On 14 January 2014, HM Treasury published the “Final review of the Investment Bank Special Administration Regulations 2011” conducted by Peter Bloxham. The report meets Parliament’s requirement that the Treasury hold an independent review of the special administration regime (SAR) for investment banks within two years of it coming into force. Continue reading
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.
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:
- 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
- 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
- a decision notice is then issued, which may be appealed before a Tribunal
- 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:
- the regulator must determine that the bank is failing or is likely to fail
- it is not likely that any other action can avoid the failure
- 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.
On 26 September 2013, HM Treasury published a consultation paper regarding secondary legislation for non-bank resolution regimes. The consultation will remain open until 21 November 2013.
As currently drafted, the Special Resolution Regime (SRR) established by the Banking Act 2009 applies to most deposit-taking institutions such as banks and building societies. The Financial Services Act 2012 widened the SRR to include undertakings in the same group as a failing entity, investment firms, and central counterparties (CCPs). However, these provisions have not yet been brought into force. The consultation seeks comment on a number of proposed statutory instruments required to underpin the widened SRR as detailed below:
- The Banking Act 2009 (Exclusion of Investment Firms of a Specified Description) Order 2013
- The Banking Act 2009 (Banking Group Companies) Order 2013
- The Banking Act 2009 (Restriction of Partial Property Transfers) (Recognised Central Counterparties) Order 2013
- The Banking Act 2009 (Third Party Compensation Arrangements for Partial Property Transfers)(Amendment) Regulations 2013
Broadly, the issues discussed include:
Exclusion of certain investment firms from the scope of the SRR
The government is proposing to narrow the scope of the SRR so that it applies only to those investment firms that are required to hold initial capital of €730,000 (“€730k investment firms”) as specified in the Capital Adequacy Directive. The government believes that there are approximately 2,000 investment firms in the UK, about 250 of which are €730k investment firms. Non-€730k investment firms which fail will continue to be dealt with under normal insolvency procedure, or enter into the special administration regime (SAR).
Extension of stabilisation powers to “banking group companies”
At present, the SRR only permits the Bank to exercise stabilisation powers over a failing institution. However, these powers are to be extended to cover banking group companies (“BGCs”), being:
subsidiaries of the failing institution;
parents which are “financial holding companies”; and
undertakings which are in the resolution group (i.e. subsidiaries of the “resolution group holding company”).
By virtue of the application of the SSR to investment firms and CCPs, the Bank’s SRR powers will also extend to undertakings within the same group as a failing investment firm or CCP (though the legislation refers to all such group undertakings as “banking group companies” irrespective of whether they are grouped with a bank, a building society, an investment firm or a CCP).
Introduction of further partial property transfer (“PPT”) safeguards
PPTs transfer some, but not all, of the property, rights or liabilities of a failing institution to a private sector purchaser or bridge bank. A number of safeguards currently exist in relation to PPTs. These safeguards are designed to protect contractual and market arrangements (and so provide clarity to, and bolster the confidence of, the market) within the context of a flexible regime which is able to resolve failing institutions effectively. Specifically the safeguards include protection for set-off arrangements, netting arrangements and title transfer financial collateral arrangements; secured liabilities; capital market arrangements; and financial markets. The government proposes to extend these safeguards to investment firms and banking group companies. It also proposes to make a separate statutory order to enact PPT protections with respect to recognised CCPs. These would protect collateral and netting arrangements by only making a PPT possible with respect to a complete segregated business line of a CCP (i.e. a product set cleared by a CCP that is covered by a segregated set of default protections).
Introduction of further ‘no creditor worse off’ safeguards
Section 60 of the Banking Act 2009 permits the Treasury to make regulations about third party compensation arrangements in the case of PPTs, often called ‘no creditor worse off’ (“NCWO”) provisions. As an example, an independent valuer is required to be appointed to determine whether pre-transfer creditors should be paid compensation and, if so, what amount, and the principles they must apply when making the valuation. The government proposes to extend the NCWO provisions to PPTs made in respect investment firms and banking group companies.
Extension of the Bank Administration Procedure (BAP) rules
The government is proposing to amend insolvency rules to extend the bank administration procedure to (the residual part of) investment firms and banking group companies. However, the BAP has not been extended to CCPs, as the resolution authority has powers of direction over the administrator of an insolvent CCP.
