Britain's financial regulator will step up scrutiny of investment banks' management of conflicts of interest and risk in the wake of a number of high profile cases such as WorldCom, Enron and Parmalat.
Hector Sants, head of the UK Financial Services Authority's wholesale and institutional markets division, told the banks in a letter that senior executives needed to ensure proper management of conflicts and risk or the banks could be vulnerable to costly litigation and damage to their reputations, damage that could ultimately hit revenues.
"Where your business profile gives rise to these risks, you should expect to receive increasing scrutiny and challenge about current and developing practices from our supervisors in the coming months," Mr Sants said in a letter sent to investment bank chief executives and senior management on September 17.
The investment banking industry has already paid out billions of dollars in claims arising from the corporate scandals in the United States, such as the collapse of US telecoms company WorldCom and energy trading group Enron.
In Europe, Parmalat has taken several investment banks to court over dealings with its former management which the Italian food group says helped push it into insolvency.
"High profile cases such as Enron, WorldCom and Parmalat have highlighted that financial institutions may face substantial risks when they participate in financing transactions that may be used by their customers to avoid regulatory or financial reporting requirements," Mr Sants said in the letter, which the FSA published on Friday.
He said the banks' senior management were accountable for managing the full range of risks arising from all financing transactions in the businesses for which they were responsible.
The FSA has already taken action to stamp out conflicts of interest in equities research, but has also looked more broadly at management of conflicts of interest in investment banks. Mr Sants emphasised the need for adequate disclosure and documentation and a clear audit trail relating to the "business intent" of any transactions.
He said the FSA was also concerned about inadequate disclosure of the fairness and efficiency in the operation of the markets for debt and derivatives, including credit default swaps.
"We would therefore advise you to take care that the disclosure of transactions that may impact market perceptions, across all relevant asset classes, is clear, fair and not misleading," he said.
The FSA is currently investigating Citigroup for a controversial trade in government debt on August 2 that prompted sharp price moves in the government bond market.