Banking Reform Bill Update

On 23 October 2013, the Financial Services (Banking Reform) Bill 2013-14 (the “BRB”) completed its committee stage in the House of Lords.

A revised version of the BRB has been made available on the UK Parliament website.

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HM Treasury Publishes Draft Annex to SRR Code of Practice

Introduction

On 8 October 2013, HM Treasury published a draft annex on the new bail-in option to the Special Resolution Regime (SRR). The bail-in tool is being introduced through amendments to the Banking Act 2009 by the Banking Reform Bill 2013 for the purpose of offering a new stabilisation option to the Bank of England as lead resolution authority. It will be available to failing banks and investment firms, with necessary modifications to building societies via secondary legislation and under specified conditions to banking group companies.

The draft annex to the Code of Practice supports the legal framework for the SRR and provides guidance as to when and how the bail-in tool may be deployed by authorities in practice.

A summary of the key points include:

General and Specific Conditions for Use of SRR Tools (Section 7)

The conditions for use of the bail-in option are identical to those for the stabilisation options set out in the existing Code :

  • the regulator must determine that the institution is failing or likely to fail;
  • it is not reasonably likely that action will be taken by or in respect of the bank to avoid its failure; and
  • the Bank of England is satisfied that exercising the bail-in power is necessary having regard to the public interest.

When choosing between the original resolution tools, the Bank of England will consider the relative merits of the stabilisation options and the bank insolvency procedure given the circumstances in addition to general considerations . The Bank of England may also choose resolution by way of bail-in for situations where the use of another stabilisation power would threaten financial stability or confidence in the banking systems.

Use of the Bail-in Powers (Section 8)

The bail-in option gives the Bank of England the power to cancel or modify the terms of any contract in a resolution scenario for the purposes of reducing or deferring a liability of the bank (“special bail-in provision”). A conversion power also exists that allows for liabilities to be converted into different forms. Certain liabilities are excluded from the scope of the power to make special bail-in provision including:

  • deposits covered by the Financial Services Compensation Scheme (FSCS) or an equivalent overseas scheme;
  • liabilities to the extent they are secured;
  • client assets, including client money;
  • liabilities with an original maturity of less than seven days which are owed to a credit institution or investment firm (save in relation to credit institutions or investment firms which are banking group companies in relation to the bank);
  • liabilities arising from participation in a designated settlement system and owed to such systems, or to operators or participants in such systems;
  • liabilities owed to central counterparties recognised by the European Securities and Markets Authority (ESMA) in accordance with Article 25 of Regulation (EU) 648/2012;
  • liabilities to employees or former employees in relation to accrued salary or other remuneration (with the exception of variable remuneration);
  • liabilities owed to employees or former employees in relation to rights under a pension scheme (with the exception of discretionary benefits); and
  • liabilities to a creditor arising from the provision of goods or services (other than financial services) that are critical to the daily functioning of the bank’s operations (with the exception of creditors that are companies which are banking group companies in relation to the bank).

Prior to taking resolution action or converting liabilities, resolution authorities are expected to carry out a valuation of the assets and liabilities of the institution as is reasonably practicable.

The UK has chosen to exercise the discretion granted to it under the Recovery and Resolution Directive and has included derivatives in the list of liabilities which can be bailed-in. Specific power to make special bail-in provision to derivatives and similar financial transactions can be found in Sections 8.14 – 8.17 of the Annex. The Bank of England will, where appropriate, exercise its power to close-out contracts before they are bailed in with any applicable close-out netting being taken into account. If a liability is owed, it will be excluded from bail-in so far as it is secured and compensation arrangements will follow the “no creditor worse off” principle. This ensures that no person is worse off as a result of the application of the bail-in option than they would have been had the bank gone into insolvency.

Banking Reform Bill Bulks Up

H.M. Treasury yesterday published 86 proposed amendments to the Banking Reform Bill. The bill is due to enter its committee stage in the House of Lords on the 8th October 2013. The proposed amendments were widely-flagged and broadly mirror the 11th March 2013 recommendations of the Parliamentary Commission on Banking Standards.  Highlights are as follows:

  • Payments: the introduction of a wholly new and distinct payment systems regulator, the intention being to stimulate competition by facilitating access to payment systems for new market participants, as well as decreasing the costs of account portability. A special administration regime to deal with cases where a key element in a payment fails or is likely to.
  • Misconduct: an extension of the FSMA approved persons regime. If passed, the amendments will allow the regulators to: make the approval subject to conditions or time-limits, extend time limits for sanctions against individuals, impose “banking standards rules” on all employees , and to hold senior managers responsible for regulatory breaches in areas which they control. PCBS chairman Andrew Tyrie, (perhaps confusing Ford Open Prison with Guantanamo), had previously advocated putting “guilty bankers in bright orange jump suits”; as widely expected, the proposals introduce criminal sanctions for reckless misconduct in the management of a bank.
  • Electrified ring-fence:  proposed new powers to formalise and streamline the “electrification” power introduced at the Commons report stage. The electricity in the ring-fence is the regulator’s power to compel separation of a banking group which breaches the boundary between retail and investment banking. The effect of the new powers is to make the ring-fence into a “variable-voltage” device. Under the proposal, the regulator will:
  1. issue a preliminary notice, the affected party will have a minimum of  14 days to reply and 3 months to make necessary changes to its behaviour/structure
  2.  failing this and with the consent of the Treasury, a warning notice will then be issued, itself triggering a minimum of 14 days for representations by the affected party
  3. a decision notice is then issued, which may be appealed before a Tribunal
  4.   a final notice is issued which set s a dead line by which a bank must separate its activities

The whole process will take approximately 14 months and the various notices will be issued in accordance with general FSMA principles.