On 23 April 2013, HM Treasury published the initial report prepared by Peter Bloxham on the special administration regime for investment banks (SAR). The independent review makes a number of immediate recommendations, which include:
- The SAR should continue to have effect;
- The introduction of a mechanism to facilitate the rapid transfer of customer relationships and positions, where feasible;
- The bar date mechanism should be broadened to include client monies;
- The statutory objective in relation to client assets should be modified to include a reference to the “transfer” of assets to another institution in addition to the option of the “return” of client assets;
- SAR administrators should be permitted to make distributions of client assets during the period after the bar date process has commenced;
- Limited specific immunities to be introduced for SAR administrators;
- Good practice recommendations for firms, the FSA, and other institutions;
- A number of recommendations relating specifically to the work of the Financial Services Compensation Scheme (FSCS).
The report also sets out further areas to be reviewed as part of a second phase of work which will be co-ordinated with the FSA’s review of its Client Assets Rulebook. A final report is expected by the end of July 2013.
HM Treasury made a further announcement in a written statement to the House of Commons on 23 April 2013, accepting the main recommendations of the report. The Treasury agrees that SAR should be retained and accepts that amendments to that regime will be necessary in order to fulfil its objectives.
On 18 March 2013, HM Treasury published an amended version of draft Financial Services and Markets Act 2000 (Ring-fenced Bodies and Core Activities) Order (the “Ring-Fenced Bodies Order”). The Ring-Fenced Bodies Order is one of the pieces of secondary legislation to be made under the Banking Reform Bill.
The main change from the original version of the Ring-Fenced Bodies Order, published on 8 March 2013, seems to relate to high net worth individuals (“HNWI”) and small and medium sized enterprises (“SME”). As detailed in our previous blog post, deposits are exempt from the requirement to be held within a ring-fenced body if they are held on behalf of:
- HNWI (i.e. individuals who have, on average over the previous year, held free and investible assets worth GBP 250,000 or more); and
- SME which are also financial institutions.
Under the original order, HNWIs and SMEs could effectively self-certify their status as such. Under the amended order it seems that the institution in question is now responsible for determining whether HNWI or SME status is indeed appropriate.
On 11 March 2013, the Parliamentary Commission on Banking Standards (PCBS) published its second report on banking reform in the UK.
The second report addresses the UK government’s response to the first report of the PCBS and specifically the suggestions made therein in relation to banking reform. It makes a number of recommendations and observations, including:
- Independent Review: the PCBS encourages the government to implement a fully independent review of the workings of the ring-fencing mechanism, and not just a regulator review as currently proposed. This, the PCBS claims is “wholly inadequate” and amounts to no more than the “regulator marking its own examination paper”;
- Full industry–wide structural separation: despite the government’s rejection, the PCBS continues to believe that the Banking Reform Bill should include legislation which would enable full structural separation of the banking industry if the independent review of the workings of the ring-fencing mechanism proposed above concluded that this were necessary;
- Ownership structures: the PCBS is ‘disappointed’ that the government has chosen not to restrict the ability of an investment bank to own a ring-fenced bank; and
- Leverage Ratio – the PCBS regards the case for maintain the acceptable leverage ratio of a bank at 3% (i.e. 33 times leveraged) as “extremely weak” and continues to press for a 4% (i.e. 25 times leveraged) limit.
The PCBS intends to publish its final report by mid-May 2013.
On 8 March 2013, three draft statutory instruments to be made under the Financial Services (Banking Reform) Bill 2012-13 (the “Banking Reform Bill”) were published by HM Treasury:
- The Financial Services and Markets 2000 (Ring-fenced Bodies and Core Activities) Order (the “Ring-fenced Bodies Order”);
- The Financial Services and Markets Act 2000 (Excluded Activities and Prohibitions) Order (the “Excluded Activities Order”); and
- The Financial Services and Markets Act 2000 (Fees and Prescribed International Organisations) Regulations 2013 (the “Fees Order”).
These statutory instruments are starting to put flesh on the bones of the Banking Reform Bill, a piece of framework legislation which was published last month. For more detail on the Banking Reform Bill in general, please see our previous blog post.
