Responsible Banking and Finance – the way forward, speech by Sharon Bowles MEP
We are at a crucial time in the reform of banking and financial services. In the UK there have been changes in the supervisory authorities, reports and paving legislation for ring fencing, new rules on LIBOR and last week's Parliamentary Committee on Banking Reform. Investigations into rigging and mis-selling have been centre stage, gnawing away at the reputation of retail banks as well as the toxic casino description given to investment banking.
The detailed legislation governing all financial services is done at EU level, and with less publicity than purely domestic matters we have been getting on with it. By the time we go to the elections next year, 40 pieces of financial services legislation will have been dealt with by the Economic and Monetary Affairs Committee, tightening all areas of regulation and moving into those previously unregulated. We have also made our contributions to legislation that falls into company law, accounting and corporate governance.
A large part of this legislative agenda coordinates with the international agenda that was laid out at the Pittsburgh G20. Much has and is being done to make the system safer with more capital, capturing derivatives and shadow banking activity in a tighter regulatory environment, and with greater transparency.
At the same time everyone is watching everyone else to try and make sure there is a global level playing field for fear of loss of competitiveness - not a minor issue given that in the end we need banks and the financial system to put money efficiently into the economy.
Investment banking, hated by many, has a role to play: investors, including pension funds, need to be financially connected to companies. So the intermediation by banks, creating and trading assets, is important for allocating capital to the people, entrepreneurs and businesses that are likely to be profitable and beneficial to society. There are also other channels of asset allocation, but to cut a long story short, they all became long and over correlated despite seeming diverse. We became dependent on numerical measures such as credit ratings instead of 'knowing the business'.
In the European Parliament we have tried to breathe life back into relationship lending with legislation, but so far success has been limited as we have been met by the demands of 'how is it to be defined and checked?'. An obvious conclusion from this is that there needs to be both vocational and ethical training in finance as well as manufacturing.
Maybe that conclusion is not a million miles from the one made by the UK's Parliamentary Commission on Banking Reform to have a stricter senior persons regime for banks and licensing with a full range of enforcement powers.
I have always been impressed by the way in which professional engineers have profound understanding of how their work, buildings and innovations change society. There are of course many senior people in banking that understand these things of their profession too, and such characteristics are in the ascendancy now under political pressure, but I hear that there is still a problem in getting the new ethics down through all layers of a bank.
My thoughts here turn to lessons from competition policy and how dominant companies face a different, tougher set of criteria. Things that are 'normal business' for an ordinary company become disallowed for a dominant company. The whole company can suffer if a few people even low down offend.
One way a dominant company issue has been settled, in order to stave off forced break-up, has been to set up an ethics code that every employee has to know, and for it to be checked at regular intervals that this is understood and procedures are being followed. It seems to me that this technique could be well used in banks and the financial industry. Any annual award should also take into account how adherence to the principles has been demonstrated.
I have already referenced the UK Parliamentary Committee on Banking Reform's report.
Now for a confession - I haven't read it, well not yet, only summaries, and my guess is that a lot of treasure will be in the detail. The summaries do not explain the interaction and common thinking with what has already been going on at the EU level.
So I thought that I would go through what the media at least labelled the key points and give you that inter-linkage, then say a few words on my further thoughts.
Two key points of having a senior persons regime and licensing I have mentioned. Corresponding European legislation is in the Capital Requirements Directive and Regulation, its latest comprehensive update known as CRD4, and also in the markets legislation (MiFID), which covers fit and proper persons. The Parliament would have preferred stricter EU rules but some Member States could not be persuaded and preferred to keep this national, so tighter UK rules are welcome, but they cannot be imposed on those approved in other EU countries passporting their services into the City - hence why MEPs wanted tighter EU rules.
However the direction of travel of what we did achieve such as by ensuring adequate time is given by Directors, by limiting the number of Directorships that can be held, has common thinking, for example, to the PCBS proposal for full time chairmen.
Although we did not get common high standards for administrative sanctions, I did manage to get a common 'blacklist' so that when sanctions are taken against an individual this can be found out via the EBA website, making it harder for sanctioned individuals just to decamp to another EU country. The EBA website will also publish the length of sanctions that Member States apply for offences, because some are stricter than others.
