there any other measures or legal/regulatory changes that the Commission should consider? The Commission should monitor the progress of EU initiatives on the criminalisation of certain activities, notably with respect to insider dealing and market manipulation. We do, however, caution that enforcement models can differ significantly as between jurisdictions, and reflect different political, cultural, legal and market environments. Care should be taken in undertaking comparisons. We are of the view that a carefully designed Ethical Code, and the related criminalisation of specific breaches, is a proportionate and appropriate mechanism for the UK banking environment. 25 January 2013

Written evidence from Ian Foxley, Lieutenant Colonel (retired) Introduction 1. I welcome this opportunity to respond to the Parliamentary Commission on Banking Standards. I would also welcome the opportunity to contribute in person to any further work investigating the broader issues of whistleblowing within the bounds of this and any future inquiry. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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About Ian Foxley 2. Ian Foxley is a retired Army officer having served for 24 years in the Royal Corps of Signals which is the IT and Telecommunications arm of the British Army. He served in UK, BAOR, and overseas, attended Staff College both as a student and a member of the Directing Staff, commanded the Parachute Signal Squadron and 3rd UK Division HQ & Signal Regiment and served on operations in Northern Ireland and in Bosnia Herzegovina. 3. He was staff trained in Defence Procurement, won the Commandant’s Prize for his year at Staff College Camberley and was a staff officer in Counter Terrorist operations and Operational Requirements in the Ministry of Defence (MoD). Most recently, he was the Programme Director for GPT Special Project Management Limited, a UK subsidiary of the EADS Group, who are the Prime Contractors for a £1.96Billion programme to modernize the communications within the Saudi Arabian National Guard Communications (SANGCOM) Project. The contract is between the Prime Contractor, GPT Special Project Management Limited, and the UK MoD. 4. In December 2010, Ian Foxley discovered documentary evidence of gross irregularities, and attempts to cover them up, within GPT and the SANGCOM Project which he reported to EADS Group Compliance, the UK MoD and the Serious Fraud Office (SFO). He therefore has direct experience as a whistleblower, its primary and secondary effects and the manner in which whistleblowers are received and treated by corporate, government and law enforcement organizations. He is the first Chairman of Whistleblowers UK, a formative charitable organization formed in 2012 by whistleblowers to support current and future whistleblowers. He will also therefore explain how these issues and effects are pertinent to all public and private sectors.

Caveat 5. Ian Foxley’s allegations of corruption and bribery within GPT Special Project Management Limited are the subject of a separate SFO criminal investigation and will therefore not be discussed within this evidence.

Recommendations for inclusion in Committee Report 6. (a) Greater protection for whistleblowers in UK Employment Law. (b) Legislative change to institute and equivalent the US Dodd Frank Act.

Executive Summary 7. This evidence discusses whistleblowing, its processes and motivation, its primary and secondary effects, the deﬁciencies of current process and legislation and what possible changes might be wrought in policy, legislation and organization by a Government interested in protecting and supporting Whistleblowers and the propagation of truth and honesty across all sections of British society.

8. Whistleblowing This evidence is about whistleblowing, its processes and motivation, its primary and secondary effects and the deﬁciencies of current process and legislation. It also indicates what possible changes might be wrought in policy, legislation and organization by a Government interested in protecting and supporting Whistleblowers and the propagation of truth and honesty across all sections of British society. 9. Whistleblowing starts before the actual process of disclosing information. It actually begins when the whistleblower recognizes that he or she has observed or discovered information or actions that are either illegal or immoral and which others might wish to conceal from wider general knowledge. The second key stage is the Whistleblower’s decision to do something positive about their possession of the information. The importance of this particular decisive act should not be underestimated: for many whistleblowers, the actual declaration is a point of critical importance and a time of extreme personal stress, and is often a moment of conﬂicting loyalties, values and personal vulnerability. It is at this point that the Whistleblower needs, expects, and deserves, the support of the corporate organization, the professional bodies that compose its staff and regulators, law enforcement agencies and the Government. Sadly, this is seldom the case.

10. What the Whistleblower should do? Initially a complainant should disclose their observations or information about irregularities to internal line or functional management and to those responsible for Compliance within the organization. The problem for the complainant arises when either the management are involved in, complicit to or “wilfully blind” to the irregularities, refuse to take action or even victimise the complainant for raising an uncomfortable and awkward issue. It is at this point that most complainants become whistleblowers through a perceived need to take the issue outside of the internal organization to an external body. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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11. So why does one blow the whistle? “Blowing the Whistle” therefore is normally the result of an observation of wrong-doing which has been reported appropriately but which has not been, nor is likely to be, remedied effectively. The view trumpeted by City bosses that most whistleblowers are motivated by a lust for money or prestige in grandstanding in the Press, or are just disgruntled employees, does not stand up to rigorous examination. In reality, whistleblowers are merely observant individuals who just don’t agree with what’s being done, are honest enough to declare it and frustrated by an organization that tries to smother their complaint—or even victimize the complainant. At WhistleBlowers UK (WBUK) we see this frequently, no matter what the sector of society the Whistleblower comes from.

12. What should one expect as a response? In drawing attention to an irregularity within an organization, a complainant places themselves in a position of uncomfortable vulnerability. Traditionally, the bearer of bad news is seldom rewarded and it is thus, often with one’s heart in one’s mouth and trust in the integrity of the organization, that one crosses the line to report misdemeanours. One expects a sympathetic response with a willingness to hear the “bad” news, validate it, and do something about it, and its proponents, in the short and long term. Most complainants and whistleblowers do not expect a reward for making a complaint—but neither do they expect the hostility and victimisation of the organisation to which they are reporting the irregularity, especially when that organization should beneﬁt from the knowledge and rectiﬁcation of the circumstances.

13. That does one find in reality? The reality is ashamedly different. The initial reaction is normally a downward spiral of disbelief, immediate personal and corporate protectionism, direct and implied threats, loss of position and responsibility, isolation and oppression. In extremis, a process of “Mad or Bad?” demonization is initiated which leads to a loss of job, with financial loss and reputational loss as direct effects, and with deeper, indirect, secondary effects: stress on family life leading to divorce, depression and even death. Examples come not just from the Banking Sector but from all sectors of British society: Dr Kim Holt (Baby P), Kay Sheldon (Care Quality Commission), Eileen Chubb (BUPA), Peter Gardiner (BAe/Al Yamamah), Paul Moore (HBOS), Martin Wood (Wachovia and Coutts Banks), myself (EADS/GPT), Craig Murray (CIA/FCO/MI6 Rendition Agreements) and even the unfortunate death of Dr David Kelly (the Dodgy WMD files). These are not isolated cases: hostility and victimisation of whistleblowers is endemic in corporate and governmental structures and something needs to be done to protect the Whistleblower now.

14. Why do we get this reaction? The source of most aggression is fear. In the context of the Whistleblower, corporate reactionary hostility, and any subsequent victimisation, is born out of Reputational Fear. This is manifested either as a personal fear, due to the disclosure of a personal culpability or complicity to the source of the revelation, and thus the ruination of personal reputation and future, and/or a corporate fear emanating from an immediate sense of failure of responsibility to protect the corporate reputation and future. The latter fear is, of course, exacerbated by the effect publicity of the irregularity might have upon on share price, corporate futures, stock options of participatory staff and management and the inevitable impact on personal wealth. 15. Whistleblowing threatens whatever belief systems and defences institutions have developed to permit the behaviour that is being exposed. They regard revelations as humiliating and attacking the institution itself and, therefore, its staff and professional advisors therefore see themselves as justified in retaliating against a Whistleblower, even to the extent of discrediting and pathologising them (the Mad or Bad? strategy). The motives and personal integrity of the Whistleblower may be publically questioned so that, through reversal and projection, the institution that is being questioned can evade any sense of responsibility or wrong-doing. It is the classic ploy of the guilty to point the finger in the opposite direction: in extremis, when the strategy works, the Whistleblower is made to feel to be the wrong-doer which, in turn, arouses feelings of serious self-doubt and depression, whilst the institution stands firm, and free, in its position as a “pillar of society”.

16. So what Support Structures exist for Whistleblowers? There is a dearth of support and appropriate advice for Whistleblowers in the UK. Public Concern at Work is singular in offering a conduit for information about the Public Information Disclosure Act (PIDA) (1998) but does not go so far as to offer legal and psychotherapeutic advice and support. Nor does it provide a focus for whistleblowers to share their experience to benefit current and future whistleblowers or appear to be actively lobbying for legislative change. It is to fulfil this need that Whistleblowers UK has been formed, by whistleblowers and their supporters, in order to provide experiential advice and focused support for whistleblowers. WBUK also seeks to communicate the mechanisms and benefits of whistleblowing and to research and promote policy development in whistleblowing law and practice, in order to effect legislative change. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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17. Legislative failure: Employment Law and Tribunals.

It is apparent that current UK Employment Law is deﬁcient in its protection of whistleblowers. For example, I made a claim for unfair dismissal on the grounds of my whistleblowing against GPT Special Project Management Limited in the Employment Tribunal in London in August 2011. A copy of the judgment is attached. In summary, it found that the Employment Tribunal had no jurisdiction and that, even though the cause of the dismissal may have been whistleblowing, there was no statutory position to support such a claim. Thus, the Employment Tribunal could not deal with this genuine whistleblowing and regulatory matter because of an insufﬁciency in current British Law. The recent Employment Tribunals (Constitution and Rules of Procedure) (Amendment) Regulations 2010 permits referrals by an Employment Tribunal to the relevant UK regulatory agency but contains no provisions for how the UK should make international referrals—such as to the Securities Exchange Commission (SEC) in the USA.

18. To exacerbate the issue, the current legislation provides at Section 43B: “(2) For the purposes of subsection (1), it is immaterial whether the relevant failure occurred, occurs or would occur in the United Kingdom or elsewhere, and whether the law applying to it is that of the United Kingdom or of any other country or territory.” Plainly therefore referral to a regulatory body should have occurred especially given that the contract is between a corrupt UK registered Company, not Saudi Arabian, and the UK Government under the terms of an International Memorandum of Understanding between the governments of the United Kingdom and Saudi Arabia. But even with this referral, there is no whistleblowing protection for a UK citizen. Surely this cannot be what HMG and Parliament intends and very certainly needs to be changed and properly reﬂected in any upcoming changes to the Employment.

19. The Phase 3 Report on the United Kingdom by the OECD Working Group on Bribery, published in March 2012, evaluated and made recommendations on the United Kingdom’s implementation and application of the OECD Convention on Combating Bribery of Foreign Public Officials in International Business Transactions and the 2009 Recommendation of the Council for Further Combating Bribery of Foreign Public Officials in International Business Transactions. In section 199—200, it noted that PIDA’s scope of coverage may be insufficient in foreign bribery cases. The Act does not apply to expatriate workers of UK companies who are based abroad unless there are strong connections with Great Britain and British employment law. Thus, this effectively excludes many foreign-based employees who are most proximate to, and thus most likely to report, acts of foreign bribery. My own recent case of Foxley v GPT starkly illustrates this limitation. The UK “explained” to the working Group that I “chose his contract to be governed by Saudi law” which thus deprived me of PIDA protection. However, the policy reason underpinning PIDA is to detect crime and protect those who report wrongdoing, and it singularly failed to do so in this case. This policy objective is undermined when the application of PIDA is dictated solely by the law governing an employment contract. I cite this, not as a personal issue, but as a clear example where the current Employment Law does not reflect the purpose for which is it was set in place.

19. Contrast with the USA.

The USA is far more advanced than the UK in its consideration and treatment of whistleblowers. It has a formally established Ofﬁce of the Whistleblower as a subset of the Securities and Exchange Commission (SEC) and Department of Justice (DoJ) with clear mechanisms for the reporting of irregularities and misdemeanours in corporate practice. Moreover, it has established a fund for compensating whistleblowers which has had a recognized, and dramatic, effect in inducing whistleblowers to come forward. Had a similar structure encouraged whistleblowers to raise concerns about the Barclay’s attempted manipulation of Libor, the abuses might have been caught earlier. But any attempts to parallel such structures will have to overcome the widespread scepticism and inbuilt prejudice against whistleblowers that would prefer to “debag the sneak” not thank an honest worker for their courage in coming forward.

20. Whistleblowers are NOT supported in this country: there is muted applause for the integrity and honesty of a brave man or woman but, in reality, corporate business reverts to snide sniggering at the naïve foolishness of those who do not understand “hard nosed commercialism”. Whilst the moral support is most welcome and necessary, it does not pay the bills! Most complainants do not assume the position of a Whistleblower out of any need for public acclaim or compensatory money, but neither did they do it to be left bankrupt and destitute for the future! The Financial Services Authority and HM Revenue & Customs can compensate whistleblowers for loss of earnings if they lose their jobs, but this principle needs to extended widely across British society to reflect the “qui tam” legal actions that private citizens were encouraged to take between the 13th and 19th Centuries by a cash-strapped English Crown in return for a cut of any fines. In the USA there is the Dodd- Frank Act which allows whistleblowers to be compensated from the fines levied on those who are found guilty of corruption, why cannot the United Kingdom have a similar process? Current legislation needs changing and we, the whistleblowers, are looking to our parliamentary representatives to do so. 24 August 2012 cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 1077

Written evidence from Ian Fraser I am an independent journalist and broadcaster focused on the banking and financial sector. I have been covering financial sector since 1997. My work has been published in The Economist, the Financial Times, the Sunday Times, Guardian, Independent, Daily Mail, Dow Jones, Thomson Reuters, The Herald and numerous other publications. I have worked on six BBC documentaries about the UK banking and financial crisis, including RBS: Inside The Bank That Ran Out Of Money. I blog at Qfinance.com, HuffingtonPost.co.uk, NakedCapitalism.com and IanFraser.org and regularly appear on BBC News channel, BBC Newsnight Scotland and other television and radio stations as an independent commentator on the banking sector.

Introduction The lack of effective regulation or oversight of the UK banking sector, especially in 2001–08, played a key role in precipitating the current banking crisis, which has in turn played the major part in tipping the UK economy into recession. In a regulatory and judicial environment in which senior bankers could be relatively confident that wrongdoing, and indeed crimes, would go unpunished and in which “growing shareholder value” was deemed to be the sole objective of corporations from the late 1970s onwards, it was perhaps unsurprising that banks and bankers behaved badly. The insuperable conflicts of interests ushered in by “Big Bang” in 1986, the deregulatory instincts of successive UK governments, the mispricing of risk promoted by securitization and the “shadow banking” sector and the financial regulator’s post 2006 faith in unrealistic models clearly made matters worse. The changes introduced since the banking and financial crisis of 2007–08, including the “ringfencing” proposals of Sir John Vickers’ Independent Commission on Banking, are a wholly inadequate response to the problems that bedevil the UK’s banking sector. Much more radical action is required if it is going to be reformed. This could include:- — More of those who were responsible for malfeasance and criminality in the banking sector need to be held to account (where appropriate through prosecution/enforcement but at the very least through losing their jobs). — The incentive structures that drive banks’ and bankers’ behaviour, including share options, need to be totally overhauled. — “Too big to fail” banks need to be broken up. — The separation between retail and investment banking must be enforced structurally, through different ownership, rather than through potentially porous “ringfences”. — It must be made easier for new market entrants. — Account switching must be made easier. — Diversity of ownership of financial institutions should be actively encouraged (I believe the UK has the highest weighting of publicly listed banks of any nation in the world). — The incestuous “revolving door” between the professions, politics, government, regulators and banks should be closed, or at least slowed down. — Politicians, civil servants and regulators, who have in recent times bent over backwards to accommodate the wishes of bankers (as a result of what former Bank of England monetary policy committee member Adam Posen has called the UK’s “festish-isation of finance”) must become much more sceptical towards the special pleading of lobbyists for the sector. They should pay greater heed to the views of organisations representing the interests of “end investors” and consumers of financial products and services including Brussels-based Finance Watch and the New Economics Foundation. — The fiduciary duties of directors of publicly-quoted companies, including banks, should be extended to encompass duties other than the maximisation of short-term shareholder value, including social/ public duties.

ASummary of what went wrong with British Banking 1. Banks became “too big to fail” owing to a failure of anti-trust regulation from the 1890s onwards, and the regulator’s apathy especially since 1997 as some banks vastly extended their reach both geographically and functionally, often into areas that their managements poorly understood. 2. Driven by analysts’ and investors’ obsession with short-term share price performance, bank chief executives and their management teams were driven to the boundaries of risk-taking, morality and legality in pursuit of short-term ﬁnancial goals. 3. According to Professor William K Black, associate professor of Economics and Law at the University of Missouri–Kansas City, the combination of investor pressure for short-term returns and the absence of effective regulation created a “Gresham’s dynamic” in the UK banking sector. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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4. Under this “Gresham’s dynamic” (named after the 16th century Elizabethan notion that “bad money drives out good”) banks and other financial firms discovered they were able to gain a competitive advantage by cheating. Banks that “cheated big and cheated early”, as Black puts it, reaped the biggest P&L rewards. Other players in the market felt obliged to follow suit. If they didn’t, they risked being left standing in the profitability stakes. 5. This “Gresham’s dynamic” fuelled the series of scandals that have blighted the British banking sector since the 1980s. These have included personal pensions misselling, endowment mortgages misselling, PPI misselling and interest-rate swaps misspelling to SMEs. Others include the “rip off” charges on pension and investment products and the abuse and asset-stripping of SME and mid-corporate customers by some UK banks. 6. The scandals suggest that, despite their often plausible exteriors, the executive directors of British banks have few qualms about swindling or ripping off their customers. In an interview with the Daily Telegraph March 2011, Sir Mervyn King, the governor of the Bank of England, decried banks for their cynical exploitation of “gullible or unsuspecting customers”. Oliver Morgans of Consumer Focus said: “PPI is a clear example of everything that is wrong with the banking sector. It shouldn’t need the intervention of a High Court to ensure that bank customers are treated fairly.” 7. The sums misappropriated from customers by banks stretch into the tens of billions of pounds. 8. The flawed incentive structures within the banking industry mean that executives responsible for promoting and executing such activity go unpunished; in fact they actually enjoy enhanced financial rewards. 9. Regulators including the Financial Services Authority became largely “captured” by the industry they were supposed to be regulating, especially in 2003–08 (the capture is considered by some to have become complete when HBOS chief executive Sir James Crosby was on the FSA board from January 2004 to February 2009). 10. It did not help that the government of Prime Minister John Major allegedly extended an immunity from criminal prosecution to large UK financial institutions and their senior executives in the wake of the Blue Arrow appeal court hearing of July 16th, 1992.* 11. The accounting standards known as International Financial Reporting Standards, introduced in the UK and Ireland in 2005, were a major contributor to the financial crisis in both countries. As Tim Bush of Pensions Investment Research Consultants has pointed out IFRS:- (a) is incompatible with UK company law and (b) enabled UK banks to live in a “fool’s paradise” in the three years prior to the crisis. 12. The bank bail-outs of 2007–08 came with insufficient strings attached. There was talk of quid pro quos relating to lending targets and bankers’ pay, but these were unrealistic and never properly enforced. The “Gresham’s dynamic” continued. For example, some banks continued to manipulate their London Inter-Bank Offered Rate (LIBOR) numbers even after the bailouts.

What is Happening Now? 1. The FSA was jolted into reconsidering its approach, and giving less credence to bank managements and more to the victims of their malfeasance, especially after the bailouts of October 2008. The regulator has since shown a greater inclination to properly regulate the banking sector, as we saw with the recent interventions at Barclays, but it takes a long time for the internal culture of an organisation such as the FSA to change. 2. In some of the cases that predate its change of heart, the FSA continues to be obstructive. This is usually because, were the regulator to properly probe cases of past bank misbehaviour and alleged criminality, it would risk showing up its past collusion with the banks and its former propensity to whitewash such things. 3. Every UK bank is a greater or lesser degree still attempting to bury and cover up some of the malfeasance and alleged criminal behaviour that occurred prior to the crisis. For example, it seems that Lloyds Banking Group is still trying to downplay multiple alleged crimes and misdemeanours committed by HBOS in 2002–08, including the behaviour of its “mid-market, high-risk” corporate team based in offices in Bishopsgate and Reading. 4. In a session with the Treasury Select Committee in November 2011, the four top executives in the FSA— Lord Turner, Hector Sants, Margaret Cole and Martin Wheatley—unanimously expressed a strong preference for cosy backroom deals, in which miscreant bankers are coerced into agreeing to lifetime bans from working in the financial sector, in exchange for agreements from the FSA to call a halt to investigations. 5. The FSA has already struck deals along these lines with former head of investment banking at RBS, Johnny Cameron, and unsuccessfully sought to strike such a deal Peter Cummings, the former head of corporate lending at HBOS. In my view such deals, together with the out-of-court settlements with banks and financial institutions favoured by financial regulators in many jurisdictions are a travesty of regulation/justice. 6. Such deals are favoured by regulators because they are much easier and cheaper to pull off than criminal investigations and prosecutions, and there is less chance they will go wrong. They also give regulators the chance to sweep much high-level “white collar” crime, as well as evidence of their own past failures, under the rug. But such deals are ineffective at the best of times and do nothing to alter behaviour. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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7. Some of the most egregious activities in the UK banking sector today are taking place in the “distressed assets” divisions of major banks. The commission should conduct a proper forensic analysis of the activities and behaviour of the Global Restructuring Group/West Register arm of Royal Bank of Scotland, together with that of its retained external consultants and advisers, especially in the period 2006 to date. This should include seeking testimony from affected parties, including directors of customer firms. 8. Often, even today, the United Kingdom seems to have to rely on US regulators, or US law suits, to get to the bottom of malfeasance and alleged criminal behaviour of UK banks and UK bankers. This is clearly disastrous for Britain’s reputation in the world. 9. The Parliamentary Commission on Banking Standards must not look at banks and banking in isolation. It must also explore the role of suppliers and professional advisers, including investment bankers, accountancy firms, auditors, insolvency practitioners, law firms, actuarial advisers, credit rating agencies etc. It is clear that the multifarious failures of the UK banking sector would have been averted, or would at least have been less severe, if the advisory community had retained its professional scepticism and been less willing to rubber stamp some of the bankers’ wilder schemes. 10. The ethical antennae of the “Big Four” audit firms were dulled by the prospect of cross-selling and consultancy fees. The House of Lords Economics Affairs Committee’s March 2011 report into the audit profession concluded that the “complacency” and “dereliction of duty” of auditors was a major contributor to the banking and financial crisis. The government needs to make clear what action it will take in response to the House of Lords Economics Affairs Committee report. 11. I would be more than happy to expand on any of these points and themes either via a supplementary memorandum or by appearing in person in front of the Banking Commission. 12. I have covered almost all these points in greater detail on my website, www.ianfraser.org.

Conclusion In the wake of scandals that plagued the Lloyd’s of London insurance market in 1986, Lord Roskill’s Fraud Trials Committee concluded:- “The public no longer believes that the legal system … is capable of bringing the perpetrators of serious frauds expeditiously and effectively to book. The overwhelming weight of the evidence laid before [my committee] suggests that the public is right. While petty frauds, clumsily committed, are likely to be detected and punished, it is all too likely that the largest and most cleverly executed crimes escape unpunished.” Twenty five years later, very little has changed. In the wake of the Libor-rigging scandal—which has confirmed how corrupt UK and international banking has become and is almost certainly the tip of the iceberg where market manipulation in the global financial markets is concerned—we have an unprecedented opportunity to rectify that. *I am able to provide further evidence of the immunity from criminal prosecution that appears to have been extended by the UK government to financial institutions and their senior executives post-“Blue Arrow” on request. 25 August 2012

Written evidence from Derek French Executive Summary: A brief summary, based on relevant personal experience, of structural changes which have contributed to the decline of banking standards in the UK including some pointers to where restorative action might be taken, including a registration requirement for individual practitioners and a community service obligation imposed on banks. This submission is made in a personal capacity although drawing on 38 years of UK and international banking experience plus 14 years, in a voluntary capacity, as campaign director of the Campaign for Community Banking Services www.communitybanking.org.uk 1. The banking profession in the UK has been on a declining trend for many years in comparison to other professions such as accountancy, legal, medicine, surveying, etc in terms of professionally qualified staff, except in the area of sales of regulated personal finance products. The profession was never so exclusive as the other examples in terms of qualification as a barrier to entry but this absence was more than compensated for by: — The fact that it was a life-long career profession, usually with one employer whose culture was absorbed over time and passed on to the next generation. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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— Much importance was attached by the largest employers to qualification in banking subjects with the professional bodies, the Chartered Institute of Bankers, and its much smaller Scottish counterpart. The former was hi-jacked by the ifs School of Finance to become a commercially orientated provider of financial services qualifications including degrees but its value as a professional body, always less than the other professions, has largely been lost. — Movement of staff, within a career progression, across functions and between geographical locations, in the UK and abroad, ensured that the bank’s culture, ethos and professional standards (including attitude to risk, integrity, honesty, conscientiousness, customer focus, need to know the customer and the market in which he operates) were transferred by example to new entrants and to those joining the profession later.

None of these exist today in the banking structure which has been allowed to develop in the UK.

Although overall business generation and profitability of the branch or business unit was always the principal aim of banking services provision, the emphasis on specific product sales was not present historically and remuneration/promotion was not tied to specific targeted areas but to all round performance. Most of the ‘deals’, lending or trading, could not be achieved by an individual but are reliant upon the brand and/or the balance sheet of the employing bank but the present remuneration policies seem not to recognise this.

I am not an expert in other countries’ banking employment but I understand that some of what we have lost/ abandoned in the UK has been retained in countries such as France and Germany.

2. Consumers, individuals and businesses, are better able than I to identify the consequences of the changed shape of the UK banking industry but from my discussions with both since leaving it is clear that consumers have lost trust in, and respect for, the experience, expertise and motives of most of those representing the bank they deal with and see little merit in moving to another of the established banks where the proﬁle is perceived to be much the same.

Of the new entrants, Handelsbanken UK deserves a mention because, for the mid corporate businesses and high net worth individuals the bank has chosen to market to, it has managed to revive the sort of service that bank customers expected and received in the past from the established UK banks; interestingly it has done this by recruiting from the established banks’ middle rank managers, who had beneﬁtted from the training and culture transfer I referred to earlier and has given them a meaningful level of discretion in matters of lending and charging that makes their job more satisfying and earns the respect of customers. I understand that reward is based on general performance.

3. See 2 above.

4.1 Incentivisation of risk taking, through excessive targeting and bonus rewards, leads inevitably, to irresponsible behaviour unless there is restraint exercised by the employer, the profession or the regulator with personal sanctions of a career damaging nature for non-compliance.

4.2 Some innovation is necessary and welcome but the product complexity needs to be fully understood by those responsible for selling it and those to whom they report. From personal experience of the early days of electronic banking and also derivatives, for both of which I had some management responsibility, I can vouch for the challenges, some would say insuperable, this level of responsibility can present.

4.3 Technology developments, especially the speed at which irreversible transactions can now be completed, is a temptation to take untoward risks or at least not think through the consequences. This has always been the case in fast moving markets such as foreign exchange but now the application is much wider and whether sufﬁcient checks and balances are in place is questionable.

4.4 In my experience which includes some crossing of the border, investment and retail banking are separate businesses which call for different skill sets and to some extent different cultures. It makes the job of managing both effectively, at CEO and Board level, too big a challenge and this is made even more difﬁcult by the disparity between reward structures. Complete separation of these businesses is the only answer.

4.5 In Retail Banking real competition between the established players is minimal. Product offerings and delivery structures are so similar that cost bases are virtually the same leaving little room to differentiate. In my present role I witness the complete absence of competition at local market level between the big retail banks. When one bank closes its branch others follow rather than actively competing for the business and in 14 years of monitoring the industry there have been only three cases where a ‘last bank in town’ has been replaced by a competitor bank—a period which saw many hundreds of communities rendered bankless, often with damaging impact on local businesses, especially retailers who can lose signiﬁcant turnover as well as suffering considerable inconvenience in carrying out necessary banking activities. The banks, despite signiﬁcant protests, will not reverse or modify a closure decision once made and the industry continues to refuse to adopt, or even trial, the ‘shared branch’ alternative to closure which is cost-effective and operates successfully throughout the USA. Full details are available on the website www.communitybanking.org.uk cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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5.1 Given the depths to which the industry has fallen, not only in the UK but especially so here, the path to recovery is long and difficult. 5.2 Culture needs to change from the top and regularly importing CEOs and Divisional Heads from other industries, cultures and countries does not help. 5.3 Personal sanctions for abuse need to be much stronger and some sort of professional registration process for banking decision takers at all levels, similar to other professions, merits investigation. 5.4 Banks need to have imposed upon them, in return for the considerable benefits they receive from authorisation, some community service obligations similar to the US Community Reinvestment Act. 6. The proposals are insufficient; ring fencing is not enough and more rules are necessary. 22 August 2012

Written evidence from Global Witness — Global Witness is a non-governmental organisation based in London that seeks to break the links between natural resources, corruption and conflict. Co-nominated for the Nobel Peace Prize for our work on conflict diamonds, we use exposé investigative reports to campaign for change in behaviour, policy and laws. Our investigations have shown how a poor culture of compliance within the banking industry and weak regulation has allowed corrupt politicians to access the financial system. — The problems that we have documented are part of a broader pattern of compliance failures within the industry that has led to a litany of scandals including sanctions busting, the rigging of LIBOR and massive unauthorised trading. — In our view these problems are a result of poor professional standards and culture within the banking industry, where profit all too often trumps obeying the rules. The compliance function is often sidelined and can have little real authority or independence. This problem is compounded by a remuneration structure that does not do enough to reward staff members for being “compliant” with the relevant rules and professional standards. — Misbehaviour by banks often goes unpunished by supervisors and prosecutors, whereas individual bankers stand to make enormous personal gains from striking deals with unsavoury customers.

Corruption and the financial system 1. Given the scale of global corruption239 it is not possible for corrupt officials to just deal in cash. They need a bank to hold accounts, make transfers and allow them to spend their illicitly-acquired funds. Grand corruption is simply not possible without access to the banking system. Banks that do business with corrupt politicians are therefore facilitating corruption, which deprives some of the poorest people of the world of much needed funds for development. 2. Global Witness’ work has shown how time and time again major international banks have been willing to do business with corrupt customers. HSBC took money from corrupt Nigerians, Deutsche Bank held accounts controlled by a Central Asian dictator and Barclays allowed the notorious son of the President of Equatorial Guinea buy a sports car and€18m of artwork despite his modest government salary. 240 3. There is a global anti-money laundering regime that requires banks to carry out checks on their customers and report any suspicious activity to the authorities. But our research suggests that this compliance framework is failing to prevent corrupt politicians, and other money launderers, accessing the financial system.

Poor culture of compliance 4. In June 2011 the Financial Services Authority (FSA) published the results of a thematic review into how banks in the UK handle high money laundering risk customers, in particular where there is a risk of corruption.241 The results provided a shocking insight into how many bankers view compliance: if the risk of getting caught is low, they are prepared to take suspect business. The FSA found that “a third of banks, including the private banking arms of some major banking groups, appeared willing to accept very high levels of money-laundering risk if the immediate reputational and regulatory risk was acceptable”.242 Three-quarters of banks in the FSA’s sample failed to identify the source of wealth and source of income of clients who were senior foreign politicians, despite the fact that this is a clear legal requirement.243 In conclusion the report said 239 It is particularly difficult to estimate the size of illicit financial flows, but a conservative estimate from the World Bank suggests that $20 billion—$40 billion is stolen each year from developing countries. World Bank/UNODC, “Stolen Asset Recovery (StAR) Initiative: Challenges, Opportunities, and Action Plan”, June 2007. 240 Global Witness, International Thief Thief: How British banks are complicit in Nigerian corruption, October 2010; Global Witness, Undue Diligence: How banks do business with corrupt regimes, March 2009; Global Witness, “Barclays account used by dictator’s son to buy€18 million of artwork with suspect funds”, 22 June 2011. 241 FSA, Banks’ management of high money laundering risk situations: How banks deal with high-risk customers (including PEPs), correspondent banking relationships and wire transfers, June 2011. 242 FSA, p. 4. 243 FSA, p. 4. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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that “three quarters of banks in our sample, including the majority of major banks, are not always managing high-risk customers […] effectively and must do more to ensure they are not used for money laundering”.244 5. This poor performance was in many cases driven from the top and cannot be dismissed as one or two “bad apples”. In nearly half of the banks that the FSA visited it found a poor anti-money laundering compliance culture and an apparent lack of leadership on this issue from senior management.245 6. Where banks were worried about the ﬁnancial crime risk posed by their customers it appears to have been driven by concern for the bank’s reputation, rather than by whether the customer was actually engaged in criminal behaviour. The FSA concluded that “as a result, senior management were willing to take on extremely high-risk customers, including where evidence appeared to point towards the customer being engaged in ﬁnancial crime, as long as they judged the immediate reputational risk to be low.”246 7. Some banks also appear to have a poor attitude towards their regulators. In an exceptionally strongly worded order, the New York State Department of Financial Services accused Standard Chartered of being a “rogue institution” which perpetrated a “staggering cover-up” by repeatedly providing false information to the regulators.247 One of the most concerning aspects of the order was that the regulator felt that the bank had shown “obvious contempt for US banking regulations”.248 As part of its order against Standard Chartered the New York State Department of Financial Services published emails which showed a Standard Chartered executive saying “You f***ing Americans. Who are you to tell us, the rest of the world, that we’re not going to deal with Iranians,”perhaps giving an indication of how compliance was viewed in that bank.249 8. Since the order was published Standard Chartered has agreed to pay a $340 million civil penalty to settle these charges with the Department of Financial Services, and it is expected that this will be follow by further penalties from other regulators.250 9. In a further example of the way some banks view their regulator, the FSA’s head of prudential regulation, Andrew Bailey, recently told the House of Commons Treasury Select Committee that Barclays had a “culture of gaming” the FSA and that in some areas trust had broken down between the bank and the regulator.251

Sidelining of compliance within banks 10. Within banks, compliance is seen all too often seen as a cost, rather than a profit centre. Compliance officers that Global Witness have spoken to describe how they often do not feel empowered to challenge the decisions of the business units. In most banks it is the relationship manager, rather than the compliance officer, who has the final say over whether a prospective customer is accepted. 11. In the worst cases compliance officers are actively sidelined or even dismissed for raising concerns. Martin Woods was a London-based compliance officer with the American bank Wachovia (now owned by Wells Fargo). He alerted the authorities to what he suspected was the massive laundering of drug money through the bank. Woods claims that he was pushed out of the bank due to his actions.252 Wachovia subsequently paid a $160 million settlement for anti-money laundering failures in relation to Mexican drug smuggling.253 12. This year, the Senate’s Permanent Subcommittee on Investigations revealed how HSBC systematically failed to implement US anti-money laundering rules. According to the committee’s chair, Senator Levin, the bank had a “pervasively polluted” culture that allowed money launderers, drug dealers and suspected terrorists to move their money through the US financial system. The committee’s report provided details of how HSBC US’s Chief Compliance Officer was dismissed after raising the issue of inadequate antimony laundering resources with the audit committee of the board of directors.254 13. Until compliance staff are properly empowered, with an independent reporting line to the board, nothing will change.

Lack of incentivisation for compliant behaviour 14. As has been widely discussed, one of the biggest barriers to lawful and ethical behaviour in the banking industry is the way in which bank staff are rewarded for their behaviour. At the moment the pay of bankers is almost exclusively linked to their ﬁnancial performance ie how much money they make for their institution, 244 FSA, p. 6. 245 FSA, p. 32. 246 FSA, p. 33. 247 New York State Department of Financial Services, “In the Matter of Standard Chartered Bank, New York Branch: Order Pursuant to Banking Law § 39”, 6 August 2012. 248 Department of Financial Services order, p. 5. 249 Department of Financial Services order, p. 5. 250 New York State Department of Financial Services, “Statement from Benjamin M Lawsky, Superintendent of Financial Services, Regarding Standard Chartered Bank”, 14 August 2012. 251 Treasury Committee, “Minutes of Evidence: Oral Evidence Taken Before the Treasury Committee on Monday 16 July 2012”. 252 Ed Vulliamy, “How a big US bank laundered billions from Mexico's murderous drug gangs” The Observer, 3 April 2011. 253 Evan Perez and Carrick Mollenkamp, “Wachovia Settles Money-Laundering Case”, Wall Street Journal, 18 March 2010. 254 Permanent Subcommittee on Investigations, US vulnerabilities to money laundering, drugs and terrorist ﬁnancing: HSBC case study, 17 July 2012, p. 21. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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rather than whether their behaviour is compliant with applicable rules and regulations or even in the long term interests of their customers.255 15. This was conﬁrmed by the FSA report, which found that: “due to the nature of an RM’s [relationship manager] role, the risk of capture or conﬂict of interest is high, in particular where they are rewarded for bringing in business or penalised for lost business opportunities”. 256 The pressure on relationship managers is to make money rather than to ensure that a particular deal or customer is compliant. 16. At present incentive structures are not linked strongly enough to how “compliant” a banker is ie how well they act in line with the bank’s policies and any relevant regulations. This needs to change.

Poor supervision 17. In Global Witness’ opinion financial regulators, including the FSA, need to get better at identifying compliance failures at the banks they supervise, and ensure that they are fixed. There are numerous examples of where banks have been found to be in breach of the rules, and yet fail to improve their systems. At times regulators have also failed to ensure that problems are resolved. 18. This is not a one off problem. For example, many of the problems that the FSA identified in its 2011 money laundering thematic review were also identified over ten years ago when the FSA carried out a similar exercise in 2001 following the revelation that £1 billion of assets linked to the former military dictator of Nigeria, Sani Abacha, passed through banks in the UK.257 This begs the question: what was the regulator doing during that period? 19. In 2010 Global Witness published a report—International Thief Thief—that detailed how two corrupt Nigerian politicians had brought millions of pounds through British banks including Barclays, HSBC and NatWest.258 This April another corrupt Nigerian politician was sentenced in London to thirteen years for fraud and money laundering. He had numerous accounts in the UK, including with Barclays, HSBC and Abbey National.259 These are many of the same banks that handled Abacha assets. However, as far as Global Witness knows none of these banks have been investigated to see whether they carried out the appropriate anti-money laundering checks on the politicians or their associates. When Global Witness asked these banks what checks they had carried out their customers, they responded by saying that they could not discuss this matter due to client confidentiality, but assured us that they had rigorous controls in place. 20. In the past the FSA has been reluctant to publically name banks that get things wrong. In 2001 the FSA did not publish the names of the banks that had handled Abacha related assets or even the names of the banks that were found to have had significant weaknesses with their internal anti-money laundering controls. It left to the Financial Times and the BBC to name the banks that had taken the former dictator’s assets.260 21. This is perhaps in part due to section 348 of the Financial Services and Markets Act (FSMA) which places stringent limits on the disclosure of confidential information by the regulator.261 Global Witness believes that this section should be amended to allow the FSA to release specific information about a financial institution’s wrong doing if it would have a deterrence effect for others in the sector and would be in the public interest. 22. Under section 166 of FSMA the FSA can require banks to commission a review of an area of activity that is causing the FSA particular concern. In 2011–12 the FSA used this power in 111 cases. However, at the moment these reviews are not made public.262 Global Witness believes that in the most egregious cases it would be in the public benefit for these reports to be published. This would provide real examples of bad practice and would serve as a deterrent to other banks. 23. Following the FSA’s thematic review, the regulator promised to be tougher on the banks it supervises with a more stringent approach to inspection visits. This was recognised by the Treasury Select Committee report into LIBOR. The Committee welcomed the FSA’s commitment to take a more “judgement-based” approach to supervision that allowed room for greater discretion from the supervisor. However, the Committee also observed that “the FSA has concentrated too much on ensuring narrow rule-based compliance, often leading to the collection of data of little value and to box ticking, and too little on making judgements about what will cause serious problems for consumers and the financial system”.263 This box-ticking approach to regulation needs to change. 255 For example see “The Kay Review of UK Equity Markets and Long-Term Decision Making”, 23 July 2012. 256 FSA, p. 31. 257 FSA, p. 6. 258 Global Witness, International Thief Thief, October 2010. 259 Mark Tran, “Former Nigeria state governor James Ibori receives 13-year sentence”, The Guardian, 17 April 2012. 260 FSA, “FSA publishes results of money laundering investigation”, 8 March 2001; John Mason and John Willman, “City banks “handled dictator’s fortune”, Financial Times, 9 March 2001; Greg Morsbach, “Abacha accounts” to be frozen, BBC, 3 October 2001 261 Financial Services and Markets Act 2000, Section 348. See also FSA, The Enforcement Guide, 27 July 2012, para. 6.6. 262 FSA Annual Report 2011/12, p. 211. 263 House of Commons Treasury Committee, “Fixing LIBOR: some preliminary findings: Second Report of Session 2012–13, Volume I,” 18 August 2012, p. 87. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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24. The Senate report into HSBC painted a damning picture of a bank that despite repeated interventions from its regulator failed to put in place the necessary systems and controls. However, again the HSBC case study points to weak supervision as part of the problem, in addition to a poor culture within the bank. The Senate report criticised HSBC’s US regulator, the Ofﬁce of the Comptroller of the Currency (OCC). The bank had been warned by its regulator in 2003 that it needed to improve its anti-money laundering systems and yet the bank did not do enough to ﬁx the problems. But neither did the regulator. The Senate report found that the OCC’s “failure for six years to take action to force correction of fundamental problems in [HSBC US’] AML program allowed those problems to fester and worsen”.264

25. Finally, the order against Standard Chartered said that the bank’s actions were particularly egregious because during the key period the bank had been subject to formal supervisory action in relation to other anti- money laundering compliance failures.265

26. Financial regulators, including the FSA, need to be more aggressive and flexible in their approach to supervision. There are some welcome signs that this is happening. The FSA’s newly appointed head of enforcement and financial crime, Tracey McDermott, has made strong statements about what will happen to errant banks: “If firms try to push things to the limit all the time, they should expect no sympathy when they fall over the edge”.266 However, these promises need to be followed by meaningful action against banks that fail to fulfil their legal obligations.

Insufﬁcient deterrence

27. Global Witness believes that at present the risk/reward ratio is skewed when it comes to compliance and financial crime. Banks stand to make (and do make) significant income from failing to properly apply the applicable rules and ethical standards. The downside, however, seems to be fairly small, with fines that may seem large but are often only a fraction of a bank’s profits, and limited personal responsibility from individual bankers. There also appears to be significant reluctance from regulators to take criminal prosecutions against banks or individuals responsible for compliance failures.

28. Under the FSA’s Decision Procedure and Penalties manual the regulator assesses the value of the financial penalty based on a mixture of factors including the harm caused by the misconduct, the need for a deterrent effect and any mitigating factors including whether the firm was cooperative with the FSA. The value of the harm caused is usually assessed by looking at the revenues the firm has made from the particular product line. This element of the penalty is calculated using a percentage of this revenue with a sliding scale to take into account how serious the breach was. However, the top end of the scale is only 20% of the revenue a bank has made from its misconduct.267 This seems to be a very low basis for calculating a financial penalty. This sliding scale should be revised upwards so that if a bank has committed serious breaches of the rules it should lose all the revenue it made from its illegal activity plus be faced with an extra penalty as a deterrence.

29. Following its thematic review into money laundering the FSA has fined three banks and is reportedly investigating a further two. The biggest fine, £8.75 million, was levied against Coutts, the private banking arm of Royal Bank of Scotland. However, this represents only a fraction of the group’s 2011 operating profit of £1.9 billion.

30. Other penalties have been more substantial. For example, the combined US and UK fine of £290 million against Barclays for manipulating the LIBOR rate is certainly high. Even this, however, is only just over a week’s worth of profits for the bank, and the UK portion of the fine represents a mere one percent of profits.268

31. The current pattern is for supervisors to agree a settlement with banks that they suspect of breaching the rules, usually accompanied by a hefty ﬁnancial penalty. This is obviously quicker and cheaper for government authorities. However, it does mean that regulatory breaches are rarely brought to full trial. In the case of major ﬁnancial institutions this never happens.

32. This has been criticised by a number of judges who have to sign off on the settlement agreements. For example, US District Judge Emmet Sullivan described a $298 million agreement between Barclays and the US Department of Justice over allegations that the bank evaded US sanctions against Cuba, Iran, Libya, Burma and Sudan as a “sweetheart deal”.269 This means that no institution or individual is ever properly held to account, leading to a culture of impunity. 264 PSI report, p. 319. 265 Department of Financial Services order, p. 4. 266 Jill Treanor, “FSA enforcer taking on City's chancers”, The Guardian, 13 August 2012. 267 FSA, “Decision Procedure and Penalties manual,” section 6.5A: The five steps for penalties imposed on firms. 268 Treasury Committee, “Fixing LIBOR: some preliminary findings: Second Report”, p. 101. 269 Harry Wilson, “US judge slams Barclays settlement”, The Telegraph, 18 August 2012. American judges also criticised settlements involving other banks, including Citigroup and Morgan Stanley. Peter Lattman, “Judge in Citigroup Mortgage Settlement Criticizes S.E.C.’s Enforcement”, New York Times, 9 November 2011 and Peter Lattman, “Federal Judge Grudgingly Approves Morgan Stanley Price-Fixing Case”, 7 August 2012. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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33. In addition, under the current rules any fine that the FSA imposes is used to reduce the annual levy that other banks have to pay. This undermines the deterrence effect of financial penalties. The Chancellor has announced a review into this.270 Global Witness believes that at the very least a portion of any fine the FSA receives should be ploughed back into supervision and enforcement activities. 34. These settlements and fines are not enough to change behaviour in the long term. Neither are promises from the banks themselves to improve their performance. As the Senate report notes, HSBC has made promises to reform its anti-money laundering systems following the recent revelations, yet the bank made similar promises in 2003 but failed to implement them.271

Recommendations Banks need to take compliance and culture seriously, and find a meaningful way of demonstrating this publically. Shareholders should also see compliance as an important aspect of long term growth for any bank they invest in. In particular, banks should: — Tie remuneration to how “compliant” a banker is. — Ensure that there are independent reporting lines to the board for the compliance function. — Ensure that dealmakers are personally responsible for the deals they strike in the long run and that the bank is in a position to claw back bonuses and share awards if things go wrong. Secondly, regulators must ensure that the banks that they supervise are compliant with the law and have the appropriate culture in place. In particular, regulators should: — Carry out regular supervisory visits that include spot checks on customer files. — Carry out mystery shopping exercises to see how well banks’ compliance procedures work in practice. — Ensure that wrongdoing is punished with proportionate, but dissuasive sanctions against both individuals and banks. For the worst offences, this should include criminal penalties against individuals and institutions. — The basis for calculating a financial penalty needs to be revised. The starting point should be that if a bank has committed serious breaches of the rules it should lose all the revenue it made from its illegal activity plus be faced with an extra penalty as a deterrence. — In the most egregious cases the FSA should publish section 166 reports that it has ordered so as to provide information to financial institutions and others on bank activity that is deemed to be unacceptable. Finally, there are legislative changes needed to help the FSA carry out its duties: — The Financial Services Bill should be amended so that at least a portion of any financial penalty issued by the FSA is used to bolster the regulators supervision and enforcement activities. — Section 348 of the Financial Services and Markets Act 2000 should be amended to allow the FSA to disclose confidential information that it collects during its investigations if it would have a deterrence effect for others in the sector and would be in the public interest. 23 August 2012

Written evidence from Goldman Sachs International Thank you for your letter of 14 February. We are grateful for the opportunity to assist the important work of the Commission. You asked us to respond to a number of questions. We have set out our answers in the attached document and included some additional materials. The last few years have represented a difficult time for Goldman Sachs and our industry. We recognised that it was important for the firm to undertake a serious and comprehensive process of self-examination. We did so not only to improve or strengthen processes, but also to engage in meaningful discussion as an institution about learning the right lessons from the financial crisis and becoming a better firm because of it. It is incumbent upon us as a firm and as individuals to recognise what we could have done differently or better. And through that process, we have reinforced the importance of personal accountability, effectively managing reputational risk and serving the long-term interests of our clients. Our culture emphasises the need to be self-critical and realistic about the environment in which we operate and we believe those cultural attributes provide a solid basis on which to improve and continue to contribute broadly to economic growth and opportunity. We trust you find this submission helpful to your work and we look forward to reading your final report. 270 Hansard, House of Commons Debate, 28 June 2012, c464. 271 PSI report, p. 9. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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Submission What are Goldman Sachs’ defining values and principles; how are these embedded through the organisation and impressed upon its workforce; and how has Goldman Sachs’ approach to instilling its values through the organisation changed since the 2008 financial crisis? 1. Our Business Principles define our fundamental expectations for the way we should interact with our clients, manage our business and attract, retain and motivate our employees. They were codified in 1979 by our then Senior Partner, John C. Whitehead, who said “…. I didn’t invent the Business Principles. I learned them from my predecessors…” Today, our Business Principles are one of the first items new employees receive when they join the firm. We have included the full text of the Business Principles at Appendix A. 2. The financial crisis and its aftermath has been a challenging time. Our industry and Goldman Sachs itself have been subject to considerable scrutiny. We established a Business Standards Committee (BSC) in May 2010 to undertake a comprehensive, firmwide review of our business standards. This Committee was comprised of members of the firm’s senior management, including several representatives based in London, and was overseen by four members of the Board of Directors of our parent company, The Goldman Sachs Group, Inc. (GS Group).272 3. The Committee conducted an eight-month review, encompassing every major business, region and activity of the firm. It published its report in January 2011. The report made 39 recommendations for change spanning client service, conflicts management and business selection, structured products, transparency and disclosure, committee governance, training and professional development and employee evaluation and incentives. The 39 recommendations, which we have implemented in full, are included at Appendix B and a copy of the full report accompanies our response. We plan to write a concluding report over the next few months, which we would be happy to share with the Commission. 4. The Committee stressed the need to reinforce certain aspects of our culture and set out a commitment to providing professional development programs to strengthen its key elements. The Committee also made clear that each employee of Goldman Sachs has responsibility for protecting the firm’s reputation: an employee can do more harm to the firm’s reputation through a single poor judgment than he or she can do to enhance it throughout an entire career. Building on previous work, the Committee recommended updating and strengthening our Code of Business Conduct and Ethics to signal its importance. 5. As the Commission has recognised, leadership commitment and tone from the top are critical to the culture of a firm. At Goldman Sachs senior leadership has been involved from the outset in the implementation of the Business Standard Committee recommendations. The day before the release of the final BSC report, our Chairman and CEO, Lloyd Blankfein, convened a meeting of the firm’s most senior leaders globally (Participating Managing Directors or PMDs—approximately 450 in number) to discuss the BSC, its recommendations and the implementation plan. This was followed by many other meetings, presentations and discussions with the firm’s Extended Managing Directors (EMDs—approximately 2000 in number), individual teams and smaller groups across the firm globally. There have been dozens of other communications to our people underscoring the key messages of client service, reputational risk management and accountability. Whenever possible, we have relied on senior management to communicate with our people, recognising the greater impact these messages have when delivered by senior leaders. 6. Our people have responded positively to these additional opportunities to hear directly from senior leadership about the firm’s culture. In feedback provided through various channels, they have said they would like the firm to continue this effort. 7. Senior leaders from across the firm were involved in setting the direction and the tone for the implementation effort, through the internal communications discussed above and by leading many training and professional development programs. Their direct involvement and frequent messaging have been critical to reinforcing the importance of reputational judgment and our culture to our people. 8. We have provided training and professional development to strengthen our culture, reinforce our core values and implement and embed the recommendations in the BSC report into our daily practices. More than 30 new BSC training programs have been created and we embedded BSC-related content into over 90 existing programs. The content for these programs spans leadership, culture and values, strengthening client relationships, reputational care, individual accountability, conflicts policies and procedures, and training on structured products. 9. The Chairman’s Forum on Reputational Excellence and Personal Accountability has been a key element of the overall BSC training effort. It was developed and rolled out to all of the firm’s PMDs and EMDs, in 23 sessions globally, including six sessions in London. It stressed the importance of, and our commitment to, client service, reputational excellence and individual accountability. Our Chairman and CEO, Lloyd Blankfein, led all the sessions in person and devoted more time to this initiative in 2011 than to any other. Each three- hour session included a brief documentary about the history of the firm and extensive remarks by Mr Blankfein followed by a question and answer session with him. In his remarks, Mr Blankfein focused on a number of key lessons and responsibilities, which highlighted the importance of sound and informed judgment, personal 272 In this submission we refer to The Goldman Sachs Group, Inc. and its subsidiaries together as the “firm”. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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accountability and the shared responsibility for the firm’s reputation. A segment of each session was focused on a case study which is set in a hypothetical set of complex situations in a stressed market environment; the case study highlights issues which involve judgment and decision making and how we interact with clients. The discussion of the case study, which for sessions in London was led by senior management for the Europe, Middle East and Africa (EMEA) region, explored how individual judgments can have significant and unintended consequences for the firm, our clients and our reputation, particularly when related to complicated issues. 10. We recently launched the Chairman’s Forum for all of our Executive Directors and Vice Presidents (the level below EMD). Members of the European Management Committee and other senior leaders in the region have facilitated 11 sessions so far in EMEA with a further eight planned during the course of this year. The sessions included the same presentation on culture and case study together with a video presentation by our Chairman and CEO.