The draft statutory instruments deal with four main issues:
- The class of institutions which are exempt from the definition of “ring-fenced body” (“Exempt Institutions”);
- The types of deposit that do not need to be held within a ring-fenced body (“Exempt Deposits”);
- The types of activities that will not be regarded as “excluded” and therefore can be conducted by a ring-fenced body (“Exempt Activities”); and
- The amount of exposure a ring-fenced entity is permitted to incur to a “financial institution” (“Permitted Exposure”).
A more detailed summary of the draft statutory instruments is provided in the Schedule below. As more information becomes known we will provide additional updates. However, even at this stage of the legislative process, what becomes immediately apparent is the huge data challenge firms will face in monitoring the height and location of the ring-fence, particularly with respect to the process surrounding Exempt Deposits and when incurring exposure to financial institutions.
The Ring-fenced Bodies Order
In general, the Ring-fenced Bodies Order defines:
- The class of Exempt Institutions; and
- The class of Exempt Deposits.
The following institutions do not qualify as ring-fenced bodies and are therefore not subject to the ring-fencing rules:
- broadly, any deposit taking institution which has held, on average, GBP 25 billion or less in deposits (calculated by reference to all UK deposit taking institutions in the group);
- insurance companies; and
- credit unions or industrial and provident societies.
Deposits are Exempt Deposits if they are held on behalf of:
- high net worth individuals (“HNWI”) (i.e. individuals who have, on average over the previous year, held free and investible assets worth GBP 250,000 or more); and
- small and medium sized enterprises (“SME”) which are also financial institutions and have been certified as such within the preceding 18 months.
An SME is:
- an enterprise which
- employs fewer than 50 staff; and
- has a turnover of GBP 6.5 million or less, or an annual balance sheet total of GBP 3.26 million or less; or
- a charity which has gross income (calculated on a group-wide basis) of GBP 6.5 million or less.
Note, however, that the following do not qualify as “financial institutions” and so deposits held for these institutions cannot qualify as Exempt Deposits irrespective of whether the institutions would qualify as SMEs:
- ring-fenced bodies;
- building societies;
- credit unions; or
- investment firms authorised to deal in investments as principal or agent.
In addition, if a statement regarding HNW or SME status is not refreshed every 12 months, or if a firm is notified that an account holder no longer benefits from HNW or SME status, and the deposit is held by a firm which is not already:
- a ring-fenced body;
- an Exempt Institution; or
- a building society
then the firm in question must notify the account holder that the deposit will become a “core deposit” (and therefore subject to the ring-fencing requirements) if the HNW or SME status is not refreshed within 18 months of its original date. The notification must also request that the account holder respond to the firm within six months:
- providing an updated HNW or SME certificate;
- nominating a ring-fenced body to which the deposit can be transferred if it becomes a “core deposit”; or
- acknowledging that the account holder will accept repayment of the deposit, together with details necessary to effect such repayment.
The account holder must also be warned that a failure to respond will result in the transfer of the deposit to an identified ring-fenced body. If the firm has a group member which is also a ring-fenced body, then the transfer of the deposit should be made to that group member.
The Excluded Activities Order
Under the Banking Reform Bill, ring-fenced bodies are not allowed to partake in “excluded activities” (i.e. dealing in investments as principal). However, under the Excluded Activities Order, a ring-fenced body will not be regarded as carrying on an excluded activity by:
- entering into a transaction if the sole or main reason for doing so is to hedge interest rate, currency, default or liquidity risk;
- buying, selling or acquiring investments for the purposes of maintaining liquid resources as required by BIPRU 12 (provided that this does not result in a breach of the “Financial Institutions Exposure Limits” detailed below); or
- entering into derivatives transactions with its accounts holders, provided that such transactions comply with the “Derivative Transactions” requirements detailed below.
A ring-fenced body may enter into derivatives transactions with its account holders provided that those transactions:
- have a linear pay-off (i.e. no options); and
- the sole or main purpose of the transaction is to hedge:
- interest rate risk;
- currency risk; or
- commodity price risk; and
- there is evidence available to assess the “fair value” of the investment; and
- the “position risk requirement” (i.e. the capital requirement applied to market risk positions under BIPRU 7) attributable to all such transactions remains less than TBD% of the ring-fenced body’s own funds; and
- the sum of the position risk requirements attributable to each individual transaction is less than TBD% of the “credit risk capital requirement” of the ring-fenced body calculated in accordance with GENPRU 2.1.51.