The UK Parliamentary Committee report suggests criminal sanctions for reckless misconduct. Criminal sanctions at EU level are still a controversial concept - not least for the UK - and in financial services we are still struggling with the criminal sanction part of market abuse although a deal with Council on the rest was agreed in principle last week. What underlies the PCBR thinking looks similar to the idea that I have been developing to give a 'duty of care' for the common good of the financial system. Indeed it may be that combining these ideas is how to justify an action in the field only of banking or financial services.
Moving on to the area of remuneration, a lot is already law from the EU, or will be soon. The bonus cap is not endorsed by the PCBR, which prefers long term deferral for senior people of up to ten years. A preference for payment in instruments other than shares has also been indicated. These preferences will not undo anything from the EU. However much if not all of it has been covered or is consistent with what has been done.
The EU bonus cap is law starting next January. The cap can be raised from one-times to two-times salary with shareholder agreement and further 'uplift' or discounting if there is long deferral, something that I won in the final trialogue on CRD4 and incentivises the greater deferral of bonus the PCBR report envisages. There have been provisions since CRD3, the previous revision, which we finished over two years ago that there be deferral of at least 40% of bonuses for at least 3 to 5 years, with clawback possible. That is a minimum so it can be made stricter.
Again chiming with the PCBR suggestions, I had already introduced in to CRD3 the possibilities for payment in instruments other than shares, although the compulsion for that that was resisted and watered down to preference - actually under UK pressure from the FSA which was nervous of 'new things'. Again from CRD3 there are restrictions in bonus payment when there is government intervention or lack of capital, and a five year deferral and clawback arrangements on large pension pots which I put in at the height of the Fred Goodwin outcry. Returning to the recent CRD4 changes - well I say recent but we have been working on it for two years - there are provisions I instigated on contract buyout which take effect in January that include clawback: the PCBS proposal seems to go a little further and ban contract buyout of bonuses.
That's enough of comparisons, but I think what it shows is that when it comes to actual legislative measures there are relatively few areas where controls can be applied and that a lot of it comes down to trying to ensure integrity of individuals.
It seems to me that integrity is also connected to complexity. Complexity can be used to hide lack of integrity, and complex sets of rules also push towards gaming the rules, and probably not a thought as to whether or not that is victimless. That refers back to the points I have made on society and ethics and professional training.
All the rules that we are making have the objective of keeping banking and investment stable for the general good. Rules are complex because modern banking is complex - even more complex that it needs to be - and because we are on a treadmill of trying to draw a precise line between the proper and improper for the sake of 'legal clarity' which really means opening the door to legal arbitrage - or gaming.
My ideal world would have far simpler rules, far harsher penalties for transgression, and be able to rely on stronger ethical codes not just in banking but in the professions that surround them - the accountants and lawyers - otherwise they drag one another down.
So in just the same way as there is now long awaited action against aggressive tax planning, there should be aggressive action against regulatory avoidance in other financial areas.
Put bluntly as I have before, good banks need good lawyers. Moral banks need moral lawyers, and that morality is not defined solely by words on a page, interpreted purely to yield advantage to a bank against the intended greater good. Many lawyers, even within a bank never mind as outside consultants, see that sole focus on the benefit of the client as precisely their duty. As with a more general ethical code counteracting 'dominance' this needs to be addressed.
My proposal is as I said earlier is to put a duty of care for the common regulatory good on to banks and their professional representatives, with penalties for circumvention of the 'pith and marrow' or basic intent of a regulation. I have my plans about where to try this in EU law, but there is nothing to stop the UK from doing it. It is a change of thinking and focus, but I believe it is central to the restoration of confidence in the integrity of banks, financial services and the City in general.
That has been a bit of a mixed bag of where we are and where I envisage changes. In summary my action points are:
Reduce complexity and increase transparency and understanding - this should be the next phase of legislative change, though I admit it may be a while.
Improve professional and vocational training for those within the financial industry.
Give a 'duty of care' as the basis to take action against those gaming regulation, extending to those acting as consultants.
Use 'dominant company' ethics methodology in all finance and banking given the societal dependence on those industries. 'Ethics' checks should be part of annual appraisal and bonus awards.