How does the legacy of the partnership model influence Goldman Sachs’ approach to business today? How has the culture changed since the flotation in 1999? 11. Our culture is rooted in our history as a partnership, when business decisions were conducted by consensus. We have a flat organisation built on mutual accountability and meritocracy. Core to generating returns in a client-service business is our reliance on collaboration, communication, escalation, personal initiative and integrity. We stress the importance of individual responsibility. Our managers have a hands-on approach. We encourage our people to challenge each other. These facets of our culture stem from our history as a partnership. 12. Our culture has adapted and evolved as the size and geographical scope of our operations has grown but our focus continues to be the long-term interests of our clients, shareholders, employees and other stakeholders, including the communities we serve. Our long-term orientation is supported by our promotion processes and by our compensation policies, both of which originate from our days as a partnership. Candidates for promotion to PMD are subject to the same rigorous appraisal by existing PMDs as candidates for partnership once were. One of the recommendations of the Business Standards Committee was that the firm strengthen its focus on the importance of leadership, culture and values in this process. This has been implemented starting with 2010 PMD promotions. While a partnership, the bulk of each partner’s annual compensation was reinvested back into the firm, aligning the long-term interests of Goldman Sachs with those of the partners. Our current PMDs receive a significant portion of compensation in the form of equity-based awards that deliver over time and are subject to a variety of restrictions, including at a minimum those required by local regulations. This compensation structure encourages a long-term, firmwide focus in the same way as when we were a partnership. 13. Good governance, accountability and prudent risk management have been hallmarks of our culture since our foundation as a partnership. Serving our clients requires us to take risk. As a result, effective management of all risk, including reputational risk, is critical; this relies upon accountability, escalation and over- communication, the independence of our control functions, the discipline of mark to market accounting and consistent investment in sophisticated risk management professionals, processes and systems. Our most senior management have long tenure and experience in managing risk. We have experienced low turnover in the ranks of our senior management and this has helped us to navigate the financial crisis. Our senior management are fully engaged in risk decisions, including through their participation in relevant committees. We discuss our approach to risk management in more detail below.

To what extent do you believe Goldman Sachs’ reputation enables it to command higher fees from clients? Do you believe this reputational advantage, if it exists, derives from the values set out in answer to Question 1? 14. Our reputation is critical to our ability to be successful. We operate across multiple business lines in highly competitive markets. We face different competitors in different markets: some competitors are global, some regional and some local. Our fees are determined by a whole range of different factors, including the competitive environment, the nature of the services we provide, the capacity in which we act and the amount of risk, including market, credit and liquidity risk, that we take on. Our focus is on serving our clients well for the long term. As our ﬁrst Business Principle states, our experience shows that if we serve our clients well, our own success will follow.

Do Goldman Sachs’ corporate governance arrangements differ significantly from its competitors, and if so, how? 15. We believe that sound corporate governance is not only important for a well-run financial institution but also provides the basis for public trust in the institution itself and the financial system as a whole. We recognise our responsibility as stewards of our franchise for our stakeholders. 16. Our corporate governance arrangements in the UK differ significantly from some of our competitors in one obvious but important respect: we do not have a publicly-listed parent company in the UK. Our operations in the UK are conducted through subsidiaries which form part of a global governance structure and we do not cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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rely on a branch structure in the UK. This has a signiﬁcant bearing on how we think about corporate governance in London.

17. In 2011 the non-executive directors of our main UK subsidiary, Goldman Sachs International (GSI), conducted a review of its corporate governance arrangements and made 22 recommendations for enhancement. Those recommendations have all been implemented. For example, the Commission has discussed how smaller boards can be more effective and one of the changes we have implemented is to reduce the size of the GSI board. It now comprises six directors, three of whom are non-executive. One of the non-executives is also an independent member of the GS Group board.

18. The recommendations build on our global, regional and entity-level governance philosophy which we describe in more detail below.

19. The GS Group Board of Directors is responsible for, and committed to, the oversight of the business and affairs of the ﬁrm. The Board has established Audit, Compensation, Corporate Governance, Nominating and Public Responsibilities, and Risk Committees, each of which is comprised solely of independent directors, to oversee certain of its responsibilities.

20. While the GS Group Board provides oversight of senior management, the day-to-day running of the firm is the responsibility of management. The most senior executive management body, chaired by the Chairman and CEO, is the Management Committee which includes the two Co-Chief Executive Officers of GSI and one of the co-heads of the Securities Division based in London. In addition, the firmwide Client and Business Standards Committee273 and the firmwide Risk Committee274 report directly to the Management Committee, several committees report to these two committees and there are many additional committees further down the reporting chain. The firm relies heavily on committees to co-ordinate and apply consistent business standards, practices, policies and procedures across the organisation. Certain of these committees such as the Risk Committee, the Capital Committee275 and the Commitments Committee276 play a crucial role in managing risk. One of the co-heads of the Capital Committee is based in London, as is one of the co-heads of the Commitments Committee.

21. The regional dimension of corporate governance is concerned with implementing global strategy in the region and overseeing risk management, capital and liquidity at the local entity level. Certain global divisional heads sit in London. Regional management also deals with matters such as regulatory interface, recruitment, promotion and involvement in regional committees.

22. Our local subsidiaries are linked to the rest of the group through a matrix structure. Business activity is organised through divisions including Investment Banking, Securities, Investment Management, and Merchant Banking. Each division is run as a global business. This means, for example, that while the strategy of investment banking in the UK has a regional dimension, it is also critically part of the Investment Banking Division which will view business opportunities and strategy globally. The same is true for sales and trading, investment management and merchant banking activities.

23. Because our local subsidiaries are part of a global group, the governance of them is aligned with the culture, governance principles and structure of the group as a whole. This means that the boards of the local entities provide direction and oversight for implementation by senior regional management of global strategy, risk management, internal controls and compliance policies. In addition they have an important role in maintaining and enhancing the culture of the local entities consistent with the culture of the group.

24. The review of GSI governance conducted by our non-executive directors articulated general principles which informed the enhancements that we have made in implementing the recommendations of that report. The GSI Board is responsible for overseeing the management and control framework of GSI. Its primary governance responsibility is to oversee implementation by management of the firm’s strategy, risk appetite and systems and controls, as determined at a firmwide and regional level, as part of global firm governance. The Board and senior managers of GSI retain discretion on how to apply and respond to directions or proposals coming from individuals or committees in other group entities. There is a clear allocation of responsibilities between the GSI Board and senior management of GSI so that there is a clear organisational structure and decision-making process and the Board, including its non-executive directors, has the opportunity to challenge proposals put forward by executive directors and other senior managers of GSI. 273 The Client and Business Standards Committee assesses and makes determinations regarding business standards and practices, reputational risk management and client service. 274 The Risk Committee is responsible for the on-going monitoring and management of all financial risks associated with the activities of the firm. 275 The Capital Committee provides approval and oversight of debt-related transactions, including principal commitments of the firm’s capital. 276 The Commitments Committee reviews the firm’s underwriting and distribution activities with respect to certain products and transactions, including underwriting equity securities. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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What key factors determine Goldman Sachs’ risk appetite and tolerance levels? How does the Board monitor the effective implementation of the risk appetite? How have the structure, activities and remuneration of Goldman Sachs’ risk management and control operations changed since the 2008 financial crisis? Determination of risk appetite 25. We have always understood the importance of capital and liquidity. Prudent risk management has been at the heart of our culture since our days as a partnership. We continually make enhancements to the way we manage risk but our fundamental approach to risk management pre-dates the financial crisis. 26. Since the financial crisis, the firm has further enhanced both the articulation of our risk appetite as well as the way in which we measure and quantify this appetite. We have developed a formal Risk Appetite Statement both for the Group as a whole and for our major subsidiaries within the UK. We take risk as an important component of the service we provide to clients. However, we endeavour not to undertake risk in form or amount that could potentially and materially impair our capital and liquidity position or our ability to generate revenues, even in a stressed environment. Consistent with this objective, we pay particular attention to evaluating risks that are concentrated, correlated, illiquid, or have other adverse characteristics, and we correctly and consistently price the risk we take. As we evaluate risk appetite, we take into consideration our key external constituents, in particular our clients, creditors, rating agencies, and regulators and shareholders. Finally, we have developed a culture and implemented a compensation structure (described further below) that do not reward or otherwise incentivise inappropriate risk taking. 27. Our risk taking has always been limited to circumstances where we believe that we: (i) understand the risks; (ii) manage the risks within prudent levels; and (iii) are adequately compensated for assuming these risks. 28. We believe that we must monitor and manage reputational risk with the same rigour as financial risk and that each employee must focus on reputational risk. Reputational excellence (both in terms of risk management and reputational judgment and compliance) is one of the key criteria in our annual performance review process, described in more detail below.

Implementation of risk appetite 29. We take the Risk Appetite Statement and the associated quantitative and qualitative metrics and objectives fully into account when considering the firm’s strategy, capital and liquidity plans, budgets and other actions. As an example, we evaluate business opportunities in the context not only of their revenue potential, but also against our risk limits and risk appetite set at multiple levels, from region/country to industry down to individual client. 30. At the legal entity and business unit level, the risk appetite is implemented through the limits and individual transactional approvals provided to each business unit. Daily monitoring of each limit ensures that exceptions are captured. The limits are set in such a way that we expect exceptions to be generated and limits are regularly increased or decreased on a temporary basis. This fosters an ongoing dialogue on risk among revenue-producing units, independent control and support functions, committees and senior management, as well as rapid escalation of risk-related matters. 31. These individual business approvals are continually calibrated to the prevailing and anticipated business climate, the firm’s available capital and liquidity, and other considerations such that they provide real time guidance. In addition we make ongoing real time adjustments of risk appetite and approvals. Our aim is to ensure that the exposures that result from the approvals given are not excessive in light of the environment we find ourselves in, or may find ourselves in. This process is enhanced by integrated technology systems and the discipline of marking to market that we describe below. 32. We perform stress tests on a periodic basis. The objective of these stress tests is to identify and measure material risks and to assess capital adequacy considering these identified risks. Results of the stress test are reported to the GS Group Board and to the boards of directors of the relevant local subsidiaries.

Structure, activities and remuneration of risk management and control operations 33. Our risk management and control operations are built around three core components: governance, processes and people. 34. Risk management governance starts with the Board of Directors of GS Group, which plays an important role in reviewing risk management, both directly and through its Risk Committee, which consists of all of its independent directors. The Board also receives periodic updates on firmwide risks from the firm’s independent control and support functions. The Board of Directors of GSI in London also regularly reviews risk management and receives updates on risks that impact the local entity from the GSI Risk Committee and from independent control and support functions. In 2011 we re-examined the process of review of risk by the GSI Board as part of the Governance Review described above and have introduced a more comprehensive risk report at each regular board meeting. 35. Day-to-day oversight of risk is the responsibility of various control, support and advisory functions, which report to the chief financial officer, general counsel, global head of Compliance and chief administrative cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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officer, or in the case of Internal Audit, to the Audit Committee of the Board, and not to revenue-producing managers. This segregation of reporting lines is an important feature of maintaining independent and objective oversight of risk and has been a cornerstone of our approach to risk management going back several decades. 36. In addition, compensation for those employees is not determined by individuals in revenue-producing positions but by the management of the relevant control function. All employees with variable compensation above a particular threshold are subject to deferral of part of their variable compensation in the form of an equity-based award. Equity-based awards are subject to a number of terms and conditions that could result in forfeiture or recapture. 37. The firm makes extensive use of risk-related committees that meet regularly and facilitate and foster ongoing discussions between leaders in the revenue-producing units and leaders on the independent control and support side of the firm to identify, manage and mitigate risks. These include the Firmwide Risk Committee and the GSI Risk Committee. 38. The firm maintains various processes and procedures that are critical components of risk management. First and foremost is the daily discipline of marking substantially all the firm’s inventory to current market levels, with changes in valuation reflected in its risk management systems and in net revenues. 39. The mark-to-market process is reinforced through independent price verification by our Controllers department. The firm believes this discipline is one of the most effective tools for assessing and managing risk and for providing transparent and realistic insight into the firm’s financial exposures. 40. Active management of the firm’s positions is another important process. Proactive mitigation of market and credit exposures minimises the risk that the firm will be required to take outsized actions during periods of stress. 41. Finally, there is a great deal of focus on the rigour and effectiveness of the firm’s risk systems. The goal of risk management technology is to get the right information to the right people at the right time. The firm devotes significant time and resources to its risk management technology to ensure that it consistently provides complete, accurate and timely information. 42. However, even the best technology serves only as a tool for helping to make informed decisions in real time about the risks being taken. Ultimately, effective risk management requires people to make judgments about ongoing portfolio interpretations and adjustments. In both the revenue-producing units and the independent control and support functions, the experience of the firm’s professionals, and their understanding of the nuances and limitations of each risk measure, must guide the firm in assessing exposures and maintaining them within prudent levels.

Why is Goldman Sachs not a member of the BBA? 43. Historically the BBA has represented clearing banks in London while the London Investment Banking Association (LIBA) represented investment banks. Since our operations in London were primarily in investment banking, we became a member of LIBA in the 1980s as our business here expanded. LIBA has now become the Association for Financial Markets in Europe (AFME) of which we continue to be a member. We are also a member of a number of other industry associations with ofﬁces in London, including the International Swaps and Derivatives Association and the International Capital Markets Association. These associations frequently work together with the BBA on matters of common interest.

What is the balance between fixed and variable compensation across all Goldman Sachs employees? How is variable pay determined at individual level? How is adherence to corporate values reflected in remuneration? 44. Our compensation philosophy and the objectives of our compensation programme are reflected in our Compensation Principles, which we include at Appendix C. 45. In particular, we believe effective compensation practices should: — Encourage a real sense of teamwork and communication, binding individual short-term interests to the institution’s long-term interests; — Evaluate performance on a multi-year basis; — Discourage excessive or concentrated risk taking; — Allow an institution to attract and retain proven talent; and — Align aggregate remuneration for the firm with performance over the cycle. 46. The firm’s compensation programme is designed to avoid incentives to take imprudent risks that are inconsistent with the long-term health of the firm. We seek to balance risks and rewards in determining employees’ total compensation, including through robust up-front risk adjustments that take into consideration a full range of risks associated with an employee’s activities, combined with consideration of multi-year performance, and deferral of compensation into equity-based awards that deliver over time and are subject to cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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transfer restrictions, retention requirements, prohibitions on hedging and forfeiture and recapture provisions (as described below). 47. Annual compensation for employees is generally comprised of salary and year-end variable compensation. Variable compensation is determined on a discretionary basis, based on multiple factors and is not set as a fixed percentage of revenue or by reference to any other formula. The variable compensation programme is flexible to allow the firm to respond to changes in market conditions and to maintain its pay- for-performance approach. Firmwide performance is an important factor in determining variable compensation. 48. Equity-based awards are made to employees earning variable compensation in excess of a specified threshold, and employees with higher variable compensation generally receive a greater proportion of their variable compensation in such awards. Our most senior employees receive at least 60% of their variable compensation in the form of equity-based awards. Paying a significant portion of variable compensation to our employees in the form of equity-based awards that deliver over time and are subject to forfeiture or recapture encourages a long-term, firmwide focus and discourages “cutting corners” or engaging in inappropriate behaviour that may only manifest itself at a later date. We apply this approach globally. 49. Employees are evaluated annually as part of a “360 degree” feedback process. This process reflects input from a number of employees, including supervisors, peers and those who are junior to the employee, regarding an array of performance measures. For example, the detailed performance evaluations include assessments of risk management and reputational judgment and compliance with the firm’s business principles and policies. These evaluations are an important input into the determination of variable compensation within the context of firmwide, divisional and business unit performance. 50. In addition, as part of the compensation determination process, members of the firm’s Compliance, Human Capital Management and Risk functions make recommendations to divisional management to take into consideration all compliance or policy-related disciplinary matters when determining compensation of individuals. These same factors are taken into account in promotion processes. 51. The firm’s global process for setting variable compensation (including the requirement to consider reputational, risk and compliance issues) is subject to oversight by the senior management of the firm in the region, the Board of Directors of GSI and the Compensation Committee of the Board of Directors of GS Group. The year-end variable compensation programme is approved each year by the Compensation Committee taking into account a variety of factors, including regulatory requirements and feedback, and financial and market conditions. 52. The firm’s compensation structure and processes are designed to comply with applicable regulatory standards consistent with the Financial Stability Board Principles for Sound Compensation Practices. However, we will need to take account of forthcoming European regulatory developments in this sphere.

As a place to do business, what are the main differences between London and New York, and what factors influence how Goldman Sachs allocates its business between the two cities? What are the key risks, if any, to London retaining its status as one of the world’s preeminent financial centres? 53. London and New York share a number of advantages that have supported the growth of vibrant capital markets: the availability of skilled local talent, a legal regime which recognises the enforceability of contracts and allows for a faster resolution to disputes, a reputation for consistent application of regulation, fair treatment of financial counterparties (including non-residents) and a supportive tax policy. It is important for London to remain competitive on these criteria and to retain its reputation as a strongly regulated and resilient financial centre. 54. In addition, London has obvious time-zone and geographical advantages that have allowed it to grow to become by far the largest hub for international capital flows globally. But perhaps most importantly, New York and London are preeminent financial centres because they sit within two of the largest financial markets in the world, the United States and Europe. 55. When it comes to executing individual transactions, the location of our clients and regulatory limitations on U.S. firms accessing European markets and vice versa will typically dictate whether we do the business from New York or London; we often do not have a choice between the two. By contrast, within Europe, because of the single market in financial services, firms have much more freedom to decide where to base their operations to best serve European clients. 56. We believe that a key risk to London’s retaining its status as a financial hub is an exit by the UK from the European Union. In common with financial institutions across the City our ability to provide services to clients and engage in investment activities throughout Europe is dependent on the passport that London-based firms enjoy to operate on a cross-border basis within the Union. If the UK leaves, it is likely that the passport will no longer be available, thereby forcing firms that wish to access EU markets to move their operations to within those markets. 57. It is important that the UK, underpinned by its expertise in the field of financial services regulation, leads the debate in the EU to ensure that reform is developed and implemented in a way that allows capital markets to continue to function efficiently. Markets need clear and proportionate rules that allow the financial cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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services sector to contribute to the growth of the European economy and the creation of jobs. It will also be important to ensure that new taxes, particularly the proposed Financial Transactions Tax, are not introduced in a way that threatens the ability of governments and businesses to raise capital and dissuades providers of capital from investing in Europe. The Tax proposed by the EU Commission would have signiﬁcant impacts in London, notwithstanding the decision by the UK not to participate.

Do you agree with the opinion, expressed in some quarters, that a regulatory “race to the top” is underway, with authorities competing to raise, rather than lower, standards and sanctions? Do you think this is a good thing? 58. We share and support the goals of global regulatory reform—to strengthen financial stability, reduce systemic risk, address the failure of a large financial institution and provide greater transparency—and believe they should reduce both the probability and potential impact of another financial crisis. Given the important role that financial institutions play in facilitating the free flow of capital, a healthy, stable, reputable and profitable financial sector is critical. We are strong supporters of the initiatives that are underway to achieve these goals. Higher standards, more effective supervision and appropriate sanctions will increase the confidence of investors in markets and bring greater depth to those markets to support jobs and economic growth. 59. Our industry faces multiple areas of regulatory change, including higher capital and liquidity requirements, expanded central clearing, greater price transparency and restrictions on business activity. We believe these changes, if implemented appropriately, will reduce systemic risk; we are working constructively with regulators to implement them. 60. The danger of an uncoordinated regulatory “race to the top” is that multiple and overlapping strands of regulation may reduce the ability of the financial system to support credit creation and economic growth. Duplicative regulation can raise the cost of, and divert resource to, compliance, and reduce market liquidity— all without realising corresponding benefits of greater financial security. This in turn can limit financial institutions’ ability to support the efficient allocation of capital. In addition, reforms should not be seen as addressing only discrete problems in isolation; rather, it is important that authorities maintain a clear view of the aggregate impact of all requirements on the financial services industry, including those being imposed outside Europe, and calibrate new regulation in a way that supports the effective functioning of capital markets and helps the real economy.

Does Goldman Sachs anticipate that differences in the implementation of global regulations (eg Basel III) at a national level, and “super-equivalence” and “front-running” in certain jurisdictions, will provide significant opportunities for regulatory arbitrage in the future? 61. It is important that authorities collaborate to implement regulatory change so that standards are raised at the same time and in a similar manner across the globe. The timing of implementation is critical. If rules are applied before there is any real progress toward international convergence, market activity will shift to less restrictive jurisdictions. It is unlikely that market participants, having moved once, will want to incur the cost of moving back—even if the rules are eventually harmonised. 62. The work of the G20 has provided an important foundation for harmonised rule-making. In some areas we have seen a relatively high degree of consistency in how the G20 commitments are being implemented. For example, the EU and the United States have been largely consistent in their approaches to central clearing requirements for standardised over-the-counter derivatives and have looked to ensure that market participants do not have to comply with two separate requirements to clear derivatives locally in each jurisdiction (which is physically not possible). 63. However, in other areas, regulators have elected to adopt different approaches in an attempt to achieve similar outcomes. This seems to be particularly the case for rules aimed at mitigating systemic risk for non- standardized over-the-counter derivatives, where regulatory proposals for capital, margin and other prudential measures are inconsistent. The recent Basel Committee work on risk weighted asset (RWA) inconsistencies shows wide variations in how banks measure risk for capital purposes, both globally and within the EU. 64. Inconsistencies in regulatory substance and implementation create a number of problems. They increase the cost of participating in global markets due to the need to comply with multiple conflicting rule sets, which in turn impedes the flow of capital to its most efficient uses. Inconsistencies distort market dynamics and reduce competition, as participants choose counterparties based on jurisdiction or regulatory regime rather than economic fundamentals. They also increase the risk of weaker regulatory oversight as markets become more fragmented and a comprehensive view of risks to financial stability becomes more difficult.

What changes has Goldman Sachs made to its business in preparation for the “Volcker Rule”? Has this caused Goldman Sachs any difﬁculties? How, if at all, has it affected Goldman Sachs’ business in London? 65. When the Volcker Rule becomes effective, U.S. banks will generally be prohibited from engaging in proprietary trading and from owning or investing in a hedge fund or private equity fund. 66. As you have heard from others, the rules to implement the relevant provisions in the Dodd-Frank Act have not yet been ﬁnalised. Draft rules were issued in October 2011 and included an extensive request for cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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comments. The proposed rules are highly complex, and many aspects remain unclear. The full impact of the rules on us will depend upon the detailed scope of the prohibitions, permitted activities, exceptions and exclusions, and will not be known with certainty until the rules are finalised and market practices and structures develop under the final rules. 67. We expect to be required to be in compliance by July 2014 (subject to possible extensions). We also expect the proposed rules to apply throughout our global operations, including to our subsidiaries in the UK. 68. In our comments on the proposal277 we have highlighted a number of points that we believe need to be addressed. In particular, without substantial revisions, the proposed rules will define permitted market making- related, underwriting and hedging activities so narrowly that they will significantly limit our ability to help our clients—governments, businesses and investors around the world—raise capital, manage their risks, invest their wealth and generate liquidity from their holdings. For example, the proposed rules may affect the ability of impacted firms to make markets in, and act as a primary dealer for, UK gilt-edged and other securities, with consequent impact on liquidity in those markets. 69. While many aspects of the Volcker Rule remain unclear, we evaluated the prohibition on “proprietary trading” and determined that businesses that engage in “bright line” proprietary trading are most likely to be prohibited. In 2010 and 2011, we liquidated substantially all of our Principal Strategies and Global Macro Proprietary trading positions, both in London and elsewhere. 70. In addition, we evaluated the limitations on sponsorship of, and investments in, hedge funds and private equity funds. We expect that the fees that we earn from such funds, and gains and losses from our investments in the funds, will be impacted by the Volcker Rule. The limitation on investments in hedge funds and private equity funds requires us to reduce our investment in each firm-sponsored fund to 3% or less of the fund’s net asset value, and to reduce our aggregate investment in all such firm-sponsored funds to 3% or less of our Tier 1 capital. 8 March 2013

APPENDIX A THE GOLDMAN SACHS BUSINESS PRINCIPLES 1. Our clients’ interests always come first. Our experience shows that if we serve our clients well, our own success will follow. 2. Our assets are our people, capital and reputation. If any of these is ever diminished, the last is the most difficult to restore. We are dedicated to complying fully with the letter and spirit of the laws, rules and ethical principles that govern us. Our continued success depends upon unswerving adherence to this standard. 3. Our goal is to provide superior returns to our shareholders. Profitability is critical to achieving superior returns, building our capital, and attracting and keeping our best people. Significant employee stock ownership aligns the interests of our employees and our shareholders. 4. We take great pride in the professional quality of our work. We have an uncompromising determination to achieve excellence in everything we undertake. Though we may be involved in a wide variety and heavy volume of activity, we would, if it came to a choice, rather be best than biggest. 5. We stress creativity and imagination in everything we do. While recognizing that the old way may still be the best way, we constantly strive to find a better solution to a client’s problems. We pride ourselves on having pioneered many of the practices and techniques that have become standard in the industry. 6. We make an unusual effort to identify and recruit the very best person for every job. Although our activities are measured in billions of dollars, we select our people one by one. In a service business, we know that without the best people, we cannot be the best firm. 7. We offer our people the opportunity to move ahead more rapidly than is possible at most other places. Advancement depends on merit and we have yet to find the limits to the responsibility our best people are able to assume. For us to be successful, our men and women must reflect the diversity of the communities and cultures in which we operate. That means we must attract, retain and motivate people from many backgrounds and perspectives. Being diverse is not optional; it is what we must be. 8. We stress teamwork in everything we do. While individual creativity is always encouraged, we have found that team effort often produces the best results. We have no room for those who put their personal interests ahead of the interests of the firm and its clients. 9. The dedication of our people to the firm and the intense effort they give their jobs are greater than one finds in most other organizations. We think that this is an important part of our success. 10. We consider our size an asset that we try hard to preserve. We want to be big enough to undertake the largest project that any of our clients could contemplate, yet small enough to maintain the loyalty, the intimacy and the esprit de corps that we all treasure and that contribute greatly to our success. 277 These are contained in two public comment letters submitted to the U.S. regulators on 13 February 2012. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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11. We constantly strive to anticipate the rapidly changing needs of our clients and to develop new services to meet those needs. We know that the world of finance will not stand still and that complacency can lead to extinction. 12. We regularly receive confidential information as part of our normal client relationships. To breach a confidence or to use confidential information improperly or carelessly would be unthinkable. 13. Our business is highly competitive, and we aggressively seek to expand our client relationships. However, we must always be fair competitors and must never denigrate other firms. 14. Integrity and honesty are at the heart of our business. We expect our people to maintain high ethical standards in everything they do, both in their work for the firm and in their personal lives.

APPENDIX B BUSINESS STANDARDS COMMITTEE RECOMMENDATIONS ClientRelationships andResponsibilities The Committee makes the following recommendations to strengthen client relationships and responsibilities: 1. The Business Standards Committee recommends that the firm reemphasize the client service values listed below. These values are embedded in our Business Principles and express how we intend to conduct ourselves in each and every client interaction. This recommendation reflects our objective of strengthening client relationships. — Integrity: Adhering to the highest ethical standards. — Fair Dealing: Pursuing a long-term and balanced approach that builds clients’ trust. — Confidentiality: Protecting confidential information. — Clarity: Providing clear, open and direct communication. — Transparency: Informing our clients so that our role in any transaction is understood by them. — Respect: Being respectful of our clients, other stakeholders and broader constituencies. — Professional Excellence: Consistently providing high quality service, responsiveness, thoughtful advice and outstanding execution. 2. The Business Standards Committee recommends that the firm implement the framework for Role-Specific Client Responsibilities to communicate with clients about our different roles and responsibilities and as a benchmark for training and professional development for employees. Above all, we must be clear to ourselves and to our clients about the capacity in which we are acting and the responsibilities we have assumed. This recommendation reflects our objective to strengthen client relationships. 3. The Business Standards Committee recommends that the firm increase its emphasis on client service and client relationships in our annual performance review and other incentive processes. Among other things, the performance review system will seek to assess how well our people represent the Goldman Sachs client franchise and how well they build long-term client relationships. This recommendation reflects our objective of strengthening client relationships. 4. The Business Standards Committee recommends that the new Client and Business Standards Committee design and implement a comprehensive firmwide program to strengthen client interactions and relationships to enhance our client franchise. This recommendation reflects our objectives of strengthening client relationships and committee governance. 5. The Business Standards Committee recommends that the firm implement a comprehensive training and professional development program on the firm’s Business Principles, client service values and the Role-Specific Client Responsibilities. Each division will tailor its program to emphasize its different roles and responsibilities to clients. This recommendation reflects our objectives of strengthening client relationships, reputational excellence and training and professional development. 6. The Business Standards Committee recommends that the leaders of each division play a critical role in the design and execution of a multi-faceted communication program to introduce the Committee’s recommendations to clients. This recommendation reflects our objectives of strengthening client relationships and enhancing transparency of communication and disclosure.

Conﬂicts ofInterest The Business Standards Committee and the BPC undertook a systematic review of the ﬁrm’s wall crossing procedures with a view to reducing the number and duration of wall crosses. The following enhancements were implemented during the summer of 2010 and resulted in a reduction in the number and duration of wall crosses. 7. With respect to Information Barriers and wall crosses, requests by Investment Banking Division (IBD) to initiate a wall cross for a Securities Division employee must be approved by a participating managing director cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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(PMD) or a senior extended managing director (EMD) in IBD who is supervising the relevant transaction or project, as well as one of a small number of PMDs or senior EMDs in the Securities Division, designated by divisional management. One of the heads of the Securities Division or his designee must approve requests when more than ﬁve Securities Division employees are needed to cross the Wall in connection with any particular transaction or project. This recommendation reﬂects our objectives of strengthening client relationships and reputational excellence.

8. The Business Standards Committee recommends that certain underwriting and origination activities be moved from the Securities Division to the Financing Group within IBD, including certain activities related to mortgage-backed and asset-backed securitization, emerging markets debt and money market instruments such as commercial paper. Business units of the Securities Division that continue to conduct origination activities will have policies and standards, approval processes, disclosure requirements and oversight that are consistent with those that apply to all origination activities in IBD. This recommendation reﬂects our objectives of strengthening client relationships and reputational excellence.

9. The Business Standards Committee recommends that the ﬁrm’s existing policies regarding written communications during underwriting and advisory assignments be supplemented to restrict Securities Division and Private Wealth Management (PWM) personnel from disseminating broadly to clients written sales communications either (i) recommending an investment or transaction, or (ii) expressing a view278 regarding the issuer or client, its securities or its other ﬁnancial instruments, or regarding other transaction parties and their securities or their other instruments as follows: — For offerings of equity or equity-linked securities or high yield debt offerings or loan syndications,279 the restriction would apply from the pricing date until 30 days thereafter. — For material strategic transactions in which Goldman Sachs is advising a party, the restriction would apply from public announcement through closing of the transaction.

This recommendation reﬂects our objectives of strengthening client relationships and reputational excellence.

10. To strengthen client relationships and reputational excellence, the Business Standards Committee recommends as follows: (i) Goldman Sachs will not be the sole financing source for acquisitions by Merchant Banking Division (MBD) private funds, other firm-managed private funds or portfolio companies controlled by those funds,280 except in special circumstances with the approval of senior management or an appropriate committee of the firm. (ii) Goldman Sachs will carefully review requests to provide financing to competing bidders when a MBD fund or other firm-managed private fund is pursuing an acquisition as a bidder. Senior management or an appropriate committee of the firm will be part of the review process. (iii) Goldman Sachs will carefully review requests to provide staple financing when IBD is selling a public company. This review will occur as part of the firm’s customary staple financing approval process. Senior management or an appropriate committee of the firm will be part of the review process. (iv) The applicable transaction oversight committees—with the assistance of the Conflicts Resolution and Business Selection Group and the Legal Department—will undertake a heightened review before approving an underwriting for an issuer in which the firm or its affiliates, including MBD and other firm-managed private funds, have a material interest as a shareholder or creditor.

11. The Business Standards Committee recommends that Investment Management Division (IMD) funds that make alternative investments should be integrated into the firmwide Conflicts Resolution and Business Selection process in a manner consistent with their fiduciary duties. This recommendation reflects our objective of strengthening client relationships and reputational excellence.

12. To strengthen reputational excellence, the Business Standards Committee recommends that the firm review and update conflicts-related policies and procedures, as appropriate. The firm will make a consolidated and comprehensive compilation of these policies and procedures available to relevant personnel in connection with training and professional development initiatives. This compilation will also serve as an ongoing resource to the firm and its employees and facilitate monitoring by the Compliance and Internal Audit Departments. The Committee stresses that all employees share the responsibility to identify and elevate potential conflicts. 278 We will continue to permit written communications with views that are consistent with recently-published GIR research or that attaches, summarizes or references that research. 279 Offerings and syndications of investment grade debt and offerings and trading of asset-backed and mortgage-backed securities are generally excluded because of their frequency and because they generally are not material to the issuer or originator of the underlying assets, in each case unless otherwise determined by the Capital Committee or a subcommittee thereof. Municipal and not-for-profit issuers will be treated as issuers of high yield corporate debt. 280 Rules to be adopted as part of financial regulatory reform may limit or restrict certain of the activities described above between Goldman Sachs and MBD funds, other firm-managed funds and / or portfolio companies controlled by those funds. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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13. The Business Standards Committee recommends that the firm employ materials written in plain language that articulate: (i) What it means that the firm has completed its conflicts resolution and business selection process in any particular situation; and (ii) What other activities the firm may continue to conduct while we are advising or financing a particular client. We recognize that the language in engagement letters and standard disclaimers is often complex. We will provide education and training for firm employees and encourage them to communicate with clients through discussions and plain language written presentations about our conflicts resolution and business selection process. We will tailor this material to the business of a specific division and update it over time. Each employee who interacts with clients will be responsible for understanding and communicating the guiding principles for conflicts resolution and business selection to clients and will be accountable for following them. This recommendation reflects our objectives of strengthening client relationships and reputational excellence and enhancing transparency of communication and disclosure. 14. The Business Standards Committee recommends that the firm enhance its training and professional development programs regarding conflicts resolution. These programs will be updated to focus on familiarizing people with the compilation of conflicts policies and procedures discussed in the prior recommendation. Each employee who interacts with clients will participate in these programs. This recommendation reflects our objectives of strengthening client relationships and reputational excellence and enhancing transparency of communication and disclosure.

Structured Products The Business Standards Committee recommends establishing a global, consistent process for determining which transactions will be subject to enhanced review, approval and documentation. Specifically, the Committee recommends a three step identification process for designated structured, strategic and complex transactions as follows: 15. Designated Structured Transactions. The Structured Products Committee (SPC) will continue to review and approve all transactions that meet the requirements of a “designated structured transaction” under the charter of the SPC. Designated structured transactions are transactions, series of transactions or products where: (i) one of the client’s principal objectives appears to be to achieve a particular legal, regulatory, tax, or accounting treatment, including transferring assets off balance sheet; (ii) the proposed legal, regulatory, tax, or accounting treatment is materially uncertain; (iii) the product or transaction (or series of transactions) have substantially offsetting legs or lack economic substance,281 or (iv) the product or transaction (or series of transactions) could be characterized as a financing, but is structured in another manner. This recommendation reflects our objectives of strengthening client relationships and reputational excellence. 16. Strategic Transactions. All strategic transactions will be subject to heightened review and approval. For this purpose, “strategic transactions” are transactions that are sufficiently large and important to a client or sufficiently large in the context of the market that they warrant heightened scrutiny. These transactions are often characterized by several of the following factors: (i) losses or gains from the transaction could reasonably be expected to materially impact the client’s financial position or have an adverse reputational impact on the firm; (ii) the transaction is likely to have a material impact on the market; (iii) the transaction requires the approval of the client’s Chief Financial Officer, Chief Executive Officer or Board of Directors; (iv) the transaction hedges a material acquisition, disposition or other business combination transaction by the client, and the hedge is material; (v) the transaction requires separate disclosure in the client’s financial statements or will otherwise be disclosed through a public filing; or (vi) the transaction represents a large financing commitment by the client. Strategic transactions may not involve complexity or unique structural features, but nevertheless merit heightened review because of these factors. This recommendation reflects our objectives of strengthening client relationships and reputational excellence. 17. Complex Transactions. Complex transactions will also be subject to heightened review and approval. While not an exhaustive list, the following factors indicate complexity: (i) leverage; (ii) illiquidity; (iii) the potential for losses in excess of initial investment; (iv) lack of price transparency; and (v) non-linear payouts. The Committee has identified these factors to guide salespeople282 in deciding which transactions are complex and merit heightened review and approval. Not every transaction exhibiting these factors is complex—in fact these factors may be present in relatively simple transactions. Identifying complex transactions requires judgment. When in doubt, salespeople will seek guidance from their supervisor or the chairs of the Firmwide Suitability Committee (or their designees). The Committee recommends the creation of new due diligence procedures. As part of the heightened review of complex and strategic transactions, salespeople will be required to complete a due diligence questionnaire 281 “Offsetting legs” refers to cash flows under different parts of a transaction (or group of related transactions) which from an economic perspective cancel each other out. Transactions with offsetting legs may lack economic substance. Transactions without economic substance have not been and will not be approved by the SPC. 282 References to salespeople include, where the context requires, marketers, structurers and other members of the Goldman Sachs business team that work on structured products. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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that discusses the factors detailed above. The Firmwide New Activity Committee will also analyze these factors when reviewing a proposed new product or activity. This recommendation reflects our objectives of strengthening client relationships and reputational excellence. 18. To strengthen client relationships and reputational excellence, the Business Standards Committee recommends redefining the firm’s approach to segmenting clients for suitability purposes into one of the following three segments: — professional investors (eg, banks, broker-dealers, investment advisers and hedge funds); — other institutional accounts (eg, municipalities, sovereigns, sub-sovereigns, pension funds, corporations, charities, foundations and endowments); and — high net worth accounts (eg, natural persons, family offices). 19. To strengthen client relationships and reputational excellence, the Business Standards Committee recommends the following additional enhancements to the firm’s overall pre-transaction sales practices: A client profile will be maintained for each client in the form of a matrix (a Transaction Class Matrix or TCM) which reflects the types of transactions (eg, cash, options, contingent liabilities) and underliers (eg, equities, commodities, rates, credit) in which the client is pre-approved to transact from a suitability perspective. The TCM must be reviewed and approved by the relevant sales manager and Compliance officer before becoming effective and before being amended. A heightened suitability review and approval will be required for any transaction or transaction class that falls outside a client’s TCM. The level of review and approval required will generally be based on: (i) the maximum probable exposure (MPE) for the transaction; (ii) the segment classification of the client determined as outlined in Recommendation 18 above; and (iii) the factors for determining complexity as outlined in Recommendation 17 above (collectively, Due Diligence Review Criteria). These Due Diligence Review Criteria will be included in the Due Diligence Questionnaire that sales professionals will complete when they seek approval for transactions with clients who have not been preapproved for those transactions. All designated structured and strategic transactions will require heightened review even when a client is eligible to execute a transaction based on its TCM. 20. To strengthen client relationships and reputational excellence, the Business Standards Committee recommends the following post-transaction sales practices for structured products: The firm will establish processes to monitor relevant metrics (eg, mark-to-market) for clients. Sales managers will be responsible for reviewing the results of this monitoring and taking appropriate actions on relevant transactions. There will be a mechanism for escalating issues to sales leadership and the Credit, Legal and Compliance Departments. Sales professionals will also be required to monitor the actual mark-to-market for transactions selected for heightened review and compare that mark-to-market against any previously analyzed stress test results that were provided to the client. In addition, divisional management will consider practices for monitoring the fulfillment by sales professionals of these post-transaction responsibilities for clients. 21. The Business Standards Committee recommends that each business unit that originates securities products283 be subject to consistent policies and standards, approval processes, disclosure requirements and oversight as contemplated by Recommendation 8. These controls will include the following: (i) each business unit will be required to have written policies and procedures incorporating minimum disclosure standards; (ii) the appropriate firmwide transaction oversight committee will review and approve the policies and procedures governing origination activities of each business unit; and (iii) each business unit will be required to designate a business supervisor who is responsible for its origination activities and compliance with applicable policies and procedures. This recommendation reflects our objectives of strengthening client relationships and reputational excellence. 22. To strengthen client relationships, reputational excellence and enhance transparency of communication and disclosure, the Business Standards Committee recommends as follows: (i) The offering documents for securities products should include appropriate disclosure of risk factors, including risks arising from the instrument structure, underlying assets, market risks and counterparty credit risks. Where appropriate, investors will be provided with scenario analyses and stress test results. The firm will formalize disclosure standards to cover instances when the firm is underwriting a securities product that is collateralized by securities issued by Goldman Sachs (including when the securities product is issued by a special purpose vehicle). In those cases, the firm will disclose any material risks, including liquidity and credit concentration risks, associated with the collateral securities. (ii) Business units must disclose to the relevant personnel responsible for approving a securities product any specific benefits to Goldman Sachs, in addition to underwriting fees. 283 “Securities products” refers to new issue securities sold by means of an offering document; it does not include bilateral derivative transactions. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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(iii) The firm will continue to undertake appropriate due diligence reviews of issuers of securities products (including third-party issuers) and third-party managers. The business unit’s policies and procedures will address when, and under which circumstances, the firm should review existing due diligence of third-party issuers or managers. For any issuance involving a third- party issuer or manager, the business unit responsible for the transaction will confirm that it has followed the firm’s due diligence procedures.

23. To strengthen training and professional development, the Business Standards Committee recommends the development of cross-divisional training and professional development programs to implement the structured products recommendations. These programs will apply to all sales and trading personnel worldwide.

Transparency andDisclosure

24. The Business Standards Committee recommends reorganizing the firm’s three existing business segments into four business segments. The reorganized segment disclosure will provide more clarity as to the nature of the firm’s business activities, particularly the activities currently aggregated in the “Trading and Principal Investments” segment. This change will better demonstrate the importance of client franchise activities and client facilitation to our revenues. The four proposed business segments are: — Investment Banking: This segment will include the firm’s revenues from its activities as an advisor together with its debt and equity underwriting activities and revenues associated with derivative transactions directly related to an advisory or underwriting assignment. — Institutional Client Services: This new segment will include the firm’s revenues from client execution activities related to making markets in various products, which form an important part of the firm’s client franchise businesses. These activities are currently included in the Trading and Principal Investments segment. Institutional Client Services will also include the firm’s Securities Services business, which, under the existing segment construct, is aggregated into the “Asset Management and Securities Services” segment. — Investing & Lending: This new segment will include the firm’s revenues from investing and lending activities across various asset classes, primarily including debt and equity securities, loans, private equity and real estate.284 These activities include both direct investing and investing through funds. Under the existing segment construct, these activities are currently included in the Trading and Principal Investments segment. — Investment Management: This new segment will include the firm’s fee revenues earned in connection with its asset and wealth management businesses, including Goldman Sachs Asset Management (GSAM), Private Wealth Management and the firm’s merchant banking funds. In addition to management and incentive fee revenues, this segment will also include transaction revenues related to the firm’s Private Wealth Management business, including commissions and spreads.

25. The Business Standards Committee recommends that the firm disclose a simplified balance sheet showing assets by business unit/activity, including: — Excess Liquidity: the amount of available cash and highly liquid securities the firm maintains over and above its day-to-day liquidity needs; — Secured Client Financing: the assets related to secured funding provided to clients in the firm’s prime brokerage, matched book and futures businesses, as well as client margin lending positions; — Institutional Client Services: the inventory related to the firm’s client facilitation business, secured financing agreements and trading-related receivables; — Investing & Lending: the assets related to the firm’s investing and lending activities, primarily including debt and equity securities, loans, private equity and real estate investments. These investments may be held directly or through funds; and — Other Assets: primarily includes the firm’s goodwill, intangibles and physical property.

26. The Business Standards Committee recommends that the firm (i) enhance disclosure with respect to liquidity stress tests by including details on both scenario assumptions and modeling parameters, as well as to provide substantial qualitative detail on the contractual and contingent cash and collateral outflows considered by the firm’s Modeled Liquidity Outflow285 and (ii) provide incremental qualitative detail on how the firm sizes its excess liquidity. 284 In the years through 2010, this segment also included the results of the firm’s proprietary trading business, “Principal Strategies”. The assets related to these activities were substantially liquidated during 2010. 285 Modeled Liquidity Outflow (MLO) is the firm’s internal liquidity model that identifies and quantifies potential contractual and contingent cash and collateral outflows during both a market-wide and Goldman Sachs-specific stress situation. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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27. The Business Standards Committee recommends that the firm implement the following: — Describe, in greater detail and in plain language, the firm’s risk management structure, culture and processes. This description will include detail on (i) the firm’s risk management governance structure, including the interaction between business units and independent control functions; (ii) how the firm uses committees to assist in managing risk, including a description of the relevant committees’ specific mandates and membership; and (iii) the firm’s risk management processes, including its use of mark-to-market, risk limits, price verification and active position management, and robust systems to ensure the timely delivery of comprehensive and reliable data. — Substantially enhance the discussion of Operational Risk, reflecting its increasing importance to the firm. — Provide additional qualitative disclosure regarding the Internal Capital Adequacy Assessment Process286 (ICAAP) to explain more clearly this aspect of how the firm manages capital. — Expand the description of credit risk to (i) include additional credit risks, such as loans and other non-derivative exposures, in our quantitative disclosure; (ii) provide increased granularity on credit exposures by industry and region; and (iii) qualitatively describe the firm’s recent credit experiences. 28. To improve the clarity of our overall disclosure, the Business Standards Committee recommends that the firm (i) rewrite its business description in the Form 10-K and its Annual Report to shareholders in plain language to better explain our business activities, our performance and how it relates to serving clients and (ii) reorganize its financial disclosure to consolidate related topics to remove, where possible, repetitive information described in both the Management Discussion and Analysis (MD&A) and financial statements, and to improve the overall clarity of the disclosure.

Committee Governance 29. The Business Standards Committee recommends that the following changes be made: Establish a “Firmwide Client and Business Standards Committee.” The Client and Business Standards Committee will function as a high-level committee that assesses and makes determinations regarding business practices, reputational risk management and client relationships. This committee will initially be chaired by the firm’s President and Chief Operating Officer and will report to the Management Committee. Its responsibilities will include: — designing and implementing a comprehensive firmwide program to enhance our client franchise; — overseeing cross-divisional client coordination and annual client strategy reviews by division; — regularly reviewing the operational and reputational risks of the producing divisions and certain control functions; — resolving cross-divisional business practices and business selection matters; — resolving appeals of business practices, suitability and reputational matters from other firm committees; — periodically soliciting and assessing client views of the firm and addressing client concerns and incidents; — overseeing divisional and regional Client and Business Standards Committees—formerly divisional and regional Business Practices Committees—and the newly formed Firmwide Suitability Committee and Firmwide New Activity Committee; — commissioning cross-divisional committee reviews to identify best practices and/or to address emerging themes; — overseeing the implementation of Business Standards Committee recommendations, where appropriate; and — overseeing the Conflicts Resolution and Business Selection Group. Establish a “Committee Operating Group” of the Client and Business Standards Committee.A Committee Operating Group will be established to assist the Client and Business Standards Committee in carrying out its functions. The Committee Operating Group will be headed by a senior leader reporting into the Chair of the Client and Business Standards Committee. This recommendation reflects our objectives of strengthening client relationships, reputational excellence and committee governance. 286 The firm’s Internal Capital Adequacy Assessment Process (ICAAP) ensures that the firm is appropriately capitalized relative to the risks of its businesses. ICAAP incorporates an internal risk based capital (IRBC) assessment designed to identify and measure risks associated with the firm’s business activities, including market risk, credit risk and operational risk. Capital adequacy is evaluated based on the result of this IRBC assessment as well as using the results of stress tests which measure the firm’s performance under various market conditions. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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The Business Standards Committee recommends: 30. Strengthen Procedures of Divisional and Regional Client and Business Standards Committees. The operating procedures of the divisional and regional CBSCs will strengthen accountability for reputational risk management and client relationships as follows: — appropriate senior leadership from divisions and regions will chair each divisional and regional CBSC. The Chairs of these regional and divisional committees will coordinate with the Chair of the CBSC in selecting members; — membership also will include senior control function leaders and, where appropriate, senior advisors such as retired PMDs. These members will help identify and elevate cross-divisional matters; — the divisional and regional CBSCs will be responsible for providing regular substantive reports to the Firmwide CBSC; and — unresolved matters and appeals will be escalated to the Firmwide CBSC. This recommendation reflects our objectives of strengthening reputational excellence and committee governance. The Business Standards Committee recommends that the following enhancements be made to the suitability and new activity review processes: 31. Establish a “Firmwide Suitability Committee.” A Firmwide Suitability Committee will be established, reporting to the Client and Business Standards Committee. This new committee will replace the existing Regional Suitability Committees. In addition, to address time zone practicalities, an Asia Suitability Committee will be formed, which will report to the Firmwide Suitability Committee. The Firmwide Suitability Committee will have the following responsibilities: — review transactions originating in EMEA and the Americas that require review as set forth in Section IV of this report relating to Structured Products; — set standards and policies for product, transaction and client suitability and provide a forum for more consistency across divisions, regions and products on suitability assessments; — review suitability matters escalated from other firm committees; and — oversee the activities of the Asia Suitability Committee, Structured Products Committee and Structured Investment Products Committee. To facilitate consistent firmwide standards and practices for suitability assessments, the charters of the Firmwide Suitability Committee and the Asia Suitability Committee will require: (i) certain membership overlap; (ii) regular reports by the Asia Suitability Committee to the Firmwide Suitability Committee; and (iii) escalation of significant Asia-specific suitability matters by the Asia Suitability Committee to the Firmwide Suitability Committee. Establish a “Firmwide New Activity Committee.” A Firmwide New Activity Committee will be established, replacing the existing Firmwide New Products Committee. The Firmwide New Activity Committee will report to the Client and Business Standards Committee and will have the following responsibilities: for significant matters, answer the critical question of “should we” engage in the new activity (considering reputational, client, suitability and other concerns) as well as a detailed “can we” review, recognizing that divisional and regional business leadership must analyze both questions prior to sponsoring a matter; oversee the activities of the Regional New Products Committees, Acquisition Review Committee and Physical Commodity Review Committee; and establish a process to identify and review previously approved new activities that are significant and that have changed in complexity and/or structure or present different reputational and suitability concerns over time to consider whether these activities remain appropriate. Considering the similarity of issues that may arise in the review of suitability matters related to transactions and new activities, the Business Standards Committee expects that the Firmwide Suitability Committee and Firmwide New Activity Committee will coordinate regularly to harmonize best practices and ensure a consistent approach. The two committees will have certain overlapping members. This recommendation reflects our objectives of strengthening reputational excellence and committee governance. 32. Establish the “Event Review Group.” The Business Standards Committee recommends that an Event Review Group be on call to senior management and select firmwide committees to perform time-sensitive, high-profile targeted reviews of incidents or other business or industry matters of concern. The Event Review Group will comprise a rotating group of seasoned firm leaders. They will have the ability to assemble resources and work closely with the Legal and Compliance Departments and other relevant control groups. The Event Review Group will document and disseminate its findings to the appropriate constituents, and develop cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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remediation, training and education initiatives. This recommendation reflects our objectives of strengthening reputational excellence, committee governance and training and professional development. The Business Standards Committee recommends the following improvements to committee procedures: 33. Reputational Risk Ownership. Committee charters will reinforce the committees’ ownership and accountability for, among other things, reputational risk management. Firmwide Risk Committee Reporting. The Finance Committee and its subcommittees will report to the Firmwide Risk Committee, and the Firmwide Risk Committee will report to the Management Committee. Capital and Commitments Committees. The Capital Committee will report to the Firmwide Risk Committee, and the Commitments Committees will report to the Client and Business Standards Committee. On reputational risk issues, both committees will engage with the Client and Business Standards Committee. On capital commitments issues, both committees will work with the Firmwide Risk Committee. Both the Capital and Commitments Committees play significant roles in reviewing underwritings and firm capital commitments. Accordingly, each of these committee’s charters will be amended to require certain membership overlap to ensure a consistent approach to reputational risk management and best practices. Formal Committee Process Framework. The Committee Operating Group of the Client and Business Standards Committee will be responsible for establishing and maintaining a formal policy framework for committee best practices, processes and procedures governing all aspects of committee operations, including charters, regular meeting agendas, minutes and statements of action. The Committee Operating Group will require formal, periodic self assessments by committees of their activities and effectiveness, including member participation. These results will be presented to their supervising committee. The Client and Business Standards Committee and the Management Committee will be able to review these self assessments. This recommendation reflects our objectives of strengthening reputational excellence and committee governance.