Financial Institution Exposure Limits
Ring-fenced bodies are prohibited from entering into any transaction under which it will incur exposure to a financial institution unless:
- the sole or main reason for entering into the transaction is to hedge:
- interest rate risk;
- currency risk; or
- default risk; and
- where the transaction is concluded with a member of the ring-fenced body’s group, it is done so on arms’ length terms; and
- where the financial institution in question is a “small credit institution” (judged by reference to the size of its balance sheet), the transaction does not increase the ring-fenced body’s exposure:
- in aggregate to small credit institutions above TBD% of the ring-fenced body’s own funds; or
- to its counterparty (i.e. to the small credit institution) above TBD% of the ring-fenced body’s own funds; and
- the transaction does not:
- increase the aggregate payment exposure of the ring-fenced body to an amount equal to or greater than:
- TBD% of the ring-fenced body’s own funds in relation to overnight payment exposure, or
- TBD% of the ring-fenced body’s own funds in relation to intra-day payment exposure; and
- increase the ring-fenced body’s exposure to the financial institution to an amount which is TBD% or more of the ring-fenced body’s own funds; and
- increase the aggregate payment exposure of the ring-fenced body to an amount equal to or greater than:
- the transaction does not:
- increase the aggregate settlement exposure of the ring-fenced body to an amount equal to or greater than:
- TBD% of the ring-fenced body’s own funds in relation to settlement exposure with a maximum tenor of t+2, or
- TBD% of the ring-fenced body’s own funds in relation to settlement exposure with a maximum tenor of t+5; and
- increase the aggregate settlement exposure of the ring-fenced body to an amount equal to or greater than:
- in relation to letters of credit issued to a financial institution on behalf of a customer of the ring-fenced body:
- the customer is not a financial institution; and
- the letter of credit:
- is issued in connection with the supply of goods or services; and
- specifies the transactions to which it relates; and
- specifies the total credit available under it; and
- is subject to the uniform customs and practices for documentary credits 2007 version; and
- the total exposure of the ring-fenced body in relation to letters of credit is less than TBD% of the ring-fenced body’s own funds.
Ring-fenced bodies will be required to disclose payments exposure, settlements exposure and exposure to letters of credit.
Inter-bank Clearing and Settlement Services
Ring-fenced bodies will be required to access inter-bank clearing and settlement systems either directly, or indirectly via another ring-fenced body.
Non-EEA Branches and Subsidiaries
Without the approval of the Prudential Regulation Authority (“PRA”), a ring-fenced body may not:
- maintain or establish a branch in any country or territory which is not an EEA member state; or
- have a participating interest in any undertaking which is incorporated in or formed under the law of country which is not an EEA member state.
Moreover, although a ring-fenced body will be deemed to have provisional approval for its application, ultimately the PRA will only be able to approve an application if, at a minimum:
- information sharing arrangements exist which will enable the PRA to obtain any required information;
- any stabilisation powers exercised by the Bank of England or the Treasury would be recognised in the jurisdiction in question; and
- approval of the application would not increase the risk that the failure of the ring-fenced body would have an adverse effect on the continuity of the provision within the UK of “core services”
The Fees Order
These regulations enable HM Treasury to charge certain expenses associated with the UK’s participation in the Financial Stability Board, to a defined class of market participants.
On 4 February 2013, the Financial Services (Banking Reform) Bill 2013 (the “BRB”) was published on the UK Parliament website. The BRB had its first reading in the House of Commons on 4 February, and its second reading on 5 February. Its purpose is to implement the recommendations of the Independent Commission on Banking (ICB) and deals with the following issues:
- ring-fencing requirements for the banking sector;
- depositor preference; and
- Financial Services Compensation Scheme.
This article focuses on ring-fencing requirements, an initiative which the UK government estimates will cost the banking industry between GBP 1.5 and 2.5 billion to implement and between GBP 1.7 and 4.4 billion per annum thereafter in terms of increased capital, funding and operational costs.
