New FSA regime poised to target rogue traders

Regulator to impose a 'fit-and-proper person' test on all existing and new proprietary dealers

The City's 2,000 proprietary traders are to be tested on their financial suitability in a clampdown on potential rogue traders. The move is part of a tough new regime in which the Financial Services Authority will also record interviews before approving directors or dealers to provide evidence in case they lied.

Proprietary traders invest their banks' own capital but some trading positions have resulted in losses, including the huge holdings of property ventures and US mortgage bonds at HBOS, now merged with Lloyds. Lloyds revealed a loss of £10bn loss last week and its share price fell 40 per cent on Friday to 55p. The heavy losses increased speculation that the Government might have to increase its 43 per cent shareholding.

Some dealers have exceeded their trading limits, leaving banks with crippling losses, including the £827m racked up by Nick Leeson at Barings in 1995 or the €5bn (£4.5bn) black hole left by Jérôme Kerviel, at Société Générale a year ago.

The FSA wants every proprietary trader to become an approved person under a fit-and-proper test that will look at drug and alcohol abuse as well as financial credentials. Banks are being consulted and an announcement is expected after Easter. The regulator has told banks: "The approval of proprietary traders on its own may not deter or stop rogue traders but when combined with effective supervision it may assist to detect and mitigate issues before they crystallise."

At least 2,000 traders will have to seek approval immediately, and 1,000 a year after that.

The FSA also plans to extend its "approved persons" regime to non-executive directors as well as senior full-time staff. Around 200 part-time directors will face scrutiny each year. "We want to get away from the idea that our approval is a box-ticking exercise," says the regulator. "In future we will be more likely to hold non-executives accountable if there is evidence to suggest that they have failed to fulfil their duties."

MPs grilled the former chairmen and chief executives of HBOS and Royal Bank of Scotland on their skills last week and there have been calls to consider banning them or the banks' non-executives from holding financial positions again. The regulator refused to say on Friday what action it is taking, but said: "In the past we have said that we will not discipline non-executives if they acted in accordance with their roles when things go wrong. In future, we will look at non-executives more closely."

The FSA estimates the clampdown on prop traders will cost the industry £1m and admits the expenditure cannot be justified on a cost-benefit basis. It concedes existing controls have not prevented rogue traders." However, the FSA hopes subjecting prop traders to a test will mean some potential rogue traders are refused approval.

Meanwhile, the Treasury is to advertise for an FSA deputy chairman after Sir James Crosby's resignation.