Bail-in:  the introduction of a bail-tool as initially mandated by the European BRRD and recommended by the domestic ICB and PCBS. The Banking Act of 2009 will be amended to include a “stabilisation option” (bail-in), covering banks and investment firms and to be applied by the bank of England as lead resolution authority.  The conditions for its use are identical to those of the Special Resolution Regime:

  1. the regulator must determine that the bank is failing or is likely to fail
  2. it is not likely that any other action can avoid the failure
  3. The BoE determines that application of the bail-in power is in the public interest

The bail-in option includes the right to modify existing contracts for the purpose of mitigating the liabilities of a bank under resolution. There are a number of liabilities which will be excluded from the provision: client money, FSCS protected deposits, employee pension schemes, payment system liabilities, debts to a creditor who is critical to the bank’s daily functioning etc.

In short- the electric ring-fence is reconnected to the mains and bail-in is set to become a reality. These and other less fundamental proposed amendments represent a significant extension of regulatory powers. It remains to be seen if they will be rigorously and consistently applied to their full extent.

Update on Banking Reform Bill

The Financial Services (Banking Reform) Bill 2013 received its second reading in the House of Lords on 24 July 2013 details of which can be found in the Hansard text. The Bill will now proceed to the Committee stage on a date to be announced according to the Parliament website.

The Bill had its first reading in the House of Lords on 10 July 2013 and HM Treasury and the Department for Business, Innovation and Skills (BIS) published a consultation paper seeking comments on draft secondary legislation proposed under the Bill on 17 July 2013.

The Tyrie Report: Now it’s Personal

On 21 June 2013 the Parliamentary Commission on Banking Standards (PCBS) published its Final Report “Changing Banking for Good”, widely referred to as the “Tyrie Report” after its chairman Andrew Tyrie MP.  The PBBS was established in July 2012, with the broad brief to conduct an enquiry into the standards and culture of UK banking and to make recommendations.  Whilst highly critical of just about everyone – the government, regulators, banks, and individuals – its final 571 page report contains surprisingly little in the way of strategic regulatory proposals.

Instead, its recommendations are strongly focused upon the senior individual, effectively imposing financial penalties and/or criminal culpability for (potentially) less pay. The substantive recommendations may be broadly grouped under two headings: people and pay.

People

  • The FSA’s “Approved Persons” regime to be replaced by “Senior Persons”.  The new regime would only apply to senior management; however they would have to accept responsibility for specific areas; and
  • Junior employees would be subject to an enhanced licensing regime.

Pay

  • A new remuneration code more closely aligning risk and reward, with emphasis upon more extensive deferment of pay.  A recommendation that bonuses may be deferred for up to 10 years;
  • Regulatory powers to cancel deferred pay/unvested pensions and/or dismiss senior management in the event of their bank requiring taxpayer support; and
  • A new criminal offence of “reckless misconduct in the management of a bank”.

The only macro-prudential elements of the report are the suggestion that the UK consumer is ill-served by lack of competition in retail banking, that this may be ameliorated by the break-up of RBS, and a characterisation of the government’s management of Lloyds and RBS as “interference”.

During Prime Minister’s Questions on the 19 June 2013, David Cameron affirmed his intention to append at least the bonus clawback and new criminal offence proposals to the Banking Reform Bill, which is currently making its way through Parliament.

Paul Tucker Speech on Resolution

On 20 May 2013, Paul Tucker, Deputy Governor of Financial Stability at the Bank of England gave a speech entitled “Resolution and future of finance” at the INSOL International World Congress in the Hague.

Within the wider context of discussing solutions to the problem of “too big to fail”, the speech gives a useful summary of the ways in which both “single point of entry” and “multiple point of entry” resolution would operate in practice.  It also touches upon the interaction between resolution regimes and bank structural reform, noting the way in which bank ring-fencing, as will be implemented in the UK via the Financial Services (Banking Reform) Bill, represents a back-up strategy to resolution, under which essential payment services and insured deposits would be provided by a “super-resolvable” ring-fenced and separately capitalised bank.  This, it is believed, should make it easier for the UK authorities to “retreat to maintaining at least the most basic payments services” if a preferred strategy of top-down resolution of a whole group could not be executed.

Update on Banking Reform Bill

On 9 May 2013, the Financial Services (Banking Reform) Bill was reintroduced to Parliament, having been carried over to the 2013-14 session.  The text of the bill is the same as that originally published on 4 February 2013 (see this blog post for more detail).  The bill completed its committee stage on 18 April 2013 and will now proceed to the report stage, although the date upon which this is scheduled to take place is not yet known.