The Banking Reform Bill: Secondary Legislation Hints at the Data Challenge Facing Banks

Introduction

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:

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.

Schedule

The Ring-fenced Bodies Order

In general, the Ring-fenced Bodies Order defines:

  • The class of Exempt Institutions; and
  • The class of Exempt Deposits.

Exempt Institutions

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.

Exempt Deposits

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

Exempt Activities

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.

Derivative Transactions

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[1], 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
  • 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[2]; 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
  • 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[3]; 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.

Other Developments

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.


[1] The implication appears to be that incurring payment exposure which is greater than overnight is not permitted.

[2] The implication appears to be that incurring settlement exposure in excess of t+5 is not permitted

[3] As published by the International Chamber of Commerce

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Bank Ring-fencing in the UK: The Financial Services (Banking Reform) Bill 2013

Introduction

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.

Ring-fencing

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

Simple Derivatives

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

“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[1] 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.

Conclusion

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.


Ex Freshfields partner to review special administration regime for investment banks

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.

HM Treasury Publishes Summary of Responses to Consultation on Non-bank resolution

Introduction

On 17 October 2012, HM Treasury published a summary of responses received to its August 2012 consultation paper, entitled “Financial Section Resolution: Broadening the Regime” (the “Consultation Paper”).  Broadly, the Consultation Paper had proposed the widening of resolution regimes to systemically important non-banks, specifically:

  • Investment firms and parent undertakings;
  • Central counterparties (CCPs);
  • Non-CCP financial market infrastructures (non-CCP FMIs); and
  • Insurers.

For a full summary of the Consultation Paper, please see our previous blogpost “HM Treasury Consultation:  RRP for Financial Market Infrastructures” dated 8 August 2012.

Summary of Responses

HM Treasury received 45 responses to the Consultation Paper prior to the 24 September 2012 deadline.  Broadly, respondents were supportive of the original position of the Government, which reconfirmed its intention to develop the UK regime in advance of European legislation.  The main changes to be implemented in light of the Consultation Paper are set out below.

Investment firms and parent undertakings

The Government proposes:

  • to narrow the definition of investment firms which are subject to the resolution regime proposals so as to promote consistency with the Recovery and Resolution Directive by excluding small investment firms that are not subject to an initial capital requirement of €730,000; and
  • an extension of stabilisation powers to group companies in order to facilitate resolution, but subject to certain conditions, such as limiting such powers to financial groups (rather than financial elements of any group that contains a bank, as was proposed in the Consultation Paper).

Central Counterparties

The Government proposes to include an additional objective for intervention in a failing CCP, which seeks to maintain the continuity of critical services.  It notes the mixed response from the industry regarding the intervention power generally but continues to regard this as justified given the systemic consequences which closure of a CCP’s critical functions could have, particularly where there are no obvious substitutes for the CCP.  However, the Government also accepts that recognised clearing houses that do not provide central counterparty clearing services should be excluded from the regime altogether, meaning that they are likely to be covered by proposals relating to non-CCP FMIs.

The Government also noted the strong industry opposition to its proposal to allow resolution authorities to impose on the clearing members of a CCP any losses which were above and beyond those dealt with by the CCP’s existing loss allocation provisions.  It was felt that this proposal would cause uncertainty, could potentially lead to distorted incentives such as the early termination and exit of members, might put UK CCPs at a competitive disadvantage and could have capital and liquidity implications for clearing members.  In light of this, the Government has decided not to pursue the proposal, but remains of the view that taxpayers should not be expected to meet the cost of restoring a failed CCP.  As such, it proposes to make loss allocation rules mandatory for the purposes of authorisation as a Recognised Clearing House within the UK and will re-consult on this new proposal in due course.

Non-CCP FMIs and Insurers

The government accepts that the case for a full resolution regime for Non-CCP FMIs or insurers is less clear cut.  Most Non-CCP FMIs have no financial exposure, similar to those faced by CCPs, and any failure is more likely to be operational or technological in nature.  In addition, there seems to be a general recognition that traditional insurance activities – whether general or life insurance business – do not generate or amplify systemic risk.  In contrast, non-traditional insurance and non-insurance activities (such as derivative trading) are regarded as sources of systemic risk.