The BRB will implement ring-fencing in the UK via amendments to the Financial Services and Markets Act 2000 (“FSMA”). As currently drafted, the Prudential Regulation Authority (“PRA”) will be charged with ensuring that the business of “ring-fenced bodies” is carried on in a way that avoids any adverse effect on the continuity of the provision in the UK of “core services”.
A “ring-fenced body” is a UK institution which carries out one or more “core activities”. Currently, the only “core activity” is the accepting of deposits. It is widely assumed that a de minimis exemption will apply for UK institutions with less than GBP 25 billion in deposits from individuals and small and medium sized entities (“SMEs”). In addition, building societies are not regarded as “ring-fenced bodies” or otherwise subject to the BRB, although the Treasury is empowered to pass similar rules for these institutions.
“Core Services” include the provision of:
- facilities for the accepting of deposits or other payments into an account which is provided in the course of accepting deposits;
- facilities for withdrawing money or making payments from such an account; and
- overdraft facilities in connection with such an account.
Additions to the lists of “core activities” and “core services” are possible but, broadly, require the Treasury to form the view that an interruption of the provision of the activity or service in question could adversely affect the stability of all or a part of the UK financial system.
The Location and Height of the Ring-Fence
The location and height of a ring-fence at any time should be considered within the context of the general powers of prohibition granted to the Treasury. These powers allow it, inter alia, to prohibit a ring-fenced body from entering into transactions of a specified kind or with persons falling within a specified class if it considers that it would be more likely that the failure of a ring-fenced body would have an adverse effect on the continuity of the provision in the UK of core services. With that in mind, some clarity has been provided as to the type of services that can, and cannot, reside inside a ring-fence.
Outside of the Ring-fence
Ring-fenced bodies are not permitted to carry out “excluded activities”. Presently, only the regulated activity of dealing in investments as principal constitutes an “excluded activity”. However, the Treasury has powers to define other “excluded activities” if it considers that the carrying on of that activity by a ring-fenced body would make it more likely that its failure would have an adverse effect on the continuity of the provision in the UK of core services. In addition, the Treasury has power to allow a ring-fenced body to deal in investments as a principal if this would not be likely to result in any significant adverse effect on the continuity of the provision in the UK of core services.
Inside the Ring-Fence
Secondary legislation will define the conditions under which ring-fenced banks may enter into derivatives contracts. The government has confirmed that this will reflect the recommendations of the Parliamentary Commission on Banking Standards (“PCBS”), which require:
- the implementation of adequate safeguards to prevent mis-selling;
- agreement on a “limited and durable” definition of “simple” derivatives; and
- the imposition of limits on the proportion of a bank’s balance sheet which can be allocated to derivatives.
“Non-Core Deposits” are deposits made by high-net-worth private banking customers and larger organisations. They may be taken by a bank which is either inside or outside of a ring-fence. However, outside of a ring-fence, safeguards will be enacted via secondary legislation to ensure that depositors are able to make an informed choice prior to placement of the deposit. These safeguards are likely to include monetary thresholds and a requirement that eligible individuals and organisations must actively seek the exemption if they wish to use it.
Retail and SME Lending
Banking groups will not be required to carry out retail and SME lending exclusively from within the ring-fence.
Electrifying the Ring-fence
In order to ensure its robustness and effectiveness over time, the PRA will be required to report annually on the operation of the ring-fence. Specifically, it will be required to address:
- the extent to which ring-fenced bodies have complied with ring-fencing provisions,
- steps taken by ring-fenced bodies to comply;
- enforcement measures taken by the PRA; and
- the extent to which ring-fenced bodies have acted in accordance with guidance regarding the operation of the ring-fence.
In addition, the government has confirmed that it will amend the BRB in order to give the PRA the power, if required, to enforce full separation between retail and wholesale banking with respect to an individual banking group. However, it has chosen not to act on the recommendation of the PCBS to grant the PRA the power to enforce industry-wide separation, considering that decisions over the fundamental structure of banking in the UK should be left to Parliament rather than to a regulator.