Trainingand Professional Development The Business Standards Committee makes the following recommendations on our culture and leadership: 34. The firm will initiate professional development and training, beginning with its senior leaders, to immediately focus those leaders on reinforcing the firm’s culture and on strengthening client relationships and reputational excellence. In addition, the firm will use milestones in people’s careers as opportunities for targeted training on the Goldman Sachs culture. This recommendation reflects our objectives of strengthening client relationships, reputational excellence and training and professional development. 35. Our Chairman and CEO will lead the new Chairman’s Forum on Clients and Business Standards, a global program engaging all of the firm’s 2,200 PMDs and EMDs. This initiative will represent a large investment of time of our senior management team over the course of 2011 and will reinforce the most important attributes of our culture through in-depth discussions and case studies. The significant involvement of the CEO and other senior management communicates the importance of the program and its messages. This recommendation reflects our objectives of strengthening client relationships, reputational excellence and training and professional development. 36. To strengthen reputational excellence, the Business Standards Committee recommends that the firm emphasize the following criteria in the annual performance review process: (i) adherence to reputational risk management and (ii) reputational judgment and compliance. These enhancements were implemented for the 2010 performance review process. 37. To strengthen training and professional development, the Business Standards Committee recommends that the firm and each affected division design and implement training and professional development programs which address the Committee’s specific recommendations. 38. The Business Standards Committee recommends that the firm strengthen its focus on the importance of leadership, culture and values in the PMD and EMD promotion process by communicating to all involved their responsibility to thoroughly evaluate candidates on these attributes. This was accomplished in the 2010 PMD and EMD promotion process. Communications during performance reviews, promotion and compensation conversations must be clear and specific so that our employees understand the correlation between recognition and behaviour, particularly behaviour related to leadership, culture and values. This recommendation reflects our objective of strengthening reputational excellence. 39. To strengthen reputational excellence and training and professional development, the Business Standards Committee recommends that the firm update and strengthen the Code of Business Conduct and Ethics. Through that process, we will signal its importance and articulate the need for every employee to operate in accordance cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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with the code. The ﬁrm should reinforce the importance of the Code of Business Conduct and Ethics by requiring employees to certify their compliance with the Code, highlighting it in orientation and training sessions and posting it more prominently on the ﬁrm’s external and internal website.

APPENDIX C GOLDMAN SACHS’ COMPENSATION PRINCIPLES We recognize that every financial institution is different, shaped by its activities, size, history and culture. It would be unrealistic to construct a specific model of compensation that is effective and appropriate for all financial institutions. But, that does not diminish the need for firms to set forth a set of practical principles and defined standards focused on compensation. An enhanced framework for compensation establishes a direct relationship between the longer-term evaluation of performance and an appropriately matched incentive structure. We believe strongly that, for Goldman Sachs, such an outcome aligns the long-term interests of our shareholders with those of our people, while advancing our ethos of partnership. Effective compensation practices should: (1) Encourage a real sense of teamwork and communication, binding individual short-term interests to the institution’s long-term interests; (2) Evaluate performance on a multi-year basis; (3) Discourage excessive or concentrated risk taking; (4) Allow an institution to attract and retain proven talent; and (5) Align aggregate compensation for the firm with performance over the cycle.

Encouragea Firmwide Orientation and Culture — Compensation should reflect the performance of the firm as a whole. — Employees should think and act like long-term shareholders. Being significantly invested in our stock over time, as part of an individual’s compensation, advances our partnership culture of stewardship for the firm. — An individual’s performance evaluation should include annual narrative feedback from superiors, subordinates and peers, including peers from outside of an individual’s business unit and division. — Assessment areas should include productivity, teamwork, citizenship, communication and compliance. — To avoid misaligning compensation and performance, guaranteed employment contracts should be used only in exceptional circumstances (for example, for new hires) and multiyear guarantees should be avoided entirely.

Evaluate Performance Over Time — Compensation should include an annual salary (or commissions) plus, as appropriate, discretionary compensation awarded at the end of the year. — The percentage of compensation awarded in cash should decrease as an employee’s total compensation increases in order for long-term performance to remain the overriding aspiration to realizing full compensation. — Cash compensation in a single year should not be so much as to overwhelm the value ascribed to longer term stock incentives that can only be realized through longer term responsible behaviour. — Equity awards should be subject to vesting and other restrictions over an extended period of time. — These would allow for forfeiture or “clawback” effect in the event that conduct or judgment results in a restatement of the firm’s financial statements or other significant harm to the firm’s business. — A clawback should also exist for cause, including any individual misconduct that results in legal or reputational harm. — Equity delivery schedules should continue to apply after an individual has left the firm.

Discourage Excessive or Concentrated Risk Taking — No one in a risk taking role should get compensated with reference to only his or her own P&L. — Contracts or evaluations should not be based on the percentage of revenues generated by a speciﬁc individual. — As part of an individual’s annual performance review, the different risk proﬁle of businesses must be taken into account. Factors like liquidity risk, cost of capital, reputation risk, the time horizon of risks and other relevant factors should be considered. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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— An outsized gain, just like an outsized loss, should be evaluated in the context of the cumulative record of that individual’s risk judgments. — The degree to which revenues are high quality and recurring should be considered. — Significant discretionary compensation for a particular year should not be awarded for expected future-year revenue. — All individuals, but particularly those working in legal, compliance, operations, technology and other non-revenue and critical parts of the firm, should be evaluated on their ability to protect and enhance the firm’s reputation or contribute to its efficiency and overall well-being. — Risk managers should have equal stature with counterparts in business units and compensation should establish and/or maintain that stature. — Revenue producers should not determine compensation for risk managers.

Attract and Retain Talent — Attracting and retaining talent is fundamental to our long-term success as a firm. Compensation, when structured appropriately, is one means to reinforcing the firm’s culture and mores. — Compensation should reward an individual’s ability to identify and create value, enhance the firm’s culture of compliance and its reputation and build and nurture a dedicated client base. — The recognition of individual performance must be constrained within the overall limits of the firm and not be out of line with the competitive market for the relevant talent and performance. — There should be no special or unique severance agreements.

Directly Align Firmwide Compensation with Firmwide Performance — Firmwide compensation should directly relate to firmwide performance over the cycle. — Junior people may experience less volatility in compensation. Senior and more highly paid people may experience more variability in their compensation based on year-to-year changes in the firm’s results. — Overall compensation should not automatically be the same ratio of revenues year in and year out or an overly flexible formula that produces outsized compensation to real long-term performance. — Any compensation decisions should be overlaid with a management culture that continually invests in and is guided by strong risk management, judgment and controls. — In addition to performance, a wide range of risk factors, in conjunction with underlying industry and market dynamics of individual businesses, should be weighed carefully by executive and divisional management when allocating aggregate discretionary compensation amounts to divisions and business units. — To more effectively compare and contrast individual performance as well as the results across different businesses, compensation should be reviewed by a specific compensation committee within each division of the firm as well as the firmwide compensation committee. 8 March 2013

Written evidence from C. S. Harries Introduction My submission is a result of the direct experiences I have had with both Barclays Private Bank and Barclays PLC.

LIBOR The world’s ﬁnancial system teeters on the edge of a complete collapse due to a ‘vortex of unvarnished greed’. The rigging of Libor is an exemplar of this statement since it is both criminal and a conspiracy to defraud. It can be prosecuted under current laws and, in view of its systemic affects which have led to the biggest ﬁnancial scandal the world has known, should be .( See my letter 14.1.13 to Mr Tyrie). Requesting information from Barclays Wealth in relation to the libor effects on our disastrous equity portfolio I was advised in writing by the bank as follows: 1. ‘The investigation uncovered very serious and completely unacceptable conduct by a relatively small number of people within Barclays’ .Untrue as evidenced by the list of names supplied to Guardian Care Homes 2. .. ‘it is important to note that Barclays current account, savings and credit card products were not linked to the Libor rate..’ This cannot be true. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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Money Laundering HSBC 3. In 2003 the Sunday Times ran a two page article in respect of $54 million of Colombian drug money passing through Barclays Private Bank. This behaviour took place while during the period we were clients and was the subject of a Freedom of Information request I made to the FSA and subsequently the Information Commissioner. The decision by the Information Commissioner that I should receive the information was appealed by the FSA to the Information Tribunal who upheld their appeal—see Information Commissioner reference FS05147636 and Information Tribunal Appeal Reference EA/2008/0061. The FSA were represented by a senior QC and seven members of staff were present. 4. In view of the appalling revelations relating to HSBC’s money laundering (see my letter 21.12.13 to Mr Tyrie) I made a renewed request for this information recently and was advised that ‘overall, taking into account the above factors, we would consider that the need to protect the commercial interests of regulated ﬁrms, and Barclays Private Bank in particular, (my italics) outweighs the public interest in increasing the transparency of our processes’. This view is for obvious reasons unconscionable (not least because my sister in law died at 27 form a heroin overdose and my stepson from a drug related illness) and had the proper action be taken at the time and senior managers arrested and prosecuted as was the initial intention of the NCS then it is beyond doubt that HSBC bankers would have desisted in their criminal behaviour. It is clear that the only break on identiﬁed misfeasance would be prosecution leading to jail sentences if proven guilty. This is the only sanction that will focus minds of those inclined to perpetrate what they must know is criminal behaviour, deliver justice to those who have suffered and act as some sort of catharsis to those whose lives have been ruined.

HBOS 5. On the 12.11.2007 I queried via the Director of Savings the bank’s exposure to sub-prime losses. In a letter to me dated 16.11.2007 Ms Duggan writing from the Executive Office said inter alia ‘Firstly, the HBOS Group is one of the strongest financial institutions in the world. It has an exceptionally strong balance sheet and very significant capital recourses, and with overall deposits of £225 billion is the largest savings institution in the UK. Additionally, the Group is the largest player in new investment products in the UK. Our Tier 1 Ratio—the main capital measure in banking—is at 8% one of the strongest in both the UK and continental Europe. In addition HBOS has very strong credit ratings. Bank of Scotland plc, the Group’s UK banking entity has credit rating of Aa1 from Moodys, Aa from Standard and Poor’s and AA+ from Fitch’. One year later it was bankrupt so were these statements true at the date they were written or was I misled?

Conclusion It would be desirable if those who were actually in the positions of authority at the time of these events were summoned before the commission. Refusal to do so would allow conclusions to be drawn. It appears that existing, relevant laws and regulations have not been applied and thus there has been no deterrent to the activities detailed above. The system is now as a result so systemically corrupt that it is questionable whether it is possible to remedy that which has evolved over very many years. I have watched with disbelief much of the testimony before the Commission and the parade of unimpressive, delusional participants who then compound the horror of their involvement by failing to accept responsibility for the clearly identiﬁed misfeasance that took place during their tenure They should be prosecuted for breach of ﬁduciary duty and the obscene remuneration (which in many cases does not appear to require full time involvement) they extract from shareholders, who nominally own the organisation, be returned to those who own the company. Letters I have sent to the Chairman of the Commission over the last few months amplify these statements in greater depth. I have been extremely impressed by the Commission’s forensic questioning of those testifying and would hope that the foregoing will be considered relevant and if so considered with the letters I have sent over the past few months to the Chairman. 9 February 2013

Written evidence from I Hawkins This statement is made by Ms I. Hawkins with regard to the inquiry by the parliamentary select committee on banking standards. The following issues are matters dating from 1990 till 2012. In 1990 I decided to re-mortgage my business with Citibank Trust Ltd who had approached me with an offer of very low interest rates. They valued my home a Georgian Mansion for 1.1million and agreed to advance me the sum of £880,000 to develop the property into a nursing home. Their brokers and solicitors conducting the conveyance were very quick to complete the re-mortgage. Subsequently I discovered that the offer of £880,000 was not forthcoming and I was informed it was to be £770,000. Upon completion my solicitors informed me that the £770,000 was incomplete and consequently I did not sign the deeds and a dispute arose whereupon the Chairman of the commercial division came and visited me at my home and insisted that I borrow more money in sum of £350,000. I refused as I did not wish to be indebted for such a large sum which I did not require. I received a letter from the executive chairman of the bank who threatened me with bankruptcy cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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if I did not accept their offer, so being helpless, I signed the offer letter which was placed on a deadline and I unable to take independent advice upon the matter. Once I had signed the offer letter for the sum of £350,000 the money was retained by their lawyers and not given to me. In 1994, Citibank Trust was renamed Citibank International Plc, part of Citibank Corporation NA. Two of the bank’s executives would visit me and keep demanding that I pay higher interest rates and they informed me that I should I pay as much as possible and they would give me back £1.00 for each £1.00 I paid so that the debt of 1.3 million would be cleared quicker. I disputed that the amount loaned to me at 12% interest was incorrect but they continued to harass me and told me that I had to make my repayments in cash each month and a person would come and collect the sums of £8,000 to £15,000. No receipt was ever given by the persons collecting the money. At times the two senior executives would collect the money and no receipts were given. I asked for my bank statements and this was promised but never set up. In 1996 they alleged that I was in arrears, but an expert report showed that I had paid my repayments for up to four years ahead according to the bank’s agreement. At this time the property had been turned into a nursing home but could not complete the building works due to defects and the banking executive decided to arbitrate on the building works issues and would not give me the money I had been forced to sign for by way of a further advance. He also threatened me not to go to court. The building matter went into arbitration and then to the High Court where the Judge declared that the Arbitrator has misconducted himself as he refused to allow me to attend my arbitration hearing. However, the Judge said he was to conduct a rehearing and that has never been done. In 1996 I went on holiday to Portugal and returned two weeks later to discover that the bank had sold my property by forging the charge deeds. I learnt about it by accident through third parties. Then they sent their same solicitor with bogus receivership documents signed by a banks director who did not exist. I issued counter proceedings and when the matter went to County court for repossession I was informed by the judge I could recover the property back or have compensation in damages. He decided that I could have the compensation as the property had been “sold”, the same solicitor sold the property in an auction by sealed bid sale to himself through his holding agents for conversion. In fact I had bid for the property and my bid was the highest but it was ignored. Citibank valued the property in 1989 for 1.1million, they say they spent the additional £350,000 bringing it to 1.2million and they sold it to themselves for £450,000 through their agents by forging my signature. Hence the judge gave directions that I was to put in my counterclaim in excess of 2.8 million. The same solicitor then went to court and obtained and injunction against me and also obtained an ex-parte bankruptcy order and when I appealed they went to the court for the appeal hearing without the court notifying me of any hearing and got further ex-parte judgments which were given freely and without question by the court. The same solicitor then picked another solicitor and his friend to be my trustee in bankruptcy and the trustee and his solicitors continued to harass and asset strip me leaving me penniless. I told the trustee and the official receiver and the judges but all except a few turned a blind eye to the multimillion frauds. When I made applications to the High Court a very senior judge allowed my permission appeal the ex-parte bankruptcy order but the same solicitor and the same barrister came and asked another junior judge to put a restraining order on me so that I could not proceed with the appeal. Therefore all fraud by the banks and their solicitors are concealed by injunctions and restraining orders. I have been unable to find a solicitor on legal aid to assist me further. Fraud is not allowed to be mentioned in the courts especially against banks, the penalty is a restraining order or injunctions and costs and bankruptcy orders against the victims. This is standard procedure; in fact court staff appears to take pride in concealing such crimes. When one judge saw the forged deeds he said he would not switch the transcription machine on. When I told another judge that my deeds had been forged he said, “We live in the real world don’t we?” he was a deputy judge and a Queen Counsel! I have complained to the Serious Fraud Office, the Police, the Land registry, the Citizens Advise ,Law Centres and the law society and other professionals who pretend to be deaf when the above issues are mentioned. Since the above matters arose I have been informed from the banks own people that the same solicitor is used to carry out their instructions involving larger institutions, hotels, other nursing homes and various other money institutions. I believe the operation is vast and has been going on since Citibank Trust Ltd came to this country in 1974 according to the company house documents. Since the above I have been informed by Citibank International Plc that they have never heard of me or my bank account numbers. I have the evidence should you be interested in this matter. In this case it is not only fraud but forgery, perjury, false accounting, misrepresentation, conspiracy to pervert the course of justice, misleading the court just to name a few. I have given a very brief description here. Hence I would like to provide further better written or oral evidence and I would like to attend as a witness as I can provide the evidence if the select committee is really serious about cleaning the banking industry. Please do not hesitate to contact me should you require further information. “Evil will triumph when good men do nothing” 24th August 2012 cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

Ev 1106 Parliamentary Commission on Banking Standards: Evidence

Letter from Sir Hector Sants In response to your request, I write to offer my thoughts on the issue of the design of an effective approach to conduct regulation of banks. These observations are made in a private capacity.

General Background There is a fundamental difference between conduct and prudential regulation in respect of the feasible role of the regulator.

Prudential regulation In the case of prudential regulation the relevant authority can expect to achieve six outcomes: 1. Establish a set of regulatory rules primarily for capital, liquidity and resolvability. These rules should set the perimeter within which management can exercise their judgement. There are three principle outcomes to be achieved by the rules. Firstly, to significantly decrease the possibility that bad judgements by management will lead to the failure of the bank. Secondly, to ensure if it does fail that it can be resolved in a way which does not have systemic consequences for the economy. Thirdly, that any failure does not incur cost to the taxpayer. 2. Collect the right information from the banks which would enable the supervisor to make its own judgement as to the sustainability and resolvability of the bank. It is debatable however whether the supervisor should be resourced to check that the data is accurate and in particular whether the data on the quality of the individual loans is correct. I believe that a prudential supervisor should be resourced to achieve that goal. This resourcing can either come from specialists, employed directly by the regulator or by outsourcing to third parties, such as auditors, or a combination of the two. 3. Make an assessment of whether the bank has sufficient oversight mechanisms to enable the bank’s management to judge whether the prudential limits are at risk of being exceeded. 4. Ensure that the bank’s senior management have the right technical skills and necessary probity for the roles they are carrying out. 5. Deliver effective enforcement when its rules are broken. In particular, the regulator needs to have the necessary powers to both ban individuals from carrying out senior management roles for which they are not competent and to suspend them while investigations are pending. It should also have powers to attach conditionality to its authorisation of individuals. It is reasonable to give the prudential regulator powers to sanction banks through fines for failures to either maintain quality of data or have the right systems and controls. 6. Make a judgement as to whether the bank has the right culture to encourage individuals within the institution to comply with these rules. It would be reasonable for the supervisor to set rules to ensure that the individuals are incentivised by the bank itself to behave in the right way especially with regards to compensation.

Conduct regulation In the case of conduct regulation the feasible aims of a supervisor are more constrained. In particular it is not realistic to construct a conduct supervisor which could discover misconduct by individuals which is not visible to the firm, with any reliability. Discovering individual acts of wrong doing requires a forensic level of investigation for which it is not realistic to equip a regulator. This role should rest with the internal control mechanisms for the individual bank, namely management, compliance and audit. A conduct supervisor can however be expected to achieve the following seven outcomes: 1. Establish a set of regulatory rules which: (a) determine how markets and transactions between professional counterparties should be carried out; and (b) determine the rules which cover interaction with retail consumers. 2. Ensure that firms have appropriate oversight mechanisms in place to seek to ensure adherence with those rules. The testing of whether the oversight framework is in place can include periodic detailed assessment of particular oversight mechanisms, for example with regards to product suitability. However, as I mentioned above, it should not be set up with the goal of picking up individual acts of wrongdoing. 3. Operate an effective redress mechanism which returns money promptly to consumers. 4. Operate an effective authorisation regime for key management roles which includes making judgements on competency and probity. 5. Operate an effective enforcement regime. My definition of an effective enforcement regime would be “one which ensures that when individuals are contemplating wilfully committing wrongdoing they believe there is a reasonable chance of them being caught and that the cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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sanctions are severe enough to provide credible deterrence”. This was the substance of my speech in which I stated that individuals needed to be afraid of the regulator. 6. Operate a set of detection and analysis mechanisms which maximise the chances of detecting wrong doing once it has become reasonably prevalent in the system but prior to it becoming systemic. 7. Make a judgement as to whether the bank has the right culture to encourage individuals within the institution to comply with these rules. In particular, the supervisor should set rules which ensure that individuals are incentivised by the bank itself to behave in the right way, in particular the compensation structure needs to be correctly aligned.

Specific Observations with regard to Conduct Regulation I expand below on each of the seven points. 1. Regulatory rules The central policy question in respect of rules is the degree of specificity which is required. This sits at the heart of the “principles versus rules” debate. Experience suggests a hybrid approach remains the only realistic solution. Superficially the concept of a simple set of rules such as “Treating Customers Fairly” appears desirable as it should be less bureaucratic to administer and would appear to avoid the opportunity for enforcement arbitrage. However, the fact is that any enforcement process ultimately gives the defendant recourse to the legal system. The absence of clarity creates the opportunity for the banks to resist sanction even when it is clear to the society that they have transgressed such as in the case of PPI. Consequently there has to be a mix of principles and detailed rules and the regulator has to seek the right balance between maximising enforcement success, giving clarity to firms, whilst minimising the administrative burden. 2. Conduct supervision If the Financial Conduct Authority (FCA) is to be successful it is in the area of supervisory expectation that Parliament needs to be clearer. Currently the expectation of the media and Parliament is that any wrongdoing should be preventable by the supervisor. Thus, any wrongdoing by a firm is seen as a supervisory failure. This is an unachievable expectation which also creates unnecessary costs, regulatory burden and creates defensive behaviour by supervisors. It would be helpful if Parliament would make clear that it does not expect the regulator to discover wrongdoing before it has become visible in the marketplace not least because having the capability to do so would not pass a cost benefit test. The role of supervisors should be to detect wrongdoing once it is visible in the marketplace and also seek to ensure that firms have appropriate oversight mechanisms in place which themselves deter the wrongdoing. 3. Redress mechanisms The ability to deliver redress to consumers is an essential element of conduct regulation. The Ombudsman service has worked broadly well in relation to individual complaints, but there is clearly scope to give greater power to the regulator to achieve speedier mass redress. The current Finance Act has improved the regulator’s powers in respect of delivering mass redress, but more could be done. 4. Authorisation regime In relation to the authorisation regime, the supervisor needs powers to make it easier to make a judgement on technical competency. It also important that individuals recognise that they need to promote the right culture in the institution. The problem here is that this is a subjective judgement. Therefore, if this is an obligation on the regulator it lays it open to the risk it is being seen to misuse its powers. There is therefore an argument that this judgement should be made by the industry operating its own code of conduct and register. This would have to work in conjunction with the authorisation process. However, notwithstanding the reputational risk to the regulator, on balance I favour keeping all the judgements relating to authorisations with the regulator but in either case statutory backing would be beneficial. Finally, it would be helpful if authorisation of individuals could include conditions, albeit for a limited period of time. This would enable the regulator to formally identify actions which it requires members of management to carry out as a condition of maintaining their authorisation. 5. Enforcement regime In respect of ensuring an effective enforcement regime it could well be that fines need to rise again; even above the levels the changes made by the FSA in 2010 will have achieved. Furthermore, the regulator needs to be given additional powers. Firstly, to suspend individuals while their investigation is pending. Secondly, to enshrine in law that if an individual has been associated with a bank that either prudentially fails or commits an act of serious conduct wrongdoing, there is a presumption that the senior individual cannot hold a senior post again, unless they can demonstrate reasons to the contrary. In general I would not be in favour of imposing criminal sanctions for poor commercial decision making. It is however important that the Serious Fraud Office (SFO) is well resourced and effective and encouraged to use its powers in support of the regulator. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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The central point as I said earlier, is to ensure those who are contemplating wrongdoing are deterred by believing there is a reasonable probability of being sanctioned in a material way. This concept of fearing the regulator sits alongside the regulator being seen as respected and authoritative by those who are wishing to operate within the rules 6. Detection capability As has been discussed in the FCA document the detection mechanisms need to include much stronger analysis of business models, product suitability and, critically, complaints data by the regulator. This capability would supplement the existing obligations on regulated markets operators to provide the necessary data. This will require a significant investment by the FCA in terms of both people and technology. It will also require a change in culture, and in particular a greater willingness to listen to consumers. One particular innovation I would encourage would be to put much greater investment into encouraging consumers to contact the regulator directly with their concerns. This would require a vastly expanded call centre capability. 7. Oversight of culture As I made clear in previous speeches at the FSA I do not think the regulator should have responsibility for determining the culture within a particular bank, but it should make a judgement as to whether there is a culture in place which supports the regulator’s objectives. This would include making judgements on the effectiveness of Boards and the incentives, deterrence and oversight structures which individual firms have in place. Undoubtedly this would be a contentious area of focus as it is highly judgemental. Thus, some general obligation in statute requiring the regulator to make such a judgement would be helpful in giving it the necessary authority. In particular, the regulator should ensure that the banks have the following three elements in place: (a) A clear statement of purpose and values which places an obligation on employees to give consideration to the impact of their actions on society as whole. (b) An effective incentive regime which encourages individuals to see themselves as the custodian of their institution and which, in particular enables claw back for wrongdoing and does not reward high pressure selling. Further changes to the current compensation arrangement should include: — Making clear that any discretionary compensation is linked to compliance with the general statement of purpose. The specific changes below would assist in this aim. — For senior Executives extend the deferral period to five years. — As is being proposed, a clear ban on commission arrangements which encourage high pressure selling. — Clarity that fines should come out of the bonus pool. This would then encourage a greater ownership of good behaviour by everyone. One of the changes required is not just aiming to deter deliberate wrongdoing, but also to eliminate passive acceptance behaviour by everybody else. (c) A strong and independent compliance function which is tasked with ensuring adherence to the purpose and values statement, not just with regulatory rules. This would be encouraged by the setting up of a Board Committee to sit alongside the Risk and Audit Committee which would focus on operational conduct and behavioural risks, leaving the current Risk Committee to focus on balance sheet risk

Summary In summary, the central point I wish to make is that the approach to prevention differs between prudential and conduct regulation. In prudential regulation the supervisor can make a forward looking judgement within the framework of the rules as to the likelihood of a firm achieving the regulators desired outcome and intervene if it thinks they are not going to be achieved. In the case of conduct regulation an inspection based regime is unlikely to reliably detect individual wrongdoing in firms. The focus of the regulator thus needs to be on ensuring the firms themselves take responsibility for achieving that goal. In pursuit of that goal the regulator needs to give greater emphasis to ensuring firms have the right culture and behaviour than has been done in the past. Ensuring firms have the right culture should be a statutory objective of the regulator. The historic approach has emphasised the need to ensure the right systems and controls are in place, this is still a valid approach, but it must be complimented by a focus on culture. Also in assessing controls, greater emphasis needs to be placed on ensuring that there is a strong and independent oversight function within the firm. This approach needs to be backed up by clearer enforcement powers which ensure individual accountability. It should however be recognised that whilst in this letter, I have emphasised the importance of culture, I am doing so because it has historically not been a focus of regulators. I continue to hold the view of the importance of also implementing the proposed proactive intervention strategy based on in depth market and business model analysis which has been laid out in recent FSA publications. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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I hope these observations are helpful and I would be happy to expand on any of them if you would ﬁnd that of assistance. 20 January 2013

Written evidence from Hermes Equity Ownership Services 1. To what extent are professional standards in UK banking absent or defective? How does this compare to (a) other leading markets (b) other professions and (c) the historic experience of the UK and its place in global markets? We are not aware of significant and actively pursued professional standards in banking, whether in the UK or globally. It appears to us that currently banking is not a profession in the sense that it does not seek to assert and impose formal professional standards and related training, and nor does it seek to exclude from its ranks those individuals who have failed to live up to the expectations of others in the trade. These are to us the minimum requirements of a profession (they are features of, for example, the legal, medical and accounting professions). We thus do not believe that at present banking should be dignified with the name “profession”. We are aware of debate over recent years about the possibility of introducing a Hippocratic Oath for the financial sector (not just banking). While recognising that the standards for the medical profession clearly go significantly beyond this one expectation, we did understand the desire for a “first do no harm” standard for finance. Our view was, however, that this was not the right framing of the basic standard for the finance industry: instead, we proposed that the equivalent for finance ought to be “first—or always—serve your client”. It is the failure to focus on client interests and the failure to deliver on genuine client needs which go to the core of the failure in recent years of the banking sector, and of the finance sector more generally. The corporate culture of every financial services firm must above all be to serve the interests of its clients. By delivering value to clients, the firm will prosper for the long run. It is also the nature of much of the financial services industry that it acts in a fiduciary capacity, stewarding assets on behalf of their beneficial owners. It concerns us the extent to which much of the financial services industry fails to consider fully the implications of the fiduciary duties which apply to it—too few firms state that they put clients’ interests first, and fewer still have the culture, structures and practices in place to deliver on such assertions. We believe that there would be considerable value in reassessing and perhaps reasserting the understanding of fiduciary duty such that it is more fully at the forefront of the minds of every individual within banking and the financial services industry more generally.

2. What have been the consequences of the above for (a) consumers, both retail and wholesale, and (b) the economy as a whole? It is clear that the failure to focus ﬁrst and closely on client needs and client interests have damaged the interests of those clients, both retail and wholesale. The impact on the economy as a whole is a damning indictment of the ﬁnance industry’s failings.

3. What have been the consequences of any problems identified in question 1 for public trust and in, and expectations of, the banking sector? Given the repeated mis-selling of products and services and the introduction of additional frictional costs of business, it is unsurprising that public trust in banking, and the financial sector as a whole, is at its lowest ebb. The public seem to expect next to nothing from the banking sector—indeed most seem to expect the sector to abuse its position—and it is hard to be confident that this is a mistaken position given recent experience.

4. What caused any problems in banking standards identified in question 1? Culture and compensation ratios The professional standards for the banking sector, such as they were, were never akin to those developed, imposed and enforced by the genuine professions. The question is therefore why has the culture of the finance industry shifted from the tradition of “my word is my bond” and a genuine focus on the needs of clients to the current situation where neither consideration seems significantly high on individuals’ agendas. This is clearly a cultural failure. It is a cultural failure that arises from a number of areas, among them: individual greed, a misalignment of remuneration and incentives, a failure to apply appropriate capital charges to risky activities, and a desire to generate greater returns on capital to compensate for too much of the revenue earned by banks being swallowed by their staff. One of the most significant drivers of the shift in culture occurred when investment banks changed from being partnerships to being limited companies. This removed the risk to partners’ capital from any failure and so dramatically increased the risk appetite as well as created a more sanguine approach to leverage because its risks are faced by the shareholders rather than the executives. Ironically, this shift was not accompanied by a change which ought to have followed automatically: a dramatic reduction in compensation ratios, the proportion of overall banking revenues which are paid to staff. While banks were partnerships with individuals’ own cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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capital at risk the compensation was in effect a return on their capital investment; once the structure of the industry changed there should have been a dramatic reassessment of how the returns on the business are allocated between those operating within it and those who provide the capital. The failure of compensation ratios to fall in recent times goes a long way to explaining why there is currently very limited appetite among investors for bank equity: put simply, the compensation paid to the staff means that little (if anything at all when looked at over a lengthy time-horizon) is left over for shareholders.

The role of shareholders At present the greatest threat to increased and increasingly effective shareholder involvement in the governance of financial institutions is that they are crowded out by the close involvement of the FSA and other regulators. The approval process for directors limits the scope for shareholders to impose themselves in the nominations process and makes it harder for investors to seek the removal of individuals that they see as failing to perform in their roles. The FSA seems indifferent to investor views on director quality, preferring its own judgements to those of others—its response to attempts at communication have in our experience been decidedly unwelcoming. The situation is even more extreme with regards to remuneration, where the detailed prescription on pay structures and levels set by the FSA and other regulators mean that the role for investors risks being extremely limited. Where we disagree with the approach of the regulators, our voice is inevitably ignored. We do not think that shareholders should be required to exercise a stronger role, but we do think that they should do so, and further we fundamentally believe that it is in their interests for them to do so—certainly it is in the interests of their underlying beneficiaries that they should do so. Perhaps the most radical and welcome element of the Walker recommendations was in this area, requiring the establishment of a Stewardship Code in the UK and its oversight and regular review by the Financial Reporting Council. The introduction of the Code has had some impact, and many fund managers have asserted their compliance with it; however, the extent to which this is genuinely delivered in practice is open to question. The unwillingness of the industry to encompass the Stewardship Code in fund management mandates is perhaps the strongest indicator that there may be less delivery in practice than is asserted in theory. An industry delivering fully on its fiduciary duties to customers would be more active in taking forward stewardship responsibilities.

Accounting issues The allegation is sometimes raised by various parties that fair value accounting played a role in the crisis, and this question will no doubt be raised once again to you. We are not convinced that this is the case and so feel it is appropriate to discuss this complex issue briefly. It is worth stepping back to consider what the purpose of the reported accounts is. Under English law, this is to communicate corporate performance and the current position to the current shareholders. The communication enables shareholders to understand the performance of their company, and just as importantly it forms a basis for shareholders to hold management and the board to account for their stewardship of the company’s assets. So our test for whether accounting for banks is appropriate is whether it best serves this underlying purpose—providing the information that shareholders need to assess performance and where necessary to call management and boards to account. We see no practical alternative to fair value accounting for financial instruments; while this offers no more than a snapshot which will not remain representative of values even a short time after the snapshot is taken, it is necessary to have a basis on which to call management to account. It provides a better insight into performance than the alternative valuation measures. A key area criticised under the headline of fair value accounting is with regards to the impairment of debt. IFRS was clearly wrong about this, and we welcome the IASB’s agreement to move to an expected loss approach rather than a incurred loss model. It is unfortunate that this change to the far more appropriate expected loss approach is being delayed and we are encouraging the IASB to accelerate this key change. We have also in recent times been encouraging banks to make more disclosures around impairments such that it is possible for investors to understand what the expected losses might be even though the new standard is not yet in place. But we are not convinced that the incurred loss model is correctly called fair value accounting—at least one academic points out that the expected loss approach can much more accurately be considered to be the fair value of the debt. Having highlighted these two specific areas, there is a more general issue. One major allegation with regard to fair value accounting is its procyclicality—boosting performance in the upswing of markets and making the downswing much more painful. Procyclicality is clearly unhelpful but we are not sure that fair value accounting was the biggest driver of procyclical behaviour in the run-up to the crisis. Rather, money was too cheap (in the form of consistently low interest rates, lowered every time there was a chance the long boom—laughably then considered the “great moderation”—showed signs that the bubble might have sprung a leak); regulators acted in a procyclical manner, rather than countercyclically, by relaxing supervision and regulations and basing capital requirements on banks’ flawed internal models; and all of us were sucked into beginning to believe that the prices in markets were reflections of reality rather than leveraged gambles that prices would continue to rise. There were large numbers of real transactions in those unreal markets, particularly in terms of property cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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and securitisation. In many ways, securitisation is simply a way for banks to turn illiquid assets into realised proﬁts. There is no question of whether an asset should be valued at mark-to-market or mark-to-model, or held on the books at historic cost, when it has been sold in an open market transaction. Thus procyclicality was a function of inﬂated prices in the market—real transactions in unreal markets, perhaps they might be called— as much as any accounting assessment. Accounting can never be a substitute for common sense, whether on the part of investors, directors, auditors or regulators. It can never be a substitute for effective regulation and supervision. All parties need to think and to act in a countercyclical manner. The irony is that in the aftermath of the crisis almost all of these parties are continuing to act in a procyclical manner by tightening standards and their approaches in the downswing. This is perhaps no more than human nature.

Auditor dialogue with regulators We share the disappointment felt by the House of Lords Select Committee on Economic Affairs that the practice of active dialogue between auditors and regulators fell into disuse. We welcome the fact that these discussions appear to be happening again, though we are clear that this needs to be a two-way dialogue in order for it to be most effective in limiting systemic risks and safeguarding value for shareholders.

5. What can and should be done to address any weaknesses identified? To what extent are such weaknesses subject to remedial corporate, regulatory or legislative action, domestically or internationally? We believe that it is necessary to carry through in full the ring-fencing of retail banking from investment banking as proposed by the Independent Commission on Banking. We believe that one of the fundamental reasons why banks have tended to take on inappropriate risk is because capital is fungible between investment banking and other risky activities and the banks’ less risky operations. We believe that unless and until different banking activities face specifically appropriate costs of capital there is in effect a cross-subsidy to the high risk businesses from less risky activities. Without the appropriate costs of capital being applied the risks of activities are not appropriately priced in, and banks may continue to make mistaken assessments as to the risk/reward trade off of certain activities. This need for appropriate costs of capital goes beyond what ring-fencing can ever deliver (for example much of the riskiest lending in the credit bubble was on commercial property, an activity which seems likely to be on the retail side of the ring-fence), so the capital discipline needs to be applied by boards, with appropriate influence from regulators and shareholders; the ring-fence is not a panacea. The introduction of the ring-fence will ensure that there is no cross-subsidy of capital costs from the retail side of the business to investment banking—including ensuring that the implicit government guarantee of the retail bank does not subsidise the broader activities of banking firms. This is necessary in terms of ensuring that the implicit government guarantee is not overstretched but perhaps more importantly it will ensure that the separate parts of the business must apply a properly segregated cost of capital to relevant operations. Ensuring that risky activities face a heightened cost of capital such that performance is understood in a fully risk-adjusted way is necessary for any understanding of performance of both the bank and of the individuals. We suspect that significantly less risk will be taken once a proper cost of capital is applied to the most risky activities. We hope that ring-fencing will be taken up internationally such that this same capital discipline applies to all banking activities wherever in the world they occur. This may over time facilitate a return to investment banks operating as partnerships and so subject to the risk management disciplines which are inherent in that structure. We have also been struck in our dialogue with bank executives and non-executives just how significant the challenges are in managing such big businesses; we hope that over time their scale can be reduced such that not only are banks not too big to fail but they are also no longer too big to manage effectively.

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ﬁnancial institutions prior to the crisis is widely accepted to have been inappropriately low but we fear that the swing of the pendulum may have gone too far and there may now be excessive intrusion. It risks disempowering boards and making them less effective rather than more so. The risk is that rules will inevitably lead to formal, legal compliance with the letter rather than the spirit of the law or regulation. In turn this leads to behaviour that is focused on formal, defensive compliance (which easily drifts into a gaming of the system) rather than the sort of culture and approach that we should all be seeking, which is a dynamic of seeking improvement within appropriate risk parameters rather than mere compliance. We believe that it is this culture which is more likely to secure the successful future of the banking industry and limit the risks of future failures. Regulation which bolsters the principle of ﬁduciary duty—both in terms of the duties of directors and in terms of the duty to clients—is more likely to be effective than detailed and prescriptive rule-based regulation.

7. What other matters should the Commission take into account? We attach some documents outlining possible next steps in the areas of remuneration and banking regulation. Our Banking Remuneration Principles lay out our expectation of banks in which we invest, both in terms of pay itself and in terms of the governance structures which frame it. In our discussion paper Rewriting the Rules of the Banking Sector we highlight ways in which the regulatory regime can be further enhanced. We also attach a discussion paper that we produced regarding pay more generally—the discussion paper being our commentary compiled ahead of a seminar we held which brought together the remuneration committee chairs or their representatives from 44 FTSE 100 companies with their underlying owners in the ﬁrm of trustees and executives from leading pension schemes. We believe that our ideas on pay provide the basis for a better long-term model than the regulators’ reliance on at-best medium term deferral of bonuses which does not get to the heart of the short-termism which is currently too prevalent in banking and ﬁnancial services more generally. We believe that each of these three documents is relevant to the Commission’s inquiry and may be helpful in your deliberations. The following three attachments have also been submitted and are available upon request: — HEOS Rewriting Bank Rules. — HEOS Banking Remuneration Principles. — HEOS Proposed Reforms to UK Executive Remuneration. 24 August 2012

Written evidence from Geoff Hill The Commission’s Initial Questions In this section, I use the question numbers in the Call for Evidence: 1. In my experience during the last six years, professional standards in UK banking are not just defective: they are notable only by their absence, especially in respect of lending policies and money-laundering compliance. (a) My case suggests UK banking standards do not compare favourably (if at all) with those in The Federated States of Micronesia [“Fiji”] and Australia. (b) Generally and speciﬁcally in respect of compliance with the UK’s anti-money laundering regime, the standards in the legal and accountancy professions (and their supervisory bodies) appear to be as poor as in the banking sector. I refer to (2.3) above. Of course, this has side effects on banks’ conduct too since most of their work in respect of bank-related crime is handled by in-house solicitors, who it appears, have nothing to fear from their own regulatory authority, much less the FSA. (c) On returning to the UK in 1990, after four years abroad, I perceived a distinct change in culture in UK banks—from a customer-focussed approach in which a “Bank Manager” had kudos and authority, to sales/commission-based operations, over-reliant on call centres. In respect of the UK’s place in global markets, I can refer only to my preceding answers. For example, from the viewpoint of ﬁnancial crime it appears that Fiji and Australia are a safer place to do business that the UK. 2. I perceive that the consequences of (1) were: (a) To create two classes of consumer: — Those with limited spending power because they are struggling to pay off existing debts, incurred whilst banks were lending recklessly. — Consumers, who would spend and/or invest now, if borrowing facilities were more readily available at more attractive interest rates. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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Both are adversely affected by interest rates—whilst Base Rate dropped to and is held at an all time low, interest rates for consumers (especially on credit cards, overdrafts and loans) have not reduced in parallel. Indeed, rates on credit cards have increased. (b) To depress the economy as a whole by lack of investment (including inward investment) and consumer spending. By definition, this adversely effects employment too. 3. Public trust and in, and expectations of, the banking sector are at an all time low. I suggest respectfully that the Commission looks for reasons beyond “casino banking”, directors’ bonuses and other major scandals, such as allegations about LIBOR rate-setting process. Whilst concentrating on high profile and/or risky investments, bank directors’ failed to uphold standards at branch level, where service reduced to the extent that few Bank Managers have decision-making authority and the anti-money laundering regime is ignored, save for checking the identity of new clients. That said, I must add that, when Business Managers did have authority to approve borrowing facilities pre- 2006, they often abused it by reckless lending, for example at (4.3)—probably encouraged by lack of controls and the incentive-based culture. To illustrate my point, I do not believe it is an exaggeration to say, in terms of public esteem, that bankers are ranked below estate agents and timeshare salesmen—a far cry from the past when someone with the title, “Bank Manager” was held in high regard in his community. 4. In addressing problems in banking standards, I limit my comments to subjects in which I have personal experience or in which there is a clear public perception. They arose inter alia from: (a) Generally, I believe a number of factors led to main board directors taking their “eyes off the ball” in terms of domestic business. — The culture of incentivised risk-taking, “casino banking” and greed at high level. — The rush for global expansion distracted directors from core business. — Financial innovation also distracted directors from controlling standards and culture in their core business. — Technological developments allowed banks to reduce staff levels in their traditional business sectors by relying on automated decision-making and call centres at the expense of face-to-face contact with clients. Even on a company account, I do not know the name of my so-called “Customer Relationship Manager.” Depersonalisation of traditionally customer-facing roles is naturally detrimental to client relationships, branch staff morale, ethical standards and culture. This is not to dismiss technological developments per se. Internet banking and the “fast payment system” inter alia brought significant benefits. However, they cannot replace the personal knowledge that a Bank Manager should have about his clients when they apply for overdrafts, loans and funding for business development. — Corporate structures, which in practice if not in theory, caused senior management to prioritise high-risk investment banking over traditional business. — Lack of competition in the retail market (especially in UK with four banking groups dominating) provides no incentive to drive down interest rates for consumers and improve services. “Retail” includes small to medium-sized businesses. — Lack of robust regulation and effective remedies for consumers has allowed senior bank officials to neglect its traditional business and related compliance issues. It is evident that (whether by example, lack of adequate supervision or specific direction the unethical culture, evident at senior level, has filtered down to branch level. (b) I believe that there are clear weaknesses in the following areas: — Institutional shareholders are insufficiently robust in exercising their powers: many of course are financial institutions themselves. — Non-executive directors are insufficiently robust in their role and/or too easily over-ruled by executive directors. I refer, for example, to (10.5) above. — In terms of compliance, I can say with certainty that banks’ compliance with their obligations to disclose suspicious activity in accordance with ss.330/331 of POCA was completely absent in my case. At branch level, mangers and staff saw the requirements of anti-money laundering procedures as no more than carrying out identity checks on new clients. If main board Directors of banks (for example (9.1), (10.4) and (10.5) above) and Legal Counsel (for example (10.2), (11) and (15) above) set such a bad example in denying their POCA obligations, it is unsurprising that less senior executives do not comply. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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— Any remuneration incentives at regional or branch level can only have a negative impact on the willingness of bank officials to admit that their employer and/or their employers’ clients have been defrauded. — I anticipate that the low esteem in which bankers are held now will be detrimental to staff recruitment and retention and, ironically, could result in banks having to offer yet higher remuneration packages to attract the right calibre of staff. — There has to be stronger safeguards in place for whistle blowing. If non-executive directors (for example at (10.5) above) and MLROs (for example at (10.8) above) can be influenced unduly in carrying out their responsibilities, then less senior executives are likely to be completely cowed. — It is unlikely that banks’ external auditors and accountants will be able to identify weaknesses in anti-money laundering compliance at regional and branch level. However, when major transgressions occur, banks do engage independent firms of accountants to investigate. For example, in the FSA’s “Decision Notice” (of 2 August 2010) in respect of RBS Group, the FSA gave RBS credit for instructing, “A leading firm of accountants” in early 2008 to independently review relevant matters. Unfortunately, the FSA went on to say that RBS did not take the required remedial action until several months later. Banks must be encouraged to extend this practice to lower level crime and money laundering. For example, it is highly unlikely that small terrorist cells would engage in transactions substantially greater than those in my case. Indeed, I believe an independent audit of all banks’ compliance with the UK’s anti-money laundering regime (at their expense) should be a priority for Government, especially with ever decreasing law enforcement budgets. — The regulatory and supervisory approach, as it stands now, clearly is ineffectual. Three supervisory bodies appointed to supervise money-laundering compliance in the regulated sector have failed to take meaningful (or any) action against those they profess to supervise. I refer to the FSA, ACCA and the SRA. — With decision-making authority and the ambit of discretion largely removed from customer- facing bank staff, the corporate legal framework and modern banking ethics do not lend themselves to compliance with the criminal law (POCA) or indeed common law in terms of banks’ duty of care to their clients. 5. The weaknesses identified require remedial corporate, regulatory and legislative action: I will limit my comments to domestic action. I do not believe that the UK is in a position to talk of international action until it is compliant with the requirements of FATF domestically. 5.1 Clearly, remedial action by financial institutions is required from the top downwards. It should include but is not necessarily limited to: (i) Intensive training in POCA disclosure obligations and compliance issues generally from top to bottom of the corporate structure. (ii) A change in attitude to reporting suspicious activity. Rather than trying pro-actively to find reasons not to make disclosures and/or seeking higher authority before doing so, bank officials should be encouraged to act on their own initiative. In my case, the banks had more than “suspicion” of Catcher, they had prima facie evidence yet officials still refused to act on their own initiative. One wise Bank Manager, not involved in my case, tells me that if his colleagues ask him about a suspicious transaction, he responds: “If you have sufficient suspicion to ask me, then you have sufficient to make a disclosure.” All bank executives should give staff this advice. One person cannot tell another if the latter has “suspicion”. As such disclosures would be made to the banks’ MLRO, this provides adequate safeguards against malicious or negligent disclosures. Equally, there must be adequate safeguards in place to ensure staff they will not be penalised unfairly for fulfilling these obligations, even if the bank loses money as a result. POCA includes safeguards for persons making disclosures in good faith so there is no reason why this should not be extended to banks’ internal policies. (iii) Banks should be compelled to make available to customers (on request) the name and contact details of their MLRO to limit the opportunity for other bank officials to cover up suspicion and/or prima facie evidence of money laundering. Solicitors’ firms are obligated to disclose their MLROs’ identity on request. There is no valid reason why other regulated businesses and their supervisory bodies should not be compelled to do likewise. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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However, I am sure that Government cannot rely on corporate action alone to remedy non- compliance. A strong, effective regulatory and supervisory regime is required with the means and a willingness to take punitive action against banks to set an example. 5.2 As stated at elsewhere, it is impractical to expect a local law enforcement agency to investigate individual allegations of unlawful conduct by banks (such as non-compliance with POCA) and supervisory authorities (such as non-compliance with MLRs). (i) In my case, Hampshire police would have had to investigate seven banking groups, the SRA, several solicitors, ACCA and one accountant of its members—at least 11 organisations—all for non-compliance. This would be asking the impossible of one police force but also it would turn all 11 organisations into hostile witnesses (no doubt accompanied by an army of lawyers to confuse the jury) when the predicate offender was brought before the Court. (ii) Undoubtedly the difficulties experienced by the police in my case are not limited to Hampshire. It would be perverse and a further waste of resources for each local police force to have to investigate non-compliance in its own area, especially as, in my experience, local staff have a valid defence, ie lack of adequate training. Therefore, banks’ compliance with POCA can only monitored and enforced economically by a strong and proactive supervisory regime, prepared to investigate individual cases; build up a national picture and take robust, punitive and exemplary action, including if necessary prosecution (via the CPS). I doubt that this can be achieved with industry-led supervisory authorities. Whilst not industry-led, the Supervisory Authority can still be industry-funded by means of a Government imposed levy. Fines imposed should be returned either to the “victim” of misconduct (if identifiable) or to the public purse. They should not directly benefit the Supervisory Authority, which should be allowed only to recover its costs. In the event of prosecution, the Judge can be asked to make an order for reparations to victims and award costs to the Supervisory Authority as well as imposing a fine. 5.3 In as much as “the letter of the law” is concerned, existing money-laundering legislation appears adequate: (i) The Regulated Sector has disclosure obligations under ss.330/331 of POCA. (ii) Supervisory Bodies have disclosure obligations under r.24 of MLRs 2007, which are not limited to suspicious conduct by those they supervise. (iii) Other POCA offences apply to all individuals and organisations in the UK. Unfortunately, this regulatory framework cannot be relied upon because no Government department or agency (from HMT and the Home Office downwards) is prepared to take responsibility for “policing” compliance by Supervisory Authorities and businesses in the regulated sector. The tendency always is to refer a case back to the local police. The only way to remedy this is to appoint a national law enforcement agency to enforce compliance, basing its work on witness reports from individuals and businesses, backed by referrals from local law enforcement agencies (including the CPS). It is a matter for Government to determine if this can be best achieved by means of a simple policy change (to give an existing agency powers of investigation and prosecution [via the CPS]) or if new legislation is required. 6. Unfortunately, in the time allowed by the Call for Evidence, I have not been able to consider the changes already proposed by the Government, regulators and industry. However, I would make the following general observations: 6.1 Whatever the good intentions of Government legislation and any proposals by the Bank of England/FSA as to how new Committees and Authorities will operate in practice, they are meaningless without an adequate and robust means of enforcement. 6.2 Government must provide consumers with adequate protection and cost-effective means of redress against serious misconduct by banks, which is not currently available through the FSA, FOS or other bodies in the existing regulatory framework. I refer to (16) to (19) above. It is unsatisfactory that UK consumers have no realistic recourse against a bank when its conduct is inherently linked to criminal conduct. “Realistic recourse” excludes prohibitively expensive and innately high-risk Court action and the subsequent potential for banks to appeal. For example, in respect of (10) above, my solicitor, Counsel and MP were unanimous and correct to advise me to settle out of Court on costs grounds alone. Solicitor and Counsel felt that the importance of the issues involved would lead AIB to use its financial muscle to appeal to a higher Court each time a lower Court found in my favour. This constitutes abuse of power, especially when a criminal investigation is in progress into the same transactions, which should not be tolerated in a democratic society. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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6.3 Government must also legislate to provide better protection for honest and ethical bank officials, who are prepared to act even if the interests of the law appear to conflict with the interests of their employer. The SRA Code of Conduct is made inter alia under Part II of the Solicitors Act 1974. It makes clear that solicitors’ primary duty (rule 1.01) is to uphold the law and the proper administration of justice. This takes precedence over duties to their clients [in the case of in-house lawyers, their employers]. Government should ensure that any new legislation in the banking sector and associated Codes of Practice make similar provisions with regard to bank executives upholding the law over their duty to their employer. It may seem like, “stating the obvious” but clearly it needs to be said. 7. I believe that the Commission should take into account the public’s lack of knowledge about banking law, especially when the consequences are criminal, and make recommendations to improve public awareness. 7.1 So that consumers can better hold banks to account, The Banking Code should contain far more information about a bank’s legal obligations and compliance issues. Banks are expected to explain why identity checks are required but should go into more explicit detail about the anti- money laundering regime. 7.2 The very fact that consumers are told about a bank’s disclosure obligations might itself act as a disincentive, especially to first-time offenders for example in low-level crime, tax evasion and benefit fraud. 7.3 In briefing consumers about the anti-money laundering regime, banks should also take the opportunity to address the misconception that the obligation to disclose suspicious activity is not limited to the regulated sector. Most of the offences under POCA apply to all individuals and businesses in the UK. In my case, even august bodies such as the FRC (ref. (8.5) above), The Rugby Football Union and Harlequin Football Club Ltd argued that they had no obligation to make money laundering disclosures because they are not in the regulated sector. Smaller businesses did not accept even solicitors’ letters informing them of their obligations. In fact, all regulated businesses should be required to “educate” their clients in this respect. It would help clients hold banks to account in addition to being a disincentive to low-level crime. 24 August 2012

Letter from the Chancellor of the Exchequer Leverage Ratio: International Comparisons and Definitions When I appeared before the Commission on 25 February, I was asked to comment on the different minimum leverage ratios that are applied internationally. The Commission rightly noted that some countries operate higher minimum leverage ratios than the 3% proposed under Basel III. It is, however, important to note that these different leverage ratios are calculated on a different basis from the Basel III standard, with the result that the minimum levels set according to the different standards are not directly comparable. This was recognised by Mark Carney in his recent evidence to the Treasury Select Committee, when he acknowledged that comparing different leverage ratios could be an “apples and oranges comparison”. For example, the minimum leverage ratio according to the definition used by the US Federal Reserve differs from the Basel III leverage ratio in that it both excludes off-balance-sheet exposures (captured within the Basel III definition) and uses the US GAAP accounting standard (rather than IFRS) to calculate total assets, which allows greater netting of derivatives. Both of these differences will mean that a given bank would appear to have a higher leverage ratio (ie would appear less leveraged) according to the US definition than under the Basel III definition. Similarly, the minimum leverage ratio used in Canada is calculated using a bank’s total regulatory capital, not just its Tier 1 capital as in Basel III. This too will tend to make banks appear less leveraged according to the Canadian than the Basel III approach. A different definition still of the leverage ratio has been used by the Bank of England in their Financial Stability Reports: this definition uses total equity (which is narrower than Tier 1 capital) divided by total assets (excluding off-balance sheet exposures). Leverage ratios calculated according to this definition—which was also the approach used by the ICB in its publications287—will not, therefore, be directly comparable to Basel III leverage ratios. To illustrate how much difference the choice of definition used can make to a bank’s leverage ratio, I have included below a simplified illustrative bank balance sheet showing the key relevant variables. The leverage ratio for this illustrative bank is then calculated according to a range of different international standards. As you will see, depending on the definition used, the same illustrative bank’s leverage ratio varies from a minimum of 3.08% (under the Basel III definition) to a maximum of 5.34% (under the US Federal Reserve definition). 287 See, for example, Figure 4.3 on page 98 of the ICB Final Report. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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This shows that it is not, therefore, valid simply to compare the minimum values for the leverage ratio set in different jurisdictions, without taking account of the different deﬁnitions according to which leverage ratios are to be calculated. The Government strongly supports the Basel III Accord, including its proposal for a minimum leverage ratio as a backstop to risk-weighted capital requirements. The Basel III deﬁnition of the leverage ratio, which measures Tier 1 capital only against a bank’s total exposures, including off-balance- sheet exposures, is the most prudent standard available. The Government has consistently pressed for the full implementation of the Basel III Accord, in the EU though European legislation. I am copying this letter to members of the Parliamentary Commission on Banking Standards. George Osborne

Annex IMPACT OF DIFFERENT LEVERAGE RATIO DEFINITIONS Illustrative Bank Balance Sheet Assets £millions Liabilities £millions

Funded Assets £750,000 Liabilities exc Derivatives £700,000 Derivative Assets £400,000 Derivative Liabilities £395,000 Total Capital £55,000 of which: Tier 2 Capital £15,000 Tier 1 Capital £40,000 of which: Non-Equity Tier 1 Capital £3,000 Equity £37,000 of which: Intangibles £1,000 Tangible Equity £36,000

TOTAL £1,150,000 TOTAL £1,150,000

Total Exposures (Basel III deﬁnition) £1,300,000

Leverage RatiosAccording to Different Deﬁnitions Leverage Ratio Standard How calculated Resulting Leverage Ratio Basel III Tier 1 Capital/Total Exposures 3.08% US Federal Reserve Tier 1 Capital/Tangible Funded Assets 5.34% OSFI (Canada) Total Capital/Total Assets plus Off-Balance-Sheet Exposures 4.23% Bank of England Equity/Total Assets 3.22% Tangible Equity Tangible Equity/Total Assets with netted derivatives 3.14%

8 March 2013

Written evidence from HSBC HSBC welcomes the opportunity to respond to the call for evidence with regard to the Commission’s consideration of: (a) professional standards and culture of the UK banking sector, taking account of regulatory and competition investigations into the LIBOR rate-setting process; and (b) lessons to be learned about corporate governance, transparency and conﬂicts of interest, and their implications for regulation and for Government policy. The comments below respond to the initial questions posed in the Commission’s call for evidence.