It seems that the Government accepts that a strengthening of the existing regimes appears to be the most appropriate option and will engage in further dialogue to determine how best this can be achieved.

Next Steps

The changes to proposals regarding investment firms and their parent undertakings, deposit taking institutions and CCPs will be effected by changes to the Financial Services Bill that is currently before Parliament.  For non-CCP FMIs and insurers, the government will take further time to consider the arguments presents by respondents to the Consultation Document and decide the best way to proceed.

HM Treasury publishes draft legislative clauses for RRP for non-banks

On 23 August 2012, HM Treasury published draft clauses together with an explanatory note, to inform responses to its ‘Financial sector resolution: broadening the regime’ consultation paper, published in August 2012 (see previous blogpost “HM Treasury Consultation:  RRP for Financial Market Infrastructures” dated 8 August 2012), the purpose of which was to consult on extending RRP requirements to systemically important non-banks.

The draft clauses constitute proposed amendments to the Banking Act 2009 and the Financial Services and Markets Act 2000. They have been prepared on the basis that the Financial Services Bill 2012-13, as introduced to the House of Lords on 23 May 2012, has been enacted and is in force.

Broadly, the amendments seek to extend:

  • the resolution objectives in relation to which the Treasury, FSA and BoE must have regarding when using the stabilisation powers, to include:
    • the protection of client assets, and
    • the minimisation of adverse effects on institutions that support the operation of financial markets (e.g. exchanges and clearing houses);
  • stabilisation powers to the UK parent companies of banks, provided that certain conditions are met; and
  • the special resolution regime established under the Banking Act 2009 to investment firms and UK clearing houses.

HM Treasury Consultation: RRP for Financial Market Infrastructures

On 1 August 2012, HM Treasury published a consultation document entitled “Financial sector resolution: broadening the regime”.  Citing the collapses of Bear Stearns (an investment firm) and AIG (an insurer), the UK Government is reviewing the need to establish a resolution regime framework for non-banks on a more accelerated timetable than that currently envisaged in ongoing international work.

The consultation is open for responses until 24 September 2012.  It asks for views on the most appropriate type of policy response with respect to systemically important firms, specifically whether existing administration/run-off arrangements should be extended/strengthened or whether a new comprehensive resolution regime should be introduced.  The consultation paper addresses four broad sectors:

  • investment firms and parent undertakings;
  • central counterparties (CCPs);
  • non-CCP financial market infrastructures (non-CCP FMIs); and
  • insurers.

HM Treasury considers that each of the above categories may be systemically important.  In addition, it does not preclude the possibility that other types of non-bank financial institution may also be systemically important, specifically referring to hedge funds.  However, it accepts that the case against insurers in “less clear cut” and recognises that, in practice, it is likely that only some, if any, of each type of entity within a category will actually be systemically important.

The UK Government expects the benefit of taking action pursuant to a formal resolution regime to exceed the costs of disorderly failure.  As such, it believes that there is a strong case for introducing powers earlier than is expected as part of any European process.  However, it does not propose to introduce stabilisation powers for insurers, non-CCP financial market infrastructure or shadow banking entities at this stage.  A more detailed summary of the consultation paper is provided in the schedule below.

 SCHEDULE

1. Investment Firms

The consultation paper notes that the UK Special Administration Regime (“SAR”) introduced under the Banking Act 2009 has strengthened the UK’s ability to manage the failure of investment firms.  However, due to the fact that the resolution powers established under the Banking Act 2009 only apply to deposit-taking institutions, it believes that there is no suitable regime for managing the failure of:

  • systemically important investment firms;
  • parent undertaking(s) of systemically important investment firms; or
  • parent undertaking(s) of deposit-taking institutions.

As such, the UK Government intends to legislation in order to plug this gap.

1.1 Investment firms that would be subject to the new resolution regime 

The UK Government believes that it would be inappropriate to apply a prescriptive definition of ‘systemic investment firm’ due to the fact that:

  • some factors which will be relevant in assessing systemic importance will inevitably change over time; and
  • too restrictive a definition may make it difficult to take action to resolve a non-systemic firm before it actually reaches the point of failure.