Independence of the Ring-Fenced Body
Ring-fenced bodies will be required to ensure that, as far as reasonably practicable:
- the carrying on of core activities is not adversely affected by the acts or omissions of other members of its group;
- it is able to take decisions independently of other members of its group;
- it does not depend on resources from group members which would cease to be available in the event of the insolvency of the group member; and
- it would be able to continue to carry on core activities in the event of the insolvency of one or more other group members.
In order to give teeth to these provisions, ring-fenced bodies will be required to:
- enter into contracts with group members on arm’s length terms;
- restrict the payments (e.g. dividends) that it makes to other group members;
- disclose to its regulator information relating to transactions between it and other group members;
- include on its board of directors members who are independent both of the ring-fenced body and the wider group as well as non-executive members;
- act in accordance with a remuneration policy and a human resources policy meeting specified requirements;
- make arrangements for the identification, monitoring and management of risk in accordance with specified requirements; and
- implement such other provisions as its regulator considers necessary or expedient.
In addition, the government has confirmed that:
- directors of ring-fenced banks should be personally responsible for ensuring that their banks comply with ring-fencing provisions; and
- a director of a ring-fenced body must be an approved person so that the full range of PRA disciplinary powers may be applied to any director who is knowingly concerned in a contravention of any ring-fencing obligation.
The Treasury may also require banking groups to split pension schemes between ring-fenced and non ring-fenced entities as the former cannot become liable to meet, or contribute to the meeting of, liabilities in respect of pensions or other benefits payable to or in respect of persons employed by non ring-fenced bodies. However, this requirement will not enter into force until 1 January 2026 at the earliest.
The BRB inevitably leaves many question unanswered, including:
- the exact scope of the ring-fence i.e. the activities and assets which can (or cannot) be within the ring-fenced body: whilst some guidance has been provided at the edges the majority in the middle remains unknown;
- the exact nature of exemptions (including the de minimis exemption) from ring-fencing;
- specific prohibitions on the activities of ring-fenced banks; and
- the definition of a “simple” derivative: despite the recent mis-selling scandal it would appear that interest rate swaps used for the purposes of hedging can be sold from within the ring-fence. Presumably the same will be the case for vanilla currency swaps.
Much of the detail of the BRB remains to be fleshed out via statutory instrument. However, despite this, fundamental questions already exist about the enforceability of ring-fencing as current drafted. For example, the prohibition on non ring-fenced group companies benefiting from funding providing by a ring-fenced entity does not appear to be entirely consistent with Article 16(1) of the draft EU Recovery and Resolution Directive (“RRD”), which requires Member States to “ensure” that group companies can enter into an agreement to provide financial support to one another in the event of financial difficulties.
The UK government remains lukewarm at best to the idea of implementing further reform along the lines of the Volcker Rule, as advocated by the PCBS. Neither is it minded to increase the Basel III Leverage Ratio from its current 3% to 4%; another PCBS suggestion. Further afield, attempts to implement structural reform of banks at a national level within Germany and France may yet halt the momentum behind the Liikanen reforms. Ultimately, time will tell, but perhaps UK banks should be thankful for small mercies in that they may only face the prospect of having to split themselves in two, rather than three or even four, parts.
Whatever the final form of the BRB and other structural reform initiatives, one thing is certain: the process of separating a retail bank from a wholesale bank will be a monumental undertaking. It will require a detailed analysis of assets and liabilities for the purposes of allocation inside or outside of the ring-fence, fundamental legal and operational re-structuring, wholesale re-papering of contractual relationships and robust policies and procedures for the purposes of monitoring the location and height of the ring-fence on an ongoing basis. Despite the 2019 deadline and the many blanks in the legislation yet to be completed, any bank likely to be subject to the BRB should already be planning how it will implement organisational change on this scale.
 In the HM Treasury paper “Banking reform: a new structure for stability and growth”
On 13 December 2012, HM Treasury published a press release announcing that Peter Bloxham, a former Freshfields partner, has been appointed to review the special administration regime (“SAR”) for investment banks.
HM Treasury expects that an initial report will be published by the end of January 2013, with further recommendations and a fuller report being produced by the end of June 2013. The review will be co-ordinated with the FSA’s own review of its Client Assets Rulebook, which is also expected to conclude by the end of June 2013.