1. To what extent are professional standards in UK banking absent or defective? How does this compare to (a) other leading markets (b) other professions and (c) the historic experience of the UK and its place in global markets? 1.1 Absence of or deﬁciency in professional standards in UK banking has to be judged ultimately from the perspective of those who use or comment upon the use of banking services; their judgement today would not be ﬂattering. However, it would be inconsistent with the evidence to conclude that the pattern of improper cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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behaviour and practices, albeit recurring, means that there is a systematic absence of professional standards in UK banking. On the retail side,288 customer satisfaction and recommendation scores point to a fairly consistent and high level of service. Indeed within this, First Direct has consistently topped independent customer service surveys across all sectors, not only banking. Customer behaviour, in terms of complaints about core banking services and incidence of switching providers, again does not point to an industry bereft of professional standards. On the wholesale side, London has until the LIBOR scandal enjoyed a relatively untainted position in terms of conduct: the major issues have been around conﬂicts of interest in the structuring and distribution of securitised and structured products which were largely an issue for the major investment banks operating in the US. The 2010 report of the US Senate Permanent Subcommittee on Investigations: “The Anatomy of a Financial Crisis” provides examples of some of these conﬂicts and behaviours.

Regulatory Developments 1.2 Neither can it be said that staff and management in banks are unaware of society’s expectations of them and how these are evolving. On the retail side, the FSA’s “Treating Customers Fairly” initiative which was completed in 2008 was embraced enthusiastically by banks as a framework for building customer satisfaction. The FSA’s interim report in November 2008 noted “TCF remains central to our retail strategy—it has gained enormous buy-in from firms and their senior management, and is a hugely important part of our retail agenda for consumer protection”. 1.3 From January 2009 the FSA’s Advanced Risk Recognition Operating Framework (ARROW) assessments of firms with retail activities included a TCF component with: — a review of TCF outcomes: direct testing of the customer outcomes with reference to a firm’s own management information (where (the FSA) believes it is robust), other relevant intelligence about the firm’s conduct; and — an assessment of the firm’s culture to understand potential reasons where there is poor performance or identify where good performance might not be maintained.289 1.4 Thus culture and behaviour have been an area of growing regulatory importance and management attention over the last five years. At HSBC, the TCF framework was embedded into the UK bank’s “Best Place to Bank” and “Best Place to Work” programmes. These were customer and staff focussed initiatives driven by a simple view that highly engaged staff and satisfied customers would drive required financial performance in a sustainable way. 1.5 On the Commercial Banking side of the business, the Business Finance Taskforce set up following publication of the Government’s green paper “Financing a Private Sector Recovery” in July 2010, committed to 17 actions aimed at improving banks’ relationships with customers, ensuring better access to finance and promoting understanding of the needs of business customers. Customer reaction and tracked metrics all point to the success of this initiative. 1.6 The last three to five years have therefore seen major co-operation between the industry, regulators and government around improving banks’ service propositions to core retail and commercial customers. From our experience as a global bank, we believe that these programmes establish standards of conduct as good as any elsewhere in the world. Indeed these are now more developed than in many countries given the UK’s more integrated and sophisticated markets and as a consequence of the problems that have had to be addressed. Furthermore, in all areas of regulated activity, sanctions for non-compliance have been significantly toughened and more extensively applied with increased “naming and shaming”. There can be no doubt that the UK’s regulatory regime is now tough and demanding. The issue therefore is not with the design or promulgation of the standards under which the UK industry is designed to operate, or any absence of adequate regulatory sanctions for their non-observance; rather the issue is with ensuring the consistent application and enforcement of these standards within regulated institutions. 1.7 So how can it be with all this management focus on the TCF and “Better Business Finance” initiatives, accompanied by extensive industry training and governance, both internally and externally through the FSA’s ARROW reviews, that there have been recurring failures in the application of the required standards in retail and commercial banking? On the wholesale side, the key question is what factors might have contributed to a belief among albeit a small number of traders that attempted manipulation of a key reference rate, whether for personal gain or otherwise, was anything other than totally unacceptable behaviour?

Environmental Developments 1.8 It is worth reflecting on how an industry once known and trusted within the community for its high standards of propriety has fallen to such low public esteem. Without attempting to justify poor behaviour and practices, there are a number of environmental factors which can be identified objectively, and which need to 288 For the purposes of this document, “Retail” refers to the provision of financial services to individuals, within the Retail Banking and Wealth Management operations of HSBC; “Commercial” refers to the provision of services to small and medium sized enterprises and middle market corporations with the Commercial Banking operations of HSBC; “Wholesale” refers to the provision of services to international corporate and markets activities within the Global Banking and Markets operations of HSBC. 289 FSA Annual Review 2008/9 page 39 cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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be understood if we are to draw a line under the past and begin to rebuild confidence in the financial industry which is also an essential precursor to economic growth. 1.9 Firstly, the aftermath of the dotcom and tech bust saw the financial markets flooded with liquidity, and yields on government debt fell to historically low levels. This drove an urgent search for yield amongst investors and intermediaries to find products to match embedded liabilities and meet expected returns. Market expectations for returns continued to stay higher than was justified by the prevailing risk free interest rates. This led to a tolerance and then implicit acceptance of higher risk and more structured products (essentially through leverage) to deliver the required higher yields. 1.10 One further consequence of this extension in product range was a growing and mutually rewarding relationship between the retail and commercial side of banking and the markets side. What had historically been a relatively passive risk transfer relationship added progressively a product provider/distributor relationship, more marked in some firms than in others. There is absolutely nothing wrong with this—indeed it is a characteristic of a sophisticated and efficient financial market enabling customers to better manage their financial risks such as interest rates, foreign exchange rates and commodities prices so that they can concentrate on their commercial activities. There are however clearly tensions and conflicts that have to be managed to appropriately govern the extent to which product flow is demand led or supply driven, and to ensure adequacy of product information and sales training on more complex products. Recent history has clearly evidenced that this was not always done adequately. 1.11 A second observation on environmental factors is that product ranges in retail and commercial banking expanded over the last decade. This was largely driven by customer demand for outcomes that required the acceptance of greater risk and more structuring of product features. It is possible that customers’ enthusiasm for the desired outcome was also taken, to an extent more than was justified, to incorporate a full acceptance and understanding of the underlying risks and structuring features. 1.12 A third observation would be that in the mid 2000’s there was significant investor pressure to increase equity returns through either financial or business leverage. In financial terms, this was focused on reducing capital ratios. HSBC resisted what was quite intense pressure during this period—at one point there were external broker reports calling for up to $20 billion to be returned through share buyback. In business terms, the focus was on the development of originate-to-distribute models, with assets being packaged and sold on to investors (who did not have a direct relationship with the customer) thereby removing the capital requirement from the bank. It is possible that this very strong public call for leverage and structuring from many institutional shareholders, combined with a very strong focus on shareholder value creation which was at the time dominated by a Total Shareholder Return (“TSR”) metric, contributed to an overweighting of short term shareholder perspectives rather than a longer term customer relationship focus. The fact that management’s long term remuneration at that time was also typically heavily weighted to TSR would also have been a factor, but we will deal with remuneration issues in more detail below. 1.13 Fourthly, also driven by the co-ordinated flood of liquidity to the financial markets post the dotcom/ tech bust and more recently by very low official interest rates in the wake of the financial crisis, the value of banks’ deposit bases declined as the spread between the average deposit rate which banks needed to pay to attract deposits and the yield on high quality liquid assets fell to historic lows and in some cases turned negative. This revenue reduction was critical as, historically, deposit spread revenue was the most important part of a retail and commercial bank’s revenue model given that it required the acceptance of very little risk (and therefore capital) on the deployment of excess deposits into liquid assets. 1.14 Fifthly, as regards retail and commercial banking, the revenue model that had underpinned banking for most of recent history was being dramatically transformed. As noted above, deposit spread revenue declined notably during the last decade both from lower yield on high quality liquid assets and from higher deposit costs in banks that were being forced to lower their dependence on wholesale funding. There has been increasing public and regulatory focus on the structure of bank charges within the UK and, particularly, the existence of cross-subsidies inherent in a “free if in credit” model. Over the last few years, there have been successive regulatory-driven adjustments to the fees, margins and charges which were a consequence of “free banking” for most customers, but no longer fitted with the “cost plus” model that the industry was moving towards. On top of this, post 2008, under the “Treating Customers Fairly” initiative described above and also as a consequence of the FSA’s Retail Distribution Review, there is a continuing focus on unbundling fees and charges so far as possible, making the intermediation costs embedded within financial products much more transparent. We object to none of this—it represents an overdue modernisation of the revenue model of banking. The point is simply that all the cross subsidy elimination and unbundling has taken place while the causal driver of that revenue model—”free” banking—remains intact. 1.15 In addition to the impact of market forces, banking has therefore adjusted its revenue model over the last decade in response to regulatory intervention, to accommodate significantly lower overdraft fees and charges, lower credit card over limit and late payment fees and charges, and lower credit and debit card interchange fees. It has also begun paying interest on business current accounts. The commission-based revenue model for wealth management products will be eliminated as a consequence of the Retail Distribution Review and many in the industry including HSBC have significantly withdrawn from this market, unable to match the cost of meeting revised expectations with the market’s acceptance of a fee basis of charging. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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1.16 Addressing the cost challenge of an industry in transition has clearly also contributed to the declining reputation of the industry. This has arisen as certain services of value to some customers but not economic to deliver are withdrawn, as physical infrastructure, namely branches, are rationalised to match growing customer online and direct banking preferences, as certain activities are consolidated into centres of excellence to gain economies of scale but causing regional job losses, and as some work was moved to centralised Group service centres outside the UK. The public sees these cost adjustments alongside the high remuneration of senior bankers, at the top of the bank and in the wholesale side of the business which have a different remuneration and employment model, but this adds to public anger. It is, however, possible that this disconnect will be clariﬁed as we implement the ring fencing proposals from the Independent Commission on Banking when it will be clear that the higher remuneration in the wholesale bank is not subsidised or in any way supported by the retail and commercial banking activities.

1.17 At the same time, as costs in the retail and commercial bank were being contained throughout the last decade for the reasons noted above, there were growing offsetting pressures on the cost base from regulatory interventions and reforms. These arose from the Business Finance Taskforce undertakings, the greater customer screening and due diligence requirements under the “Treating Customers Fairly” programme, as well as the enormous commitment of resource to the regulatory reform agenda. This simply illustrates that the important and shared goal of a more transparent and potentially safer ﬁnancial system, with greater customer protection, cannot be achieved without greater cost

1.18 So the background environment in retail and commercial banking in recent years has been one of revenues constrained because of economic slowdown, exacerbated by a signiﬁcant reduction in deposit spread income as a consequence of low interest rates and further pressured due to the progressive elimination of or reduction in so-called “cross subsidy” revenues as the banking model is modernised to be more transparent and fair to all consumers.

International Comparisons

1.19. In terms of international comparisons in retail banking, Great Britain is marked out by its “free” banking model. This was only extended to Northern Ireland relatively recently, and in response to action by the Competition Commission. In many European countries, the provision of core banking services is delivered through public sector or mutual banks who do not seek to make the same return on capital as a private sector bank. While this could be seen as a form of economic subsidy, as a competitive alternative this model has also exhibited ﬂaws, most recently with the Spanish Cajas.

1.20 Asian retail and commercial banking is distinguished by a focus on ensuring that the industry as a whole self-capitalises, generating the returns necessary to satisfy capital providers, absorb unexpected losses and fund growth. There is no less focus on treating customers fairly but there is perhaps more recognition that a long term commercial balance is required for any banking model to be sustained. The result can be a more interventionist approach to the viability of the industry, for example, when unrealistic loss-leader propositions emerge that could damage the market as a whole, and promotion of a closer industry dialogue than has been the case in recent years in the UK. Part of the difference in approach is also reﬂected in product approval philosophies: in Asia most markets offer product approval safeguards so that once approved, banks can be reasonably sure that, subject to following agreed procedures, product sales will be regarded as compliant. Competition is still strong but the collaborative approach to create a broad vision of a sustainable industry may give a better impetus towards delivering the desired retail market outcomes than has been seen hitherto in the UK.

Conclusions

1.21 The above is offered by way of background and context. It does not seek to justify or condone poor practices. The aim is to capture some of the forces which can shape the development of an industry, and which need to be considered if we are to create an environment conducive to high professional standards and focused on the interests of customers in both the short and long term, underpinning a sustainable banking sector making a sound contribution to the economy. Signiﬁcant actions have already been taken to address inadequate standards with the Business Finance Taskforce and Treating Customers Fairly initiatives being particularly positive to ingraining the right values and setting clear expectations from society on “fair dealing”.

1.22 Comparison with other professions is a very relevant benchmark. We would submit that the banking industry has progressively seen its historic professional standing diluted largely as a consequence of its failings. On top of this, as the industry grew more sophisticated, detailed regulation increasingly replaced a traditional reliance on judgement, reﬂecting the increased range and complexity of banking activities. The historic sense of public duty and a relationship banking model, much admired in the past, has been juxtapositioned increasingly against a more transactional business mentality and a more mechanistic regulatory approach. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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1.23 In thinking about this response we were reminded of the testimony of J P Morgan back in 1933 which still stands today in our view as what the aspiration should be. First-class business in a first-class way “I should state that all times the idea of doing only first-class business, and that in a first-class way, has been nefore our minds.” J.J. Morgan, Jr. “I have ventured to frame a brief statement of my views on the subject of duties and uses of bankers. The banker is a member of a profession practiced since the middle ages. There has grown up a code of professional ethics and customs, on the observance of which depend his reputation, his fortune, and his usefulness to the community in which he works. Some bankers are not as observant of this code as they should be; but if, in the exercise of his profession, the banker disregards this code—which could never be expressed in legislation, but has a force far greater than any law—he will sacrifice his credit. This credit is his most valuable possession; it is the result of years of fair and honorable dealing and, while it may be quickly lost, once lost cannot be restored for a long time, if ever. The banker must at all times conduct himself so as to justify the confidence of his clients in him and thus preserve it for his successors. If I may be permitted to speak of the firm of which I have the honour to be senior partner, I should state that at all times the idea of doing only first-class business, and that in a first-class way, has been before our minds. We have never been satisfied with simply keeping within the law, but have constantly sought so to act that we might fully observe the professional code, and so maintain the credit and reputation which has been handed down to us from our predecessors in the firm. Since we have not more power of knowing the future than any other men, we have made many mistakes (who has not during the past five years?), but our mistakes have been errors of judgement and not of principle. The banker must be ready and willing at all times to give advice to his clients to the best of his ability. If he feels unable to give this advice without reference to his own interest he must frankly say so. The belief in the integrity of his advice is a great part of the credit of which I have spoken above, as being the best possession of any firm. Another very important use of the banker is to serve as a channel whereby industry may be provided with capital to meet its needs for expansion and development. To this end the banker can serve well, since, as he has at stake not only his client’s interests but his own reputation, he is likely to be specially careful. If he makes a public sale and puts his own name at the foot of the prospectus he has a continuing obligation of the strongest kind to see, so far as he can, that nothing is done which will interfere with the full carrying out by the obligor of the contract with the holder of the security.” J.P. Morgan, Jr., May 23, 1933, Excerpt from statement made before the Sub-Committee of the Committee on Banking and Currency of the U.S. Senate. 1.24 It is not the case that this sense of public duty and responsibility has been lost irreparably or in all cases. There still exists clearly this sense of public responsibility and accountability where bankers are proximate to the communities they serve and where they are relevant to those communities. We see this most notably in Hong Kong where the Hongkong and Shanghai Banking Corporation is identified closely with the success and prosperity of Hong Kong and is, notwithstanding its scale, seen also as a community bank. This shared identity is also seen in regional and local markets where the bank, local authorities and communities work closely together to build economic activity. First Direct is a clear example of a brand and level of customer service which its customers appreciate, trust and recommend to others. 1.25 One of the tragedies of the current public anger over banking reputation is that the very substantial majority of our employees do not, and should not, in any way identify with the criticisms being levied as their own activities are performed diligently, valued by their customers and aligned with society’s expectations of the industry. 1.26 The current reputation of the UK’s banking industry also sits very uncomfortably with the strong reputation of the UK’s leading professions—legal, medical and accounting inter alia—which is particularly problematic as, at least as regards the legal and accounting professions, a great deal of their business, expertise and reputation derives from London’s position as a leading international financial centre. It is therefore critical, beyond the banking industry itself, that the UK’s banking industry reputation is restored to its historic high level of international respect.

2. What have been the consequences of the above for (a) consumers, both retail and wholesale, and (b) the economy as a whole? 2.1 Other than the growth of a general lack of trust, with its long term consequences for customer relationships, lapses in the application of standards have created the need for customer redress programmes in respect of certain retail and commercial offerings on a scale not seen before. On the wholesale side, there is a growing burden of regulatory enquiries and litigation to establish if losses have arisen which should not cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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have occurred both from those who are generally aggrieved or have fiduciary responsibilities on behalf of end investors. 2.2 As a further consequence of the expanded regulation and more intrusive and extensive supervision necessitated by and attributable to recurring behavioural lapses, the industry’s operational and compliance cost base has risen as has its litigation and regulatory sanction cost exposure; ultimately such costs are borne by society through higher intermediation costs to consumers or through lower returns to pensions and savings systems. 2.3 For the economy as a whole the consequences are both current and prospective. — Currently the consequences include: — Loss of activity occasioned by lack of confidence in the banking industry; — Diversion of a portion of industry management’s attention from economic activities to management of redress and litigation exposures; — Higher intermediation costs and lower shareholder returns; and — Investor concern over the sustainable business model given recurring redress and remediation impacts; sectoral capital allocation to the UK is at risk of being diverted to other banking markets if current issues are not expeditiously addressed. — Prospectively the consequences may incrementally include: — Risk of greater financial exclusion given redress experience in certain customer segments; — A narrower product range from major banking providers; — More focus on execution only, non-advisory services; and — Loss of wholesale activities to competing international centres if London’s reputation is not restored, with consequential impacts to related services sectors; there is also a risk of some UK headquartered companies following the move progressively to those competing centres.

3. What have been the consequences of any problems identified in question 1 for public trust and in, and expectations of, the banking sector? 3.1. Trust in the banking sector is clearly at an all-time low driven by the combination of: (i) recurring mis-selling findings requiring significant customer redress; (ii) industry-wide downward revisions to fees and charges to eliminate non-transparent cross subsidies; (iii) scandals over LIBOR rate fixing and money laundering allegations; (iv) anger over remuneration levels in a sector judged to have caused much of the financial crisis and to have required taxpayer support; (v) perceptions of a lack of support for the real economy through lack of meaningful growth in lending to the “real economy” such as SMEs; (vi) a decline in the availability of low deposit mortgage credit which, wrongly as it turned out, had come to be seen as the norm; and (vii) declining levels of physical infrastructure and advisory services as the industry manages down its cost base and responds to changing regulatory requirements. All of these are seen in the public’s eye as evidence of declining or absence of standards in banking in the UK and are in aggregate mutually reinforcing. 3.2. Expectations of the banking sector can be seen through three prisms: — The public has low expectations of a change in behaviour given recent experience, continuing media outrage, a clamour for further redress and a very public change in regulatory focus towards more severe sanctions including exploring the need to seek criminal sanctions; — Regulators and government expect visible actions from within the industry in the short term to restore confidence in a sector essential to the UK economy; and — Investors continue to have little confidence in their ability to forecast the sustainable business model, structure and financial returns of the industry. This is evidenced inter alia by the substantial discount to book value that most banks trade at, as well as the discount evidenced on the recent divestment of Lloyds Banking Group branches. Essentially most investors don’t know what to expect.

4. What caused any problems in banking standards identiﬁed in question 1? 4.1 In the ﬁnal analysis, problems around the application of banking standards lie with management either through failing to ensure standards were applied as intended or in failing to recognise that society’s expectations of the conduct expected of the industry had evolved and not keeping pace with that change. 4.2 Paragraphs 1.8–1.18 above set out in some detail background and contextual factors that contributed to a recurring negative perception of industry standards. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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4.3 A critical analysis of these factors highlights two key issues which likely contributed to instances of inappropriate standards of behaviour, certainly when judged with hindsight.

4.4 Firstly, the very low interest rate environment and bullish market sentiment in the early part of the century respectively fuelled and rationalised the need to identify or create products that secured higher returns (for both customers and banks) than those available from more traditional investment products. This led to greater structuring and complexity of ﬁnancial products which, in turn, needed to be supported by higher levels of sales training, monitoring of sales practices and more thoughtful sales incentivisation. History shows that governance over sales processes was not as good as it should have been.

4.5 Secondly, actions to eliminate cross subsidies and improve transparency, ultimately brought together under the TCF regime, which the industry fully supports, led to a steady stream of adjustments to the revenue model of retail banking over an extended period. This pattern of adjustment both contributed to the deterioration in public trust as each adjustment was seen as an individual failing within the industry rather than as part of a package. It also created pressure both to cut costs and to identify replacement revenues. Cross selling of insurance was one consequence that in principle was logical and potentially to the advantage of the consumer but was clearly poorly executed.

4.6 Looking at lessons learned in the retail and commercial banking businesses would point to a number of other contributory factors:

— During the last decade there has been a shift towards seeing banks more as retail businesses than was previously the case. There was focus on creating more of a “sales culture” in response to market encouragement to monetise the depth and loyalty of the customer base, in part in response to greater and highly selective competition from established retailing and marketing brands. One illustration of this change in emphasis was that senior management was increasingly recruited from retail businesses; and there was greater use of sales targets and related incentivisation to deliver these targets. While there was and is nothing wrong with this approach, it is clear that lessons were learned over this period in terms of: (i) better targeting of sales incentives and better training around the sales process; (ii) better documentation of the sales process itself and of the customer’s understanding of inherent risks; (iii) reviewing sales outcomes more critically against expectations; (iv) assessing post sale product performance more often; and (v) segmenting target markets more ﬁnely so that product sales are more likely to be appropriate. All of these lessons and more are embedded in the TCF regime and in our own procedures but many of the current redress situations are legacy issues arising from earlier times.

— Customer patterns of interaction with their bank have moved progressively and rapidly towards greater use of direct channels, further encouraged by banks seeking to manage their cost structures. But this has reduced face-to-face interactions outside the Premier segment, probably contributing to the loss of a community bank “feel” amongst a growing number of customers and staff. This has been exacerbated by the role of service centres, sometimes located offshore, to improve efﬁciency and reduce service delivery costs at the expense of branch contact. For some customers, this reduced personal interaction has meant a loss of personal empathy recalled from prior times even though an overwhelming proportion favours the convenience and efﬁciency of ATM machines and internet banking. The challenge for banks is to satisfy both populations within the same structure.

4.7 With regard to the wholesale side of the business, the following observations may be relevant.

— Leading up to the financial crisis, there were clearly structural deficiencies in remuneration policies in many firms that allowed cash bonuses to be awarded and vest on the basis of short term financial performance that subsequently turned out to be overstated or false. Underpinned by new regulation at a UK and EU level, these deficiencies have now largely been addressed through deferral and clawback arrangements across all leading markets and participants. At HSBC, we have gone further to require long term compensation awards to the most senior executives once vested to be retained until retirement.

— The prior arrangements also led some institutions and staff therein to focus on structuring products that front loaded accounting proﬁts, and therefore bonuses, through aggressive mark-to-market and mark-to-model accounting. With hindsight, there were inadequate controls and governance over such arrangements and again this has been remediated both by better controls within banks and extensive regulatory changes to eradicate the arbitrage opportunities that led to this behaviour. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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— Progressive sophistication, complexity and speed of trading, all increasingly fully automated, have probably also contributed to a remoteness in some parts of financial institutions between what happens within segments of trading rooms and the consequences of that activity on real world investors and businesses. Arbitrage activity is essentially institutionalised where it serves as a mechanism to aid price transparency and liquidity. The role of some trading operations—for example high speed trading—seems increasingly designed to serve the efficiency of the market itself rather than be tied to any direct individual customer relationship and this de-personalises the activity. This may be where policy makers want to see markets activity develop but if so it becomes a much more technical activity in nature with society’s benefit coming from the enhanced efficiency created. It is difficult to ascribe culture and values to algorithmic or high speed trading once programmed, so the controls have to be in the design. That is not to say that the activities serve no useful purpose nor that those who design them do not have appropriate values or integrity but it does emphasise that the controls have to be evident in the design of the systems as once designed they will simply respond as programmed. The recent automated trading losses arising from software errors in a US trading platform highlight this point. — There is also a need to reconsider the definition of a “sophisticated” counterparty when considering the sale of high-risk complex financial instruments to ensure that these are only sold to truly sophisticated investors. — In August 2008, The Counterparty Risk Management Policy Group (“CRMPG”) issued a report “Containing Systemic Risk: The Road to Reform” to Henry Paulson, Secretary to the US Treasury and Mario Draghi, Chairman of the Financial Stability Forum which recommended establishing fresh standards of sophistication for all market participants in high-risk complex financial instruments. In the financial crisis that followed the issue of the report its findings were subsumed into the plethora of regulatory reform initiatives but they remain relevant today. — In recommending specific characteristics and practices for participants, CRMPG was guided by the overriding principle that all participants should be capable of assessing and managing the risk of their positions in a manner consistent with their needs and objectives. All participants in the market for high-risk complex financial instruments should therefore ensure that they possess the following characteristics and make reasonable efforts to determine that their counterparties possess them as well: — the capability to understand the risk and return characteristics of the specific type of financial instrument under consideration; — the capability, or access to the capability, to price and run stress tests on the instrument; — the governance procedures, technology, and internal controls necessary for trading and managing the risk of the instrument; — the financial resources sufficient to withstand potential losses associated with the instrument; and — authorisation to invest in high-risk complex financial instruments from the highest level of management or, where relevant, from authorising bodies for the particular counterparty. — CRMPG further recommended that large integrated financial intermediaries should adopt policies and procedures to identify when it would be appropriate to seek written confirmation that their counterparty possesses the aforementioned characteristics. 4.8 With regard to the role of governance in all its forms in relation to causation of inadequate or absent standards of behaviour we offer the following observations: — Non-executive directors increasingly play a critical role in establishing risk appetite, monitoring “tone at the top” and assuring that reward and succession planning are aligned with both required performance and standards of behaviour. The G30 report “Toward Effective Governance of Financial Institutions” published in April 2012 established a best practice framework that has added greatly to clarifying the Board’s accountabilities in these areas. Hitherto there was less clarity as to the Board’s responsibilities as against those of executive management. — Compliance and internal audit functions predominantly operated on an exception reporting model rather than an assurance model leaving responsibility with business management to address deficiencies; hindsight suggests this was less effective than it was designed to be. HSBC recognised this upon its management succession in 2011 and moved to an assurance model with compliance and audit functions given greater authority to enforce their recommendations. The audit process also was redesigned to be more holistic rather than concentrating on narrow adherence to Group standards. — In terms of the themes identified by the Commission for consideration in the context of problems around banking standards we have no observations in the following areas: — Taxation, including the differences in treatment of debt and equity; — Creditor discipline and incentives; — Arrangements for whistle blowing; cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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— External audit standards; and — The corporate legal framework.

5. What can and should be done to address any weaknesses identified? To what extent are such weaknesses subject to remedial corporate, regulatory or legislative action, domestically or internationally? 5.1 We risk deceiving ourselves if we believe that it is possible to engineer a regulatory system that eliminates failure and unintended consequences. However regulators and public policy makers on behalf of society clearly have a duty to respond to the failures highlighted in the crisis and beyond. They have the ability to modify and recalibrate the framework under which the industry operates but with this privilege goes the responsibility to do so only if the changes made are proportionate and in the long term interests of society. 5.2 There also has to be recognition that no framework of regulation and oversight can deal explicitly with every circumstance to which they need to apply. And if we train a future generation of bankers to follow an immensely detailed rulebook, not only will complexity ensure unintended breaches, but we risk intelligent minds identifying numerous unintended consequences and so rationalising non-compliance or structuring solutions which are form-over-substance or which arbitrage local variations. A consequence of rationalising arbitrage and structured solutions to mitigate unintended consequences is that this inevitably leads to more self-interested behaviour. A mindset is created around it being okay to get around rules if they don’t make sense. 5.3 So once again we come back to how public policy can address “behaviour”. It is worth noting that a simple word search in the Independent Commission on Banking Report mentions capital 463 times, liquidity 140 times and behaviour seven times. In the FSA’s report into the failure of RBS, the numbers are 1,389 for capital, 733 for liquidity and 16 for behaviour respectively. Simplistic—but all the same instructive. 5.4 If we are to learn the lessons of the crisis, improve the sustainability of the financial system and demonstrate its overwhelming social value it will be not only because we have changed behaviour but because expectations of behaviour have changed as well. 5.5 Capital, liquidity and infrastructure enhancement will also play a role as will better governance and supervision but the greatest opportunity for improvement will come from defining, teaching, reinforcing, rewarding and enforcing values in terms of how the industry and those within it must operate to serve the societies that entrust to the industry their financial security, needs and aspirations. 5.6 If we are ever to rely on behavioural values it also has to be based on trusting organisations to deliver them and organisations trusting their people to deliver—and that trust has to be built over time and evidenced by experience. And we need to find a way to build assurance into the system that trust has been earned. At HSBC we have instituted a programme of training around values establishing a code of conduct that defines what is acceptable based on what we call “courageous integrity” which requires staff to do what is right even if difficult or unpopular. Progression and reward depend upon exhibiting the values; failure to do so results in retraining or departure. As the recent G30 report also concluded, there is value in firms designing and enforcing such codes of conduct. 5.7 The industry together with the relevant regulatory and public policy bodies need to work together and think more deeply about how they can get to understand, and as necessary shape, the character and culture of organisations critical to the financial system. It is only the aggregate of behaviour evidenced within the system and in particular how it has changed that will change society’s perception of banks rather than thousands of pages of worthy new regulations designed to work in theory. 5.8 So rather than supervisors obsessing about whether an organisation can break down exposures by the hour, by product, by customer, by industry classification, by business line, by country, by region—there has to be more attention given to tone from the top, how individuals are screened for behavioural characteristics when recruited or promoted, how ethics and values are taught and reinforced, how values are enforced and rewarded and how an organisation looks for and adapts to changing expectations within the communities it serves. 5.9 On top of this, consideration might usefully be given to developing a behavioural monitoring “audit” requirement, independent of the supervisory process and perhaps akin to the social responsibility or sustainability reviews currently conducted, with public reporting thereon periodically. Without minimising the challenge inherent in designing such a programme, there is a need to find a way to attest to the essence of what banking as a profession has to embody in serving society—independence of thought, character, judgment, accountability, responsibility, a duty that goes beyond each individual’s self-interest or the narrow interest of the employer to personal undertakings of fair dealing, trust and integrity. 5.10 A further aid to improving public trust in the industry would be to find a way that the industry can get more certainty up front that product attributes and sales processes are acceptable if delivered as agreed. The current application of regulatory principles to go back up to ten years (eg re interest rate protection products) to characterise failings in industry behaviour engenders great uncertainty and is damaging to public trust of the industry and confidence in the protection provided by the regulatory process. 5.11 Finally, there is a need to distinguish unacceptable personal behaviour from unacceptable corporate behaviour in terms of sanctions. While institutions must continue to be accountable for the culture of the organisation and how their employees are incented to behave, there is a need to ensure that sanctions, including cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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criminal sanctions, can be levied in appropriate circumstances against individuals whose behaviour falls well outside deﬁned norms in order to reinforce personal responsibility and accountability. Inability to pursue individuals for behaviours deemed wholly unacceptable by society but for which there are no sanctions available has contributed to deterioration in public trust in the industry.

7. What other matters should the Commission take into account? 7.1 We have no further matters to raise. 24 August 2012

Letter from Martin Scheck, Chief Executive, International Capital Market Association The International Capital Market Association (ICMA) has set standards of good market practice in the international capital markets for debt securities for over 40 years, and currently does so, for example, through the ICMA Primary Market Handbook, the ICMA Secondary Market Rules and Recommendations and the Global Master Repurchase Agreement. We do not think that these international capital market standards are directly relevant to the Parliamentary Commission on Banking Standards, which we understand is investigating questions relating to professional standards and culture within the UK banking sector. But if you would like more information about ICMA’s role in the international capital markets, please let us know and we would be happy to provide it. 24 August 2012

Written evidence from ifs School of Finance 1. About the ifs School of Finance The ifs School of Finance (formerly the Chartered Institute of Bankers) is a registered charity, incorporated by Royal Charter, with more than 130 years experience in delivering effective financial education. It is the only professional body with the power to award its own taught degrees reflecting the quality and relevance of its qualifications. The ifs provides financial education to financial services professionals in the UK and across the world, as well as to consumers in the UK. This includes GCSE, AS and A level equivalent qualifications in financial studies through to our own undergraduate and postgraduate degree programmes in Banking Practice & Management; Finance &Accounting for Financial Services; and in Finance, Investment & Risk. The ifs is also the leading provider of regulatory qualifications, for example the Certificate in Mortgage Advice & practice (CeMAP) for mortgage advisers and the Diploma for Financial Advisers (DipFA). The ifs also offers a range of CPD opportunities ranging from entry level to provision for Non-Executive Directors.

2. Response Summary With more than 130 years experience in the delivery of effective ﬁnancial education to the banking industry, the ifs School of Finance (formerly the Chartered Institute of Bankers) is well placed to assist the Commission with regard to the issue of professional standards in banking. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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There has been a significant reduction in traditional banking qualifications since the deregulation of the financial services industry in the 1980’s. Although the concept of a one-size-fits-all professional qualification for “bankers” is outmoded, unrealistic and probably inappropriate, education and the underlying and ensuing knowledge that then grows with experience empowers bank staff to provide excellent service to the customer as well as giving him/her the intellectual wherewithal to challenge and question internally the decisions of peers and superiors. Education across an organisation empowers that organisation to serve not just the needs of the customer, but of society at large. Practitioners, at all different levels, and across all functions, must be appropriately educated.

3. Detailed Response To what extent are professional standards in UK banking absent or defective? How does this compare to (a) other leading markets (b) other professions and (c) the historic experience of the UK? Recent events from PPI mis-selling to the LIBOR fiasco have demonstrated severe shortcomings in the behaviour of some of those employed within the financial services industry. However, the actions of a few should not be seen as indicative of the behaviour of the many. The financial services industry employs well over one million people in the UK and the banking sector comprises approximately half of this number—of which the vast majority are diligent people, working with the best interests of the consumer in mind. They do so for levels of pay that are far from excessive. That said, in order to address the failings of the minority, action needs to be taken to improve the culture and standards of behaviour in the industry. Clearly, more needs to be done to restore trust and confidence for consumers, policymakers, the media and the industry itself. A key part of achieving this is to ensure the UK banking sector is staffed and led by professionals performing to the highest levels of competence and ethical behaviour. Given the wide range of skills needed to operate a very large and complex organisation, such as some of the UK’s big banks, a variety of professionals are now employed all with appropriate qualifications from their respective professional bodies. Some of these professions require compulsory CPD in order to remain “qualified” to practise. Within other sections of the financial services industry there is some compulsion when it comes to qualifications. The Financial Services Authority insists that those performing certain roles in the distribution of financial products to consumers meet a pre-determined qualification level. Indeed, from the 1st January 2013 new FSA regulations will come into force that require anyone giving financial advice to hold an Ofqual QCF level 4 qualification as well as undertaking an annual programme of quality CPD. Such compulsion does not exist for those working in the banking sector (unless they are governed by those rules applying to professions such as lawyers, accountants, actuaries etc. as mentioned above). Indeed, there has never been formal compulsion for anybody working in a bank to take “banking” qualifications. Until the end of the 1980s there was an important understanding that if somebody was serious about a career in a bank, he/she would have to “do their banking exams”. The benchmark qualification at that time was the Associateship of the Chartered Institute of Bankers (ACIB) which was the forerunner to today’s ifs School of Finance degree programmes. Take up of traditional banking qualifications has slumped in the last 20+ years. There is no longer even an expectation that anybody wishing to aspire to top office in a bank should have a “banking” qualification. Witness the number of senior executives in the industry that have a range of qualifications, but not one specifically in “banking”. One of the reasons for the decline has been that in today’s complex financial services industry ,that demands increasing specialisation, the term “banker” could be used to describe a range of individuals in a bank performing a very wide variety of different roles having achieved professional qualifications from a variety of professional bodies. The concept of a one-size-fits-all professional qualification for “bankers” is outmoded, unrealistic and probably inappropriate. But while the traditional qualification might have been in decline, other more appropriate qualifications are being taken across some organisations contingent on the speciality and skills required. On the other hand, there are those organisations that have in many instances forsworn qualifications in favour of short-term just-in-time “training” aimed usually at skilling staff to “sell” products. The practice of the supermarket was thought to be appropriate to “selling” financial products. However, we are now also seeing some examples of good practice, especially over the last 12–18 months. For example, some of the large high-street banking firms in the UK have started to put their staff through qualifications such as the ifs School of Finance’s recently developed Certificate in Retail Banking Conduct of Business (CertRBCB®) and Diploma in Retail Banking Conduct of Business (DipRBCB®). These qualifications for frontline bank staff have been taken by over 5,000 bank staff. This number is expected to cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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more than double over the next 12 months. The point of these qualiﬁcations is to raise the bar in terms of knowledge, understanding and application of the Banking Code so as to improve customer service. Furthermore, some banks have made the ifs Professional Certiﬁcate in Banking or Diploma in Banking Practice & Management an integral part of their management and executive trainee schemes.

Consequences of the above Consumer trust in UK banking has clearly been affected by recent events. August 2012 research from consumer group Which? suggests that 84% of consumers think that the banking industry has not done enough to change to ensure another credit crunch does not happen again—an increase from 76% in September 2011. Similarly, 71% think banks have not learned the lessons of the financial crisis that began in 2007—up from 61% a year ago. The public used to trust their bank to look after their money and their bank manager to give them suitable advice based on their individual needs, aspirations and attitude to risk. This advice was given by appropriately qualified staff that had knowledge of the products they were advising on. In recent years, against the backdrop of an increasingly pressurised sales and target driven culture, retail bank staff became less and less knowledgeable about the underlying structures and risks/benefits inherent in the services and products they are being told to sell. The wholesale side has mirrored this steady decline away from customer-centric services, but here the movement has been towards engaging in excessive levels of risk as a result of the desire for both personal gain and the need to meet often unrealistic growth targets to meet the need for ever-increasing shareholder returns. Both of the trends have had a corrosive effect on trust and confidence in the sector. The public rightly expects the banking industry to meet the highest standards in relation to skills, knowledge, trust, integrity and ethical behaviour. The apparent decline in these standards in some parts of the industry and in some organisations did not begin with the financial crisis of 2007. The seeds were sown much earlier, with the deregulation of the market in the 1980s and the drive by traditional commercial banks for those ever- increasing shareholder returns. Those boring pillars of the community and the bedrock of economic stability had joined the high risk strategies of the investment banking world. Oil and water do not mix. Restoring trust and confidence will not be achieved overnight and the consumer does not believe the industry can put its own house in order. Self-regulation and so-called light-touch regulation will not work, has not worked, and the consumer will expect the Government and/or regulatory bodies to take a leading role in solving these problems.

What has caused the problems identiﬁed above? It is also worth noting that innovation has had some impact on this area. For example, a wide range of decision making has been taken away from suitably qualiﬁed branch staff and replaced with automation thus bringing about a loss in individual skills in assessing loans; weakening the customer/banker relationship; and having serious implications for the wider economy in tough economic times when suitable individuals and organisations are denied loans. As an organisation we do not wish to comment further on the causes in relation to the Commission’s suggested themes of corporate structure, competition, taxation etc. as these are outside our remit.

What can and should be done? As our suite of qualifications demonstrates, availability of appropriate qualifications is not the problem; it is the uptake of such qualifications and CPD that needs to be addressed As we have noted, complexity in modern day banking has led to an increasing degree of specialisation. This requires a range of skills and competencies provided through a variety of professions. However, there is now a need for education leading to qualifications at different levels within these large complex conglomerates. Collectively these qualifications encompass frontline retail activities through to corporate business and challenging risk-based analysis. To repeat, the one-size-fits-all qualifications of the past are not appropriate today. As the leading provider of educational services to the banking sector in the UK we have always avoided making any call for a one-size-fits-all mandatory professional qualification or for compulsory membership of a professional body. These calls belie the complexity of the industry. They are an over simplification believing that there are easy tabloid-headline grabbing solutions. This is about culture and there are no quick fixes when it comes to culture. An organisational ethos is built up over decades, lost in an instant. Education and the underlying and ensuing knowledge that then grows with experience empowers the individual to provide excellent service to the customer as well as giving him/her the intellectual wherewithal to challenge and question internally the decisions of peers and superiors. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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Education across an organisation empowers that organisation to serve not just the needs of the customer, but of society at large. And that is what banks are meant to do, serve a much wider social remit than their own narrow interests. Our current economic malaise is due to the industry forgetting this key responsibility.

Practitioners, at all Different Levels, and Across all Functions, Must Be Appropriately Educated. The Key Word Here Is “Appropriate”. Other matters When it comes to “codes” for governing behaviour or standards for skills and competencies or a range of qualiﬁcations to educate practitioners, few sectors in the economy could better the banking sector where the list is almost endless. Yet despite this plethora of “codes” and “standards”, including those already supposedly enforced by the regulator, public trust in banking is at rock bottom. Another list of “standards” or yet another “code” will not make any discernible difference to public perception that the industry is simply not capable of self-regulation. The Commission must avoid falling into the trap of wanting to be seen to be doing something and so coming up with yet another list of do’s and don’ts that will be treated with inevitable and understandable scepticism. One way the Commission could encourage a long-term view of culture is to ensure appropriate regulatory (Bank of England) scrutiny and vetting of all staff (and not just the executive committee) appointed to senior positions in a bank or indeed any ﬁnancial services organisation. It is not a guarantee of probity, but an independent look at background, education, attitudes, performance etc would put both candidate and organisation on notice that the regulator is looking for the right calibre person with the appropriate credentials. The FSA has had a role in this process, but it needs to be widened and deepened. 24 August 2012

Written evidence from the Institute of Business Ethics The Institute of Business Ethics was established in 1986 to encourage high standards of business behaviour based on ethical values. It was launched for business people the day after Big Bang by the then Lord Mayor and concerned business leaders that the concept of “my word is my bond” would not withstand the new regulatory and market environment. Today the IBE, a charity, leads the dissemination of knowledge and good practice in business ethics, though helping organisations strengthen their ethics culture to encourage high standards of business behaviour based on ethical values. More information is available including a list of our subscribers on www.ibe.org.uk.

Summary — It is a pity that the arrogance of the few and their misdemeanours have led to a public perception that there are no professional standards in the banking sector at all. — Mis-selling cases have been perpetrated by the industry, not just a single institution which has caused such a collapse in trust in the sector. — Public expectations of the sector are generally low. — In both retail and wholesale markets the problem has been the mismatch of knowledge and understanding between the parties to a transaction which gives power and influence to the party selling the product. — Few firms in the sector effectively embed their codes from the board down. — Boards ought to have an Ethics Committee to look at culture and ethical matters specifically to ensure the firm is following best practice. — Decision-making processes should be reviewed to take into account, not just financial and legal issues but ethical issues too. — Proposed regulatory changes may be sufficient but change will only come about by the firm itself, the board, the senior team and every member of staff committing every day to do the right thing by all they come into contact with, because it is the right thing to do. — The Regulator could call for evidence of ethics training of employees working in the wholesale market.

Detailed Response 1. To what extent are professional standards in UK banking absent or defective? To say professional standards are absent and defective is too sweeping a statement given the vast majority of those employed in the banking sector are indeed working professionally as they conduct their day to day jobs. It is a pity that the arrogance of the few and their misdemeanours have led to a public perception that there are no professional standards in the sector at all. This arrogance has developed over time. Any poor behaviour has not obviously been stamped out by ﬁrms due to the competitiveness of the market, not only in the UK but globally. This is particularly the case, it cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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would appear, in the investment/wholesale side of the market where remuneration/bonus schemes have clearly driven behaviours—the quantum of potential success was too big, not to go for it, for some. Historically those in the sector were seen as professionals and respected as such because the markets were more personal, both in retail and wholesale. One knew one’s counterparties and if you did not trust them, then you did not do business with them but given the electronic and global nature of today’s markets that personal touch is long gone and so the nature of business moves from being relationship driven to transaction driven. This is a very different basis where care and attention to one’s counterparty and the concept of mutual beneﬁt in doing a deal is lost, and so is trust.

2. What have the consequences been for consumers and the economy? The consequences have been serious for both retail and wholesale customers given the number of mis-selling cases there have been over recent years. Such cases have been perpetrated by the industry, not just a single institution which has caused such a collapse in trust in the sector. This has hit public conﬁdence in a sector that is needed in the economy—banking services are not an option, they are an economic requirement, unless we return to a system of barter.

3. What have been the consequences for public trust in the banking sector? Due to low public trust in the sector the expectation of many is that they will not be treated fairly and every banker is out to feather their own nest. This is probably a collective view (media view) as often the day to day experience of someone of their High Street branch is likely to be more positive. Expectations are generally low.

4. What caused the problems and weaknesses in the banking sector? One of the issues, in both retail and wholesale markets is the mismatch of knowledge and understanding between the parties to a transaction which gives power and influence to the party selling the product. In the retail market it has also been proven that the sellers did not necessarily understand their products or their effects properly either! In both cases if the pressure is there to meet targets, achieve bonuses, then the seller can take advantage of the buyer. In the wholesale market this can be compounded in specialised areas of finance such as tax. With knowledge comes power, and arrogance leading to a culture epitomised in phrases such as calling customers “muppets”. Specific weaknesses identified include lack of knowledge by senior staff/Boards as to the actual culture and behaviours of their staff through a lack of governance and corporate awareness.

5. What can be done to address the identified weaknesses? All firms have codes of conduct (usually rules based) but few have codes of ethics (principles based on the firm’s values), and even fewer have codes or train about expected behaviours. Few effectively embed their codes from the board down, which can be remedied through training, communications, awareness raising using a combination of face to face training, e-learning and other media mechanisms to engage with all employees. The importance of this should be led by the board by setting up an Ethics Committee to look at these matters specifically to ensure the firm is following best practice (to date banks tend to rank themselves in this arena against each other and not against the best international commercial firms globally, many of whom are more advanced in their approach and management of doing business ethically). Decision-making processes should be reviewed to take into account, not just financial and legal issues but ethical issues too. The same process should be followed for all decisions—new products, M&A, taking on new customers etc in order to create a consistency in decision making within the firm, so it becomes part of the firm’s DNA. Speak Up processes (often called Whistleblowing) need to be reviewed. Using a positive term, such as speak up, is a way to encourage employees to raise their concerns and help create an open culture, not one of fear that if “the deal fails, so do I” which can lead to poor behaviour and ultimately outcomes for the individual and the bank. Internal audit needs to be up-skilled to be able to “audit” non-financial matters effectively. There are many indicators which can be reviewed to see if an organisation is “living up to its values”. The combined effect will be to strengthen the firm’s ethical approach to doing business. This is proven to enhance the long term bottom line, improve recruitment and retention and develop customer brand loyalty.

6. Are changes proposed sufficient? Proposed regulatory changes may be sufficient but change will only come about by the firm itself, the board, the senior team and every member of staff committing every day to do the right thing by all they come into contact with, because it is the right thing to do. This should be placed above doing the deal for the sake of it cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 1131

or because of its return, either to the individual or organisation. It is such deals that in our 24/7 world that are the causes of failure in reputation. Responsibility needs to be taken by all, individually and corporately.