As such, all UK incorporate investment firms will be subject to the new resolution regime.  For these purposes, an ‘investment firm’ means a UK institution which is an investment firm for the purposes of the Capital Adequacy Directive.[1]  However, it is important to note that the proposed stabilisation powers would only be exercisable with respect to a systemic investment firm.  Nonsystemic firms would be entered into the existing SAR.

1.2 The application of the new resolution regime to parent undertakings

Certain restrictions will apply to the use of stabilisation powers with respect to parent undertakings:

  • the intended legislation will only provide resolution powers for UK firms and parent undertakings;
  • the proposed stabilisation powers will only be exercisable in relation to financial elements of the holding company; and
  • where there is an overall parent holding company which owns both financial and non-financial subsidiaries and an intermediate holding company which owns the systemic financial subsidiary, stabilisation powers will only be exercised at the intermediary level.

1.3 Trigger conditions for intervention

Intervention will only be possible with respect to a systemically important firm, and will require the relevant firm’s regulator to be satisfied that the firm is failing, or likely to fail, its regulatory threshold conditions and that it is not likely that action (other than resolution action) will be taken to enable the firm to meet its threshold conditions.

1.4 Objectives for the resolution of investment firms and parent undertakings

The objectives for resolution of a systemically important investment firm and its parent undertakings will largely mirror the objectives for resolution of a deposit-taking institution, but will include the following additional objectives:

  • protection of client funds and client assets; and
  • avoiding unnecessary interference with the operations of financial market infrastructure.

1.5 Design of stabilisation powers

The powers to resolve a systemically important investment firm and/or its parent will be broadly similar to those contemplated in the draft Recovery and Resolution Directive (the “RRD”) i.e. transfer to a third party purchaser or a bridge institution.  However, the following powers will not be implemented separately from the RRD process:

  • bail-in;
  • transfer to an asset management vehicle; and
  • a stay on the exercise of early termination and close-out netting rights in financial contracts held by counterparties of a failed firm.

1.6 Safeguards

Safeguards to protect property rights affected as a result of the exercise of property transfer powers will be established by secondary legislation.

2. Central counterparties

2.1 Scope of the intended resolution regime

The Government’s proposed resolution regime for CCPs would capture any clearing house  incorporated in the UK and recognised under Part 18 of FSMA 2000. However, only systemically important CCPs would be subject to the resolution powers.  Before being able to exercise a stabilisation power to resolve a failing clearing house, the Bank of England would have to be satisfied that the exercise of stabilisation powers is necessary in pursuance of specified public interest aims. The powers would be similar to the stabilisation powers proposed for investment firms albeit that it is not envisaged that HM Treasury would have the power to transfer a clearing house into public ownership.

2.2 Trigger conditions for intervention

Conditions for intervention in order to ensure the continuity of clearing services would be triggered where a clearing house had breached, or is likely to breach, the conditions which the clearing house must meet in order to be, and continue to be, a recognised clearing house.  Two further preconditions to intervention would be that:

  • it is not likely that other actions would enable the clearing house to once again meet its authorisation conditions; or
  • notwithstanding that other actions would restore the clearing house to compliance with its authorisation conditions, such actions would undermine the continuity of clearing services.

2.3 Resolution Powers over CCPs

2.3.1 Power to direct clearing houses

The Bank of England would have the power to direct the actions of a clearing house if it was satisfied that this is in the public interest with respect to:

  • protecting, or maintaining confidence in, the UK financial system; or
  • protecting or maintaining the continuity of the services provided by the CCP or the CCP itself.

This power would enable the regulator to direct a CCP to take, or refrain from taking, action to address risks to its solvency or any other matter.  Specifically, a CCP could be required to amend/activate its rules or introduce emergency rules.

2.3.1 Power of Direction over an Administrator

The resolution authority would have power to direct the administrator of a failed CCP (subject to certain conditions) to take action to address risks to financial stability and ensure the continuity of services in support of an acquirer of the CCP’s business.

2.4 Objectives for operation of a resolution regime for CCPs

The objectives of the authorities with respect to the resolution of clearing houses would closely follow those already applicable to deposit-taking institutions under the Banking Act 2009 but would include an additional objective reflecting the need to maintain the continuity of the provision of critical central counterparty clearing services. As such, the set of resolution objectives would be as follows:

  • to maintain the stability of the financial systems of the United Kingdom;
  • to protect and enhance public confidence in the stability of the financial systems of the United Kingdom;
  • to maintain the continuity of the provision of central counterparty clearing services;
  • to protect public funds; and
  • to avoid interfering with property rights in contravention of the Human Rights Act 1998.

