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.