7. What other matters should the Commission take into account? Professionalism is being strengthened in the retail market through the introduction of RDR, perhaps more should be done, by the Regulator asking for evidence of ethics training in the wholesale market—either via professional bodies in setting examinations or in-house training modules. 31 August 2012

Written evidence from the Institute of Chartered Accountants in England and Wales 1. ICAEW welcomes the opportunity to provide evidence to the Parliamentary Commission on Banking Standards. We have extensive experience of professional standards and would be pleased to provide oral evidence to the Commission.

Key Points and Recommendations 2. ICAEW strongly supports systems that support public confidence based upon professional standards. We also recognise the challenges of operating such systems effectively. 3. The UK should rearticulate its vision for effective principles-based regulation. This vision has been lost, first by the distraction of promoting so-called “light-touch” regulation, and then in the reaction against this approach. Effective principles-based regulation is demanding and should lead to better outcomes than alternative approaches. 4. Regulation can crowd out professional standards, with participants relying too heavily on regulatory compliance or not taking sufficient account of professional judgement or the principles that may lie behind regulatory objectives. 5. The financial services sector should promote ethics and integrity at an organisational level. Ethics and integrity are too often thought about as being matters for individuals. In addition to personal integrity, and the correct tone from the top, there is a need for an organisational structure that encourages and rewards people for acting with integrity, and which seeks to avoid creating conflicts among staff. 6. Markets need market-based solutions, including self-regulatory measures. This should not be in place of independent or government regulation, but should complement and go beyond this. Both individuals and banks should have affiliations with bodies that cut across organisations, promote high standards of professional behaviour and are prepared to lead and censure their members where appropriate.

Reponses to Specific Questions Questions 1: To what extent are professional standards in UK banking absent or defective? How does this compare to (a) other leading markets (b) other professions and (c) the historic experience of the UK and its place in global markets? 7. The Commission should challenge the banking sector to develop an effective model of professional standards that supports and encourages personal and organisational integrity, is supported by effective monitoring and enforcement mechanisms and that can be seen to promote confidence. A sound and effective regulatory system will always be required, and should complement such a model. If the banks took professional standards seriously (and could demonstrate that they did), government or independent regulation may become a backstop, rather than a primary means of maintaining confidence in the financial system. However, it may take a generation to achieve this objective of having professional standards in banking that inspire confidence. 8. ICAEW has a long history of applying professional standards. We are also aware of the challenges, tensions and issues that need to be addressed in such an approach. Codes of ethics are an important feature of a professional standards-based approach. Ethics and integrity involve an element of human judgement and, as such, are very hard to address through hard law, such as legislation or detailed regulation. 9. The financial services sector is, of course, heavily regulated, with a multitude of detailed rules rather than having an approach based on professional standards. The direction of travel has been to increase the extent, and amount of detail, contained in regulation, particularly in the face of too frequent problems, crises and scandals. Even when professional standards are proposed, they are often subsumed by rules-based regulation. For example, the FSA’s Retail Distribution Review started by looking to replicate the professional standards- based model of the accountancy profession, initially proposing establishing an independent Professional Standards Board (PSB) to set standards but the final rules abandoned this approach with rules, rather than standards, set by the FSA in the same way as all other FSA regulations. This reversion to the regulator setting rules was presented as a development, rather than a change, in the FSA’s proposals. This indicates a lack of cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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understanding as to how to adopt a professional standards-based approach, as well as some potential discomfort about a more judgement based regime. 10. A potential unintended consequence of extensive rules-based regulation is that it can result in banks and individuals taking too much of a compliance approach to the way they conduct their business, and taking less responsibility themselves for their actions. Self-regulatory mechanisms, such as the need for responsible behaviour, can therefore become diluted. Banks can design their processes to take judgement away from individuals, instead building centralised decision-making processes to reduce the risk of individual error (as has happened with lending decisions). Individuals can then be tasked with operating within those frameworks and subject to approval from compliance departments. 11. When setting regulations it is important to consider the potential impact upon behaviour and the extent to which stronger regulations may undermine professional standards and self-regulatory structures. It is almost always in the long-term interests of banks and the banking sector to act with integrity, because the sector is based upon public confidence, and problems around confidence are very damaging, not only to individual institutions but to the sector as a whole. The long-term interests of banks and the banking sector, and those of the public interest and regulators, are closely aligned in terms of standards of behaviour. 12. However, short-term pressures can often lead to conflicts with these long-term goals. Self-regulatory mechanisms should focus upon addressing conflicts between short and long-term interest. Regulation, including professional standards, principles and rules, should seek to strengthen, rather than replace, self-regulation, including providing monitoring through supervision and sanctions. Regulation should also seek to address gaps in self-regulation and to take action where collective action is needed across the banking sector, but where it may not be possible for a bank to take unilateral action, for example because it would become significantly uncompetitive. 13. Self-regulation is often misunderstood and its importance under-estimated. We include among self- regulatory measures desirable features of any social group like integrity, self-discipline, adherence to norms of behaviour and peer-based enforcement of these norms. These features apply at both a personal and organisational level. The objective of increasing professional standards in banking should be to increase trust in banks and bankers. For such increased trust to be deserved, needs responsible people to behave in a responsible way. Self-regulatory measures can help to encourage and reinforce responsible behaviour. External regulation is also needed, not least because people do always not behave responsibly. However, even a regulatory system based upon highly prescriptive rules will not promote public confidence in banks if the underlying system is fundamentally corrupt and lacks self-discipline. 14. ICAEW’s experience includes working with the World Bank on a number of capacity-building projects in developing nations. Developing a credible financial sector is seen as an important foundation for growth. Establishing professional bodies to raise professional standards is often one of the first steps towards developing this, particularly in the professions such as accountancy. We believe that a continued focus on professional standards is important, even when sophisticated regulation is in place, as both professional services and banking services are founded on trust and confidence. 15. There are a number of professional bodies in the UK working specifically in the financial sector, notably the Chartered Institute of Bankers in Scotland (CIOBS) and the Chartered Institute of Securities and Investment (CISI). Both these bodies provide specialist qualifications, set their own ethical codes and require members to undertake continuing professional development. We note that the former Chartered Institute of Bankers (the English and Welsh equivalent of CIOBS) changed its name in 2006 to the IFS School of Finance, to reflect a change in strategy towards being a business school for and about finance. 16. ICAEW has a well-developed code of ethics, and ethics are embedded within the training of all ICAEW chartered accountants. We also supplement this by providing a series of case studies and an ethics advisory helpline. The accountancy profession’s approach to ethics is based upon “threats and safeguards”. This recognises that ethical dilemmas and conflicts are inevitable, but that these can often be managed by adopting appropriate safeguards, which may include certain prohibitions. We believe that this approach, while potentially more difficult to apply as it requires judgement, leads to more ethical problem solving as it forces people to confront the ethical aspects of their behaviour. 17. The codes of ethics for financial services bodies tend to be set at a very high level. For example, the CISI and CIOBS codes of ethics set out in 8 and 9 principles. These bodies supplement this, for example through providing members with case studies setting out ethical dilemmas and running ethics training. It may be that their codes of ethics could be further developed and that their enforcement mechanisms and sanctions could be strengthened. 18. The accountancy profession has traditionally applied its ethical codes against both individuals and firms, with an ability to take disciplinary action against both. This ability is reinforced by our statutory responsibilities for licensing firms for audit, insolvency and undertaking investment business under the FSA Designated Professional Body regime. This link to organisations is important, because it extends ethical responsibilities beyond individuals. Being part of a wider constituency that cuts across organisations can be a powerful tool in promoting professional standards of expected behaviour. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 1133

19. Trade associations perform a different function to professional bodies. The financial services sector has a number of well-established trade associations, with the British Bankers’ Association being the main banking body and the Association of Financial Markets in Europe the main investment banking body active in the UK, with a number of other, more specialist, bodies also focusing on particular areas, for example the International Swaps and Derivatives Association and Council of Mortgage Lenders. Their role focuses more on representing the interests of member firms. Working with member firms allows them to undertake cross industry initiatives to promote matters such as integrity, or reach agreed common treatments. They do not traditionally take on disciplinary functions against their members so their initiatives can lack bite, compared to those of professional bodies where disciplinary actions, potentially including exclusion, have real teeth.

Question 2: What have been the consequences of the above for (a) consumers, both retail and wholesale, and (b) the economy as a whole? 20. While regulations may be set to achieve better consumer outcomes, they often fail in that objective. There may be three reasons for this: — Banks may pay less attention to the substance of their actions, and take less responsibility for their behaviour, because they focus too much upon whether something complies with regulations. — Rather than protecting consumers, regulations may protect those subject to the regulation by creating safe-harbours and barriers to competition. Clear rules may also allow the industry to game the rules, to seek loop-holes or just push their business model more aggressively within the safe-harbour of the rules. — Consumers may over-rely on consumer protection regulation to protect themselves, and as a result pay insufficient attention to their own financial decisions. 21. In early 2007, ICAEW’s Financial Services Faculty established a programme Inspiring confidence in financial services to examine issues around confidence. We identified four themes of responsible providers, responsible consumers, better regulation and better information. These four themes are heavily interconnected, and changes in one area can affect others, positively or negatively. The objective should be for solutions that encourage more responsibility from both the industry and consumers, that are supported by more effective and efficient regulation and clearer information.

Question 3: What have been the consequences of any problems identified in question 1 for public trust and in, and expectations of, the banking sector? 22. The financial crisis, continuing uncertainty over the soundness of the financial system and repeated scandals and problems in the sector have undoubtedly undermined public confidence both in banking and the wider financial sector. This is borne out by evidence from surveys, showing high levels of mistrust. 23. There are potential long-term consequences of this, not least with an ageing population and the challenge of ensuring that adequate post-retirement provision is made. Trust in the financial sector is important in encouraging people to save more for their future needs. 24. The financial sector also provides funding for the economy. A strong, trusted banking system is needed to support this. Even before the latest problems hit the front pages, our research290 showed that the relationship between banks and many small and medium-sized businesses had broken down. Businesses, particularly smaller businesses, rely on banks for finance and other vital services, including advice. If such businesses are not able to trust the advice they receive from their banks, this is likely to damage the wider economy, particularly at a time when credit conditions are tough and businesses may need more advice.

Question 4: What caused any problems in banking standards identified in question 1? 25. There are a range of potential factors that could have affected banking standards. Many reports have examined the financial crisis and sought to attach blame to different areas, including the many areas highlighted in the Commission’s call for evidence. One of the frustrations to policymakers seems to have been that it has been hard to do so, or find a smoking gun. 26. People generally adapt to the environment in which they operate. It would be wrong to characterise the problems as being about a small number of bad apples contaminating the whole sector. While undoubtedly this does happen, any well-developed sector should be able to cope with this type of problem without it causing too great a damage. The deeper question is why the financial services sector continues to run into problems which have been allowed to become pervasive. 27. Although a number of improvements have been made to areas such as regulation, corporate governance, internal controls, financial reporting and external audit, we do not believe they were a direct cause of any lack of banking standards. These are all areas where continual improvement is sought, and often new requirements are introduced in response to lessons from past problems. We have conducted our own research in particular into accounting standards and continually monitor the independent academic evidence on this, which is substantial, and have found no credible evidence that accounting standards contributed to the financial crisis in 290 ICAEW SME Access to Finance Research Report, 2011 cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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any substantial way. In fact, the evidence that has emerged points towards current accounting standards addressing issues more quickly and transparently than earlier standards. 28. However, in keeping with our analysis that regulations and standards can shift behaviour, it may be the case that tightening both regulations and standards may have subtly shifted behaviour from judgement towards compliance, to the extent that people have accepted with less questioning whether the answers given by their systems provide the right answer.

Question 5: What can and should be done to address any weaknesses identified? To what extent are such weaknesses subject to remedial corporate, regulatory or legislative action, domestically or internationally? 29. We propose three measures that can and should be taken to promote higher standards of professional behaviour in the banking, and wider financial services sector: — Ethics and integrity are multi-faceted concepts. More focus should be placed upon considering ethics and integrity at an organisational level. Ethics and integrity are too often thought about as being matters for individuals. ICAEW has carried out extensive work in these areas, with projects including Reporting with integrity, Instilling integrity in organisations and Real integrity. This work has found that sending individuals on ethics training can only go so far in promoting organisational integrity. In addition to personal integrity, and the correct tone from the top, there is a need for an organisational structure that encourages and rewards people for acting with integrity, and which seeks to avoid creating conflicts among staff, including through reward structures. — Self-regulatory measures should be actively sought. This should not be in place of independent or government regulation, but should complement and go beyond this. Both individuals and banks should have affiliations with bodies that cut across organisations, promote high standards of professional behaviour and are prepared to lead and censure their members where appropriate. — The UK should remember and rearticulate its model and vision for effective principles-based regulation. This vision has been lost, first by the distraction of promoting so-called “light-touch” regulation, and then in the reaction against this approach. 30. We believe our last point is important. The UK approach of principles-based standards is the right approach for promoting responsible behaviour. This should not be equated with light-touch regulation. In fact, properly implemented principles-based regulation can be far more effective than a system based upon detailed rules as principles are far more capable of being applied to changing circumstances. To highlight this, although LIBOR was not regulated as such, the FSA was able to take enforcement action based upon breaches of its core principles. 31. Under a principles-based approach, participants are forced to consider not only whether the letter of the rules has been complied with, but also the spirit based upon underlying principles. Regulators must also be prepared to supervise behaviour according to their principles. Because there may be judgement involved, a principles-based approach may also require a different approach to enforcement, based upon professional judgement. This is the basis of our threats and safeguards approach to ethics mentioned above, and of our approach to enforcing professional standards. ICAEW has recently published a paper Acting in the public interest: a framework for analysis which, among other things, considers a variety of implementation and monitoring approaches, generally categorised as “carrot, stick and sermon”. Professional bodies’ approaches tend to be a combination of all three. 32. Principles-based approaches are also better at coping with changing situations. Drafting detailed rules can exacerbate problems of individuals gaming the system, with regulators having to continually adapt their rules to keep up with new innovation. Principles, if properly formulated, have a better chance of staying ahead of innovation, and coping with it. 33. We will be responding separately to the Wheatley Review into interest rate benchmark setting. However, as an example of our support for principles-based regulation, we would not favour introducing explicit offences of manipulating benchmark interest rates as we believe that the existing provisions of the Fraud Act cover these matters, in addition to the FSA’s core principles. We believe that the Fraud Act is very well drafted, and would welcome case law to establish that it can cover such market manipulation. We would support extending the Market Abuse Directive so that it can cover issues such as LIBOR manipulation, but had it been drafted in a more principles-based way, the Directive may have already caught this.

Question 6: Are the changes already proposed by (a) the Government, (b) regulators and (c) the industry sufﬁcient? Respondents may wish to refer to the Financial Services Bill and the Government’s proposals for the Banking Reform Bill. They may also wish to refer to proposals by the Bank of England and the Financial Services Authority on how the Financial Policy Committee, Prudential Regulation Authority and Financial Conduct Authority will operate in practice. 34. Signiﬁcant changes have been adopted, or are in the process of being adopted, both regulatory and non- regulatory. It is still too early to tell how effective they will be. This will only become apparent after it has been possible to assess how behaviour has changed, both positively and negatively. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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Question 7: What other matters should the Commission take into account? 35. ICAEW supports the development of market solutions to issues, particularly where the industry works with regulators and all other stakeholders to develop them, and where the objective is to promote trust and confidence. Such solutions often do not need regulatory or legislative intervention and can be developed more quickly. In addition to our work on integrity mentioned above, ICAEW’s Financial Services Faculty is undertaking a project Market failures: market solutions which aims to develop ideas for steps the banking sector can take to restore confidence. 36. ICAEW has developed its own market solutions to some of the challenges highlighted by the crisis. Our report Audit of banks: lessons from the crisis provided recommendations on actions auditors can take to improve their contribution in light of the crisis. This report followed up evidence ICAEW provided to the Treasury Committee and, subsequent to its publication, ICAEW has worked with the Bank of England and FSA to develop a code of practice for better communication between auditors and supervisors, issued guidance to improve dialogue between auditors and audit committees, established an auditor-investor forum to improve this dialogue and developed professional guidance for undertaking skilled persons’ reports under the Financial Services & Markets Act 2000, working closely with the FSA in developing this guidance. We believe that each of these will promote confidence but none required formal legislation or regulation. 37. ICAEW has also just started a project to develop guidance for providing external assurance on banks’ interest rate benchmark submissions, such as LIBOR. There is currently no general requirement for any such submissions to be audited, although Barclays, as part of their settlement with the Commodities and Futures Trading Commission (CFTC), has been specifically required to obtain external assurance. While the future processes for LIBOR are under review, we believe there may be a quick win for banks to be able to say they are voluntarily having their submissions reviewed, even in the absence of a regulatory requirement. We also believe that our guidance will add significant credibility to such assurance as it will be based upon international standards. We are committed to working with the FSA, CFTC and other interested parties in developing this guidance.

Who We Are 38. ICAEW is a world-leading professional accountancy body. We operate under a Royal Charter, working in the public interest. ICAEW’s regulation of its members, in particular its responsibilities in respect of auditors, is overseen by the UK Financial Reporting Council. We provide leadership and practical support to over 138,000 member chartered accountants in more than 160 countries, working with governments, regulators and industry in order to ensure that the highest standards are maintained. 39. ICAEW members operate across a wide range of areas in business, practice and the public sector. They provide financial expertise and guidance based on the highest professional, technical and ethical standards. They are trained to provide clarity and apply rigour, and so help create long-term sustainable economic value. 40. The Financial Services Faculty was established in 2007 to become a world class centre for thought leadership on issues facing the financial services industry acting free from vested interest. It draws together professionals from across the financial services sector and from the 25,000 ICAEW members specialising in the sector and provides a range of services and provides a monthly newsletter FS Focus. 24 August 2012

Written evidence from The Institute of Operational Risk The Institute of Operational Risk (IOR) welcomes the opportunity to submit its views to the Commission. As an independent professional institute that is unfettered by sectional self interest, we can offer a balanced, objective and risk based perspective on the important issues raised. The IOR seeks to promote the discipline of managing Operational Risks, and to foster its development and to disseminate and promote knowledge, education and training. Operational risks derive from failures of people, business processes and systems. Much of what we have seen damaging banks, including the roots of the ﬁnancial crisis starting in 2007 with the collapse of Northern Rock, derive from operational risk causes, usually either because of individuals or business units acting (at the least) improperly, or because banks have instituted faulty business practices and processes. We welcome the setting up of the Commission following recent high proﬁle incidents, including the LIBOR debacle. It is vital that the Commission recognise that the recent incidents are rooted in manifest operational risk events inadequately anticipated or responded to and it is vital that proposals for reform are properly targeted to reduce the possibility that failures by people, processes and systems will again threaten banks and their clients. We would like to comment and make proposals on two aspects: (1) Culture and Conduct. (2) Regulation and Reform. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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1. Culture and Conduct As a professional institute we have a strong belief in the value of personal codes of conduct providing more awareness of how wrong attitudes can lead to the damaging consequences. Professional codes can play an important role in improving industry standards, reducing the risks arising from misconduct, and helping to restore the public’s trust in the industry. Professional codes can help to promote greater mindfulness, in other words ensuring that management pay greater attention to risk and the potential for failures in their people, processes and systems. This should be associated with improvements in risk reporting and with measures to enhance the risk cultures of banks, ensuring that they behave in more sustainable ways in the future. Of course, codes of conduct alone are not sufficient to change risk cultures, and the role and leadership of senior management—“tone from the top”—is absolutely crucial here, with the most senior management in regulated firms exhibiting behaviours that demonstrate their integrity, fitness, propriety and suitability for their roles. We believe that training and competence and a broadening of the UKFSA approved persons regime also have important parts to play in improving professionalism in the industry. Remuneration practices also have a part to play, in ensuring that variable remuneration does not create incentives for uncontrolled risk taking. However, we do not believe that arbitrary limits, ratios or formulaic approaches are helpful, and may indeed create risks rather than reduce them.

2. Regulation and Reform We wish to make two points in relation to Regulation and Reform. First, the IOR believes that the large volume of regulatory reforms already in train (many of which are not yet implemented) are sufficient, provided they are implemented in a timely and effective way. The reforms have addressed an enormously diverse range of topics including industry structure, capital and liquidity, remuneration, governance, derivatives markets reform, and conduct of business. Effective implementation will be critical, and it would be disastrous to repeat the failures of the past where regulation was either implemented unevenly or not implemented at all, for instance as in the case of Basel 2 implementation in the USA. In addition to effective implementation, we believe strongly that the success of reforms in practice will require a sophisticated approach to supervision, which places greater emphasis on a comprehensive risk based approach which is focused on challenging the judgements about management and the business models of regulated firms, and which is focused on the issues highlighted above in on training and competence, professionalism and so forth. To this end, we urge regulators, both the new ones in the UK and those internationally to collaborate effectively on providing a consistent and joined up approach to supervision via global colleges that is consistent with the G20 commitments that reforms should be international coordinated. Second, it should not be assumed that regulation is a free good just because the costs are not transparent and dispersed widely over the regulated industry. Regulation in detail tends to increase costs of banking, reduce diversity of sound banking services and products, and reduce the ability of UK banking to compete internationally. The IOR is firmly of the view that detailed rule-based regulation leads to an emphasis on meeting the micro letter of regulation (“box ticking”) rather than recognising and ensuring appropriate attitudes, cultures and risk control. A risk or principles based approach is more likely to bring about the cultural and behavioural changes that are necessary. Not only are there significant costs of compliance and dangers of regulatory capture, but the sheer volume of regulatory change is also a major source of operational risk for regulated firms which must be managed. The volume of policy combined with changes to regulatory frameworks (eg break up of the UKFSA, creation of the ESAs and so forth) creates in itself a significant increase in complexity and risk, and any further proposals for either policy or changes to frameworks will need to be careful weighed against potential benefits.

The Institute of Operational Risk The Institute was formed in 2004 and has an international membership of managers and practitioners. It works in the ﬁeld of non-ﬁnancial risks, generally called Operational Risks, but including other areas of risk sometimes referred to as strategic risk, reputational risk, regulatory and compliance risk and legal risk. It is a professional Institute recognised at its inception by the then Department of Trade and Industry. Admittance to membership is based on an appraisal of a candidate’s expertise and experience. As a result, membership of the Institute is an independent accreditation of the person’s competences in this discipline and provides the Institute with a membership of great practical and theoretical knowledge at all levels in banking. Among its activities, probably the most notable and best known outside the membership are a set of Sound Practice Guideline Papers in Operational Risk Management. Thousands of copies of these have been down loaded by people around the world. The Institute has a website at www.IOR-Institute.org 21 September 2012 cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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Written evidence from Intellect Financial Infrastructure & the Reform of the Financial System 1. ExecutiveSummary The problem In reality, financial infrastructure refers to a complex myriad of technology systems, networks, applications servers, databases, physical storage systems, and end-user computing systems and devices. It is the foundation upon which every function within every financial institution sits upon and the provision of economically critical banking services is reliant on. It is also the ‘plumbing’ that allows data to flow within and between financial institutions and which informs banks’ operational decision making—from risk to lending, as well as decisions made by the regulatory authorities. However, as the financial system has developed, the infrastructure that underpins it—which in some cases was designed some thirty or forty years ago—has become complex to the point where it no longer serves many banks, it hinders them. It does not allow banks to know their customers sufficiently, have a holistic view of their own operations, hinders transparency, is an obstacle to timely change and increasingly is an operational risk to the financial system. It is, to all intents and purposes, no longer fit for purpose. Banks are essentially technology companies. Without the technology infrastructure there would be no bank. There is no regulatory change that can be implemented without adapting this infrastructure, and in considering reform of the financial system—ie how to address the weaknesses and failings exposed by the financial crisis and events since—it is impossible to do so without taking into account the limitations and realities of this infrastructure. It is important, therefore, that the Parliamentary Commission on Banking Standards has an understanding of the role that this infrastructure is playing in inhibiting beneficial change, and the role that it could play in establishing a foundation for the mutually beneficial evolution of the financial system.

Why does substandard infrastructure need to be addressed? — Prevents regulators from doing their job, inhibits transparency and threatens financial stability. Global efforts to standardise data (eg Legal Entity Identifiers) will be undermined if the issue of the ‘plumbing’ by which data travels within banks and to regulators, is not addressed in tandem. Regulators cannot hope to fulfil their brief of mitigating financial crises before they happen, if the data they receive from banks does not accurately reflect banks’ complete exposures. — Inhibits the delivery of customer centric services, inhibits access to finance for many businesses & undermines economic growth. Banks do not know their customers as well as they should do, and this has a knock on effect on their ability to ensure the customer actually is at the heart of their operations. — Threatens the provision of continuous banking services to customers and the wider economy—and poses both operational and systemic risks. As exposed by systems failures in the summer of 2012, when a bank is unable to operate, regardless of the reason (lack of liquidity or systems failure) the end result is the same—disruption to the provision of essential banking services. Many systems are just getting increasingly complex, which in turn increases the potential for future disruptive systems failures. — Restricts competition across the retail banking sector, as demonstrated by Santander’s decision not to buy 316 RBS branches as a result of the state of the technology that underpins them. — Inhibits banks from ‘knowing their own operations’ and therefore stopping abuses. Events in 2012 such as the exposure of money laundering failings in leading banks, and rogue trading that came close to collapsing a global bank—have both been attributed in part to substandard systems that do not allow banks to know what is going on across their own operations. There are not many other industries that do not have a firm grasp of what is happening across their own operations. — Limits banks’ ability and therefore willingness to change. The complexity and cost of implementing any change that impacts upon core systems is one of the underlying reasons why banks are resistant to change and limits how quickly the financial system can be changed to address the failings of the financial crisis, or evolve to adapt to changing market and customer requirements. — Threatens the continuing viability of the revenue streams of many UK banks. Revenues are falling, costs are increasing and the market share of established banks will come under increased threat from new, disruptive entrants to the market if these established banks cannot remove the primary barrier to timely and mutually beneficial change—their own technology infrastructure. This will have a knock on effect on these banks’ contribution to the UK economy and the position of the City as a leading global financial centre.

Why is financial infrastructure not fit for purpose? — While significant investment has been made in certain products and services that yield a short term return on investment such as systems to support algorithmic (high frequency) trading and low latency trading, many of the more ‘mundane’ but fundamental areas of financial infrastructure have been neglected . cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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— The cost and complexity of implementing any significant changes, as a result of bank’s ageing legacy systems, is significant. Therefore necessary change is rarely undertaken and systems just get more and more complex. Banks are already spending huge sums on implementing regulation which is sometimes overlapping and which is, currently, not guided by an ‘end state’ for the banks to aim at. — In many boardrooms across the UK’s banks, there has, in the past, been a lack of focus on and understanding of technology issues which in turn has led to a lack of investment in the infrastructure that underpins banks operations. In many cases this has led to an uncoordinated approach to business change. This has contributed to the development of ‘information silos’ where data is not shared sufficiently across a bank, which in turn limits the ability of banks to make operational and strategic decisions based on accurate information. — Mergers and acquisitions that have taken place in many banks over a number of years cause systems challenges for banks which, in some cases, are not addressed sufficiently because of the cost and disruption of doing so. The end result is that in many cases M&A activity merely increases the incidence of information silos and further restricts the ability of banks to know their own operations. There are a number of reasons why banks should look to address this issue as part of the ongoing reform of the financial system—rather than as ‘just another’ thing to implement. There are significant longer term cost benefits, highlighted by financial institutions that have undertaken the task of addressing their infrastructure frailties. Similarly at a time when the importance of ‘the customer’ is rising up both banks’ and regulators’ agendas, addressing infrastructure is an important facet of enabling banks to become more attune to their customers and better able to react to a changing market place. The cost of not changing—the loss of revenue and market share to new, disruptive entrants who are not as shackled to old ways of working—provides a strong argument for banks to address this issue.

How could change be facilitated? The pressure on banks’ resources to implement unprecedented levels of regulatory change, yet contend with declining revenues and rapidly changing markets should not be underestimated. Consequently there is no realistic case for the wholesale ‘ripping and replacing’ of banks’ infrastructure over a short timeframe. Instead, Intellect believes there needs to be a co-ordinated regulatory roadmap, set by the regulators, which gives a clear ‘end state’ at which banks can aim at, and a time frame within which to do so. This will help reduce duplication of cost and effort within banks in implementing regulation; free up resource for banks to address underlying issues such as infrastructure (which will in turn reduce the complexity and cost of implementing future regulation); and improve the customer experience. This could be accompanied by a programme of ‘system, process and data mapping’ by banks—which they have to do anyway as preparation for the introduction of Living Wills. However, instead of being a regulatory ‘tick box’ exercise, this could actually be seen by the banks as an opportunity to produce a blueprint for the modernisation of their infrastructure. Finally, this should be accompanied by a platform by which all parties with an expertise in this issue can engage in meaningful dialogue around the issue of technology infrastructure and speciﬁcally how the challenges to change can be surmounted.

2. FinancialInfrastructure &A‘Fit forPurpose’FinancialSystem—InextricablyLiked 2.1 It is widely acknowledged that banks are essentially technology firms. The financial system, and each individual bank, insurer, asset manager, stock exchange, etc within it, is built upon a foundation of technology— its technology infrastructure. It is this technology infrastructure that underpins every function in a bank—from processing transactions to assessing loan applications. It is also widely acknowledged that the technology infrastructure across the financial system is exceptionally complex. To the point where it no longer serves many banks, it hinders them. 2.2 Financial infrastructure is the ‘plumbing’ that allows data—the lifeblood of the financial system—to flow within and between financial institutions. In reality, financial infrastructure refers to a complex myriad of systems, networks, applications servers, databases, physical storage systems and end-user computing systems and devices. It is the foundation upon which every function within every bank sits upon and the provision of economically critical banking services is reliant. 2.3 Today’s legacy systems and processes within banks consist of multiple layers of technology platforms that, as banks and the technology available to them have evolved, have been built on top of each other to facilitate changes and new requirements. These legacy systems are at the heart of established financial institutions’ operations, are business critical, interdependent upon other elements of a bank’s technology infrastructure and are often running 24 hours a day. 2.4 While significant investment has been made in certain products and services that yield a short term return on investment such as systems to support algorithmic (high frequency) trading and low latency trading, many of the more ‘mundane’ but fundamental areas of financial infrastructure have been neglected. Infrastructure and core systems have been upgraded on a patchwork basis rendering them ever more complex and therefore ever more prone to failure—as systems changes are perennially ‘bolted on’ to what is already there, rather than replaced by more modern (and simplified) systems that are better suited to the provision of modern banking services. This combined with merger and acquisition activity has left many financial cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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institutions with disconnected silos of information, duplicative processes and a tangled web of underpinning systems. This has meant that most banks have had significant problems with data quality and, crucially, turning this data into actionable information. On an institutional level it is a significant challenge for banks to have a holistic view across their organisation of anything ranging from risk to fraud to customer behaviour. Instances of money laundering and rogue trading in 2012 are directly attributable to substandard technology infrastructure. 2.5 When data cannot flow freely across a bank, actionable information is therefore not available where it is needed and banks cannot make decisions based on an accurate assessment of their own operations, exposures or risks. The data quality gap, an acknowledged cause of the depth and severity of the financial crisis, is an evolutionary outcome of years of mergers and internal realignments within financial institutions, exacerbated by business silos and inflexible IT architectures. Therefore global efforts to entrench data standardisation across the system—and therefore increase transparency—are entirely welcome, but are not the whole solution. 2.6 Intellect’s submission to the Parliamentary Commission on Banking Standards will therefore demonstrate that effective reform of the financial system cannot take place without a focus on the technology infrastructure that underpins the financial system and each individual bank therein. In many cases this infrastructure is not fit for purpose and will undermine attempts to rectify the failings exposed by the financial crisis, and those exposed since then. 2.7 So, why is this relevant to the Parliamentary Commission on Banking Standards? Ultimately this issue has a bearing on the functioning of the financial system, has played a role in its failures and is relevant to the Commission’s terms of reference. Ie to evaluate the ‘lessons to be learned about corporate governance, transparency...and their implications for regulation and for Government policy’. This submission will set out why this issue is important, specifically why substandard infrastructure: — prevents regulators from doing their job, inhibits transparency and threatens financial stability — inhibits the delivery of customer centric services, inhibits access to finance for many businesses & undermines economic growth — threatens the provision of continuous banking services to customers and the wider economy—and poses both operational and systemic risks — restricts competition across the retail banking sector — inhibits banks from ‘knowing their own operations’ and therefore stopping abuses — limits banks’ ability and therefore willingness to change — threatens the continuing viability of the revenue streams of many UK banks This submission also suggests how initial steps can be taken to address this issue, to the mutual benefit of the banks, their customers and the wider economy.

3. Why Does Current Financial Infrastructurenot Supportan Efficient Banking System? 3.1 “Many financial institutions are trying to run services on disparate systems whose complexity and inflexibility make it difficult to respond to regulatory demands. Decades of ad hoc technology investment, combined with merger and acquisition activity, has left them with disconnected silos of information and duplicative processes. Systems that were developed in an attempt to stay ‘ahead of the game’ when they were implemented are now holding firms back.”291 [JWG Group, March 2012] 3.2 The operational infrastructure within individual financial institutions (most notably established banks) has long been regarded as inefficient, overly complex and an obstacle for cost-effective and efficient business change, be it driven by commercial, regulatory or consumer necessity. Intellect is not stating that complexity in itself is negative—the financial system is naturally complex, by virtue of its global reach, multiple markets/ operators and years of evolution. However, there are issues of over-complexity and opacity which stem from the ever increasing complexity and frailty of the technology infrastructure that underpins many banks across the financial system. It is this over-complexity that means that banks do not truly know their own operations and customers; regulators cannot hope to undertake their forward-looking roles effectively; and all future business change is impeded by systems that cannot be changed without significant cost and disruption. The effect of this infrastructure inadequacy is focused on in a separate section of Intellect’s response to the PCBS.

3.3 What are legacy systems and why do they present a challenge? “Fully 70% or 80% of big banks’ current IT spend, which is very extensive, is about the maintenance of legacy systems. Many of those systems are antiquated, and we need only think back to the unfortunate events at RBS a few weeks ago to see the costs of having such antiquated legacy systems. It strikes me that the time is overdue for something of an IT transformation within the banking industry. It is one of the real peculiarities that banking, which is an information industry, has not invested more wisely in IT to improve the customer 291 P3, ‘FS infrastructure: ready for G20 Reform?’, JWG, March 2012 cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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proposition... Change needs to come. Maintaining legacy systems is costly and, at some point, will cease to be an option.292“

[Andrew Haldane, Executive Director for Financial Stability, Bank of England; 7 November 2012; at the Parliamentary Commission on Banking Standards] 3.4 Today’s legacy systems and processes consist of multiple layers of technology platforms that, as banks and the technology available to them have evolved over the past thirty or forty years, have been built on top of each other to facilitate changes and new requirements. In reality these systems are made up of thousands of programmes each performing a function across a bank’s operations and which are, in many cases, linked by ‘fragile connections’293. 3.5 Adding new elements or removing them is a complex and expensive process that impacts upon a multitude of different aspects of the bank’s systems. Banks are therefore unable to clearly differentiate layers of operation and system functionality, rendering the introduction of each additional change increasingly complex and costly to implement. This is a problem because if change is increasingly expensive and complex, it will be the case that only essential changes (ie those that are absolutely necessary or mandated) will take place. This has negative connotations for the implementation of better customer services, efficient implementation of regulatory change and indeed resistance from banks to reform (due to the cost of change). 3.6 As these systems are ‘always on’ and so intertwined, making changes to them have been described by some in the industry as ‘open heart surgery’ for banks’ and by the Director of Transformation at Nationwide Building Society as ‘akin to replacing the engines on a Boeing 747 whilst in flight’294. The dangers of elements of these interdependent systems failing (and in doing so reducing the ability of these institutions to function in the market place) are very real if parts are switched off or replaced. It is not unusual for integration testing to account for 50% of the cost of implementing new systems—a laborious and painstaking process—because of the risk that change poses for systems failures. In many cases, the architects that established the systems in the first place—in some instances thirty or forty years ago—are no longer working in the industry and today’s architects are faced with the resource-intensive task of painstaking evaluation of the potential impact of making changes to these old systems. In fact most graduates coming into the workforce are not trained in the coding language that these banks’ systems were originally coded in (COBOL—Common Business-Oriented Language—created in 1959) and this in itself presents a significant future operational risk for banks across the world295.

3.7 The risk of addressing the root problems of the complexity of these systems is therefore a decision that many within banks choose not to take, instead choosing to ‘bolt on’ changes to existing systems. This is understandable, given the necessity for banks to operate ‘24 hours a day’ and the potential cost of implementing large business-change programmes. However this does exacerbate the existing problem—with each change that is bolted on merely adding to this complexity and ensuring that when point in time when addressing this complexity issue is unavoidable (and it will), the task will be signiﬁcantly harder and more expensive than had it been undertaken before. In fact, as is well known across the banks themselves and set out in this paper, failing to address this issue it ultimately restricts banks’ abilities to serve their customers and the wider economy and is increasingly an operational risk with implications for ﬁnancial stability. The longer this is left, the more acute this challenge becomes—as does the risk of not doing anything.

3.8 This has been an issue that policy makers and regulators have long chosen not to acknowledge as a failing of the system, but with the RBS systems failure of summer 2012 (by no means the first such systems failure in a retail bank, but one that was picked up by the media on a large scale) there has been something of a watershed in attitudes towards this issue. There can no longer be an assumption that the technology that underpins the financial system ‘just works’. It is important to note that the financial system cannot be reformed to address the problems and deficiencies exposed by the financial crisis effectively—and issues since—if the fundamental platforms upon which banks’ entire operations (the good and the bad elements) are not addressed as part of this wider reform.

3.9 Intellect’s submission to the Parliamentary Commission on Banking Standards explains the detrimental effects of this technology infrastructure in more detail, below.

4.0 Why isBanks’TechnologyInfrastructure soComplex? 4.1 Change is costly and complex, and therefore undesirable

The cost and complexity of implementing any significant changes, as a result of bank’s ageing legacy systems, is significant. Therefore necessary change is rarely undertaken and systems just get more and more complex. 292 Andrew Haldane; Oral Evidence taken before the Parliamentary Commission on Banking Standards; 7th November 2012 293 ‘Banking: Finances’ Fifth Column’; Financial Times; Sharlene Goff & Maija Palmer; 25th July 2012 294 Darin Brumby, Divisional Director Business Systems Transformation, Nationwide Building Society in ‘‘The challenges of a transactional banking project—akin to replacing an aircraft engine in mid-flight”; IFB Group Annual Report 2007/08 295 ‘Brain drain: where COBOL systems go from here’; ComputerWorld, 21st May 2012 cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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4.2 As set out above, more often than not, decisions do not get taken to address this underlying and detrimental complexity and instead merely take the path of least resistance—that is to ‘bolt on’ changes to these systems. 4.3 So, in many cases it is not in the broader ‘short term’ interests of a financial institution to instigate substantial systems changes because of the costs and the disturbances that decommissioning these un-needed systems can incur. Intellect’s members who play central roles in transformation and business change projects across the industry estimate that 70% of the cost of implementing new business functions is attributable to the cost of integrating new functionality into the existing systems. 4.4 These large-scale transformation projects ‘burn’ senior technology stakeholders within banks and, as a result, some are reluctant to recommend and undertake significant programmes of change, regardless of how necessary they may be, preferring instead to just ‘keep the lights on’. In such circumstances, ‘innovation’ largely revolves around bolting on systems and process around the edges of these legacy systems. This is lower risk, but ultimately does not solve any of the fundamental problems that are at the heart of the banks’ infrastructures. Instead, by adding further layers to these systems, this approach is in many cases further adding to the problem by increasing the complexity of the banks’ systems. 4.5 In this vein, resistance to complex policy changes often stems in part from the impact that such changes will have upon the bank’s core systems; the resource that will have to be applied to achieve compliance; and the potential disruption that there will be to everyday banking activities. A current example of this would be successful lobbying by the banks for a long lead in time for the implementation of a ring fence for retail banking operations. The complex task and cost of unravelling the legacy systems that underpin the established universal banks so that clearly defined retail and investment banking operations can function largely independently, was the subject of significant consideration during the Independent Commission on Banking’s review. 4.6 It is often the inflexibility of these common legacy processes and systems that is at the heart of the obstacles that banks now face in implementing changes required by regulation, competitive pressures and wider market changes and which make it difficult for them to effectively implement change programmes or introduce new products and services. In practice, legacy systems are a barrier to beneficial change and have, to date at least, acted as an anchor on the reform of the financial system and even contributed to the financial crisis itself by helping to create the opacity of the financial system.

4.7 Mergers and acquisitions increase the complexity of technology infrastructure Mergers and acquisitions that have taken place in many banks over a number of years cause systems challenges for banks which, in some cases, are not addressed sufficiently because of the cost and disruption of doing so. 4.8 One of the underlying challenges for many European and American banks stem from the fact that they have expanded rapidly over recent decades, acquiring and merging with competitors, or acquiring operations in adjacent markets (eg insurance). From the perspective of the PCBS’ terms of reference, this is of course a consideration from a competition perspective, but it also presents an infrastructure issue. 4.9 There are a number of recent examples of mergers that have led to significant internal programmes to integrate the acquired and the acquiring bank’s platforms, and which take significant timeframes to complete. For instance, Lloyds Banking Group’s acquisition of HBOS has led to significant consolidation of IT systems across the two organisations (focusing on IT infrastructure including data centres and networks; an integrated IT platform for retail banking; and a single dealing and trading platform for wholesale banking). The project began in early 2009, underwent testing in 2011 and is already nearly four years old. It took RBS over two and a half years to migrate NatWest’s customer base (ie the systems and data relating to NatWest’s banking customers), following its acquisition in November 2000. 4.10 Given the costs and disruptions that are incurred in changing existing bank’s legacy systems, it is often the case that the systems and processes of newly acquired banks are not integrated as seamlessly as might be assumed. In fact, it is rare for financial institutions to fully integrate newly acquired operations onto their existing platforms because of competing demands on time and resource. This has a knock on effect on the ability of the banks’ to view their customers’ ‘touch points’ across all their lines of business, and from accurately measuring exposures and risk. It has effectively helped to maintain ‘information silos’ across the operations of banks.

4.11 Disjointed/overlapping regulatory requirements and implementation Many banks have taken a single view of each regulatory compliance requirement and this has further siloed data and information systems across individual institutions (eg Sarbanes Oxley, Basel II, International Financial Reporting Standards, etc). Currently there are a number of regulatory implementation programmes being undertaken at the same time within individual institutions that are, in many cases, not joined up. Over the years this has contributed to a substandard infrastructure that is, to all intents and purposes, a ‘hotch potch’ of systems that are constantly being altered on a point-by-point (rather than holistic) basis. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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4.12 The sheer amount of regulatory change, especially since 2008, has meant that banks have had to focus on ‘fire fighting’ rather than long term infrastructural change. As many banks today are responding on the basis of point solutions, the vast majority of their business change resources have been allocated to meeting regulatory requirements (often with significant duplication of resource), rather than taking a more holistic approach and using regulation as an enabler for innovation and better customer service. This is a legacy of the size of many of these institutions and, as set out above, a siloed way of working. It is a self-fulfilling prophecy—the more that the business changes through uncoordinated implementation of regulation, the more siloed it becomes, the less it is able to share data across its operations and the less ‘fit for purpose’ it becomes. Ultimately this uncoordinated approach to the implementation of regulation is reducing the likelihood of regulators realising their ‘end’ objectives (eg financial stability, banks knowing their customers, etc..). 4.13 To compound the challenges for the regulatory authorities, individual institutions also often interpret regulation requirements in subtly different ways to each other, leading to a more complex regulatory landscape. However, it is the approach of the regulatory authorities that have in many ways caused this issue. In the past, the regulators’ unwillingness to stipulate exactly what is required to achieve compliance allows different institutions to apply their own interpretation. The result is heterogeneity and therefore a Herculean task to normalise data/information, gain a homogenous view of risk and therefore an accurate picture of the financial system. A lack of coherence between international standards adds a further layer of complication to this issue. 4.14 However, the regulators have the means to address this, and in doing so address the issue of compartmentalised, point-by-point implementation of regulation by individual institutions as well—through a co-ordinated ‘regulatory roadmap’ that will allow banks to plan for the future, and identify areas of overlap between regulations that can be costly to implement.

4.15 Lack of internal ‘ownership’ of change programmes In many board rooms across the UK’s banks, there has been in the past a lack of focus on and understanding of technology issues which in turn has led to a lack of investment in the infrastructure that underpins banks operations (see below) and in many cases an uncoordinated approach to business change. 4.16 Within banking, as is the case in many industries, projects are known for their implementation challenges and there have been many failures either through lack of collaboration between IT and the business, lack of specification and design or poorly managed projects and suppliers. Often, this has resulted in more reluctance to undertake large business change projects and migrations, instead implementing workarounds which further complicate the systems landscape. 4.17 This is, however, gradually changing with the rise of technology-knowledgeable individuals to senior positions within a number of banks and, following from the RBS systems failure, an increased focus on operational risk by the regulators. An FSA communication to the Chairmen of the major banks and building societies in 2012 asking for the names of senior managers responsible for a bank’s technology infrastructure and effectively for confirmation by each board that these individuals are competent, may also serve to increase this focus. In the U.S. operational risk is increasingly seen by the regulators as the leading threat to the stability of the financial system—overtaking credit risk. It is likely that this will increasingly be the case in the UK and, as reputational risk is increasingly attached to the safety and soundness of a banks’ technology infrastructure. This will almost certainly increase focus on this issue at board level across UK banks.

4.18 Lack of (appropriate) investment & market short termism “Much of the money invested in IT still goes into making things faster rather than more transparent.296” [The Economist, 2009] 4.19 Unlike other industries that treat technological capability as a key competitive differentiator—a foundation for better, more customer-centric service delivery and formulating business strategy—the financial services industry has often treated it as an afterthought (with exceptions, such as algorithmic trading that can deliver a relatively quick return on investment). As set out above, this is a stance that stems from the board where there is often no representation of the technology departments within the bank. As a result there has been limited board level priority attached to ensuring that the systems and infrastructure underpinning their operations are fit for purpose, largely because such expenditure would not generate a short term return on investment. Banks are typically listed companies and as the markets are concerned with quarterly results, their boards are not usually prepared to invest in longer term projects (such as infrastructure renewal). As the ‘Kay Review of UK Equity Market & Long Term Decision Making’ has set out, there is a significant degree of institutional ‘short termism’ across the City that has rendered it unfit for purpose. 4.20 This is not to say that banks do not invest heavily in technology. Investment in technology that delivers short term return on investment such as algorithmic trading and improving banks’ ability to generate returns from their investment banking activity, has been high for a number of years. As a recent paper by Deutsche Bank Research sets out, financial services institutions spend more on technology than most other industries297. In fact, at the time of the RBS systems outage in 2012, RBS was spending £1.5bn a year on technology. 296 ‘Silo but deadly: messy IT systems are a neglected aspect of the financial crisis’; The Economist; Dec 3rd 2009 297 ‘IT in banks: What does it cost?’; Deutsche Bank, DB Research; Dec 2012; p2 cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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However, this does not mean that banks are actually spending on improving the way their systems serve the bank. In addition to trading technology, in many cases this cost is increasingly down to the large proportion of budget that goes on maintaining banks’ ever more expensive and inefﬁcient systems, rather than improving their operations or delivering innovative services for customers. As these systems increase in complexity— with necessary changes being bolted onto them—this cost will also increase. The result will be that banks’ IT budgets will increase or, as is more likely given the current squeeze on resources, there will be an even smaller proportion of the budget available for improving operations or delivering better services for customers. 4.21 It is the case—according to RBS executives—”that the retail business suffered under-investment in the years leading up to the credit crunch, when the former management under Fred Goodwin, chief executive, was ﬁxated on expanding the investment bank298“.

5. WhyDoesInfrastructureComplexityNeed to beAddressed? 5.1 Ie why is the current infrastructure not ﬁt for purpose and what are the effects on the ﬁnancial system and the provision of banking services? Why is change needed?

5.2 Give the regulators the tools they need to do their jobs “Many of the data needed for identifying and tracking international linkages, even at a rudimentary level, are not (yet) available, and the institutional infrastructure for global systemic risk management is inadequate or simply non-existent.299” [The Bank for International Settlements, April 2012] 5.3 The data quality gap, an acknowledged cause of the depth and severity of the financial crisis, is an evolutionary outcome of years of mergers and internal realignments within financial institutions, exacerbated by business silos and inflexible IT architectures. Ongoing efforts to ensure data standardisation (ie Legal Entity Identifiers), is a step in the right direction but is not the whole solution. Global efforts to standardise data will be undermined if the regulatory authorities are not empowered to take advantage of this—and specifically, data standardisation efforts will be undermined if the failings of the infrastructure of the financial system are not addressed in tandem. 5.4 This is a problem with the foundations upon which banks and the aggregated financial system is built upon. Financial infrastructure is the ‘plumbing’ that allows data—the lifeblood of the financial system—to flow within and between financial institutions. If this was fit for purpose it would have allowed banks to know, in a short timeframe, their exposures to other banks during the financial crisis. If it was fit for purpose, if Lehman Brothers had collapsed at all, it would not be taking four years and counting to unravel who owes what to whom. The bottom line is that current infrastructure does not allow banks to have a complete view of the extent of their operations and exposures and does not allow them to aggregate what data they do have in a short period of time. If the banks themselves are not able to build this holistic view, it is impossible for the regulatory authorities to do so. It is therefore even less likely that they will be able to perform their new role of identifying and mitigating threats to stability before they occur—supposedly a step to reduce the chances of another financial crisis of the magnitude the global economy is still recovering from. 5.5 The Senior Supervisors Group, which includes representatives from regulators across multiple countries, including the UK, stated in a document published at the end of 2010, that ‘some firms still require days and weeks to completely aggregate risk exposures; few firms can aggregate data within a single business day.300“ Regulators can currently have little confidence in their ability to receive data in suitable time frames and with any great confidence that it accurately reflects the exposures and positions of each of these firms, and therefore the financial system as a whole. Many banks do not only run on complex legacy IT systems, but these systems are also built around the legacy of a batch reporting day. Reporting more regularly than once per day does and indeed will prove to be difficult to such organisations and if timely assessment of systemic risk is required for regulators to make timely market interventions, this may not be possible. 5.6 Manipulation and modelling of data will only be possible if the infrastructure is in place to channel this data from all corners of an institution, and then from every institution, to the regulators. Such modelling is crucial in allowing the Financial Policy Committee to not only predict future risk events and act before the worst effects are felt (as is its remit), but also, to allow it to bury down into the cash flow of an instrument or investigate a specific ‘corner’ of the financial system. It will therefore be able to target its interventions more accurately—reducing the wider impact of intervention on the economy. Against the backdrop of a global financial system that continues to be unstable, as the sovereign debt crisis remains unresolved, it is clear that ‘blunt instrument’ approaches to regulatory intervention that affect large parts of the market can further add to this instability or detrimentally affect delicate sectors of the UK economy. Blanket, ‘all or nothing’ interventions based on an interpretation of data that tells a story about what has happened in the past [quite some time ago] risks enflaming this instability further by not taking on board the current realities, risks and characteristics of a rapidly changing financial system. 298 ‘Banking: Finances’ Fifth Column’; Financial Times; Sharlene Goff & Maija Palmer; 25th July 2012 299 P1, ‘Systemic Risks in Global Banking: What Can Available Data Tell Us and What More Data Are Needed?’ Working Paper 376; Bank for International Settlements; April 2012 300 P10, “Observations on Developments in Risk Appetite Frameworks & IT Infrastructure”, Senior Supervisors Group cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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5.7 Addressing existing infrastructure fallibilities will enable better risk management within banks, as a more accurate picture of the whole of the banks’ operations and exposures will be extracted. This will improve the ability of banks to make strategic decisions themselves based on greater degrees of certainty. From the perspective of the Prudential Regulatory Authority which will be receiving these more accurate positions, this will allow for more accurate interventions—and allow it to do so in a targeted and timely manner. Improving the infrastructure—ie how data is passed and processed through the system—will allow banks to report to regulators on a more regular basis and with the added ability for the regulators to scrutinise particular areas of a bank’s operations, without adding to their workload. 5.8 Building on a more accurate aggregated view of individual institutions, addressing the current inadequacies of financial infrastructure would in turn allow the FPC to have a more accurate view of the build up or risk across the financial system and, crucially, have confidence that the information it is receiving reflects full and complete positions and exposures, and not just portions of it.

