Bank of England in stand-off with FCA over trading firms’ capital

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The Bank of England has raised concerns over plans to cut the capital requirements of specialist trading firms, including Citadel Securities, Jane Street and Hudson River Trading, creating a stand-off with other UK regulators.

The disagreement has been sparked by proposals outlined at the end of last year by the Financial Conduct Authority to ease the capital rules for the trading firms it regulates in an attempt to boost liquidity in financial markets.

The plans have met with scepticism from the BoE, where officials are worried they could increase financial stability risks by making major trading firms less able to withstand a crisis, several people familiar with the discussions told the FT.

One of the officials familiar with the talks said: “You want trading to be there in bad times as well as good times. We need to think about what incentives this [proposal] will create and what impact it will have.”

Over the past decade, trading firms have reshaped Wall Street’s trading landscape, outcompeting big banks such as JPMorgan Chase and Goldman Sachs. Groups such as Ken Griffin’s Citadel Securities, Jane Street and Alex Gerko’s XTX buy and sell hundreds of billions of dollars’ worth of securities in milliseconds, making a small profit every time.

Some of these companies also use their expertise in market-making to make outright bets in the markets.

The trading firms started to seize market share in the years after 2008, capitalising on the electronification of financial markets and post-crisis banking regulation.

Unlike the big banks on Wall Street and in the City of London, they do not have to deal with a panoply of regulations to make sure they are well capitalised should they lose money in markets or face a run on the bank by depositors.

“If you are unnecessarily tying up capital [with regulations] that is not going to be attractive,” said an executive at one large US trading firm. “When you have other places to trade it won’t be your first option.”

Trading companies in the US, Canada and Hong Kong have to comply with a net capital rule, which is often less stringent than the equivalent requirements in the UK or the EU.

The FCA outlined possible reforms to the capital requirements for trading firms in December, following a call from the Treasury as part of a push for growth and competitiveness in financial services. The current rules were inherited from the EU and are largely based on rules that applied to investment banks’ trading operations.

The FCA said in its proposals that because trading firms did not accept deposits or have external customers, they could have less systemic impact than banks or asset managers if they failed. It said the aim of its reform proposals was to “encourage wholesale trading, improve market liquidity and in turn reduce barriers to entry for specialised trading firms”.

However, the BoE has taken an opposing view. It is also worried about the exposure of the banks it supervises to trading firms. Rebecca Jackson, a BoE executive director, said in a speech earlier this year that banks needed to improve their risk management capabilities to handle the increased scale and risk of trading firms to which they provide lending and other services.

The BoE’s financial policy committee — on which the head of the FCA also sits — has the power to direct the regulator to take certain action if it spots a specific risk to financial stability.

Trading firms have welcomed the FCA’s proposals. The European Principal Traders Association said in its response to them that “a bank-type framework has unduly constrained liquidity provision” in the UK and said the rules “should reflect the actual risk of harm”.

But traditional banks have been more critical. The Association for Financial Markets in Europe, which represents many big banks, warned the FCA it had “significant concerns” that it could “heighten the likelihood and impact of systemic risks crystallising”.

The BoE declined to comment. The FCA, which is expected to publish updated proposals later this year, also declined to comment.