2.5 Stabilisation powers for CCPs

The stabilisation powers applicable to CCPs would broadly follow the design of existing stabilisation powers for banks, namely enabling the transfer of securities, property, rights and liabilities to a private sector purchaser or a ‘bridge’ CCP.  In order to ensure that clearing services remain uninterrupted, the Bank of England would also have power to:

  • temporarily suspend termination rights and ensure that any application of the stabilisation powers did not constitute an event of default with respect to any of the CCP’s contracts;
  • transfer membership agreements and clearing member positions and transfer and/or amend the rules of operation of a failed clearing house for a specified period of time or until a specified event occurred;
  • direct the actions of any insolvency practitioner appointed in relation to a clearing house; and
  • impose liabilities on shareholders and/or members of a CCP (potentially subject to a liability cap), to require them to contribute funds to restore a clearing house to viability.

2.6 Safeguards

Safeguards will include:

  • requirements that creditors are not discriminated against on grounds of nationality;
  • compensation arrangements for those affected by the exercise of stabilisation powers; and
  • measures to protect against partial property transfers.

3. Non-CCP financial market Infrastructures

3.1 Improving the regulatory framework for managing the failure of non-CCP FMIs

Non-CCP FMIs include:

  • central securities depositories and securities settlement systems;
  • payment systems;
  • exchanges and trading platforms; and
  • trade repositories.

There is currently no resolution regime for non-CCP FMIs, which are subject to ordinary UK insolvency law.  However, the failure of a non-CCP FMI would likely result in the cessation of critical services.  As such, the UK Government believes there is a need to legislate in this area and identifies two broad approaches:

  • strengthening the existing insolvency arrangements to ensure that the available insolvency mechanisms are adequate; and
  • developing a new, comprehensive resolution framework.

The trigger for intervention seems likely to occur when a firm is failing, or likely to fail, to continue to meet its regulatory recognition/authorisation/operational requirements, with no reasonable prospect of remedial action to address this.

Under the first approach, a modified administration regime is contemplated under which an administrator would have the specific objective of ensuring the continuity of services, supplemented by additional powers to enforce a stay on early termination rights and a moratorium on payments to creditors.

Under the second approach, a new resolution regime would be put in place, supplemented by appropriate powers such as:

  • the power to transfer some or all of a non-CCP FMI’s operations to a third party provider or to a bridge institution;
  • loss allocation or cash-call powers under which the system’s owners or members/users could be required to bear losses and/or provide additional funding; and
  • step-in powers under which the authorities could take over the management of the FMI, irrespective of any insolvency proceedings.

4. Insurers

4.1 Improving the regulatory framework for managing the failure of insurers

The UK Government broadly accepts that disruption to core insurance activities in themselves is unlikely to cause financial instability.  However, it is of the opinion that insurance institutions can still have a degree of systemic potential depending on:

  • the complexity of business models, particularly interconnectedness with banks;
  • dependencies and inter-linkages with other financial institutions (including through undertaking non-traditional insurance activities);
  • institution size; and
  • market share in insurance products that are necessary, or compulsory, for the functioning of economic activity.

As such, the Government wants to ensure that, on the failure of any insurer:

  • an orderly market exist can be facilitated; and
  • an appropriate degree of policyholder protection should be achieved, including, where appropriate, though continuity of cover.

The UK does not have a specific resolution regime for insurers.  Presently, failed insurance firms are dealt with through ‘run off’.  However, this process can result in the effective subordination of longer-dated policyholders.  With the goal of ensuring the continuity of payments and protection for policyholders, particularly (though not exclusively) long-term policyholders, the consultation paper identifies two possible options for managing the failure of insurance firms:

  • reviewing the adequacy of existing insolvency arrangements; and
  • assessing whether evidence exists to justify the establishment of a comprehensive set of resolution stabilisation tools specifically for the insurance industry, including the power to transfer assets and liabilities from a failing insurer to a third party.


[1] Directive 2006/49/EC