5.9 Inhibits the wider ability of banks to ‘know their own operations’ and reduce abuses A number of ‘events’ in 2012 have demonstrated the deficiencies and weaknesses around the way that banks operate and the inability of existing infrastructures to allow sharing of important information across departments and geographical boundaries—most recently issues around money laundering and rogue trading. As above, it is current infrastructure that inhibits banks from fully knowing their own operations as a result of business and information silos and a lack of integration between existing systems, yet also presents obstacles to implementing change to address this. 5.10 Mergers and acquisitions, organic growth and banks’ legacy systems have all contributed to the creation of business application silos within individual financial institutions (with banks largely being structured along lines of business). Whilst serving banks well in the past, the information silos that have resulted have meant that at an institutional level it is a significant challenge to achieve a holistic view of anything ranging from risk to fraud to customer behaviour. As well as operating in lines of business silos, many banks’ data and systems operate in front, middle and back office silos further adding to this opacity. This is currently providing challenges for banks to address market, liquidity and other risks as, for the first time, the front office is now dependent on data being sourced from the back and middle offices. 5.11 Two specific events from 2012 that have now publically exposed the frailties of some banks’ infrastructure and therefore their ability to identify unlawful behaviour: 5.12 Rogue trading The FSA has recently highlighted the serious defects in UBS’ systems that were meant to detect unauthorised (rogue) trading in the case of Kweku Adoboli who at one point risked inflicting a loss of £7.4 billion on UBS and ultimately lost £1.4 billion. Specific criticisms of the technology systems in place included a risk system that did not adequately detect risks associated with unauthorised trading, a trade monitoring system that did not detect all trades (allowing Adoboli to manipulate it) and a lack of integration between the two301. This was despite UBS incurring a fine in 2009 for a similar failing of its systems and processes. The prosecutor in Adoboli’s trial, Sasha Wass, stated that Adoboli ‘was a gamble or two from destroying Switzerland’s largest bank for his own benefit302‘ and action was only taken once Adoboli had himself admitted to his activity. 5.13 Money laundering In 2012, both HSBC and Standard Chartered settled the largest penalties in history over instances of money laundering with US regulators, which in the case of HSBC had been taking place unaddressed for nearly a decade. The cases highlighted that the way information flows throughout large banking operations, across multiple national boundaries, was insufficient for them to be able to identify suspicious activity and react to this. This, again, was a result of infrastructure that, as the bank grew on a global basis, did not receive sufficient investment so that it could support an increasingly complex organisation and could not provide the means for data to flow to where it was needed. Notably HSBC has admitted the failings of its systems in allowing money laundering to take place without any action by the bank over so many years: 5.14 “...it is now clear to many of us that the bank’s business and risk profile grew faster than its infrastructure. We have learned that implementing the kinds of robust policies and practices expected of a global banking leader can take longer than anticipated. The bank underestimated some of the challenges presented by its numerous acquisitions, and despite efforts to meet these challenges, we were not always able to keep up.”303 [David Bagley, former Head of Group Compliance, HSBC Holdings plc] 5.15 As these two 2012 examples demonstrate, it is the ability of many banks to share and interpret data which identifies illegal and dangerous activities across their own operations which has suffered as their operations have grown and become more complex, but their technology infrastructure has not been adapted to 301 P12; ‘Final Notice, UBS AG’; Financial Services Authority; 25th November 2012 302 ‘UBS trade Kweku Adoboli gambled away £1.4bn’; BBC Online; 14th Sep 2012 303 David Bagley, Head of Group Compliance, HSBC Holdings plc; Written Testimony for Senate Permanent Subcommittee on Investigations; July 17, 2012 cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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support this. Of course, it is also a cultural issue as well. The attitude of business units and the people operating within them towards their day to day operations and roles has led to a silo mentality—with many business units largely operating independently from other units, with their own objectives and proﬁt lines to worry about. In effect this has created ‘internal competition’ between departments in many banks and is a major obstacle to generating a holistic view of their operations.

5.16 Inhibits access to affordable ﬁnance & undermines economic growth

As a facet of re-establishing trust in the banking system, Intellect believes that a sea-change in attitudes towards the collation and use of data within individual banks—either voluntary or mandated by Government— will also facilitate the side-beneﬁt of improving the availability and cost of credit to small businesses in the UK.

5.17 The Office of Fair Trading found in 2010 that credit information collated and held on micro companies (which the Government has deemed to be the engine of the economic recovery) was poor to non-existent304. Poor collation and sharing of credit risk data—a result of the substandard infrastructure that the banks are built upon—has played a significant role in the drying up of finance to small businesses since the financial crisis and therefore the need for government coercion (ie the Merlin Agreement) or encouragement (ie Funding For Lending Scheme) in order to get banks lending again. Data on the smallest companies has never been of a very high ‘standard’—however before the crisis a combination of a liberal risk attitude towards lending and a localised, branch-orientated decision making process meant that finance was available to many small businesses—and at affordable rates. However this was not based on an accurate assessment of credit risk. This same dearth of accurate data on the smallest businesses remains in existence in the post-crisis era, but is now accompanied by a more centralised decision making process (and therefore a reduction in the ‘local knowledge’ that branch-based decision makers had of their customers) and a highly risk averse attitude to lending. The result has been that affordable finance has been scarce for the smallest companies, those deemed by the Government to be the catalyst for economic growth in the UK, as banks cannot differentiate between those companies that represent a sound investment opportunity (ie with reduced risk) and those that do not. Consequently, due to a lack of granular data, these smaller businesses are all largely treated as a risk by lenders—with finance either being unavailable or at unaffordable rates of interest.

5.18 This is severely restricting the ability of the banking sector as a whole to act as a catalyst for the wider economy and compelling the Government to intervene to improve the flow of credit to business—small business especially. The most recent lending figures from the Bank of England demonstrate that this intervention is not having the desired effect. Banks do not see lending to these businesses as commercially viable as their infrastructure inhibits their ability to accurately evaluate the credit risk of specific businesses.

5.19 This deficiency is restricting banks from being able to play the economic catalyst role that they should be playing—at a time they need to be playing it. Intellect believes that addressing the infrastructure—or plumbing—issues that are restricting the flow of data across banks’ operations will have the side benefit of banks being able to more accurately assess risk and, by this virtue, will provide opportunity for businesses, the banks and the economy to benefit through better assessed, more affordable yet commercially viable finance. Ie a better informed market, rather than the state, can drive finance to those companies that are viable recipients of it.

5.20 Inhibits competition in retail banking

If reduced concentration across the retail banking sector is seen as an important facet of increasing ﬁnancial stability and improving customer choice, it is again the substandard infrastructure of many established banks which is providing an obstacle to this.

5.21 The recent failure of the RBS/Santander branch divesture deal was due to the complexity costs of RBS’ technology infrastructure which were too much for Santander to want to continue with the purchase. The recent RBS systems outages demonstrated the scale of the challenges that Santander would have had to address in order to successfully integrate the RBS systems onto their own. This issue of complexity will stifle competition in the sector in the short-medium term. At the time of writing, RBS is still looking for a purchaser for these 316 branches. The subsequent announcement of £80m to be spent on RBS’ systems is largely an upgrade which, whilst very welcome, will not deal with legacy complexity which is still the drag on significant progress within RBS, and indeed across the financial system.

5.22 Separately, some of the new entrants and smaller banks rely upon established banks’ infrastructure to deliver their own services to customers—therefore if this fails, it is not only the customers of the established bank that suffer, but those of the new entrant as well. This can pose significant reputational issues for the new entrants, who will already face significant challenges in establishing a foothold in a market. Whilst not the only instance of this detrimental knock-on effect, in both October 2012 and on the 31st December 2012, when Lloyds Banking Group’s systems failed—with disruption to 22 million of their own customers—it also impacted upon the customers of the Co-operative (and its subsidiary Smile Bank). 304 ‘Review of barriers to entry, expansion and exit in retail banking’ Office of Fair Trading, November 2011. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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5.23 Restricts banks from ‘knowing their customers’ and reacting to customer demand Infrastructure across the financial system currently inhibits the ability of banks to know their customers, provide timely products to market and play a more constructive (and less coerced) role in economic growth (see above). Research conducted by research house Datamonitor in 2007 has found that ‘existing legacy core banking systems are increasingly incompatible with new business requirements and do not provide a foundation for future growth’305. Six years later and this infrastructure has become even more complex and more time consuming to adapt to changing customer demands. 5.24 A recent survey by KPMG of attendees of the 2012 International Payments Summit found that fewer than 1 in 10 respondents believed that banks are currently effectively mining their customer data, resulting in a mismatch between customer needs and product offerings306. The result is financial products that have either been brought to market after demand has shifted, or do not suit the market to which they are being delivered. If it were not for the existence of poor infrastructure, banks would know their customers significantly better than they already do and, for instance, it would have not been necessary for the government to compel the investment of over £1billion by UK banks to improve their Single Customer View capabilities to enable the Financial Services Compensation Scheme to operate effectively. 5.25 To compete and succeed in today’s business environment, banks need to become more agile so that they can better understand market dynamics and anticipate customer needs; design, introduce, or modify products and services; implement a new value added delivery system, even if that means reshaping the information infrastructure; and identify resources (people and goods) internally or externally. 5.26 To all intents and purposes, many established banks are not able to do this because the infrastructure— and in particular these legacy systems—upon which they are built have not evolved as the financial system has. Implementing new services or products, if they require amendments to core systems (as most do), can take upwards of two years to implement, by which time customer requirements may have already shifted. A recent exception has been the implementation of Barclays PingIt mobile payments service which, as a result of largely bypassing change to its core systems, hasreduced development times from two years to just seven months through the use of cloud computing307—rather than having to rely on multiple patches and code re- writes of existing infrastructure. The uptake of cloud computing across the broader financial sector however, remains notoriously slow when compared to other industries. 5.27 A completely unfettered view of every touch point of every customer within a bank will not be achieved until the information silos within these banks are removed. It will only be at this point that banks will be able to completely know their customers well enough to improve the services that they are able to offer them, and the manner in which they do so. There is plenty of data on individual customers floating around a bank. The challenge is ensuring that this data can be fully aggregated from across every corner of a bank’s operations, with no holes or gaps.

5.28 Ever-increasing operational risk = systemic risk As many banks’ systems are becoming more complex with every change (at a time when unprecedented regulatory changes are being imposed upon banks), they are consequently posing an ever increasing risk of systems failures and the continued delivery of banking services. Concurrently, the propensity for human error will also get greater as the environment they are responsible for changing becomes more and more complex. 5.29 The effects of systems failure have been no more visible to the public than in recent months with the issues surrounding RBS batch payments processing. While the exact causes of this are not yet publically known, the disruption of services to customers has been widespread and plain to see. Across all banks, the more complex their systems become—as a result of ‘bolt-on’ updates to existing infrastructure and systems— the greater the operational risk. 5.30 Operational risk, generally defined as the risk of loss due to failures of people, processes, systems and external events, is a perpetual threat to banks as a result of the constant need to apply changes to their technology infrastructure. As more updates are ‘bolted on’ to banks’ systems, their complexity grows and with it, so does the risk associated with applying future updates and the potential for future systems failures. 5.31 In a recent speech to the Exchequer Club in the U.S., Thomas J Curry, Comptroller of the Currency, (US Treasury Department) stated that “Operational risk is heightened when these systems and procedures are most complex. Given the complexity of today’s banking markets and the sophistication of technology that underpins it, it is no surprise that the OCC [Office of the Comptroller of the Currency] deems operational risk to be high and increasing. Indeed, it is currently at the top of the list of safety and soundness issues for the institutions we supervise.”308 5.32 If a bank cannot operate, it cannot fulfil its role in the interlocked financial system and, as was seen during the financial crisis, the knock-on effect can turn a market event into a crisis and a crisis into a recession. 305 ‘Core Banking Infrastructure Renewal’; Financial Services Technology; May 2007 306 ‘High street banks inability to exploit data leaves customer experience wanting’, KPMG, April 2012 307 ‘Barclays banks on cloud and Linux to slash development costs’; FinExtra; 10th Jan 2013 308 Remarks by Thomas J. Curry, Comptroller of the Currency, before the Exchequer Club; 16th May, 2012 cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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In terms of end result there is no difference in a bank being unable to operate within the interconnected system as a result of a lack of liquidity (as demonstrated by the strains on interbank lending during the crisis) to a bank being unable to operate as a result of systems failure. It is, in essence, a systemic risk. 5.33 Adding new elements or removing them from these systems is a complex and expensive process that will impact upon a multitude of different aspects of the banks’ systems. In many cases, the architects that established the systems in the first place—in some instances up to 30 years ago—are no longer working in the industry and today’s architects are faced with the resource intensive task of painstaking evaluation of the potential impact of making changes to these increasingly complicated systems. Banks are unable to clearly differentiate layers of operation and system functionality, rendering the introduction of additional change increasingly complex, a risk to operations, and costly to implement. It is not unusual for integration testing to account for 50% of the cost of implementing new systems—which in itself indicates the level of resource required to mitigate the threat of systems changes causing a systems failure. Logic would dictate that as these systems grow ever more complex with additional changes, this figure will also rise. The more of a bank’s budget that is spent on implementing regulatory change—and ensuring that this change does not cause systems failures—the less scope there is for banks to implement new services or products that can facilitate better customer service. 5.34 The longer banks leave it to modernise their operations, the greater the risk of systems failure, and therefore the risk of disruptions to the provision of banking services becomes greater—as do the potential financial and reputational costs.

5.35 Limits banks’ ability and therefore willingness to change Resistance from banks to substantial business change (such as ring fencing, account portability, etc) often stems in part from the impact that such changes will have upon banks’ increasingly complex core systems; the resource (time, money, etc) that will have to be applied to achieve change and compliance; and the potential disruption that there will be to everyday banking activities. Current infrastructure is, to all intents and purposes, an obstacle to any change that can beneﬁt customers, the banks themselves and the wider economy.

6. WhyShouldBanksWant toAddress thisIssue? 6.1 Aside from mitigating the adverse reactions of the issues above, there are a number of commercial cases for addressing this issue:

6.2 Efficiency savings In the medium to long term, addressing the inefficiency (eg cost and resource of implementing change, huge cost of system testing, duplication of processes, poor information sharing, etc) that is inherent in many banks’ infrastructures will deliver significant efficiency savings to banks—at a time when revenues and profit margins are falling. To date the majority of UK banks have taken the view that continuing to maintain their existing infrastructure—despite the spiralling cost, complexity and risk of doing so—is less expensive in the short term than comprehensively addressing their technology platforms and beginning with a relatively ‘clean slate’ from which they can operate. There are significant challenges and costs to doing so—it can be equated to open heart surgery for banks, given the necessity for the bank to keep functioning during the transformation; and the costs are significant. However there are examples in the UK, Europe and globally of financial institutions addressing their infrastructure deficiencies and subsequently reaping the benefits. Examples include: 6.3 Deutsche Bank In 2010 Deutsche Bank began Project Magellan, a programme to migrate it’s 24 million customers off their 40 year old legacy systems and onto a new platform that would not only deliver savings through reduced complexity, but would make the integration of future systems following acquisitions less time consuming, complex and costly. The project, which is due for completion in 2015, is expected to cost around€1billion but in 2012 alone it is expected to report that it will have made€200million in efficiency savings from operational IT costs as a result309. As Deutsche Bank has replaced its fixed coded legacy systems with a more flexible architecture, it is able to implement regulatory/market/customer driven changes far quicker than previously was the case—reducing implementation cost and increasing its agility and ability to adapt to suit changing requirements (from customers or otherwise). 6.4 Santander Santander has used its own core banking system, Partenon, to consolidate its systems and run the businesses of acquired banks—which is seen by many analysts as one of the most advanced in the industry. In simplifying its own core systems, whenever Santander acquires new banks (as it did with Abbey, Alliance & Leicester and Bradford & Bingley) it is able to do so at a reduced cost. Fortune Magazine (CNN) has praised Partenon as the “key to cost savings... which has slashed back-office expenses at all its subsidiaries”310 Carol Wheatcroft, an analyst at Tower Group, a research company specialising in the 309 ‘Deutsche Bank moves first customers to new core platform’; FinExtra; 11th July 2012 310 ‘Banco Santander's Emilio Botín takes on the world’; Fortune, CNN Money; 12th March 2012 cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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ﬁnancial services industry, says Partenon is “probably the best of breed” due to its speed and ability to take the strain off of back ofﬁce IT systems311. 6.5 Whilst there are still risks to migrating the systems of one bank to another—and Santander has experienced this during some of the integrations over the last decade—the approach that it has taken in investing in a platform that can receive the huge amount of customer data from its acquired institutions has meant that it is able to facilitate a more advanced single customer view than other rival banks—across various business lines (where many banks struggle) such as mortgages, credit cards and insurance. As all of a customer’s relationships with the bank are automatically linked, and can be viewed immediately by bank employees, it is easier to more accurately cross-sell services to customers.

6.6 Better serve customers To compete in today’s business environment, banks need to become more agile so that they can better understand market dynamics and anticipate customer needs; design, introduce, or modify products and services in a timely manner; implement a new value added delivery system, even if that means reshaping the information infrastructure; and identify resources (people and goods) internally or externally. To all intents and purposes, many established banks are not able to do this because the infrastructure upon which they are built—and in particular their legacy systems—have not evolved as the financial system has. 6.7 Organisational changes, increasing competition and new regulatory requirements demand that infrastructure complexity gives way to business agility for future growth and improved customer service. The challenge for banks is to see that changes being driven by regulatory mandates are an opportunity to improve their operations and infrastructure (as they will be changing them anyway) and render them more adaptable to a changing market. Those financial services providers that appreciate and act upon this will ultimately benefit from doing so. Those that do not, will risk losing business to others in the market that are able to react in a timelier manner to the demands of their customers. 6.8 Nationwide Building Society In 2008 Nationwide said publically that the legacy systems its operations were running on were restrictive to their future growth plans and in order to compete, it had to use its technology as a platform for better customer service delivery. Specifically it stated “the new platform will enable us to respond to future changes in the industry, as well as provide faster product development and innovation processes that will translate to increased benefits to our customers.”312 6.9 Nationwide, although not a bank, does operate within the retail banking market and has been increasing its market share within this area. It has spent £1 billion (as of November 2011—most costs available) on improving its IT systems and fully integrating Cheshire, Derbyshire and Dunfermline building societies, which it took over in 2009. The company has also delivered a new internet banking site, new types of current account, significantly reduced mortgage and ISA application times, improved its ability to price loans across its customers and constructed what it has itself termed a “state of the art” data centre. The purpose behind these changes—and the replacement of the core systems that underpin its entire operations—it to provide better customer service and product innovation. Nationwide’s operating profits are not as large as many of the established banks—it does not operate in capital markets where established banks are able to make profits that mask the poor contribution to profits from their retail banking arms. Nationwide has taken the decision to make its operations as customer centric and efficient as possible in order to improve customer experience and it is anticipated that this will eventually improve its ability to generate profit. 6.10 Whilst Nationwide has stated that generating savings was not the primary driver for addressing its infrastructure inflexibility, it is also expected that this will be a benefit that it will ultimately enjoy. As part of its transformation programme it has reduced its ration of servers from 12 to 1, eliminating un-needed capacity that was a legacy of its ageing systems, through the virtualisation of its data centre estate. It is anticipated that this action alone will generate £8 million in savings by reducing operational and energy costs313.

6.11 The cost of doing nothing... ‘A shift in consumer mindset and growing demand for anytime, anywhere access to applications is giving rise to a new kind of competitor. Banks are being left behind as search engines and technology companies capitalise on the online opportunities to deepen customer engagement and create more connected end- user experiences.’314 [Monitise, November 2012] 6.12 Banks are currently experiencing the ‘perfect storm’ of both falling revenues and rising costs. Investment banking is no longer as proﬁtable as a result of increased regulatory supervision, increased capital requirements and continued uncertainty across the global market. News of redundancies from investment arms of banks operating in the UK (and indeed Europe, the U.S., etc) is commonplace. Retail banking has never 311 IT integration essential for Santander’s M&A strategy; Computer Weekly, June 2009 312 ‘Nationwide invests in IT change’; Computing; 20th March 2008 313 ‘Nationwide banking on £8m saving with server virtualisation’; ComputerWorld; 3rd Feb 2010 314 P2; ‘Mobile money and the battle for customer engagement’; Monitise; November 2012 cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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been a significantly profitable business for most banks—largely because revenues are smaller and the ability to maximise margins is severely hampered—ie most simply do not know their customers sufficiently well and their operations are not nearly efficient enough. Costs are almost always high compared to revenues. In many cases the short term option of ignoring this and simply concentrating on returning more profit from the investment arm was taken (hence the significant resource allocated to developing ‘faster’ trading, which increased returns). 6.13 However, as this is no longer possible, where will future revenues come from? There has been no significant change on the retail banking front, where the technology infrastructure is as inefficient as ever and (as set out above) it prohibits banks from knowing their customers or reacting swiftly to demand for products or services. Banks are therefore faced with a serious medium term threat—change or be disintermediated by disruptive new entrants to the market. The delivery of an account redirection (switching) system in September 2013 that will allow customers to vote with their feet if they feel they aren’t receiving a suitable service, will further add pressure to established banks to rectify this. 6.14 In the longer term, there is a significant challenge to established banks from disruptive, non-traditional entrants to the retail banking sector. At current rate and speed, banks cannot offer customers what they want today, let alone in five or ten years. The next generation of bank users may never go into a branch and may see Google Wallet or PayPal (for instance) as their main bank account, transferring their salaries to these services on a monthly basis. Operators providing digital wallets may, in the future, also see the benefit of providing broader digital retail banking services—a natural progression from the provision of digital payments services. If these disruptors choose to only offer payments services, and shy away from banking services, established banks may become merely transaction/payments utilities, in which case they lose revenue streams they can ill afford to lose. If these disruptors see the commercial potential for offering retail banking services, the situation for these established banks—if they do not address their current infrastructure shortcomings— may be far more serious. This will, of course, have knock on effects on the City of London as a financial centre, and the wider UK economy.

6.15 Reduce financial crime (fraud, cyber attacks, etc) Fraud is one of the most prominent and persistent threats to the operations of UK banks and on many levels this threat is increasing. Given this persistence, it is increasingly regarded as an operating cost by banks and credit card companies alike. For credit card companies, it is often cheaper to write off fraud losses than investigate them. As the most recently available statistics demonstrate, there was a 23% increase in attempts to open current accounts in UK banks in Q1 2012, compared to Q4 2011, with 44 in every 10,000 applications for an account determined to be fraudulent315. Whilst this ratio itself may not seem significant taken out of context, banks have millions of current accounts and this can amount to significant levels of fraudulent activity at both individual bank and industry wide levels. 6.16 Infrastructure renewal will also help reduce the incidence of fraudulent activity—by facilitating a more accurate single customer view and by allowing banks a greater holistic oversight of their operations (ie breaking down silos) to better identify it in good time—through the reduction in the opacity of a bank’s own operations. As a general rule of thumb, the more accurate, comprehensive and readily available the data is on a banks’ customers and transactions, the more likely they will be to spot fraud at an earlier stage—with a reduction of costs to the banks. 6.17 However, the true benefit for the wider industry will be the ability to more readily collate and aggregate data on potential fraudulent activity on a cross industry basis. In many cases fraudsters do not target just one bank at a time and financial products can be taken out by fraudulent means across any institution. However, there is currently limited provision in place for information sharing between institutions on interconnected fraud—especially on a granular and timely basis that can help institutions identify and limit the effects of fraudulent activity in good time. As individual institutions will attest, fraudulent activity is most likely to be identified when banks are viewing activity across the breadth of their own individual operations (ie across credit cards, debit cards, online banking, etc—ie all transactions of an individual customer being viewed together). However, current practices do not allow aggregated activity to be viewed across institutions

6.18 More accurately gauge exposures & therefore capital requirements More accurate reporting of risk—based upon regulatory confidence in the accuracy and breadth of reporting from banks—could lead to savings for firms such as a haircut on capital requirements. Ultimately better, more accurate and timely understanding of risk across an individual institution may well have significant effects on the capital requirements of that specific firm—which are currently estimates of the exposures that banks have. If these exposures can be more accurately mapped across the entirety of a bank’s disparate operations, there is no reason why (if the regulator is confident in the accuracy of their views of the ‘whole’ of individual institutions) that capital requirements on banks cannot be reduced to reflect actual, rather than perceived or estimated risk. 6.19 Additionally, there is no reason why the banks themselves cannot utilise this data for their own benefit. By sharing appropriate information with a potential lending bank, more appropriate terms can be agreed, based 315 ‘Current account fraud hits highest level ever, according to Experian’; 10th June 2012 cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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upon a more accurate assessment of the risk exposure that the funds represent. Morgan Stanley has estimated that in the United States, the implementation of a systemic risk utility—and the associated requirement to standardise data at individual institution level—would result in a 20—30% reduction in operational costs for most banks. In the U.S. it has been estimated that operational costs would also be reduced by helping individual banks cut down the time it takes for them to cleanse their legal entity and reference data and signiﬁcantly reduce the amount of effort required to clear trades. Again, Morgan Stanley has estimated that it could save the ﬁnancial services industry in the U.S. as much as $1 billion per year.316

7. What Roledoes Account Portability Playinthe Reformofthe Financial System? 7.1 In November 2011, Intellect produced a concept paper entitled ‘Facilitating a central account switching & mass account migration solution for the UK banking industry: How to achieve the interlocked objectives of consumer choice & financial stability’317. This purpose of this paper was to demonstrate how— by taking into account the ‘technological art of the possible’ at an early stage, a potential central utility could facilitate two seemingly unconnected priorities for the reform of the financial system. Ie — the competitive switching of current accounts between retail banks (account portability) — the provision of continuous banking services in the event of a failure of a retail bank (mass migration of current accounts from a failing bank, to a number of healthy banks ‘over a weekend’) 7.2 The paper set out, from an objective perspective, one approach that could be taken in implementing such a central utility and, crucially, a theoretical projection of what the end state of this technological change might be—an ‘Overall Vision’. This Overall Vision sees account portability and mass account migration as steps towards the realisation of retail banking operations and supporting systems that are utilised by multiple retail banks on a shared service model—with potential benefits for banks and customers. 7.3 However this was not intended to be a statement that a central utility should be implemented— instead it is an overview of this technological art of the possible, ie how one could be established, what it might consist of, and what the benefits of doing so might be. Intellect believes that there could ultimately be a number of benefits that could be accrued by customers, the economy and banks themselves but before any decision is made to implement an account portability utility, a comprehensive evaluation should be conducted by an independent body (ie not the technology industry and not the banks or a body representing the banks) of the costs, benefits and challenges of doing so. Vested interests should not play the central role in this process. However, Intellect also believes that this evaluation should be focused on the UK banking sector, and not on the findings of similar reviews in other countries—the UK’s financial system has its own characteristics, strengths and weaknesses and these should be the primary determinants. Intellect members reserve the right to their own opinions of whether such a utility should be established or not.

7.4 The Intellect proposition 7.5 Overview A Central Utility, developed in two phases, that will allow for the competitive switching of current accounts by consumers and then the facilitation of mass migration of accounts in the event of a failure of a retail bank. The Central Utility will consist of a central mandate facility, unique identifiers to differentiate individual consumers across the banking system and will be scalable to accommodate the mass migration of up to 30 million accounts in a short time frame. Each Phase of the Central Utility will be built with the next in mind, so that the ability to expand it to fulfil the above dual objectives, is not limited by design. The development of this Central Utility would be guided by an ‘Overall Vision’, which need not necessarily represent an actual intended goal or even an aspiration to be planned for in detail. Rather, it provides a delineation of what is technologically possible and could be beneficial to banks, consumers and the wider economy under current circumstances and that can serve as the theoretical reference point for specific decisions. 7.6 Why? A Central Utility could fulfil two key objectives (see above) that are currently being examined separately by policy makers and regulatory authorities. Intellect’s members believe that approaching these dual objectives as two separate endeavours, represents a duplication of effort and expenditure for all stakeholders. Such an approach is also deemed to be counterproductive to the timely and effective achievement of these objectives, especially in respect of mitigating systemic risk from a potential bank failure and achieving a functioning recovery and resolution regime that the public will have confidence in. 7.7 How and what? Phase 1 of the Central Utility—facilitating account portability—would see the establishment of a central mandate facility (holding direct debit, standing order and recurring card transactions information), and unique identifiers to differentiate individual customers (be they personal or business account holders)—in effect 316 P11; Testimony Before the Subcommittee on Security, International Trade and Finance (Committee on Banking, Housing and Urban Affairs), United States Senate; ‘Providing Financial Regulators with the Data and Tools Needed to Safeguard Our Financial System’; Allan Mendelowitz & John Liechty; 10th Feb, 2010 317 ‘Facilitating a central account switching & mass account migration solution for the UK banking industry: How to achieve the interlocked objectives of consumer choice & financial stability’; Intellect; Nov 2011 cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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building the infrastructures and operating processes that will allow customers to switch accounts in hours rather than days. There would be no need for an explicit redirection service, as there would be a de facto, automatic, permanent redirection service operating for all accounts as information on all direct debits, standing orders, bill payments, etc would be attached to the unique identifier and as an account was transferred to a new bank, this information would follow. Moreover, it would also work for subsequent switches ie if the customer switched accounts more than once. 7.8 Phase 2 would be the enablement of mass account migration—of up to 30 million accounts ‘over a weekend’—which will follow and use the architecture, operational and technical infrastructure created in Phase 1 as its basis. 7.9 In essence each phase and introduction of additional capability, such as the scale required for mass account migration, will be delivered by building on what was put in place by earlier phases. The fundamental principle is that of ‘keeping doors open’ through the adoption of standards, infrastructure and operational guidelines that facilitate scalability and applicability across a range of usages that is broader than that required to cater only for competitive account switching requirements. 7.10 Objectively, Intellect believes that the current account switching system being built does not achieve this final point—that it can be built upon in the future and used as a means to fulfil other roles/duties and therefore deliver further benefits to both customers and banks without having to build a completely new system. It was designed, with cost in mind, as a single purpose vehicle and to this degree it could therefore be considered as a missed opportunity. 7.11 Phase 3—the Overall Vision—which represents the technological ‘art of the possible‘—ie it is what technology could facilitate if there was the will to do so. From a functional perspective, the Overall Vision sees account portability and mass account migration as steps towards the realisation of retail banking operations and supporting systems that are utilised by multiple retail banks on a shared service model—with a reduction in operational costs for all participating banks. These are in turn linked to individually differentiated operations and systems that provide competitive advantage to each specific retail bank, to their management’s own design and choosing. It demonstrates a progression of the Central Utility, potentially providing significant economies of scale in all non-competitive operational functions and reducing the incidence of fraud (amongst other potential benefits) through greater centralisation of the information held about individual accounts across multiple banks, allowing a more holistic view of potentially fraudulent activity. However, it is conceptual. It need not necessarily represent an actual intended goal or even an aspiration to be planned for in detail. Rather, it provides a delineation of what is technologically possible and could be beneficial to banks, consumers and the wider economy and that can serve as the theoretical reference point for the specific design decisions made on the Central Utility, ie a point to aim at.

7.12 Is an account portability/central utility a silver bullet for challenges facing the UK banking sector? On its own, no. Although in the longer term, if taken as a strategic option of a wider set of reforms to the substandard infrastructure that underpins the financial system, it could feasibly deliver significant benefits to customers, banks and the wider economy. 7.13 However it is only one part of the wider challenge facing the banking sector currently and will not, on its own, address the broader shortcomings and failings that have been exposed since the financial crisis. These are issues that all point towards the fact that it is the infrastructure that underpins the financial system that is no longer fit for purpose and cannot support a modern banking system, or allow banks to play a meaningful role in an increasingly digital economy. 7.14 There are benefits that could be accrued from the development of a central utility such as enhanced fraud detection and prevention, reduced operational costs for banks, greater competition and, ultimately, enhanced financial stability if functionality was incorporated to facilitate the mass migration of accounts in the event of a bank failure. However it is impossible to give anything other than educated approximations as to the quantitative benefits and costs of doing so, as there is very little in the way hard facts in the public domain about the costs and benefits of technology expenditure by banks and the specific limitations of each individual bank’s own infrastructure. Banks are not required to include any of this information in annual reports and figures from statistics agencies are scarce318. 7.15 What is clear however, is that a significant proportion of the cost of a bank implementing an account portability solution will stem from the ‘distance they have to travel’ to bring their own technology infrastructure up to a point where an account portability utility would be able to function effectively. This is again, a data issue, and the fact that the customer data that bank A holds, will be different (and in a different format) from the customer data that bank B holds. Account switching is a process that currently takes weeks because often incompatible analogue data has to be transferred between banks and mandates are not readily available between Bank A and Bank B. To implement an account portability utility where all banks’ customer details are held centrally will require a significant data standardisation programme across the retail banking sector which, under the current limitations of many banks’ own technology infrastructures, would be a very expensive and complex process. 318 ‘IT in banks: What does it cost?’; Deutsche Bank, DB Research; Dec 2012; P2 &6 cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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7.16 However, this is not to say that addressing the widespread problem of ‘too much data, not enough actionable information’ is a task that banks should not be undertaking anyway—regardless of account portability.

7.17 As set out in this submission to the Commission, it is this infrastructure that is holding banks back from truly knowing their customers, accurately evaluating exposures, identifying abuses such as money laundering and rogue trading in good time, implementing timely and cost effective change etc. Ultimately it is this ‘plumbing’ that will undermine the effectiveness of any initiative that requires banks to use their data in a more effective manner—which indeed account portability would. Currently banks have significant difficulty in building a detailed and holistic view of their entire operations—so to fix part of this whilst neglecting the rest of it would seem to be, again, a missed opportunity.

7.18 By way of analogy, building an account portability utility without dealing with banks’ substandard infrastructure could be compared to building a conservatory for a house that is suffering from subsidence. It might well add value and provide additional beneﬁts to those using the house, but ultimately its being built on foundations that are not sound and is ignoring the real work that needs to be done ﬁrst or building the conservatory will be an unnecessarily expensive and complex process.

7.19 The process of transformation that banks would have to go through, in order to comply with any account portability/central utility requirements might go some way to addressing the problems that banks have with knowing their own operations. However, the logical (and ultimately less costly) way of approaching this issue would be to address the fundamental problems ﬁrst—which the banks are going to have to address sooner or later anyway—which will go some way to addressing the broader challenges that the post reform system is facing. Once progress has been made here, industry could then look at other initiatives such as account portability—if indeed they are still required.

7.20 Whilst Intellect supports the concept of an independent evaluation of the beneﬁts and feasibility of an account portability solution, this should be undertaken as part of a wider evaluation of the suitability of banks’ existing infrastructure for the provision of modern banking services to an economy that does not want to see a repeat of the 2007/08 crisis.

7.21 On the broader issue of ‘central utilities’...

Across the ﬁnancial system, although not necessarily in the UK, there has been some degree of warming to the concept of a central utility across some areas of the system, in order to reduce the operational costs that banks incur through their own technology infrastructure.

7.22 A central utility can be a means by which all participating banks can share some non-competitive systems (ie those systems that all banks have and which could be used collectively without a loss of competitive differentiation) in order to improve efﬁciency and cut costs. Much of the technology used by banks is similar, with many developers and technology providers often replicating the signiﬁcant proportions of systems built at one bank once for other banks. It is these duplicative systems that could, feasibly, be recreated in a central utility whose functionality is shared by subscribing banks.

7.23 In 2012, Deutsche Bank proposed that a central utility be created for banks operating in the wholesale market where participating organisations can lower the collective cost of creating and maintaining trading software319. This demonstrates that there is an increasing openness to examining all possibilities for reducing the extremely high costs of maintaining technology infrastructure, and Deutsche Bank in particular believes that the sharing of software will save banks billions of dollars that they might have otherwise have spent on software that was duplicated across the industry.

7.24 However, it is unsurprising that many banks are not open to the concept of such signiﬁcant change within the current environment of high regulatory costs and falling revenues, regardless of the longer term beneﬁts. Barriers to achieving any sort of central utility would be the short term cost of implementing it; the requirement for some sort of agreement to be reached and co-ordination amongst participating banks; and a (somewhat misplaced) belief that all a bank’s technology is its competitive advantage.

7.25 “Everybody thinks that IT is a source of competitive advantage... Is all of the stuff we do in IT creating competitive advantage? I’m not sure it is.”

[Kevin Rodgers, Global Head of Foreign Exchange, Deutsche Bank]

7.26 The ability to share systems, reduce costs and bypass the inefficiencies of banks’ individual infrastructures was a driving principle behind Intellect’s ‘Overall Vision’. This could form part of a wider programme of renovation of existing infrastructure across the financial system. However, as with the creation of an account portability utility, it would only form part of a potential solution to the larger challenge of addressing substandard infrastructure across the financial system and would not be a solution in itself. 319 Deutsche Bank urges rivals to share IT cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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7.27 Industry utility case study—Faster Payments The Faster Payments service, implemented by VocaLink, allows customers to make faster automated payments, typically using the phone or online banking, enabling the payments to get to the destination within a couple of hours. As would be the case with renewal of the wider infrastructure across the financial system, Faster Payments has delivered two major benefits since it was implemented in 2008—increased efficiency and greater transparency. 7.28 Efficiency—It facilitates near real-time payments, enabling money to move quickly between customers, corporates and banks. This in turn delivers greater efficiency and frees funds and resources for other crucial segments of business—a benefit enjoyed by both banks and the wider economy. 7.29 Transparency—Facilitating increased traceability and a clearer view of cash flow, which means customers no longer have to rely on their banks to confirm that a payment has been received. This creates a more streamlined, transparent process, whereby it is easier to identify discrepancies, such as overpayment. This has similar benefits for banks as it can help identify and act upon fraudulent activity quicker. 7.30 Near real-time payments helps to bring banks back into alignment with their customers’ needs and, crucially, provides a platform on which they can develop more value-added services for customers. Despite the fixed technology costs that banks incurred bringing their systems in line with the requirements for the Faster Payments utility, it soon became evident to banks that there were revenue benefits for them in doing so. A study carried out by VocaLink and PWC shortly after the utility went live demonstrated that banks had already identified that revenues were exceeding costs and a return on investment was an eventuality, rather than a possibility320. 7.31 Similarly, Faster Payments has provided the foundation upon which future opportunities and market requirements can be built—most notably online payments and latterly mobile payments, the popularity of which is widely expected to increase in popularity and transaction volumes exponentially over the coming months and years. The Payments Council’s own mobile payments platform, which will go live in 2014, will utilise the Faster Payments utility—demonstrating that it can deliver additional value for banks and their customers. 7.32 The creation of an industry utility is not a radical concept. Faster Payments demonstrates that when it suited the industry to do so, it has been able to implement something that delivers benefits to all stakeholders across the financial system. The creation of an industry utility to give the regulatory authorities the means to have a holistic and real-time view of the financial system and its exposures is by no means impossible and could form part of a wider process of renovation of the infrastructure that underpins the financial system.

8. How canSubstandardInfrastructure beAddressed? 8.1 In an ideal world, banks would see that by addressing their infrastructure issues, they will provide a foundation in the longer term for decreased costs, increased revenues, improved customer service delivery and a reduction in operational risk. The industry would make addressing this issue infrastructure an underpinning priority to all other change—as it would make all other change simpler, less costly and less risky. However in reality, given the current weight of (often disjointed) regulatory change upon banks; reluctance to invest in business change projects that do not deliver immediate returns on investment; and the scale of change that is now required after years of not addressing their infrastructure frailties, this is an issue that many, although not all, banks are reluctant to address voluntarily. 8.2 Intellect fully appreciates the pressure on banks’ resources to implement unprecedented levels of regulatory change, yet contend with declining revenues and rapidly changing markets. Consequently there is no realistic case for the wholesale ‘ripping and replacing’ of banks infrastructure over a short timeframe. However, at the other end of the spectrum, change does need to take place or the UK’s banking system, its customers and the wider economy will suffer. 8.3 The middle ground, where Intellect believes the most realistic path to change lies, is through a consolidated regulatory roadmap that sets out to banks precisely what will be required of them in the future and allows them to work towards this with greater certainty over a number of years. Through cross industry dialogue (with the regulators, technology industry, academia, interest groups etc) the banks can then work towards this prescribed ‘end state’ but do so in a way that allows them to plan ahead and address these infrastructure issues as part of this ‘journey’.

8.4 Consolidated regulatory roadmap and ‘end objective’ Banks currently face an unprecedented regulatory burden that is costing billions of pounds to implement with no clear ‘end objective’ at which to aim. The difﬁculty of co-ordinating regulation set by multiple regulators, government and policy makers on a global scale is immense and whilst signiﬁcant progress has been made in improving co-ordination since the crisis, the lack of an end state to aim at is encouraging banks to undertake implementation one project at a time, in a ‘tick box’ manner. As a result of the siloed nature of 320 ‘Tomorrow happened yesterday—How banks are building a business case for Faster Payments’; VocaLink & PriceWaterhouseCoopers; 2009 cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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business lines and departments in banks, such implementation often results in duplicated efforts across operations. In addition regulation is becoming increasingly complex and banks have to dedicate even greater internal resource to achieving compliance. Ultimately this reduces the resource available to banks to implement more customer-focused services or increase the availability of ﬁnance for business.

8.5 An aggregated estimate from Intellect’s members is that approximately only 4% of banks’ technology budgets are spent on actual innovation, improving the way that it operates or generally improving the customer experience321. Intellect would argue that this is actually counterproductive to the broader objectives of the reform of the ﬁnancial system.

8.6 If the amount spent on implementing regulation by reducing duplication, reducing confusion, encouraging co-ordination across individual bank’s operations and the wider industry can be reduced, this will free up resource for banks to address underlying issues such as infrastructure (which will in turn reduce the complexity and cost of implementing future regulation), and improve the customer experience.

8.7 In order for this to happen however, Intellect believes there needs to be a co-ordinated regulatory roadmap which sets a clear ‘end state’ at which banks can aim at, and a time frame within which to do so. This naturally falls to the regulatory authorities to set, based on what they feel the banks should be able to do in the future. This will require further consolidation of existing regulatory initiatives and the provision of a regulatory ‘bottom line’ which all banks will need to comply with. In short this requires the regulatory authorities to show leadership on this issue, where there has been little to date.

8.8 Mapping systems

The onus, however, is not just on the regulators to consolidate requirements and provide a vision for the future. Banks should also be developing their own maps of their complex existing systems, so that they are able to plan and implement change more efﬁciently and so that simpliﬁcation can be undertaken where current budget allows. In essence, they should now be plotting how to move from analogue to digital operations, in line with the trajectory of the rest of the UK economy, and factoring in how this can be done as part of ongoing regulatory change programmes and despite of budgetary restraints. This is, in effect, preparation for a point when banks can aim towards the ‘end state’ set by the regulators.

8.9 Banks are currently having to undertake the sizeable task of mapping all their systems, processes and data ‘obligations’ across their operations in order to comply with resolution plans under Living Wills—a task that many might have expected banks to have already undertaken as a basic facet of running a large corporate entity, this has in many cases regretfully not been the case. However this represents a signiﬁcant opportunity for the banks, as they are being compelled to undertake this task for regulatory purposes, they should use this as an initial blueprint from which they can map their modernisation.

8.10 There has been signiﬁcant investment and many examples of technologically advanced, cutting edge innovation devised by hugely intelligent people in algorithmic trading—this was where the immediate return on investment was for the banks, and therefore this is where signiﬁcant effort was applied. Intellect would suggest that there is a strong case for banks to refocus these people they have working for them—both as employees and as contractors from the technology sector—from driving quick returns on investment to solving this all encompassing infrastructure challenge for the banks, and in doing so ensuring that these banks have a sustainable business in the future.

8.11 Cross industry dialogue

If this deﬁnitive roadmap is produced, it will then afford the banks and authorities a platform on which to engage in meaningful dialogue around how the ﬁnancial system’s infrastructure can be designed to not only implement ongoing reforms in a more cost effective and joined up manner, but also allow banks to better serve their customers, the economy and indeed their own shareholders. This is a discussion that will be best served by involving other key stakeholders such as academia and the technology industry, amongst other organisations.

8.12 Innovative solutions to some of the specific challenges posed by the financial crisis are being developed by bodies consisting of a cross section of the financial system, such as the EDM Council and ISITC. Intellect aims to create such a forum through the launch of its ‘Financial Infrastructure’ programme, with the objective of facilitating targeted and insightful discussion amongst interested organisations; and provide the foundation for tangible outputs to inform mutually beneficial change across the financial system. 321 80 per cent of banks’’ technology budgets spent on maintaining existing complex and inefficient systems (‘run the bank’) leaving 20 per cent available for implementing any sort of change (‘change the bank’). Of this 20 per cent, 80 per cent of that is spent on implementing regulatory requirements—equating to approximately 4 per cent of banks’ total technology budget for innovative, non regulatory change. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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8.13 Timeframe This is not a problem that can be ﬁxed overnight, more something that should be addressed as part of ongoing reform. There is a time dimension however; as banks cannot continue on the path they are on without harming themselves, the City as a ﬁnancial centre and the wider economy. 22 January 2013

Written evidence from the Investment Management Association 1. Executive summary 1.1 The key points in our submission are as set out below. — It is not necessarily a lack of professional standards that culminated in the financial crisis and the more recent banking scandals but more the changes to the structure of the banking sector and the underlying incentives over the last forty years (paragraphs 3.1 to 3.3). — Investment banking now dominates the sector with more of a focus on transactions as opposed to relationship banking. Investment banks not only transact with their customers but also offer them advice and guidance meaning they are inherently conflicted (paragraphs 3.4 and 3.5). They also advise on mergers and acquisitions where a significant percentage of the fees are fixed and contingent upon the deal being finalised, thereby creating an incentive for them to steer a company’s management to complete it. There are a number of examples of acquisitions which destroyed rather than maximised value (paragraph 4.3). — The underlying incentive structures within banks encourage risk taking. Traders and executives receive large payments for activities that focus on increasing profit in the short-term, as opposed to the long term return on assets and prudent management of leverage. Such activities often proved damaging to the bank (paragraphs 6.1 to 6.3). — Derivatives have an important role in risk management, but are complicated and can pose risks to stability if proper controls are not in place. Whilst few consider derivatives caused the crisis, uncertainty about where the exposure to credit default swaps lay, arising from both the opacity of the market and the extent of interbank dealing and exposure, precipitated further loss of confidence. The OTC clearing regulation (EMIR) and MiFID’s proposals on moving more derivatives to trading venues address these concerns, but may over address them and burden certain clients, such as pension schemes, with unnecessary costs (paragraph 6.9). — Shareholders or fund managers in acting as fiduciaries on behalf of clients, invest in companies in order to secure a return for their clients. Whilst the main asset managers are committed to good governance and engagement, as evidenced by the growing number of signatories to the Stewardship Code, it is now apparent that in the run up to the crisis, engagement did not necessarily achieve the desired results, highlighting its limitations and the fact that banks are a special case (paragraphs 6.14 To 6.22). — The fact that current accounting requirements allow all changes in fair value to be taken to the profit and loss needs to be addressed in that it drives the belief that profit can be created without necessarily having to be converted into cash. This reporting of temporary value changes as income impinges on the concept of prudence and results in the payment of remuneration and dividends out of profits that are not only unrealised but unrealisable. It also potentially misrepresents information when those changes have to be reversed in subsequent periods (paragraphs 6.31 to 6.33). — We supported proposals in the final report of the Independent Commission on Banking that a bank’s retail operations should be ring fenced. However, in view of recent developments, the question needs to be asked whether this goes far enough in that certain of our members consider there should be full separation (paragraph 6.11). In addition, Government did not adopt the report’s proposal that derivatives should be outside the ring fence in its White Paper in June which set out how it is proposing to implement the Commission’s recommendations. The subsequent identification of interest rate swap mis-selling adds weight to the importance of derivatives being outside the ring fence. Government should now review its position (paragraph 4.2).

2. Introduction 2.1 IMA represents the asset management industry in the UK, which is responsible for the management of approximately £3.9 trillion of assets invested on behalf of clients globally. These include authorised investment funds, institutional funds (eg pensions and life funds), private client accounts and a wide range of pooled investment vehicles. The Annual IMA Asset Management Survey shows that IMA members manage holdings amounting to about 34% of the domestic equity market. 2.2 In managing assets for both retail and institutional investors, IMA members are impacted by banks as investors in securities both of the bank itself (debt and equity) or originated by the bank, such as asset-backed structures. As importantly, banks are key components of the sell-side (to which our members are a signiﬁcant community of the buy-side) and integral to many payment and clearing systems. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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2.3 Banks play a vital role in the economy in allocating funds from savers to borrowers, operating secure payment and clearing systems, safeguarding retail deposits, managing financial risks and providing specialised financial services. Given recent banking scandals and the banking failures that precipitated the 2007–2008 financial crisis, the establishment of the Parliamentary Commission on Banking Standards is welcome. However, in any final recommendations it is important that the Commission bears in mind that the UK’s leading position in the international financial services industry is not pre-ordained and needs to be fostered not squandered.322 In addition, given the role of banks, any measures to address patent failings needs to consider any impact on credit provision to the real economy. 2.4 It is from these perspectives that we respond to this Call for Evidence.

3. To what extent are professional standards in UK banking absent or defective? How does this compare to (a) other leading markets (b) other professions and (c) the historic experience of the UK and its place in global markets? 3.1 IMA does not believe it is necessarily a lack of professional standards that has culminated in the financial crisis and the more recent scandals. We consider the present culture in banking reflects the structural changes over the last forty years and the underlying incentives. 3.2 The internationalisation of London started in the 1960s with arrival of the Euromarkets, followed by the floating of exchange rates and abolition of exchange controls. But it was essentially Big Bang in 1986, and the abolition of single capacity and permitting corporate membership of the Stock Exchange, that gave rise to the main changes. Whist Big Bang brought efficiencies in that it made trading simpler and cheaper, it allowed jobbers, brokers and investment banks to merge to form integrated banks. A further consequence was that the UK investment banks were no longer expected to be separate from the retail banks. Their need for capital to enable them to grow and compete with New York resulted in a series of takeovers, particularly by US banks, which at the time were still restricted by the Glass Steagall Act. This brought a more aggressive culture, dominated by investment banks with their higher remuneration structures.323,324,325 3.3 Nor was this just a UK phenomenon. Whilst in the US the 1933 Glass Steagall Act, which followed the Great Depression, required investment and retail banks to be separate, it was repealed in 1999 allowing US banks to merge and diversify. A number of commentators have stated that this was an underlying cause of the financial crisis.326 3.4 This domination by investment banks changed the focus from the old style long-term relationship banking to one more focused on transactions. Investment bank professionals issue, recommend, trade and “sell” securities for buy-side investors, asset managers, to “buy”. They are remunerated by charging clients fees and commissions for services. The relationship is transactional and is close to a zero-sum game, ie one participant’s gain or loss is balanced by the losses or gains of another. Moreover, in not only transacting with their customers but also offering advice and guidance, they are inherently conflicted. 3.5 This contrasts with the business model operated by the asset management industry: an asset manager’s clients’ money and assets are segregated from those of the firms, and the manager’s activities do not put their security at risk. In a bank, on the other hand, client funds are held on the balance sheet and used in the business. Moreover, asset managers are paid a percentage of the value of the assets they manage. This firmly aligns their interests with those of their clients. Unlike banks an asset manager has no incentive to over-trade as it would have an adverse impact on performance and revenues because of the costs involved.

4. What have been the consequences of the above for (a) consumers, both retail and wholesale, and (b) the economy as a whole? 4.1 The conflicts within banks have had consequences for consumers, both retail and wholesale. This manifested itself in the recent mis-selling of interest rate swaps and payment protection insurance. 4.2 In this context, the final report of the Independent Commission on Banking proposed that a bank’s retail operations should be ring fenced and that derivatives such as interest rate and currency hedges should be outside the ring fence.327 This was not adopted when the Government issued its White Paper in June which set out how it is proposing to implement the Commission’s recommendations.328 The subsequent identification of interest rate swap mis-selling adds weight to the need for derivatives to be outside the ring fence. Government should now review its position. 4.3 There have also been consequences for the wider economy. For example, in practice UK listed companies retain a corporate broker, now mainly integrated into the investment banks, to provide advice. They advise on 322 See IMA, Asset Management in the UK, 2009–2010, pp 77–81. 323 http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/8849116/How-the-Big-Bang-created-new-life-in-the-Square- Mile.html 324 http://www.bbc.co.uk/radio/player/b00qbxwj 325 http://www.telegraph.co.uk/finance/financialcrisis/8850654/Was-the-Big-Bang-good-for-the-City-of-London-and-Britain.html 326 http://prospect.org/article/alarming-parallels-between-1929-and-2007 327 http://bankingcommission.s3.amazonaws.com/wp-content/uploads/2010/07/ICB-Final-Report.pdf 328 http://www.hm-treasury.gov.uk/d/whitepaper_banking_reform_140512.pdf cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

Parliamentary Commission on Banking Standards: Evidence Ev 1157

mergers and acquisitions where a significant percentage of the fees paid are fixed and contingent upon the deal being completed. Thereby creating an incentive for the bank to steer a company’s management to finalise the deal. There are a number of examples of acquisitions which in the long-run destroyed rather than maximised value. See, for example, Chapter 1 of The Kay Review’s Final Report.329

5 What have been the consequences of any problems identiﬁed in question 1 [3] for public trust and in, and expectations of, the banking sector? 5.1 As a result of the above, trust in the banking sector has been undermined. Trust is vital to the effective operation of the capital markets. If the intermediaries that make up those markets cannot be trusted to operate with integrity, it can have a corrosive effect on the system and impact the whole of the ﬁnancial services sector.

6. What caused any problems in banking standards identified in question 1 [3]? The Commission requests that respondents consider the following general themes: — The culture of banking, including the incentivisation of risk-taking 6.1 One of the main incentives that encourage risk taking is the underlying remuneration structures within banks. Traders and executives often receive large payments for activities that focus on increasing profit in the short-term, as opposed to the long term return on assets and prudent management of leverage, and which subsequently proved damaging to the bank concerned and in some cases to the wider economy. A Financial Services Authority (FSA) discussion paper accompanying the Turner Review of 2009 stated: “there is widespread concern that remuneration policies may have been a contributory factor to the market crisis. The policies in common use during the period leading up to the crisis, mainly but not exclusively in investment banking, tended to reward short-term revenue and profit targets. These gave staff incentives to pursue risky policies, for example by undertaking higher risk investments or activities which provided higher income in the short run despite exposing the institution to higher potential losses in the longer run. In any case, remuneration policies were running counter to sound risk management, in effect undermining systems that had been set up to control risk.”330 6.2 A House of Commons Treasury Committee report argued that: “cash bonuses awarded on the immediate results of a transaction and paid out instantly meant individuals often paid little or no regard to the overall long-term consequences and future profitability of those transactions.”331 6.3 There has been much progress on this. Investors are more proactive in relation to the listed sector generally. Across Europe there is now legislation on remuneration structures at banks and indeed all investment firms and the revised Capital Requirements Directive (CRD 4) may make this tougher. — The impact of globalisation on standards and culture 6.4 The increasing interconnections between international financial markets have resulted in an increase in the number, size, and complexity of banking groups and their activities. Although this has brought efficiencies, it makes effective supervision difficult in the absence of international standards. For example, in the recent LIBOR setting scandal regulators in the US, the UK, Canada and Japan are examining possible collusion by as many as 20 banks and interbroker dealers. This globalisation could, in some instances, increase systemic risk whereby losses in one banking group affect the whole financial system. — Global regulatory arbitrage 6.5 Conduct is regulated on a host country basis and prudential regulation on a home country basis. 6.6 A bank might tend to seek to locate in those jurisdictions where it can circumvent more onerous regulation and taxation. Given the international nature of banking, opportunities for regulatory arbitrage also arise through the restructuring of transactions, financial engineering and geographic relocation. This can be difficult to prevent but its prevalence can be limited by closing the most obvious loopholes. The Financial Stability Board’s work on shadow banking has relevance here and it must be likely the G20 will return to the issue of non-compliant jurisdictions (offshore havens) in the near future. — The impact of financial innovation and technological developments on standards and culture 6.7 The root causes of the financial crisis are well documented and centered on the growth in the securitisation of subprime mortgage debt, easy credit to finance speculation and a failure of the authorities to deal with financial innovation in a globalised world. Certain of these innovations had more impact than others. 6.8 Securitisation has been a very useful tool for more efficient intermediation across a wide range of assets, enabling investors to spread their risk and giving readier access to investment capital. But in its most extreme manifestation—the off-balance sheet special investment vehicle—it introduced greater opacity for investors and ultimately became a significant source of instability. Similarly, it can lead to mismatches between a product’s apparent properties and the underlying reality, as with collateralised debt obligations. Again the Financial Stability Board is considering this as part of the shadow banking project. 329 http://www.bis.gov.uk/assets/biscore/business-law/docs/k/12–917-kay-review-of-equity-markets-final-report.pdf 330 http://www.fsa.gov.uk/pubs/discussion/dp09_02.pdf 331 http://www.publications.parliament.uk/pa/cm200809/cmselect/cmtreasy/519/519.pdf cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

Ev 1158 Parliamentary Commission on Banking Standards: Evidence

6.9 Derivatives have long played an important role in risk management, as a planning tool for businesses and as a portfolio management tool for asset managers. The role of banks in developing ready means of accessing the benefits of derivatives has been key to their success. But derivatives are complicated instruments, and if proper controls are not in place they can pose risks to stability. In the event derivatives had little impact as a cause of the crisis in the mind of most commentators. But extended uncertainty about where exposure to credit default swaps lay, arising both from the opacity of the market and from the massive amount of interbank dealing and hence exposure, acted to precipitate further loss of confidence. The OTC clearing regulation (EMIR) and MiFID’s proposals on moving more derivatives to trading venues address these concerns, but may over address them and burden some clients, such as pension schemes, with unnecessary costs. — Corporate structure, including the relationship between retail and investment banking 6.10 We set out under 3 above the structural changes in the banking sector in recent times. In this context, we consider one of the reasons banks have tended to undertake more risky activities is the fungibility of capital between investment banking and the less risky retail operations. Until the cost of capital is differentiated across the business, in effect the less risky business subsidises the riskier activities and banks continue to make mistaken assessments as to the risk/reward trade off of certain activities. 6.11 IMA supports the Independent Commission’s proposal for banks to ring-fence their retail operations. However, in view of recent developments, we consider the question needs to be asked as to whether it goes far enough in that certain of our members consider there should be full separation. — The level and effectiveness of competition in both retail and wholesale markets, domestically and internationally, and its effects 6.12 Whilst competition in both retail and wholesale banking is important, we consider it may have been lacking in investment banking internationally, particularly as regards underwriting fees and fees for mergers and acquisitions. This has worsened since the financial crisis. — Taxation, including the differences in treatment of debt and equity 6.13 A potential solution to the problem of excessive leverage that underlay the 2007–2008 financial crisis would be to address the asymmetric tax treatment of debt and equity. If banks could no longer deduct the interest they pay for debt financing then they would be likely to issue more equity. Bank lending would fall as companies would be less inclined to borrow and there would be a shift to other means of financing, for example, venture capital. However, to be effective, for the reason stated in 6.6 and global arbitrage, any such change needs to be international. The Commission requests that respondents consider weaknesses in the following somewhat more specific areas: — The role of shareholders and particularly institutional shareholders 6.14 It is important to understand that the primary role of shareholders or fund managers is to act as fiduciaries on behalf of clients. They invest in companies in order to secure a return for their clients. If they have concerns about an investee company there are two broad ways by which they exercise discipline: by selling shares or engaging with management and boards. 6.15 From about 2005, a number of active investment managers concluded that the strategies being followed by many banks were unsustainable, and that they should not keep their clients invested in the sector. The resulting sales of shares were likely to have been one factor in the underperformance of the banking sector relative to the market as a whole, which was by some 9% in 2005. This meant that they were not able to engage with the banks concerned. 6.16 Others that were not in a position to sell their shares, for example, those running index funds or with mandates from pension fund clients which did not allow them to depart very far from the index, began to express concerns to some bank boards about strategic direction, and stepped up the amount of engagement they undertook. 6.17 IMA has been a long-standing supporter of the stewardship agenda. We firmly believe that many clients of asset managers expect them to take their stewardship responsibilities seriously when they are delegated to the manager, and that managers should and do respond to this. We set out in the Annex how this stewardship role has been transformed in the last decade. However, it is now apparent that in the run up to the crisis this engagement did not achieve the desired results, highlighting the limits on what engagement can achieve and the fact that banks are a special case. 6.18 Fund managers are restricted in terms of the information that is made available to them. They do not have insider status and are not privy to the same information as the executive or indeed the non-executive directors. In many instances, it is now apparent that bank boards and management failed to appreciate fully the risks on their balance sheets, thus, fund managers could not have been expected to either; this was not a problem which could have been avoided by better engagement 6.19 UK fund managers typically have relatively small holdings, this is particularly the case with the large banks. Indeed, as noted in our opening paragraph, the UK fund management industry only accounts for a third of all UK equities. However, particularly given the lower propensity for non–UK shareholders to vote at general cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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meetings, a manageable group of UK shareholders could together constitute a significant proportion of those voting on any poll. 6.20 But there are concerns that acting collectively with like-minded investors to bring pressure to bear on management could trigger issues of insider trading, changes of control, and industry collusion and “the concert party” rules. The FSA has issued guidance and the Takeover Panel a Practice Statement to help allay these and facilitate engagement. However, there are still concerns as to whether collective shareholder action in relation to banks and other financial institutions are caught by the Acquisitions Directive332 which has been implemented across the EU. 6.21 This requires regulatory approval before an investor and those acting in concert acquire a direct or indirect “qualifying holding” in a bank, investment firm or insurance company (broadly speaking a holding of 10% or more). We understand that the FSA’s procedures do not envisage such approvals and there are concerns that the process to be followed and time taken would be an impediment to collective engagement. To address these concerns, it would be necessary to have some clarification that the Directive’s provisions are not triggered by an ad hoc agreement or understanding to vote together on a particular issue. In addition, because UK listed banks and insurers often also own regulated subsidiaries in other EU countries, the Level 3 Committees (or the European Commission) would need to confirm this understanding if shareholders are going to feel comfortable relying on any UK specific guidance. 6.22 In conclusion, there are limitations in what engagement can achieve—asset managers do not run companies; they do not set strategy nor are they insiders, in that they only have access to information that is available to the market as a whole. Managers compensate for such information asymmetries by diversifying their portfolio construction. Nevertheless the main asset managers are committed to good governance and engagement as evidenced by the growing number of signatories to the FRC’s Stewardship Code333. Thus although it is still relatively new, the Code is working and should be given time to take effect. — Creditor discipline and incentives 6.23 A number of holders of credit instruments seek to exercise discipline over and engage with the issuers of those instruments. However, they do not have the same rights as holders of equity who as providers of the risk capital and bearers of residual risk can, for example, table resolutions at meetings, requisition meetings and vote their shares. Thus creditors’ effectiveness is more limited and key creditors will tend to manage their exposures by taking collateral. The effect of collateralization is to substitute the credit risk of the issuer of the collateral for that of the counterparty to the transaction. Moreover, following the collapse of Lehmann, bank bond issues have been guaranteed by EU and US Governments and more widely. 6.24 We consider the role of collateral remains insufficiently discussed. It leads to asset encumbrance and the FSA and others are addressing the liquidity impacts from that. But it also reduces the exposure large banks have to each other. Whilst this nominally reduces risk, it also eliminates the extent to which one bank has concern for what another is doing that might endanger its credit worthiness. In other words the very parties who might impose market discipline upon one another and have the capability to do so, are in fact much less concerned than might be expected. In addition, the need to pledge more and more collateral as a collapse approaches can hasten the end of a failing bank. It is to be hoped recovery and resolution plans may address some of these impacts. — Corporate governance, including the role of non-executive directors, the compliance function, internal audit and controls and remuneration incentives at all levels 6.25 Whilst not a root cause of the financial crisis, there were clearly failings in banks’ governance and at times investors’ scrutiny and challenge to banks’ strategy. These were largely failures in execution rather than the corporate governance framework and the “comply or explain” regime. They did not cause the crisis nor would changes have prevented it but the experience prompted an examination of the framework to make it more effective. Sir David Walker issued his report in November 2009 on the governance of banks and other financial institutions which required specific initiatives, particularly by the FRC and FSA334. For many of the recommendations it is too early to assess their impact. 6.26 The FRC implemented those recommendations for listed companies in revising the Corporate Governance Code for years beginning on or after 29 June 2010. Others were implemented through its Guidance on Board Effectiveness of March 2010. The FRC also published the Stewardship Code in July 2010 and the FSA introduced a requirement that UK authorised asset managers report whether or not they apply it335. The FRC has recently consulted on further amendments to the UK Corporate Governance and Stewardship Codes. As noted in paragraph 6.22, these Codes should be given time to take effect before any further initiatives are considered in this area. 6.27 That said, one issue highlighted by the financial crisis was that non-executives were not necessarily performing an effective oversight role. It is vital that banks have high quality non-executives that are committed 332 http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2007:247:0001:0016:EN:PDF 333 http://frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Stewardship-Code.aspx 334 http://webarchive.nationalarchives.gov.uk/+/http:/www.hm-treasury.gov.uk/d/walker_review_261109.pdf 335 Financial Services Authority Conduct of Business Rule 2.2.3, which was effective from 6 December 2010. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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to ensuring they are run effectively and there is a need to increase the pool of talent and experience. Thus many consider NEDs should have fewer posts and be more involved in the companies on whose boards they sit. 6.28 On the issue of remuneration, the FSA has set out clear principles in its Remuneration Code which applies to the largest banks, building societies and broker dealers and investment firms, and requires them to apply “remuneration policies, practices and procedures that are consistent with and promote effective risk management”. Thus remuneration has to be aligned with the risks of the firm and Code Staff pay has to be disclosed. BIS is also looking to improve transparency around Executive Directors’ pay for the listed sector and give shareholders more power with a binding vote on pay policies every three years. — Recruitment and retention 6.29 This aspect of the call for evidence is outside IMA’s remit. — Arrangements for whistle-blowing 6.30 This aspect of the call for evidence is outside IMA’s remit. — External audit and accounting standards 6.31 There are certain issues with accounting requirements that need to be addressed. First, mark to market accounting. Many instruments in the trading book have no alternative but to be marked to market, in that values at historical cost would reflect an arbitrary moment in time when the assets were initially recognised and make accounts less comparable. However, under current requirements all changes in fair value are taken to the profit and loss. This drives the belief that profit can be created without necessarily having to be converted into cash. We particularly have concerns when fair value is applied to holdings: — that are so large that they could not be realised at the screen price; — when extraneous factors exaggerate the volatility of the market price; and — where there is no market in that they are marked to model inevitably adding to complexity and problems around the reliability of the model. 6.32 This reporting of temporary value changes as income impinges on the concept of prudence and results in the payment of remuneration and dividends out of profits that are not only unrealised but unrealisable. It also potentially misrepresents information when those changes have to be reversed in subsequent periods. 6.33 The Turner Review noted: “in the trading books a mark-to-market approach means that irrational exuberance in asset prices can feed through to high published profits and perhaps bonuses, encouraging more irrational exuberance in a self-reinforcing fashion: when markets turn down, it can equally drive irrational despair. And at the total system level, the idea that values are realisable because observable in the market at a point in time is illusory. If all market participants attempt simultaneously to liquidate positions, markets which were previously reasonably liquid will become illiquid, and realisable values may, for all banks, be significantly lower than the published accounts suggested. While it is difficult to quantify the effect, it is a reasonable judgement that the application of fair value/mark-to-market accounting in trading books, played a significant role in driving the unsustainable upswing in credit security values in the years running up to 2007, and has exacerbated the downswing336“. 6.34 As regards the banking book, under the current “incurred loss” model banks can only recognise the implications of events that have already occurred when making provisions, such as failures to make interest or principal payments; and not probable future events. Thus in good years this produces low figures for loan loss provisions and boosts income. By not reflecting the average future loan losses, capital ratios are bolstered, lending capacity is increased, and higher bonuses paid. The IASB is addressing this and moving to an “expected loss” model, but this is not yet effective. 6.35 No one would doubt that there are difficulties in valuing banks’ financial assets, particularly highly complex financial instruments, as compared to the assets of a trading company. This makes it even more important that auditors err on the side of prudence when undertaking their work. But in recent times the regulators have been concerned as to whether auditors exercised sufficient professional scepticism. 6.36 Scepticism is particularly important when key areas of accounting and disclosure depend on management’s judgement. However, we are concerned that auditors sometimes focus too much on gathering and accepting evidence to support management’s assertions, for example whether management’s valuations meet the requirements of accounting standards, and do not challenge enough. 6.37 This is borne out by the fact that there were significant variations in the numbers reported by different banks in relation to the same instruments, held for the same purpose and valued in accordance with the same accounting policies, even when the banks concerned had the same auditors. Moreover, the Audit Inspection Unit informed us that there were situations where conflicting judgments were accepted by the same firm for different clients in the same or similar industries. 6.38 A further area of concern relates to going concern. An example often cited by investors is the disclosures in the Royal Bank of Scotland’s accounts for the year ended 31 December 2007 which were signed off on 27 February 2008 but gave no indication that there could be future financing problems and had an unqualified 336 http://www.fsa.gov.uk/pubs/other/turner_review.pdf, page 65. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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audit report. However, as soon as April 2008 there were rumours that the bank was going to have to go to the market for additional financing. The refinancing of some £12 billion by way of one of the largest rights issues ever was completed in June. 6.39 Although some will argue that the auditors’ role is to express a view on historic figures and the subsequent refinancing was a post balance sheet event that could not have been predicted at the time, the uncertainties were such that we consider questions should have been asked. Moreover, from evidence given to the House of Lords, we understand that late in 2008, auditors received assurances from HM Treasury that Government would act to support the banks337. This was not transparent to investors. 6.40 The Sharman Panel of Inquiry, established by the FRC to consider going concern published its final recommendations in June338. Whilst it concluded that a special going concern disclosure regime was not necessary for banks, the report recommended that “the FRC should clarify that a conclusion that a bank is or would be reliant, in stressed circumstances, on access to liquidity support from central banks that is reasonably assured, does not necessarily mean that the bank is not a going concern or that material uncertainty disclosures or an auditor’s emphasis of matter paragraph are required”. — The regulatory and supervisory approach, culture and accountability 6.41 As an association that represents the asset management industry, we have no direct experience of this in relation to banks and are unable to comment. — The corporate legal framework and general criminal law 6.42 In the FSA’s Report into the failure of the The Royal Bank of Scotland339, the Chairman argued that there may be a case for changing the personal risk return trade-off for bank executives and suggested a “strict liability” regime for bank executives and directors for the adverse consequences of poor decisions or an automatic incentives based approach. 6.43 IMA considers a robust incentives based approach where rewards are based on long-term performance and where clawback is allowed and used, where appropriate, is the way forward. 6.44 FSA already has extensive powers to take action against directors of regulated businesses. However, we do not support a strict liability regime where penalties are imposed without establishing fault. This would discourage many able applicants from seeking appointment and could be considered unjust, and therefore open to legal challenge. But we would welcome stronger sanctions for those guilty of misdemeanours.

7 What can and should be done to address any weaknesses identified? To what extent are such weaknesses subject to remedial corporate, regulatory or legislative action, domestically or internationally? 7.1 As noted in paragraph 6.11, IMA supported the proposals in the final report of the Independent Commission on Banking that a bank’s retail operations should be ring fenced. However, in view of recent developments, questions need to be asked as to whether this now goes far enough in that certain of our members consider there should be full separation. 7.2 Many of the issues this Commission has raised are governed by EU legislation which governs a wide range of financial institutions including banks, which will principally be credit institutions authorised and regulated under the Second Banking Co-Ordination Directive (2BCD) and the revised CRD 4. Other banks will be regulated under Solvency II. We would not expect any bank headquartered in the UK to be outwith European regulation. What the UK may propose in legislation may be extremely limited. Even supervisory authorities can be expected more and more to follow harmonised approaches from the European Supervisory Authorities. 7.3 Moreover, the role of good governance in banks continues to be high on the international and domestic agenda. The Basel Committee on Banking Supervision issued a set of principles in October 2010 for enhancing sound corporate governance practices in banks. Basel III is being implemented, in broad terms, by CRD 4 which contains requirements on corporate governance for all banks, as well as other financial institutions such as MiFID portfolio managers. In April 2011, the European Commission published its Green paper on an EU Corporate Governance Framework an action plan on which is expected this autumn. In the UK, the Financial Reporting Council updated the UK Corporate Governance Code in May 2010 and in July 2010, published the UK Stewardship Code. It has just completed a consultation on further amendments to both of these Codes.

8 Are the changes already proposed by (a) the Government, (b) regulators and (c) the industry sufficient? Respondents may wish to refer to the Financial Services Bill and the Government’s proposals for the Banking Reform Bill. They may also wish to refer to proposals by the Bank of England and the Financial Services Authority on how the Financial Policy Committee, Prudential Regulation Authority and Financial Conduct Authority will operate in practice. 8.1 In addition to comments elsewhere in this response, IMA welcomes reforms that aim to enhance the protection of retail consumers of financial services and give a greater role to the central bank in relation to the 337 http://www.publications.parliament.uk/pa/ld201011/ldselect/ldeconaf/119/11909.htm, paragraphs 149 to 154 338 http://www.frc.org.uk/News-and-Events/FRC-Press/Press/2012/June/Sharman-panel-publishes-final-report-and-recommend.aspx 339 http://www.fsa.gov.uk/static/pubs/other/rbs.pdf cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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promotion of ﬁnancial stability. Thus the Bank of England, as the lender of last resort, is to assume responsibility as the Prudential Regulatory Authority and has an incentive to protect the taxpayer against any abuses of the insurance it provides.

9 What other matters should the Commission take into account? 9.1 The Commission may wish to consider seeking to address mis-selling and the sales-based culture. A possible solution would be if banks ceased paying sales commission to frontline staff and instead lined bonuses to levels of customer satisfaction, the fair treatment of consumers, and resolution of complaints.

Annex MEMORANDUM BY THE INVESTMENT MANAGEMENT ASSOCIATION The Development of Stewardship In 2002, investors gave new impetus to stewardship and the Institutional Shareholders’ Committee (ISC,340) whose members, including IMA, represent virtually all UK institutional investors, issued the Statement of Principles.341 This was the first comprehensive statement of best practice governing the responsibilities of institutional investors in relation to the companies in which they invest on behalf of the ultimate owners. IMA benchmarked the industry’s adherence to the Statement of Principles through regular surveys. Starting in 2003, these clearly demonstrated that engagement was evolving and becoming more transparent. The last survey to 30 June 2008 showed that 32 asset managers that managed equities amounting to 32% of the UK market actively engaged, voted their UK shares, and increasingly published their votes.342 Nevertheless, institutional investors recognised that in the run up to the financial crisis there were failings in their scrutiny and challenge to banks’ strategy and excesses, and that they needed to address this. The ISC took steps to do so and reissued the Statement of Principles as a Code in November 2009, modifying it to seek to improve the dialogue between institutional investors and companies. The Government at the time wrote to the FRC asking it to adopt the Code and, following a public consultation, the FRC issued it as the Stewardship Code in July 2010. In December 2010, the FSA made it a requirement that authorised asset managers disclose publicly their commitment to the Code or their alternative business model. This aimed to ensure that those that appoint asset managers are aware of how a manager exercises its stewardship responsibilities, if any. The Code also expects those that commit to it to report to their clients/beneficiaries on how they have exercised their responsibilities and to have a public policy on voting disclosure. It is important that this transparency is supported by practice. IMA undertook to look at the activities that underlie it and to see what impact the Code has over time. We published our first report last year our second report in June 2012. The latest report summarises the responses to a questionnaire that was sent to all 173 signatories that had committed to the Code as at 30 September 2011. 83 institutions responded: 58 Asset Managers; 20 Asset Owners; and five Service Providers. The Managers that responded managed £774 billion of UK equities, representing 40% of the UK market, and the Owners owned £62 billion. The latest report clearly demonstrates progress. For example: — as at 30 September 2011 173 institutional investors had committed to the Code up from 80 as at 30 September 2010; — all of the 2011 respondents now have complete policy statements on how they exercise their stewardship responsibilities whereas in 2010, six respondents only had a statement of their intention to produce one; — in 2011, more of the 2010 respondents have client mandates that refer to stewardship; — the 2010 respondents increased their resources responsible for stewardship by 4% in 2011; — the proportion of votes cast increased in all markets in 2011; and — a greater proportion of respondents publicly disclosed their voting records—73.4% in 2011 as compared to 69.0% in 2010. In conclusion, although it is still relatively new the Stewardship Code is working in that more UK institutional investors are committing to stewardship and are increasingly transparent about doing so. We consider that this initiative should be given more time to take effect. 340 The members of the ISC were: the Association of British Insurers; the Association of Investment Companies; the National Association of Pension Funds; and the Investment Management Association. In 2010 this was reconstituted as the Institutional Investor Committee made up of the Association of British Insurers; the National Association of Pension Funds; and the Investment Management Association 341 http://www.investmentfunds.org.uk/press-centre/2002/20021021/ 342 http://www.investmentfunds.org.uk/press-centre/2009/20090520–01/ cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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Nevertheless, it is now apparent that in the run up to the crisis this engagement did not achieve the desired results, highlighting the limits on what engagement can achieve. 24 August 2012

Written evidence from Ipsos MORI Executive Summary — The British are most likely to think that there is too little regulation of the banking industry compared to publics in other countries. — There is a strong inverse relationship between the trust levels of banks in a given country and the percentage of consumers in that country who feel they are insufficiently regulated. Therefore, in Britain, there are low levels of trust in banks and the British strongly favour further regulation. — The British believe that the most important issues for the banking industry to address are irresponsible lending practices, excessive profit and repaying government loans. Operating transparently, and creating and maintaining local jobs are also issues the British would like the financial services industry to address. — British attitudes towards banks are shaped by the financial crisis and the bailout of the financial institutions by taxpayers. Even before the Libor scandal broke, some two in five British people already thought the banks ought to consider the extent to which they operate transparently. — It could be argued that banks are best to ride out this wave of low public trust, and wait for the economy to recover, with the view that economic recovery will lead British, US and European consumers to warm up to the banks and to their interests. However, western markets do not show any parallel between the current economic climate and the level of consumers’ trust in banks. We do not believe thus, that the banking industry can count on an improvement in the economic climate to make British, American or continental European consumers more trusting of them. — To regain public trust the banking industry should provide evidence to consumers that they are tackling the issues of concern. Therefore, in Great Britain, they should place a great deal of emphasis on their responsible lending practices and on the actions they have taken to pay back taxpayers as well as emphasising the extent to which they are operating transparently.

The Evidence 1. We welcome the opportunity to submit evidence to the Parliamentary Commission on Banking Standards. The Reputation Centre at Ipsos MORI has over 40 years experience of helping clients monitor and manage their most important intangible asset, their reputation. Given our experience looking at public attitudes and specific audiences, we confine our submission to question 1 and 3 of the terms of reference of the Commission: 1. To what extent are professional standards in UK banking absent or defective? How does this compare to (a) other leading markets (b) other professions and (c) the historic experience of the UK and its place in global markets? 2. What have been the consequences of any problems identified in question 1 for public trust and in, and expectations of, the banking sector? 2. Our evidence draws on our most recent piece of global research amongst publics around the world. Four times a year, the Ipsos Global Reputation Centre conducts research on the issues affecting business sectors and the reputations of companies in those sectors. Our February 2012 wave considered the banking industry. We thought it would be useful for the Commission to see some of the global trends as well as Great Britain’s data, as banking is one of the more borderless industries and this helps us to compare issues of public trust in banking in Britain with how publics feel elsewhere and draw lessons. 3. The research was conducted via the Ipsos Online Panel system in 24 countries around the world: Argentina, Australia, Belgium, Brazil, Canada, China, France, Germany, Great Britain, Hungary, India, Indonesia, Italy, Japan, Mexico, Poland, Russia, Saudi Arabia, South Africa, South Korea, Spain, Sweden, Turkey and the United States. For the results of the survey presented herein, an international sample of 19,216 age 18–64 in the US and Canada, and age 16–64 in all other countries, was interviewed. Approximately 1000+ individuals participated on a country by country basis via the Ipsos Online Panel with the exception of Argentina, Belgium, Indonesia, Mexico, Poland, Russia, Saudi Arabia, South Africa, South Korea, Sweden and Turkey, where each have a sample approximately 500+. The survey was conducted between 7 and 21 February 2012, prior to the Libor scandal breaking. 4. Weighting was employed to balance demographics and ensure the sample’s composition reflects that of the adult population according to the most recent country Census data available, and to provide results intended to approximate the sample universe, (in the small number of developing countries where access to the internet is limited respondents are more likely to be affluent and well connected than the average member of the population). cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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Reputation Snapshot for the Banking Industry 5. Some 37% of consumers around the world say the banking sector has too little regulation, compared with 24% who say it has too much. Insurance is next on the list, with 35% saying it has too little regulation, followed by packaged food at 33%. 6. In Great Britain, in particular, there is clear desire for more regulation of banking companies. Our research shows that only 5% think there is too much regulation, compared to 27% who think there is about the right amount and 68% who think there is too little. 7. Great Britain is in line with trends across Europe and North America. Amongst 24 countries surveyed, majorities of respondents in Great Britain, Spain, France, Germany, Belgium, Australia and Korea, and pluralities in the USA, Sweden and Hungary believe there is too little regulation of banks. 8. When it comes to global attitudes about the need for more regulation, no sector shows as much polarization as the banking industry. While half of consumers surveyed across Europe and North America think that banks are not sufﬁciently regulated, only about one quarter in the rest of the work are of the same opinion.

9. In terms of the issues most important for the financial services industry to address, British consumers focus far more on financial institutions’ responsible lending practices (52%), excessive profit (42%) and repaying government loans or financial assistance (41%) than do their counterparts elsewhere. Close behind are operating transparently (39%), and creating and maintaining local jobs (39%). 10. Seemingly, British attitudes towards banks are shaped by the 2008 financial crisis and the bailout of the financial institutions by taxpayers. It is also worth noting however, that even before the Libor scandal broke some two in five British people already though the banks ought to consider the extent to which they operate transparently. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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11. Consumer attitudes towards the regulation of ﬁnancial services companies are related intimately to their level of trust—or mistrust—of them. More precisely, there is a strong inverse relationship between the average “net trust score” for banks in a given country and the percentage of consumers in that country who feel they are insufﬁciently regulated. In other words, the more consumers trust banks, the less likely they are to favour increased regulation and vice versa. Therefore, in Britain, there are low levels of trust in banks and the British favour regulation. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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12. Besides showing a great deal of mistrust of banks, countries with strong support for increased oversight of banks are often those where consumers are least confident in their ability to invest in the future eg to save for retirement or their children’s education. Eighty-three% of the people surveyed in Britain said they are now less confident of their ability to invest in the future. There are, however, a few countries showing low support for regulation despite low future investment confidence—Japan, Poland and Russia.

80% Correlation: -0.56

70% Indonesia

India Brazil 60%

c Saudi Arabia n e d i 50% f China

n Sweden o C

n 40% Canada

e Turkey Germany

m ow support So. Africa

t L Australia

s for Mexico Argentina e US v 30% regulation

n despite low I

Russia future e

r investment u t 20% confidence u Japan Korea Belgium F UK Poland France 10% Italy Spain Hungary

0% 0% 10% 20% 30% 40% 50% 60% 70% 80%

Support for More Regulation of Banks

Q. Compared to 6 months ago, are you NOW more or less confident of your ability to invest in the future, including your ability to save money for your retirement or your children's education? (% More) Q. For [Banking Companies] please indicate whether you think there is too much regulation, about the right amount of regulation, or too little regulation. (% Too little regulation)

13. Comparing the ranking of 24 countries on their level of support for increased regulation of the banking industry, as well as on two highly correlated variables—mistrust of banks and loss of investment conﬁdence— brings to light a sharp divide between developed and emerging markets.

14. Every one of the 12 most pro-regulation countries has a higher GDP per capita (based on International Monetary Fund data in U.S. dollars for 2011) than any of the 12 most anti-regulation countries with the sole, but, exception of Japan.

15. Two European countries (Spain and France) rank in the top ﬁve on all three metrics (pro-regulation, distrust of banks, loss of economic conﬁdence). Four other countries rank in the top half on all three metrics, of which three are European (Great Britain, Belgium and Italy) and the other is the USA.

16. In emerging countries, trust in banks, the perception that banking regulations are sufficient, and economic confidence tend to fuel each other. Where consumers view banks as reliable and valuable economic actors benefiting society, they do not see a need for further regulation. In these markets, confidence in the banking system goes hand in hand with—and may even drive—investor confidence, which affects economic growth in a positive way. Looking at all markets studied across Asia, Africa and the Middle East, the net trust score of banks and the percentage of consumers rating the economic situation of their country as “good” go hand in hand.

17. In Western countries, especially those most hit by the 2008 financial crisis and ensuing recession, the relationship between attitudes toward the banking sector (more often than not negative), attitudes toward sector regulation (predominantly in favour of more) and investment confidence (in general poor) could be described as a vicious circle. Without doubt, mistrust of banks, thanks to the financial crisis, explains support for regulation. It is likely that mistrust in banks is reinforced by extensive perceptions that the industry resists surrendering itself to increased regulation, or attending to issues of disquiet amongst consumers. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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18. It could be argued that banks are best riding out this wave of public mistrust, with the view that economic recovery will lead British, US and European consumers to warm up to the banks and to their interests. We do not believe that this is a likely scenario, however. 19. Our research shows that mistrust of banks tends to go together with deflated confidence in one’s ability to invest in the future. Loss of trust in banks along with the financial crisis may have played a role in Western consumers’ loss of confidence in their ability to invest in the future. In addition, an improvement in the level of trust in banks might contribute to a renewal in investor confidence. 20. Contrary to Asian or Middle Eastern markets, Western markets do not show any parallel between the current economic climate and the level of consumers’ trust in banks. Across a meta-region, that includes all of Asia, Africa and the Middle East, the correlation of the net trust score of banks and that of the percentage of consumers rating as “good”, the economic situation of their country is extremely high. Across another meta- region comprising Europe, North America and Latin America, however, there is nigh on no correlation between the average net trust score of banks and the percentage of consumers rating the economic situation of their country as “good”. We do not believe that the banking industry can count on an improvement in the economic climate to make British, American or continental European consumers more trusting of banks.

21. Each bank ought to assess its own reputation, what has shaped it and what issues they are confronted with across the various markets in their footprint as well as which messages they need and can credibly convey to consumers to gain, or regain, trust. 22. For leading global financial institutions across 24 countries, the relationship between familiarity and trust is almost purely linear. The correlation between the average level of familiarity with banking companies and their net trust score shows a high correlation. In other words, the more a person knows a bank, the more likely they are to have confidence in it. However, there is an exception to this rule. It does not apply if familiarity is the result of exposure to negative news coverage, which is the case for the banks most associated with the financial crisis of 2008, and is likely to be the case for ensuing banking scandals.

Recommendations 23. Before proffering recommendations about what banks can do to recover trust from consumers, it may be helpful to consider what they should not do. More specifically, what those that are the most strongly associated with the 2008 financial crisis and suffer from a serious trust deficit should not rely on. 24. For one thing, they should not count on economic recovery to turn the tide. While there is a strong relationship between trust in banks and economic confidence in many parts of the world, it does not appear to be the case for banks associated with the 2008 financial crisis and suffering from a serious trust deficit. The problem will not solve itself. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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25. Secondly, these banks should not expect that increasing familiarity would help them rebuild trust. While familiarity is usually an excellent predictor of trust, the familiarity/trust relationship does not apply to companies facing a reputation crisis. Consumers who strongly distrust a company are more likely to ignore advertising, no matter how much of it comes their way. 26. What they can do is tell their story, but only to those who are open to taking note. Banks need to identify the profile of those who are already on their side, those they might be able to convince and those they most likely will not. Then, they should focus on those who are favourably inclined and turn them into advocates, and on those who are neutral or have no opinion and may be rallied to their side. 27. Banks most strongly identified with the 2008 financial crisis and its aftermath and ensuing scandals will need to take ownership of their reputation and address head-on the issues that matter most to consumers. Chiefly, they should provide evidence to consumers across all geographies, including Britain, and demographic groups that they are tackling the issues of concern for consumers. However, they will need to customise their message to each country’s consumers. For example, in Great Britain and the USA, they should place a great deal of emphasis on their responsible lending practices and on the actions they have taken to pay back taxpayers. 28. We would be happy to provide the committee with the full data for this global survey and give any further explanation necessary. 24 August 2012

Written evidence from Neil Jeffares Summary — Banking is not a profession. The illusion that it can be leads to misplaced regulation. — Banking is nowhere near as profitable as people think. Until we work out how much of the industry is sustainable, policy will continue to fail. — Unbridled market forces have resulted in the selection for survival of banks and bankers whose appetites caused the present crisis. — Myths persist about remuneration; mere deferral of bonuses will do nothing to change excessive risk. — Staff compensation swallows an unsustainable proportion of profits, and probably exceeds true value added at industry level. — Stiffer compliance and more fines for misdemeanours will not change behaviour given the deep- rooted cultural issues. Neither will ring-fencing alone. In any case there are serious failings in the regulatory system. — Focusing only on the illegal or unethical misses the real threat posed by banking: its model of socially useless rent-seeking can extract far too much out of the economy without needing to break laws. — What is needed is complete separation at the level of equity capital, unbundling utility and different types of investment banking activities, so that market forces can be brought into alignment with the public interest and determine which of these activities should grow or decline. — Investment managers will need to do a better job of looking after shareholders’ interests.

About theAuthor 1. I commenced work in the City in 1982. After initial credit training in a major American commercial bank, I worked for a number of institutions, spending nearly 12 years at a British merchant bank which I joined when it was still a private partnership; it subsequently became the investment banking arm of a major European bank, and when I left I was global head of a structured ﬁnance business. I have also held a senior position in the ﬁnancial services arm of a major industrial group, as well as running an advisory boutique. I am now an art historian and am no longer active in banking. This submission is made in my personal capacity; my observations below are not directed at any previous employer.

Is banking a profession? 2. No. Banking is a strictly proﬁt-making business, and is not, and never has been, a profession in the sense that, say, medicine or the law is. Many in the City, including myself, have been confused about this, and have attached undue attention to the protection of reputation and sought to impose what we saw as professional standards on staff in the mistaken belief that such values would attract business. We adhered to the “relationship” model of banking which was inexorably supplanted by the “transactional” model in the 1990s. By the mid-1990s clever bankers understood that more money could be made by increasing risk, even if this meant downgrading their bank’s credit rating or reputation. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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3. There may be tiny parts of the industry which could be set up as professional activities, for example M& A advice, but these are activities which involve the sale of labour alone and cannot generate the level of income required to be part of a large banking business. That was why, following Big Bang, not only were these businesses taken over but they were incorporated into other activities that required, and deployed, capital (eg underwriting securities as part of the M&A transaction) for which vastly higher returns could be demanded. 4. A good many confusions follow from this error, notably the idea that professional standards could be relied upon to protect customers with (until very recently) only light touch regulation or (subsequently) more onerous regulation. Where there is a powerful proﬁt drive, neither type of regulation will be effective; the Canute-like delusion that it can be in the face of market forces reveals dangerous naïvety which persists among some regulators. The LIBOR ﬁxing scandal alone demonstrates that regulators simply aren’t able to identify or stop such practices over many years, and Lord Turner has recently accepted that the costs of attempting to handle this through more intensive compliance would be unacceptable. What is needed, as I argue below, is major structural change to the industry so that market forces are aligned with the public interest, rather than relying on compliance sitting orthogonal to the market.

Rent-seeking and the profitability of banking 5. An aspect of the present crisis which, astonishingly, has been overlooked in almost all public debate is the issue of sustainable profitability in the sector. The Vickers commission’s remit was too narrow to look at this. Politicians of neither party are likely to want to confess how, without challenge, they allowed this apparent success story to take hold of the entire economy. And figures from individual banks don’t easily reveal the story. But looking at the overall picture, it is clear that the scale of the industry and its reported profits have grown over the last 25 years at an impossible rate. The bulk of this growth has come from zero-sum activities such as trading. While some genuine earnings can come from providing the real economy with liquidity (levels of which were already more than adequate 25 years ago), the growth in derivatives has outstripped that in GDP by several orders of magnitude. This is just not credible. 6. When politicians say that the City is a major contributor to the UK economy, they may be thinking of several different things. One is the fees and income earned by UK banks from overseas customers. This is no doubt real, even if those customers are being sold products they haven’t evaluated correctly (see the further discussion below). But fewer and fewer of our banks are UK owned. Politicians may also be referring to the national insurance and income tax contribution of foreign bank employees located in London: but this is just a percentage of the total value extracted by those banks, often at the expense of UK customers or taxpayers. These geographical ambiguities foster confusion about where the national interest lies. 7. What no one has done is analyse properly the real contribution the City makes to the UK economy, taking full account of the public interest as well as the complicated way in which the City has induced the state into providing unlimited taxpayers’ support: bail-outs each time there is a crash (and Vickers, even if implemented in full, will not prevent these), as well as by siphoning off significant parts of state support mechanisms. Nor has there been any systematic analysis of the way in which derivatives and similar instruments can be and have been used to roll forward liabilities until the next crash. Until this is done Government and its various commissions will be working in the dark, and policies will remain ineffective. 8. My suspicion is that when this exercise is carried out, we will see that a sustainable banking sector will be far smaller than the current scale of activity in London. The bloated state of the industry is the result of astronomical leverage (direct as well as concealed through derivatives and similar instruments) designed to multiply unnecessary components and permit the repeated extraction of rents from the same underlying assets. The burden of this ultimately falls on the investors, depositors and underwriting taxpayers generally. Social uselessness or Emperor’s clothes, it is unacceptable to carry on any longer with our eyes shut.

Culture andNaturalSelection 9. When over twenty years unfettered market forces are allowed to shape an industry—and particularly where that industry employs clever people with every incentive to obtain results quickly—it can hardly be surprising if the resulting animal is as efficient as possible in achieving its goal. If you don’t have testing, athletes on drugs will take the prizes. Banks who cut corners achieve better results than those who do not; the winners take over the losers, and their culture dominates. (It should surprise no one, but it did, that Barclays, whose culture the FSA has criticised far more severely than any other bank’s, should nevertheless post outstanding first half earnings figures in August 2012.) Worse than this: banks which break rules also succeed and pass on their genes, even where the breach is likely to come to light: it is only necessary for discovery of the breach to be delayed until after the acquisition. 10. The same law of the jungle applies to individual bankers, a fortiori, since they can be dismissed even more readily than a bank can be taken over. Bankers who object to unethical practices, or simply to excessive risk, will be labelled as trouble-makers or just treated as “not a team player”. Their departure from the bank may be covered under a variety of headings and protected through rigorous compromise agreements. Since it is unlikely that the practices they object to will result in criminal convictions, they are rarely in a position safely to communicate their experiences in public. Whistleblowers cannot be adequately protected by public interest disclosure legislation. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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11. You do not have to believe that individual bankers are dishonest to accept this narrative. Rather, through this process has emerged a generation of bankers who have willingly adopted doctrines such as the efficient market hypothesis as an excuse for not considering the broader implications of their conduct. In most cases this is no more than bad faith—in failing to ask the difficult questions—if that, and in many cases bankers may genuinely believe that they are doing nothing wrong if neither statute nor regulation prohibits a profitable practice. While there may be cases of dishonesty which merit a more robust approach to criminal prosecution, it would be imprudent to imagine that all malpractice can be dealt with in this way. The courts are unlikely to convict bankers who have complied with inadequate rules. The industry nevertheless epitomises a trahison des clercs on an extraordinary scale, and requires a different response. 12. Government and other constituencies (investors, journalists, accountants) are not immune from blame: they have failed, and mostly still fail, to ask the questions that would have forced bankers to confront these issues. The bankers their policies have allowed to survive are merely behaving as their selection profile requires. In fairness to the regulators I criticise it may reasonably be argued that had they spoken up to oppose Government policies before the crash, they too would simply have been sacked or sidelined. 13. There is also a broader debate to be had concerning the matters I highlight in paragraphs 5–8 above. There is a core of activity in the City which now makes a substantial, if not the major, contribution to reported earnings, and which is neither illegal nor contrary to regulation nor dishonest in any way. But it is socially useless. From the perspective of the bank employee there can be no objection to entering into such a transaction, even if from the perspective of the shareholder who also invests in the unfortunate counterparty the net result is the cost of the staff bonuses. This is the major problem confronting the City: it arises not from occasional illegality, but from systemic, lawful predation. Banking crashes, which all now recognise offer an unacceptable threat to society, can arise from behaviour which will not be controlled by any acceptable statutory or regulatory framework. 14. It may help to illustrate this discussion with some examples. (a) British bank sells a complex derivative to a German Landesbank, a professional counterparty whose staff nevertheless lack the skill to price the instrument correctly, and consequently makes a loss; no actionable misrepresentation is made. (b) Same transaction, where the counterparty is another UK bank: considered from the perspective of a shareholder of the selling bank only, and from that of a shareholder in both counterparties. (c) As a, where the vendor is an American investment bank and the purchaser is a British bank. 15. My personal view is that none of these is attractive. It is not socialism, but personal self-interest, that makes me wish to prevent activity c occurring. But we cannot expect to have profits from activity a without tolerating c. What has changed since the 1980s is that now c dominates a. In that respect politicians’ complacency about the City’s contribution and the national interest (paragraph 6) needs to be examined more carefully. 16. Consider now two further variants of transaction a above: (d) In the same transaction, an unrecorded conversation takes place in which the British trader misleads the German trader as to the risks. (e) Ditto, where the misrepresentation is in a discoverable document. (f) As a, where the counterparty is a UK small company or retail customer. What these illustrate is how tempting it is for bankers to step into illegal territory. It is of course much easier for the Committee to identify the issues raised by these ethical and legal transgressions. But it would be a mistake to imagine that by improving regulatory responses to such transgressions, we are tackling in any significant way the fundamental threat to the economy offered by the rent-seeking model of today’s banking confined to lawful activities a–c, and as set out in paragraphs 5–8 above. 17. It will be said that there is more to City business than the a, b or c model transactions I have outlined. Only a detailed analysis of every line of business will provide a full response; that is the enquiry I demand in paragraph 7 above. Numerous activities come to mind which are wholly legal and perfectly sensible from the bank’s sole perspective but which simply drain resources from the economy as a whole (examples range from PFI to the promotion of tax planning schemes). Anyone who has worked in the City will recognise the model in which money flows more freely where someone has mispriced a transaction than in those deals where everyone benefits. The latter opportunities are scarce and cannot be scaled up to meet the returns demanded.

Culture andRemuneration 18. Many of the myths about remuneration practices have recently been exploded in the press, although some of us were always sceptical. One of the more ludicrous was the idea that paying bankers large bonuses would improve their decision making (that sat oddly with the misconception that they were professionals). Rather more insidious (because still prevalent in some quarters, including in government and among regulators) is the idea that deferring bonuses or paying them in restricted shares can create alignment and bridle the pursuit of personal greed. This misconception ignores the cognitive error shared by most surviving bankers, in which the risks they take are simply not objectively assessed. There was full alignment but no shareholder protection cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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in the remuneration structure at Lehmans. This will always be the case where (see paragraph 10 above) bankers who do not take risks lose their jobs: that sanction, with its immediacy and devastating personal consequences, will always trump the concern that a risk might reduce part of one’s remuneration. Moreover, even if rationally assessed, it ignores the optionality of the banker’s compensation, and its positive expectation even where the shareholder’s odds are disastrous. 19. Proposals to combat short-termism such as those recently made by John Kay are unlikely either to be adopted or to be effective at changing this pattern of behaviour without far more radical steps (see below). 20. Those who have followed the public debate with an open mind will probably now accept that an excessive proportion of bank earnings is taken by employees and that this is a continuing fraud on the shareholders (albeit one in which investment managers who control most of the shares have been complicit). What matters from this perspective is total employee compensation rather than the structure of fixed salary/ variable bonus or immediate/deferred compensation. On the other hand it is argued that banks depend on key staff who will defect if measures are brought in to restrict remuneration; alternatively entire banks threaten to emigrate to softer regimes. 21. Several aspects of this debate have not been fully explored, and they are relevant to the cultural inquiry. 22. The first is that shareholders are disadvantaged by proposals to defer bonuses, for the simple reason that employees will discount such compensation more heavily than shareholders. If retention is the object, one should pay only the minimum required by the employee: that will be least for cash than for elaborate packages. The growth of such packages (in industry as well as in banking) is really only a cover for increasing the total transfer of wealth away from the providers of capital to its managers. 23. A corollary of this which will assist in the development of a culture of professionalism is that shareholders and society are best served when employees receive nothing more than a fixed cash salary. The incentive to achieve comes down to a sense of personal commitment. That is found in all professions. 24. Secondly, although the proportion of declared operating profit going to staff is already outrageous (often in the range of 67–80% or higher in investment banks, considerably more than a generation ago), the position in relation to true value added is far worse from the point of view of shareholders and other stakeholders. This is because accounts do not consolidate the results of counterparties to zero-sum trading, in both of which shareholders may have an interest. In such cases staff compensation can amount to far more than 100% of aggregate profits. (This is another example of the failure of the public debate to grasp the whole picture.) 25. As noted above (paragraph 7) the international dimension allows the position to be further obscured while the basic logic remains. The lack of clarity about where the benefits flow also permits banks to persuade Government that the threat to emigrate is real, and the losses to the UK economy will be catastrophic. Successive governments in no position to assess these consequences have been paralysed by this fear. They have failed to see that tax havens will not offer the implicit government support on which the whole investment banking machine depends. Of course concerted action among developed Western economies will be more effective than unilateral action on compensation, but Britain is the least willing to join such initiatives because of politicians’ illusions about the City.

RetailConsumerProtection 26. I do not need to comment in detail upon the plight of retail customers of banks, cheated by a growing number of bad products designed solely to boost banks’ profits. Enough of these have been exposed in the press, and the figures of complaints to the Financial Services Ombudsmen tell the story eloquently. What is clear is that banks are now completely unconcerned about their reputation (which has no further to fall), and it is in their best commercial interests to continue to offer unsuitable products despite the risks of fines and compensation. 27. Two reasons explain this. One is that a bank which does not engage in this will generate lower profits than one that does: this is the logic of paragraph 9 above. 28. The second is more worrying. It is the breathtaking incompetence which rules at the Financial Ombudsman Service. I should be happy to provide full details of specific cases where in my view FOS staff have demonstrated a systematic inability to understand the basic principles of consumer protection. The costs of this service fall across the industry and are probably passed onto consumers; if not they are borne by shareholders, but never by the managers who benefited from the activities. As with FSA sanctions for serious wholesale misconduct, fining banks is an ineffective deterrent. This is because shareholders, many of whom are ultimately also the consumers, are not in a position to influence specific behaviour, particularly where the whole industry indulges in a sharp practice.

What is to be done? 29. In my view it is unacceptable to ignore these issues: that will simply lead to further banking crashes. And Vickers, even if not watered down and even if its provisions are in place before the next crash, will be ineffective in protecting stakeholders from those consequences. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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30. I favour an approach based on speciﬁc legislation that will enable market forces to come into alignment with the public interest, in a way which will reduce our dependence on regulation and compliance which cannot provide an answer.

31. To do this it is vital to go back to Vickers and insist on a full break-up of the banks. Ring-fencing alone, which I (as an experienced structured financier) have always argued will be easily subverted, will not only be ineffective, but will do nothing to align the interests of shareholders and regulators. Shareholders will remain unable to exert real influence over the industry when they are faced only with a handful of universal banks all running broadly similar businesses. We need to break up these institutions at the voting equity capital level. In other words, the component entities that will emerge will have shareholders associated with each business stream, in a position (through voting at AGMs or sale of shares) to influence the behaviour of individual activities.

32. The simplest paradigm for this would be the separation of utility and casino operations. This may be all that is required in legislation, although I think there would be merit (and perhaps sufﬁcient market logic to see emerge with its own momentum) in a further separation between say pure advisory and capital-intensive investment banking activities, and for further subdivisions, or “unbundling”, of different parts of these. The key point is that the market would decide, through the value of shares, which activities would receive the capital needed. The utility entities would effectively enjoy full state support, in exchange for severe restrictions on staff compensation, activities and leverage; while the Government would explicitly be prevented from supporting casino operations. Shareholders would be on notice that these businesses are extremely risky. I suspect many will conclude that their capital is unlikely to receive an adequate return for the risks involved, and the withholding of further capital will have the effect of shrinking the size of this sector to manageable proportions. It will also be more conducive to shareholder intervention (as well as addressing the “too big to fail” issue) if the businesses they own are individually smaller and more homogeneous. Accounts should be required to reveal more about the sources of proﬁts—eg from zero sum trading—in a manner that permits investors to obtain a full picture of the aggregate results from all their shareholdings. More complete disclosure of underlying exposures from derivatives and other products should also be required.

33. One area will require continued attention. Shareholders are largely represented by managers in pension or other collective funds, and their lemming-like behaviour, propensity for group-think and general passivity has allowed the present situation to take hold. My recommendations above put them into a position where they can have a real inﬂuence of the structure and performance of this industry. But they must exercise that power with far greater vigour than hitherto. It would be disappointing if they continued to invest my money in casino businesses offering only a tiny premium over the utility returns because they have failed to understand the risks. This is a group where we have every right to insist on professional standards of care and attention, and the exercise of independent thought. Politicians will need to look after the public interest by holding these managers to account. 28 July 2012

Written evidence from Dr Timothy Johnson

Summary — Certain aspects of banking (and asset management) should be made “regulated professions” by creating a statutory requirement that its participants become members of a recognised professional body, in addition to being regulated by statutory bodies. — This is the situation with, for example, The Law Society/Legal Services Board; Royal Colleges in medicine/General Medical Council; Institute and Faculty of Actuaries and chartered and the recognised institutes in accountancy/the various bodies making up the Financial Reporting Council. — Derivative markets are unnecessarily opaque, preventing oversight by civil society. This can be mitigated by changing public perceptions so that banking is regarded as having foundations in science and engaged with on the same basis as, for example, the technically complex energy or pharmaceutical, industries. — Before 1850 there was a history of very close interaction between science and finance, this re-emerged in the 1950s, but outwith the context of a strong profession. — It would be remarkable if standards in conventional STEM (Science, Technology, Engineering, Mathematics) based professions, such as chemical engineering, were seen as being susceptible to issues of globalisation, innovation, technology or regulatory arbitrage. — Since 2010 we have experienced the Deepwater Horizon and Fukushima Daiichi disasters. In July 2012 GlaxoSmithKline was fined $3 billion in relation to drug promotional practices between 1997 and 2010. There seems to have been closure by the general public on these significant events, something that has not occurred in banking. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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Brief Responses to Speciﬁc Questions 1. To what extent are professional standards in UK banking absent or defective? How does this compare to (a) other leading markets (b) other professions and (c) the historic experience of the UK and its place in global markets? — Professional standards, both in the sense of ethics and skills, are lacking in UK banking because it is not a recognisable profession, in the same way that law, medicine, accountancy, actuarial science and engineering are. — See B.7—B.10 and B.25—B.27. — The historic experience is covered in Section A.

4. What caused any problems in banking standards identified in question 1? The Commission requests that respondents consider (a) the following general themes: — the culture of banking, including the incentivisation of risk-taking; — There was a change in banking culture as virtue ethics were superseded by consequentialist/utilitarian ethics after the 1830s. In this respect banking has followed an exogenous change in culture, and I highlight Buttle v Saunders in 1950 as indicative of this. — See A.21—A.26. — the impact of globalisation on standards and culture; — I do not regard globalisation as being a significant driver in degradation of standards. Finance has always been a global phenomenon and the global derivatives markets in 1910 were not too different to the contemporary markets. The difference between 1910 and 2010 is that the tradition of “my word is my bond” seems to have been replaced by “greed is good” and I identify this with a replacement of virtue ethics by utilitarianism. — The character of Antonio in Shakespeare’s The Merchant of Venice, who was engaged in international trade, can be seen as a personification of the virtue caritas/agape. Shylock was not greedy, he would not take money, but hateful. — The global economy was tightly controlled by a few powerful governments between 1914 and the collapse of Bretton-Woods in 1972. Following the “Nixon shock” of 1972 the world has become more stochastic (random), not simply more interconnected, and in response to these changes the derivative markets re-emerged. — See A.21—A.35. — global regulatory arbitrage; — I make no comment on global regulatory arbitrage, however I do note that the plethora of qualifications acceptable to the FSA leads to the possibility of regulatory arbitrage, by selecting the “easiest” qualification to enable a person to engage in an activity. This situation would be mitigated by the existence of a regulated professional body. — See B.12. — the impact of financial innovation on standards and culture; — I do not regard financial innovation, in and of itself, as having an impact on standards or culture. Twice in the history of Europe there have been periods of significant financial innovation, in the “long twelfth century” and in the second part of the seventeenth century. During both periods science and mathematics developed in the context of developing an ethical assessment of these innovations. These are often overlooked episodes in the history of science and I bring them to the Commission’s attention. — See A.1—A.20 and A.27—A.34. — the impact of technological developments on standards and culture; — The relationship between technology and culture is a question of general interest, but complex and not widely discussed. I argue that if finance is regarded as a “STEM” based discipline, in the same way that industries such as energy or bio-technology are, it would transform finance from a hidden, “magical”, discipline into one that is subject of public debate and discussion, just as the energy and bio-technology are. — See B.13—B.22. and (b) weaknesses in the following somewhat more specific areas: — recruitment and retention; — other areas not included above. — There are concerns amongst academics that there are the technical skills in depth within banking to support the pricing and risk management of the products being traded, they are not present in breadth. Expertise is concentrated in small, often isolated, groups within the industry. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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— This has a direct impact on remuneration, grossly inﬂating the pay of a few with specialist skills. Furthermore this problem is compounded in society in general, to the extent that there is no effective oversight of the markets by civil society. — See A.36—A.54 and B.14—B.25.

5. What can and should be done to address any weaknesses identified? To what extent are such weaknesses subject to remedial corporate, regulatory or legislative action, domestically or internationally? — Many of the weaknesses of concern to the Parliamentary Commission on Banking Standards are a consequence of the lack of a strong profession underpinning the industry. The creation of a strong profession cannot be accomplished by fiat but it can be facilitated by legislation and Parliamentary action. — No comment on current international regulatory issues is made, apart from noting the influence the UK has by having strong professional bodies across a range of disciplines. — See B.8—B.22. 6. Are the changes already proposed by (a) the Government, (b) regulators and (c) the industry sufficient? Respondents may wish to refer to the Financial Services Bill and the Government’s proposals for the Banking Reform Bill. They may also wish to refer to proposals by the Bank of England and the Financial Services Authority on how the Financial Policy Committee, Prudential Regulation Authority and Financial Conduct Authority will operate in practice. — The Financial Services Bill and Banking Reform Bill (on the assumption it focuses on structures) do not address the issue of establishing a strong banking profession. — However, the experience from other fields clearly indicates that it is useful to distinguish the regulator and the professional body. — See B.26—B.29.

The Historic Experience A.1. Many of the financial products that emerged in the late twentieth century would have been recognisable to merchants operating before the seventeenth century. A.2. To avoid accusations of usury all financial products during the middle ages had to be asset backed and/ or involve risk. Usury derives from the Latin usus meaning “use”, and referred to the charging of a fee for the use of money. Interest comes from the Latin interesse, and originated in the Roman legal codes as the compensation someone was paid if they suffered a loss as a result of a contract being broken [Homer & Sylla p 73]. A.3. In light of these restrictions, the basic financial instrument in the medieval period was the census which today would be described as an asset-backed structured product. Censii originated when Carolingian monasteries guaranteed donors a fixed regular income in exchange for a bequest. These contracts developed such that a borrower would receive a lump sum secured against the future cashflow from an asset, rente à prix d’argent. Since the payment stream from the assets underlying a census was uncertain but the loan repayments were usually fixed, there would be an implicit swap involved in the contract. A.4. Censii were written on the back of assets as diverse as an estate or a craftsman’s labour. Censii evolved into prestati, which were forced municipal bonds that funded the growth of medieval Italian cities. A.5. The triple, or German, contract (contractus trinus) was developed to fund long distance trade. It involved a loan to fund the venture (the first contract), a swap to transform the variable return of the venture into fixed cashflow (the second contract), and an insurance contract to guarantee the fixed payment (the third contract). The third contract is equivalent to a modern Credit Default Swap. This contract was declared illicit on the basis that the lender received a riskless return [Detestabilia avarita, Pope Sixtus V, 1586]. A.6. Collateralisation, amalgamating loans into a different “tranches” with different risk profiles and then selling off shares in the tranches was practiced in the sixteenth century [Poitras p 269]. A.7. In conjunction with innovations in finance, Fibonacci introduced Islamic mathematical techniques into Europe in the Liber Abaci of 1202. The impact of the Liber was profound and long lasting. The techniques described in the Liber enabled merchants to record, disseminate and improve techniques for managing their affairs. It laid the basis of the “mathematisation of science” in the seventeenth century [Hadden, Kaye, Crosby], mathematicians trained by the text include Copernicus, who wrote on money before he wrote on planets, and Stevin, the tax official who anticipated many of Galileo’s observations and laid the foundations for Descartes’ Discourse on the Method. A.8. Financial practice became a subject of scholastic enquiry was another stimulus in the “mathematisation of science” and the development of probability theory. The motivation was the assessment of contemporary mercantile practice in the context of Aristotle’s Nicomachean Ethics. Notable early contributions come from the Dominicans Albert the Great, Thomas Aquinas and the leader of the Spiritual Franciscans, Pierre Jean Olivi, followed by the proto-physicists Thomas Bradwardine, Jean Buridan and Nicole Oresme. [Hadden, Kaye, Franklin] cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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A.9. Medieval morality was built on what are now called virtue ethics, the blending of the four cardinal virtues, described in Nicomachean Ethics, fortitude, justice, prudence (from Latin pru¯dentia foresight, practical understanding) and temperance (from the Latin tempera¯re to divide or proportion duly, to mingle in due proportion, to combine properly), and the three Christian virtues of faith (from Latin fı¯deˇre to trust), hope (in Latin spes) and charity (in Latin carità , related to the Greekα` γα´ πη “to treat with affectionate regard”). The blending of the virtues (temperance) acted as a focus for discussion of motives and moral character, moral education, moral judgement, friendship and family relationships, the concept of happiness, the role of the emotions in morality and the fundamentally important questions of what sort of person one should be and how we should live. Chinese morality was traditionally based on a similar system of virtue ethics. A.10. In the mid sixteenth century Cardano undertook the first mathematical analysis of probability while investigating the ethics of gambling [Bellhouse]. He observed, in relation to his analysis, that “These facts contribute a great deal to understanding but hardly anything to practical play” but that “a just gamble is one between willing and knowledgeable players”, and mathematics provided the scientific basis of a just gamble. A century later Pascal and Fermat, Huygens and J. Bernoulli laid the canonical foundations of mathematical probability in the context of commercial ethics [Sylla, Sylla]. A.11. Contemporary with Cardano, Thomas Gresham, the Factor to the English Crown in Antwerp, manipulated the market in Bills of Exchange to ensure Elizabeth I could borrow at low rates. Gresham created the Royal Exchange in 1565 and bequeathed money to establish Gresham’s College and the first chair in mathematics in the UK, laying the foundations for the Royal Society. A.12. Shakespeare’s The Merchant of Venice, probably written between 1596 and 1598, can be seen as a commentary on the four forms of love (storge, philia, eros, agape) that highlights the agape(caritas) of Antonio, The Merchant of Venice. When C. Huygens was translating the first mathematical text on probability, On Reckoning in Games of Chance (1657), into Latin, Huygens considers using the terms expectatio (from Latin expecta¯re to look out for, await) or spes, usually associated with the virtue hope, for what is now known in English as mathematical expectation. The French chose spes and use esperance rather than expectation in mathematics. A.13. The modern English financial markets emerged during the Nine Years War (1688–1697) along with the establishment of the Bank of England. The historian Anne Murphy [Murphy] estimates that 40% of trade at this time was in options on underlying stocks. A.14. In response to rampant counterfeiting, in 1696 Parliament instigated the Great Recoinage, precipitating economic collapse. In the same year Isaac Newton was appointed to the Royal Mint, abandoning the Lucasian Chair in Mathematics at Cambridge in 1701 (the salary of the Warden of the Mint was sixteen times that of the Lucasian chair). Newton would oversee the fixing of the gold-silver exchange rate 1717, an exchange rate that would shift Britain from the silver standard to the gold standard. In acknowledging Newton’s achievements at the Mint, John Maynard Keynes would describe Newton as “one of the greatest and most efficient of our civil servants”. A.15. In 1709 Daniel Defoe wrote about Lady Credit, the coy mistress, for as once to want her, is entirely to lose her; so once to be free from Need of her, is absolutely to posses her. [de Goede p29 quoting Defoe, 1709] However speculators had raped her The first Violence they committed was downright Rape … these new-fashion’d thieves seiz’d upon her, took her Prisoner, toss’d her in a Blanket, ravish’d her, and in short us’d her barbarously, and had almost murther’d her [de Goede p34 quoting Defoe, 1709]] Ten years later Defoe wrote The Anatomy of Exchange Alley in which he described stockjobbing as a trade founded in fraud, born of deceit, and nourished by trick, cheat, wheedle, forgeries, falsehoods, and all sorts of delusions; coining false news, this way good, this way bad; whispering imaginary terrors, frights hopes, expectations, and then preying upon the weakness of those whose imaginations they have wrought upon [quoted in p Poitras p 290] Elsewhere, Defoe wrote that “mathematicians might cure the reckless of their passion for cards and dice with a strong dose of calculation” [Gigerenzer p 19]. A.16. In 1720 the future Poet Laureate, Colley Cibber, wrote the play The Refusal, “Refusal” being a common term for an option contract at the time, describing the action in Exchange Alley There you’ll see a duke dangling after a director; here a peer and`prentice haggling for an eighth; there a Jew and a parson making up the differences; there a young woman of quality buying bears off a Quaker; and there an old one selling refusals to a lieutenant of grenadiers [Ackroyd p 308] The inference is that in 1720 the public were familiar with the trading of derivatives, pretty much everyone was involved, and social, religious and political differences were forgotten in the markets. A.17. 1720 saw the bubbles around the Mississippi Scheme in France and the British South Sea Company burst. There were differences in how the French and British states responded to the crisis. In France, the main cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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protagonists went unpunished; John Law, the Scottish banker was allowed to leave the country by the Regent, who died shortly after, while D’Argenson, the Chancellor, was allowed to retire to the country. While convenient, this response was unpopular; there were riots at D’Argenson’s funeral in Paris while John Law was given the epitaph (translated from the French) Here is that famous Scot This calculator without equal Who, by the rules of algebra Put France in the hospital. In Britain, there was more action than in France. The Directors of the South Sea Company were punished by Parliament, typically with fines, with the observation about one Director being “His well-known abilities could not plead the excuse of ignorance or error”. A more profound change came in the re-structuring of the Government and the establishment of Walpole as Prime Minister. Over the next century the British Government was much better able to fund the wars it fought with France, and British entrepreneurs were much better able to fund innovation than their French counterparts. A.18. Between 1740–1746 a pair of Church of Scotland Ministers aided by Britain’s most prominent mathematician of the time, Colin Mclaurin, created the first ever mathematically managed pension fund, the Scottish Ministers’ Widows’ Fund. In one sense this was a synthesis of statistics, probability and finance. However, the Presbyterian ministers may have seen it as a demonstration of faith in statistics, hope in probability and charity, in the care for ministers’ widows. A.19. In the second half of the eighteenth century Quakers became dominant in English banking (laying the foundations of Barclays and Lloyds). Their success is often put down to their absolute honesty (a blending of the virtues of fortitude, justice and faith), respect for others (caritas) and an advocacy of education and innovation (prudence, faith, fortitude and hope). A.20. In the hundred years after the emergence of the financial markets in the 1690s, Parliament would enact various laws to hobble the excesses of the markets, in 1697, 1720 (the Bubble Act), 1733 (Barnard’s Act, which restricted options trading) 1746, 1756, 1762 and 1773. All the Acts, as the 1697 Act stated, were broadly designed to “Restrain the number and ill Practice of Brokers and stock-jobbers”. The fact that a new Act appeared every decade is a testament to their ineffectiveness. A.21. Ethics is today divided into three main classes, virtue ethics, consequentialism or utilitarianism and deontology. Consequentialism maintains that an act is morally right if and only if that act causes “the greatest happiness for the greatest number”, while deontology is ethics based on obligations or rules. For example, the different ethical systems would address the question of helping someone in need in different ways: The consequence of helping someone will maximise overall well-being, helping someone is following a rules such as “Do unto others as you would be done by” or helping someone is a demonstration of charity. A.22. In the second half of the eighteenth and first half of the nineteenth century virtue ethics went into a decline. It was overshadowed by both consequentialism and deontology, based on the view that these two systems were superior because they enabled morality to be codified into a set of clear rules and principles. This view is associated with Analytic Philosophy, which places emphasis on formal logic and clarity, as opposed to “Continental Philosophy”, which places more emphasis on the contingency of experience, and relativism in morality. Analytic Philosophy has dominated the English speaking world over the last century, particularly in the form of Logical Positivism in science in general and advocated by Milton Friedman and Paul Samuelson in economics. A.23. As virtue ethics became overshadowed, the virtues became re-defined. Fortitude was replaced by courage, or bravery, temperance, becomes abstinence, charity becomes giving, while the sin sloth, what we would now describe as depression and was counterbalanced by hope, becomes laziness and characterised the undeserving poor. Virtue ethics re-emerged in the late 1950s with G. E. M. Anscombe’s paper Modern Moral Philosophy and is becoming an important topic in business, with The Journal of Business Ethics preparing a special edition on virtue ethics and Deidre McCloskey’s recent advocacy in The Bourgeois Virtues. A.24. Consequentialism, or Utilitarianism, has been closely associated with neo-classical economics since its emergence in the early nineteenth century. John Stuart Mill, who along with Bentham and Sedgewick is associated with the emergence of the philosophy, argued that [Political economy] … is concerned with him solely as a being who desires to possess wealth, and who is capable of judging the comparative efficacy of means for obtaining that end. ... [It presupposes] an arbitrary definition of man, as a being who inevitably does that by which he may obtain the greatest amount of necessaries, conveniences, and luxuries, with the smallest quantity of labour and physical self-denial with which they can be obtained. [Mill, On the Definition of Political Economy, and on the Method of Investigation Proper to It, Paras. 38 and 46]. Mill’s approach resonates with Tennyson’s “nature red in tooth and claw” and Darwinian metaphors of survival of the fittest. Alfred Marshall would complete the synthesis of economic and Darwinian ideas in the late nineteenth century. [Backhouse, Thomas]. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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A.25. The ascendancy of these theories coincides with the decline in the public perception of bankers. This was personified in the collapse of the bank Overend, Gurney and Company. Established in 1800 and run for most of the early 1800s by the prominent Quaker Samuel Gurney, it rescued banks in the crisis of 1825 and became known as the “bankers’ bank”. After Samuel Gurney’s retirement the bank transferred its capital from being primarily in liquid assets, such as cash, into investments in railways and other long term projects, which appeared to offer better returns. However this strategy exposed the bank to a liquidity crisis that it resolved by issuing equities into a buoyant stock market in 1864–1865. However in 1866 the railway bubble collapsed, bringing down the bank. A.26. A watershed in the ascendency of consequentialism in England is the case Buttle v Saunders [(1950), 2 All ER 193]. Saunders managed a trust for Buttle, and had agreed to sell a piece of land owned by the trust for £6,142 to a Mrs Simpson. Before the transaction had become legally binding, another person offered the trust £6,400 for the land. However, Saunders believed “my word is my bond” and declined the higher offer in favour of the original agreement with Mrs Simpson. The beneficiary of the trust, Buttle, took Saunders to court, and the court ruled in favour of Buttle The only consideration which was present to [the trustees] minds was that they had gone so far in the negotiations with Mrs Simpson that they could not properly, from the point of view of commercial morality, resile from those negotiations. The Court ruled that “commercial morality” had no place in financial transactions, which should be governed by the utilitarian principle. A.27. Alongside these theoretical developments, gambling became illegitimate. The 1774 Life Assurance Act outlawed many practices associated with insurance that are now considered to be wagers and established the concept of an “insurable interest”. In 1808 there was a House of Commons Select Committee that investigated the “evils of gambling” and this lead (slowly) to the suspension of lotteries as a form of public funding in 1823 (the last draw being in 1826). In 1845 there was a Gambling Act and this lead to the case of Grizewood v Blane [(1851) 11 C.B. 526] in 1851 where Blane’s successful defence for non delivery on a forward contract was on the basis that derivative contracts were wagers, and so illegal. A.28. From this point on, derivatives existed in a nether world, they were regarded as licit if written on an physical commodity that might be delivered on execution, but “contracts for difference”, where cash would change hands contingent on the prices of assets, were not protected by law. This situation was similar to the differentiation of usury and interest in the medieval period. A.29. Despite this legal ambiguity derivative contracts were widely traded. By the first decade of the twentieth century they were becoming the subject of academic interest, not just in Bachelier‘s well-known thesis but also in the work of the Croatian Vincent Bronzin, and of popular discussion, such as Samuel Nelson’s 1904 book The ABC of Options and Arbitrage. Samuel’s book describes the global interaction (incorporating Berlin, Paris, London and New York) between financial practice (exploiting arbitrage in both commodity and financial markets), mathematical theory (which was less important to American’s like Nelson than Europeans) and technology (the practices relied on fast telegraphic communications). A.30. The markets closed on the eve of the First World War, and while speculation on currency options in the US was popular in the years after the peace, the markets did not recover in Europe before the Great Depression and then the Second World War. Bretton Woods re-established fixed exchange rates in 1944 which held for at least a decade. Currency speculation increased in the 1960s as the 1944 world-order changed as the US paid to fight in Vietnam as the German and Japanese economies went into overdrive. A.31. Bretton-Woods collapsed in 1972; this had an immediate impact on interest-rates. In the 27 years between 1945 and autumn 1972, the Bank of England changed its lending rate 43 times, in the 27 years after 1972, it changed them 223 times, about every 45 days. A key economic factor had gone from being fairly stable to being a random process. Similarly, as the US dollar fell in value, price setting mechanisms in commodities, notably oil, collapsed. A.32. It was in response to these geo-political changes that derivatives re-emerged in financial markets. It is simplistic to claim that derivatives emerged either as mechanism for financiers to access profit opportunities or in response to academic developments. Derivatives were a natural, in the sense that they were not invented but re-introduced, solution to a fundamental change in the economy, switching from a broadly deterministic system into a random one. This point is often missed even by the majority of British mathematicians who do not have a firm grounding in probability theory. A.33. Care should be taken in comparing regulatory frameworks that were successful between 1930 and 1972 with what is desirable now. This is because the economic environment between the Great Depression and the Nixon Shock was somewhat benign, with state control of key indicators. To appreciate this, observe that it is easier to manage a baby before it becomes mobile, you can safely leave a 3-month old in the middle of a double bed for a few minutes, you could not do the same with a 9 month old. A.34. Similarly one should be aware that much economic theory was laid down in the century after 1820 when science treated uncertainty as a lack of information (characterised by Laplace’s Demon) rather than a fundamental feature of life that would drive the economy. This is not just true of neo-classical economics but cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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also of Marxism. The exception to this was aspects of Austrian economics (Schumpeter), American Institutionalism (Knight) and Keynesian economics which all placed uncertainty at the heart of economics. Derivatives are a pragmatic solution to dealing with randomness in the economy, and many would argue that randomness is a fundamentally important aspect of growth generation. A.35. A few years after Buttle and Saunders, Milton Friedman published the Methodology of Positive Economics, arguing that economics should be an “‘objective’ science, in precisely the same sense as any of the physical sciences”, an impersonal way of arriving at the objective truth and free from “normative” ethical arguments. This was part of the Mont Pelerin Society’s programme that would become famous for providing the intellectual foundations for US and UK economic policies in the 1980s. A.36. This coincided with a period when economics was transforming from a broadly qualitative science, as it had been in 1925, into a quantitative one. This process was accelerated by the experience of policy makers in the Second World War. The influence of mathematical sciences in winning the war was significant (eg radar, logistics/operations research, code-breaking) and was a common feature of the US, UK and USSR. Before 1935 it would have been unusual for a general to support the use of mathematics in warfare, by the end of the war, General Eisenhower was calling for more scientists to support the military [Schrader p 64]. Significant areas of contemporary financial economics have their foundations in the interface of mathematics and the military (eg quadratic programming in portfolio optimisation, the use of stochastic processes and stochastic control). A.37. While economics adopted the formalism of mathematics, mathematicians have often been sceptical about how economists were using the discipline. In 1947 the economist Paul Samuelson published Foundations of Economic Analysis, which laid out the mathematics needed to understand economics. The mathematician John von Neumann was invited to write a review of Foundations but declined because “one would think the book about contemporary with Newton” Von Neumann, like many mathematicians who looked at economics, believed economics needed better maths than it was being offered [Mirowski, p 134]. A.38. In 1948 Samuelson published the first edition of his most famous work, Economics: An Introductory Analysis, which was the first successful description of Keynesian economics, as opposed to Freidman’s monetarism, to a U.S. audience and is probably the most influential economics textbook ever written. A.39. Together, Friedman and Samuelsson encapsulate mainstream, neo-classical, economics, which is a positive and mathematical science, in accordance with the requirements of Analytic Philosophy. A.40. However, many mathematicians are concerned as to the use mathematics is put to in describing economics and financial markets. This was the central thrust of the opinions included in a submission from the leading Professors in Financial Mathematics for the Science Minister (Lord Drayson) on 2 March 2009. The failures in finance were a consequence of an abuse of mathematics rather than its use in finance. One episode reported in the submission concerned a mathematician who was involved a discussion of banking regulation, and was dismayed to find the discussion focused on the legal meaning of the statements in Basel II, not a discussion of the robustness of the mathematical models being proposed. A.41. The Turner Review of 2009 highlighted the shortcomings of the quantitative technique known as Value at Risk (VaR). VaR had come in for severe criticism from mathematicians in 1999 [Artzner et al.] and the whole approach being taken by regulators was criticised by an alliance of mathematicians and finance academics [Danielson et al.]. A.42. Another mathematical object that featured in the Basel regulations was the “Vasicek single factor model of portfolio credit loss” (which is related to “The formula that killed Wall Street“). While parts of the methodology, which was developed by a private firm, were published and well understood, there were significant gaps in the theory. In response, in 2003 a mathematician employed by the U.S. Federal Reserve [Gordy], looked at the approach to see if, mathematically, it did what it claimed to do. Gordy concluded that the formulae in the proposal to revise the Basel accord would do what they claimed to do and were a rational extension of the existing system. However, he also raised the question, were these revisions actually up to the task presented by modern finance. A.43. Modern probability theory was championed in the US by William Feller and Joseph Doob in the years after the Second World War. In a presentation of the theory to fellow mathematicians, Feller considers how economists might use the theory by making the point that Any [random] process defined by a system of differential equations ... with constant coefficients will be ... ergodic” [First Berkeley Symposium on Mathematical Statistics and Probability p 417] ie to say a system is ergodic is to say it is based on unchanging parameters. Ergodic systems can be random, but random in a stationary way (as a coin toss or dice roll is). A.44. Feller immediately goes on to discuss the implications of ergodicity in economics with reference to Pareto’s theory on income distribution. Feller finishes this discussion with the observation that if the [ergodic] hypothesis should prove false, this would not disprove Pareto’s claim, but at least it would produce doubts in certain respects. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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From the perspective of mathematics, ergodicity is helpful in simplifying things, but it is not a requirement, and furthermore, non-ergodic systems are more interesting to mathematical researchers. A.45. The implication is that if economics is going to address difficult issues it should not (must not) confine itself to ergodic systems, and there is a strong case for economics not to rely on simple maths but to drive the development of maths (as it has historically) (Non-ergodic systems are important in the physical sciences, particularly in signal processing, and are well studied.). A.46. The question why is mathematics important is often answered circularly—because it is important in a modern, knowledge based economy. It is sometimes difficult to find an explanation as to why mathematics is important in a modern, knowledge based economy. A.47. The role of mathematics in science is to provide proof were experimentation is not available. This point was first made by Henri Poincare [The Value of Science, pp 184–185] and explains why mathematics is important in many branches of physics, such as astrophysics or in identifying the Higgs Boson, which was a mathematical object up until it is discovered(?) by expensive machinery. This is the origin of the observation that mathematics is rarely useful, because it operates at the frontiers of knowledge where conventional techniques of everyday experience (machines and instruments) are not available. A.48. Mathematics developed this role because of its properties as a language. Fibonacci’s Liber Abaci was a success because it enabled merchants to record, disseminate and improve techniques for managing their affairs, mathematics is employed in modern science because it similarly enables scientists to summarise and disseminate ideas that can be improved through collaboration. Mathematics is not essential in science, compare Darwin’s development of biology without mathematics with Mendel’s contemporary work employing mathematics, but it facilitates the process and enables collaboration. Mathematics is a social science. A.49. Just as spoken language evolves, mathematics also changes. Mathematics changes in response to our knowledge; Euclidean geometry is replaced by Riemanian geometry as technology develops outside mathematics. A.50. Mathematics is essential in finance because it is not possible to experiment in the economy and the economy is too complex to be addressed without collaboration. A.51. Samuelson is closely associated with using mathematics in economics, in particular the “maximising expected utility” paradigm in economics. This synthesises consequentialist ethics with mathematics and the US economist Prof Deirdre McCloskey describes the approach in the context of virtue ethics as “prudence only”. A.52. However the use of mathematics in economics relies on a mathematical model. One of the challenges facing modern science is that in the absence of experimental verification there is always doubt and uncertainty about the model employed. The debates about climate change are as much about disagreements over models as over data. Generally in finance and economics, choosing a model chooses the result. Employing mathematics only creates an appearance of objectivity, the choice of model is often subjective and the results of the model are consequently subjective. A.53. For example, one often hears of “contagion” in relation to financial crises. If the banking system is modelled as one susceptible to contagion the solution will be to create firewalls and concentrate risky activities. This was exemplified by the change in the UK’s meat processing industry since the Foot and Mouth epidemic of 2001: a network of small local abattoirs has been replaced by a handful very large regional abattoirs in order to be better able to contain contagion. If the banking system is modelled as a communication network, with loan agreements taking the place of messages, the solution will be to build a distributed network with many pathways between different nodes. The Internet, designed by the US military as a communications network that would survive a nuclear strike, is a classic example. Hence, modelling banking as a system subject to contagion would suggest a banking system of a few large, well protected banks, whereas modelling it as a communication network will result in a system of lots of small banks, none too big to fail. A single network is typically more stable than smaller networks with a few interconnections between the two, suggesting splitting the banks into retail and wholesale institutions might not be optimal. This is one example of the scientific minefield that policy-makers must navigate. A.54. The Government’s Scientific Advisers should be assisting policy makers in navigating the modelling landscape, it is not obvious that the Treasury‘s Chief Scientific Adviser is in a position to do this.

B. Regulating the Markets B.1. The Parliamentary Commission on Banking Standards has been set up in response to the LIBOR setting crisis, an episode of widely accepted dishonesty, in the context of on-going financial turmoil. The theme of ethics figured prominently in The National Commission on the Causes of the Financial and Economic Crisis in the United States, which concluded that “there was a systemic breakdown in accountability and ethics” in the financial markets leading to the crisis of 2007–2009. A key aspect of professional standards is professional ethics. B.2. Addressing ethical issues can be done in one of three main ways, through consequentialism, deontology or virtue ethics (see A.9, A.21—A.23). cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

Ev 1180 Parliamentary Commission on Banking Standards: Evidence

B.3. Consequentialism and deontology have proved popular over the past century because they appear to be amenable to codification. However the successive failures of financial regulation, going back to 1697, suggest that deontology is ineffective. Similarly, consequentialism suffers from the problem that the model determines the answer, how the benefit is calculated is usually a subjective judgement (see A.50—A.51). B.4. From the perspective of deontological ethics, LIBOR fixing might not be considered immoral, since there was no rule or clear obligation being breached—LIBOR is not a statutory instrument. Similarly a consequentialist might argue that underreporting LIBOR was utilitarian during the Crisis. This point was made in a letter from Mr Paul Langtry published by the Financial Times on 9 July 2012 with the observation that Time is a great healer and things may look better in five or 10 years. Thus I would not blame either the BoE, Barclays or the other bank rate setters. In fact they have probably saved the financial system and capitalism for the foreseeable future. However the fact that the Parliamentary Review is taking place suggests that the LIBOR underreporting was immoral, and this immorality is captured within virtue ethics as a breach of trust (faith) and a lack of honesty (fortitude, justice and faith). B.5. The Basel II regulations, as examples of international financial regulatory frameworks, can be seen as combining consequentialism and deontology, setting down rules and obligations that a financial firm needed to follow with the consequence that “market discipline” would punish them if they fell short. Basel II proved a failure as its rules were poorly set and the consequences were illusionary. (see A.41—A.43, A.46) B.6. This leaves the option of virtue ethics, which is concerned with, amongst other topics, moral character, moral education, moral judgement, relationships, and what sort of person one should be and how we should live. This approach does not lend itself to direct legislation, but rather to the creation of communities with shared cultures (in the sociological sense). B.7. Virtue ethics, which are associated with the successful development of British finance in the eighteenth century, is closely related to professionalisation. Professional bodies create an ethical framework that extends beyond a specific firm. In the case of established professions, the professional body provides a focus for the interaction between the practice, in industry, and the academic theory. Professional bodies also provide a linkage between society as a whole and the professional practice, in a way that trade bodies cannot. B.8. The Parliamentary Review is concerned with “professional standards”. This immediately raises the question whether or not banking is a profession in the same way that Accountancy, Law, Medicine, Insurance or Teaching are professions, being state regulated professions, or Engineering is a profession with world wide expectations that professional engineers are “chartered”. B.9. The British Bankers Association is a trade body; its membership is firms not individuals with individual responsibility. The English Institute of Bankers was founded in 1879 and given a Royal Charter in 1987 and has transformed itself into the Institute of Financial Services, which is a “division” of the IFS School of Finance, focusing on awarding qualifications. The closest to a professional body for bankers is The Chartered Institute of Bankers in Scotland, who have a Professional Standards Board. However, this organisation has only around 4,000 members, and so can hardly claim to be the professional body (the Institution of Chemical Engineers, representing a smaller constituency, has 32,000 members). B.10. A lack of a professional body will have a direct impact on standards, it will also have an affect on skills. It has recently been reported that “risk management” competencies in finance are some 20 years behind engineering industries. B.11. As part of the liberalisation of financial regulations following the establishment of the Financial Services Authority, there was a relaxing in regulations regarding “appropriate qualifications” of personnel in banking. Essentially participants in wholesale markets (intrabank dealings) do not need to have the level of qualifications a consumer facing participant is required to hold. The belief was that the firms would only employ “suitably trained” personnel who had one of a range of qualifications. B.12. The plethora of qualifications acceptable to the FSA creates opportunities for “regulatory arbitrage” in the same way that a plethora of exam boards in England has led to problems, recently highlighted by the Commons Select Committee on Education in their report The administration of examinations for 15–19 year olds in England published 3 July 2012. B.13. This lack of a clearly defined profession being at the heart of wholesale finance has resulted in a lack of attributes that one would associate with a profession, in particular there is no core body of knowledge possessed by participants. This means that there is no firm foundation for communication and understanding between participants. It has a second order effect that there is often homogeneity, and not diversity, within a single organisation. This arises because groups select colleagues who share their perspective, creating an environment that supports “group think” and hinders scientific scepticism. B.14. For example, consider the important word “risk”. The primary definition in the Oxford English Dictionary is (Exposure to) the possibility of loss, injury, or other adverse or unwelcome circumstance; a chance or situation involving such a possibility. cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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Within statistics, following De Morgan in 1832, “risk” is synonymous with the “mean square error” between a parameter’s estimate and its true value, and an estimate with the lowest “risk” is chosen. Within economics, following Frank Knight’s 1921 Risk, Uncertainty and Profit “risk” is a knowable probability, such as the chance of rolling a six with a dice, this is a distant cousin of the statistical definition. An “uncertainty” is an immeasurable probability. This is different to John Maynard Keynes, who used the term “cardinal probability” for a mathematical probability and “irreducible probability” for an unknowable probability. Keynes introduced these terms in A Treatise on Probability, also published in 1921. Mathematicians often use “chance” for Knight’s “risk”, following from de Moivre’s 1718 text The Doctrine of Chances. B.15. Hence, a group comprising of a trained engineer (using the conventional definition of risk), a Chicago trained economist (using Knight’s definition) , a Keynesian economist, a statistician and a mathematician, all of whom might be working for the same team in a bank, do not use the fundamental term “risk” in the same way. B.16. There are aspects of modern finance that that should be classed as a STEM (Science Technology Engineering Mathematics). In 2009 BIS published The Demand for Science, Technology, Engineering and Maths Skills, which provides some important statistics. Of recent graduates in Physical, Mathematical, Computer Sciences and Engineering, 11% were working in finance 44 months after graduation. Of graduates of Mathematical Sciences, 10% of the above group, 33% were working in Finance, the biggest single employment sector of mathematicians. This contrasts with the whole population of these graduates, only 7% of all Physical, Mathematical, Computer Sciences and Engineering graduates work in the area while only 21% of all maths graduates work in finance. The fact that a higher proportion of recent STEM graduates work in finance reflects the increasingly “technical” basis of finance. B.17. The Royal Society’s Hidden Wealth Report notes (section 3.2) that The tools [enabling recent financial innovation] have been created by mathematicians, physicists and engineers, many of them with PhDs. Senior academics report that, in recent years, some 50% of the engineering graduates from Imperial College and other top UK engineering departments have gone straight to work in the City of London reflecting an over-representation of STEM graduates from the elite universities in finance. B.18. Recent research on what qualifications are important in investment banking suggest PhDs/MScs are as prevalent as MBAs from prestigious business schools. B.19. The high levels of pay in the derivatives markets from 1990 reflected a “profit share” to a limited number of people who had the skills to manage the new technologies supporting derivatives markets. If such skills shortages had been experienced by traditional STEM based industries, the professional body would have lobbied government for increased funding, for Masters degrees for example. This did not happen in finance and the few MSc courses in “Financial Mathematics” (as a generic term for mathematical finance, quantitative finance, financial engineering, computational finance) that did emerge were premium fee courses at a handful of universities. Apart from at Heriot-Watt, before 2006 there were no dedicated undergraduate degrees in “Financial Mathematics”. At this there was no business case for universities to supply the training and limit the demand for premium fee post-graduate degrees, with the introduction of higher fee levels in England, this situation has changed. B.20. The scarcity of skills in the technologies supporting derivatives markets has resulted in a complete lack of transparency in finance. Consumers, whether traditional investment bankers, asset managers, insurance companies, public or private corporations and individuals, of sophisticated products rely on the sellers, making them susceptible to mis-selling (they are not informed investors). B.21. Furthermore developments in finance go un-scrutinised in a way that would be impossible in other technologically based industries. Robert Peston, the BBC’s Business Editor who was at the centre of the reporting of the Crisis, famously initiating a run on Northern Rock, has been reported by an LSE academic as saying “I was very concerned about the explosive growth of CDOs (Collateralized Debt Obligations) and I tried to explain them through my reporting. Doing so was a challenge, when even bankers creating the CDOs were unable to describe them in terms that make sense to non-specialists.” Given that the general public are comfortable with Relativity Theory, Quantum Mechanics and the Higgs Boson, there is no reason to believe they cannot understand derivative contracts and the mathematics behind asset pricing. I regularly explain the basics of derivative pricing to sixteen year olds. B.22. In the UK there is a relatively narrow popular definition of “science” as relating to the physical and life sciences; science in the popular imagination is concerned with ergodic systems. A more conventional definition of science is as the “speculative, agreed–upon inquiry which recognises and distinguishes defines and interprets reality and its various aspects and parts, on the basis of theoretical principles, models and methods rigorously cohering”. The purpose of science is to enable a degree of foresight that is necessary for moral responsibility. Hence, for there to be moral responsibility in banking, there needs to be a science of banking, for there to be a science of banking their needs to be a public debate about banking. If there are to be sound professional standards in banking, the practice has to remove the veils of mystery that surround it. cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

Ev 1182 Parliamentary Commission on Banking Standards: Evidence

B.23. It might be argued that professionalization of banking will restrict access to careers in banking. It would be interesting to see if today, banking has a more, or less diverse, population in middle and senior management positions as compared with established professions (law, medicine, accountancy, and engineering). B.24. I am not knowledgeable on legal issues or the details of regulatory structures. However, I feel that the Financial Policy Committee, Prudential Regulation Authority and Financial Conduct Authority created by the Financial Services Bill are only a partial solution. B.25. Most professions have a professional body running in tandem with the statutory structures. There is the Legal Services Board and the Law Society, the General Medical Council and the medical Royal Colleges, the Financial Reporting Council and the actuarial, accounting and auditing professions. This distinction has emerged following, for example, the Clementi Legal Services Review and the Morris Review of Actuarial Standards. The bodies established in the Financial Services Bill correspond to bodies under the Legal Services Board and the Financial Reporting Council; the complementary professional bodies do not exist. B.26. The FSA’s Financial Conduct Authority: Approach to Regulation describes company culture as follows (p 32) Firms’ culture: the FCA will place particular focus on firms’ culture as a potential root cause of poor outcomes for retail or wholesale consumers, recognising its determining role in a firm’s regulatory behaviour. .. The FCA will expect boards to provide continuing oversight, particularly at times of significant change. and later (p 37) The FCA will seek to assess whether applicants have a good understanding of how to ensure good customer outcomes through corporate culture, appropriate conduct risk management and product design. B.27. While recognising this important component of regulation, the FSA provide no clear indication of what constitutes good “corporate culture” and how it can be created. This submission maintains that good “corporate cultures” will be created by a strong profession. 16 August 2012

Written evidence from C M Johnston Your terms of reference seem very wide-ranging and might best be responded to by a similar wide-ranging Political Economist Historian. But what most strikes me is absence of any specific reference (as would surely have been in 16/17/18/19 C+) of any need to re-establish Integrity of money especially as we would now most appear in mist of a crisis of money (much as long predicted). Another harvest of nominalism? Brought about by 40/70 yrs+ of political systemic monetisation of ever increasing levels of debt. Originally, more justifiably, attempting to amortise war debt. But increasingly since c1970 (not only attempting to sustain endemic government deficit spending) but even more associated with continuing unhistoric over inflation of domestic property values. (These often leading to equity release to finance further consumption). Also obligations (often metastasising from US). It must also be recognised that often equally opaque system of fractional reserve banking, easily allows exponential creation of money, given sufficient demand, by apparent solvent borrowers, especially when underwritten by endemic overinflating (untaxed) assets/houses?! So total debt becomes an ever increasing multiple of GNP. All seeming largely reflective of political policies to reward/bribe the more aspirational classes (another variant of state sponsored dependency) Many traditional forms of economic activity or capital accumulation from compound interest/dividend re-investment having been undermined by technology and other political fiscal policies? (Though maybe this post WW2 scenario now seems on the cusp of fundamental change, again by technology and political market pressures)? Yet Baby Boomers have clearly long/always expected that traditional bond holders and depositors can be systemically defrauded with impunity? At the same time post WW2 monetary and fiscal policy increasingly forced the average person into opaque collective managed life/ pension trusts. Yet now it has become increasingly apparent that, especially necessarily long term, the majority of real returns are consumed/filched/stolen by inheretently unaccountable symbiotic corporate and professional conflicts? (Effectively they have consumed the fiscal privileges)? Maybe QE will drive a final nail into the coffin of this system? And the most significant role of the new compulsory/automatic enrolment pensions will be further expose structural and statistical flaws? Yet clearly overinflating house values have massively increased costs all round. Not least government welfare payments, housing benefit? Quite different if house values continue to overinflate, that clearly creates massive generation disadvantages/inequalities. Seeming even more contrary to apparent post WW2 political intentions? I was amazed to see Sir Mervyn King earlier this year in a public speech, seem to suggest the current crisis arose almost out of the blue! He suggested that growth had been continuing at a regular satisfactory level for several years, with only moderate steady levels of inflation (2%pa above level of great inflation of 16C) but then suddenly we found ourselves in a great crisis. He seemed to completely ignore that over the previous decade house prices had increased 300%. Such an apparent lack of perception in the financial, political, media nexus might seem widespread and seemingly resultant of a blinkered company entlisation and failure to cobber Pack: U PL: CWE1 [O] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

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recognise the nature of any integrity of money. Especially that the unhistoric over inflation of house values, essentially only since c1970 (US making the final break with gold in 1971) reflects far more a phenomenon of money, rather than of houses)! Were this merely a reflection of “scarcity” the square footage rather than location fashion height rather dictate prices even in London? Let alone it might appear particularly capricious to impose CGT on equities where long-term returns (ex-inflation and net dividend reinvestment) are rather modest (most apparent gains resultant of the market/monetary near collapses of 1940s and 1970s?) Rather than continually over inflating houses. which consequently can be increasingly leverage at long term effective negative rate of interest especially post abolition (1963) of traditional imputed rental income tax on owner occupied houses surely necessary balancing item? But I am not suggesting that CGT be imposed on owner occupied houses. nearly that an annual imputed income tax be reimposed, maybe offset by reductions in other taxes? (Based on an annual self assessment on IT form? Easy enough for this to be cross checked. roll ups allowed for some categories). The aim would also be to constitute an effective 1% pa capital levy, such as under old rates plus schedule A before 1963. Another aim being to reduce real value by 50–70% from 200 (in many areas, ex sustained by foreign buyers who very significantly could not avoid this tax. real value seem to have already declined by near half the higher proposed level? And may now happen anyway). So such a tax could be reimposed fairly painlessly over 5 to 10 years. Conservatives tend to oppose re-imposition of such a tax as contrary to ideas of a “property owning democracy”. Yet endemic monetary default and fiscal distortions have merely encouraged people to concentrate their savings/security/property in domestic houses. Quite different than under gold standard and industrial revolution. Maybe also new technology will also hasten change. At the same time it would seem equally necessary for governments to re-establish some long term instrument (like 3% consols under gold standard and or significant expansion of indexed gilts) to enable average individuals to hold money/savings especially with long term security of capital an income. Some sort of extension of long term indexed gilts, though maybe in certificated form for more easy public understanding, less open to market manipulation maybe sale and repurchase directly under Bank of England/debt office? Such a development might also incidentally restrain both government peace time deficit spending and the housing market. Also, better that state underwrites money than (too) big banks! In the same context, the 21C sale of c 2/3 of this country’s gold (and at knockdown prices), apparently at whim of a few (one person) seemingly unable to recognise, tolerate anything more important thatn themselves/ self? Always appeared near unbelievable foly. Some people now suggest gold prices now v high at 1800 onz, but in real terms is that much different from $350 nz in 1934? (Espeically as to run as effective gold/bullion standing it is necessary to somewhat over value gold). Having survived political attempts to demontise the “barbarous relic” gold would now appear to have triumphantly survived, reasserted its traditional strength? Maybe it will in due course become an integral part of a revived international reserve currency, like Kenya’s Bancor, rejected at Bretton Woods owing to overwhelming dollar supremacy? Maybe I might also say that I have always had a particular interest in money as a concept. As a small child I continuously asked how much things cost before WW2 effectively under Gold standards (which I have always found a good benchmark). Later at school and university I tended to specialise in doctrinal controversies which often seemed to corolate closely to concepts of money. Especially the (still continuing into modern physics) nominalist realist controversy begun by plateau from which may be deduced “value is the real presence in money”. Everything else likely some sort of Syllogism or fraud (clearly when money becomes controlled by a bank it becomes exposed to at least three forms of risk. Default by the bank, fraud by the bank, political monetary default). This would appear the state where we have now arrived concurrently undermining public trust in politicians, bankers, financial promoters of all kinds and many others who have indirectly ridden the same tiger (concessionary mortgages and pension pots, CGT flipping also being essence of recent MPs’s expenses scandals)? I enclose abstracts from a recent letter addressed new CEO of BBA, Anthony Browne. Maybe it relates to a specific case ,which may also partly explain from where I am coming, but most of the points would seem widely applicable and maybe further illustrate why so much bank corporate integrity and professional expertise has become myopically self-referential special pleading conventional conflicts. Much essentially “Inside a dealing” against target “customers”/lay victims? Historic false accounting deceits spurious performance, disguise, deny real losses, costs.as no one would reasonably apply to their own affairs ( if they understood them) also seemingly reliant on a privileged essentially collusive clientage of prof/agents. Themselves effectively legally protected by banks espically to default on fiduciary duties rightly owed directly to any (ostensible) joint principal.(often someone to blame having first m isled, deceived). Another point Anthony Browne made a joking reference on which I did not comment earlier. That unlike “Toxic Tobacco” people actually need banks! Maybe, though not in the form they seem to have become (Let alone that government deficit spending now appears increasingly covered by QE)? Large corporations should be encouraged to securitise their debts or better raise more equity. Clearly there needs to be fiscal equality in treatment of debt and equity. Though maybe debt interest (and other allowances claimed by large corporations) should be disallowed. As it often appears misused to diminish competition and avoid paying reasonable amounts of tax. But MSB could be similarly encouraged, especially with greater fiscal equality in treatment of debt and equity. Though maybe debt interest (and other allowances claimed by large corporations) should be disallowed as it often appears misused to diminish competition and avoid paying reasonable amounts of tax? cobber Pack: U PL: CWE1 [E] Processed: [19-06-2013 15:28] Job: 027059 Unit: PG01

Ev 1184 Parliamentary Commission on Banking Standards: Evidence

But MSB could be similarly encouraged, especially with greater fiscal neutrality and monetary stability? Btu it must be very doubtful if big banks have any longer interest, intention or capacity to support small businesses yet there now seems very interesting development online but more generally there needs to be moves towards fiscal simplification towards a flat tax (maybe technology will assist/force this?) Especially as it might be recognised that the over rewards, which have caused so much public resentment , which have largely metastasised from the city, themselves, stem largely from complex monopolies artificially created by the monetary and fiscal system. Regarding the regulatory ombudsman system, we have always found these systemically obstructive, seemingly consequent of being opaquely nobbled by the symbiotic corporate and professional conflicts? Also by another aspect of myopic compartmentalisation (complained of above), in practice, recreating the problems of pre-fusion law and equity in 1870s). In particular our complaint is not about any bona fide trust company/ administration, but that we had the (overriding) “right in possession” to any monies (+ any trust) effectively ab initio. While bank was clearly in a position of multiple corporate conflict against us/ours, in every legal capacity and the bank was ultimately obliged to admit the “merits” of this complaint, by resigning without a release ie becoming legal strangers ab intio, though remaining legally liable essentially as intermeddlers, inherently unauthorised intruders and mischief makers. The 1st 1987 Bank ombudsman declined to assist us in any way, because he concluded our overriding complaint being “how do we rid ourselves of the bank” and this clearly being out with his terms of reference so he deemed it “more appropriate” to be dealt with by a Court”. The 2nd bank ombudsman in 1999, ie after bank’s resignation without a release, said his terms of reference allowed him to consider only “banking services” (as restrictively defined by BBA) which did not extend to considering complaints from co/successor trustees, “possessors” as a class etc. Also in 1988 we had objected to IMRO against MWT’s authorisation under FSAct, because its practices and behaviour clearly not compliant with published “conditions for authorisation”. But our objections ignored. Though by 1989 IMRO had been quite discredited by Robert Maxwell. Essentially by merely over-exploiting (and too quickly) same clearly widespread malpractices against which we had protested especially deceits against lay co trustee/s including by concealment of data/information, insider dealing with inherently collusive professional agents, historic false accounting conventions to disguise/ deny real damage, costs, etc. Yet self regulatory IMRO demonstrated themselves incorrigible by then further indulging symbiotic corporate and professional lobbying to again exclude from the IMRO ombudsman complaints from lay persons with insider legal rights especially lay co/successor trustees possessors as a class. ha! ha! So far (complaints now with independent assessor) FOS has behaved little better. FOS originally accepted bank’s deceitful defensive spin that the matters time barred (clearly not by application of 1980 Act of Limitations) though later FOS accepted they were still within FOS jurisdiction, by other DISP definitions. But the FOS Ombudsman (apparent past experience as an IFA and mortgage broker) seemed aggressively determined to misstate true, basic “terms of complaint”, still more ignored that banks had already constructively admitted its merits seemed determined to distort it into an entirely different form. Recklessly conflated quite separate, different legal processes and scenarios. Ought to misrepresent it as some sort of trust co/administration dispute, rather than recognise (as admitted by bank) that we had “right in possession” effectively ab initio etc. Totally ignored the legal consequences of bank’s resignation without a release. So he determined to dismiss it. Citing in particular that the 1987 ombudsman had deemed it “mere appropriate for consideration by a Court” (ie before bank resigned without a release see also ombudsman news 49) also that the 2nd ombudsman had excluded it (having been nobbled by BBA). SO this 2012 FOS ombudsman’s reasoning would appear contrary to any objective commonsense , but also contrary to basic principles of equity/English law definition of “subject matter” and “new material evidence” Especially as applicable to a plaintiff’s differential legal persona and consequent different “rights of action” Yet this ombudsman seemed determined to apply his own apparent unaided reason, the crude logic of “the main the the pub” to insist the “crux of the complaint the same”. All along?! Also despite repeated requests for a more defined explanation of relationship between traditional principles of equity, English law and disp ( let alone application of ECHR/HRA). especially as it was surely never the intention of FSM to create an obstructive scenario like pre-fusion of law and equity (1870s) which would inevitably provide a further licence for continuing market abuse, especially in more opaque, less usually exposed areas? FOS attitude here must also compare very unfairly against help to SMEs missold/misled re interest rate swaps? 25 October 2012