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
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 25 April 2013, HM Treasury published a consultation paper on the introduction of a Special Administration Regime (SAR) for inter-bank payment systems (such as Bacs, CHAPS, Continuous Linked Settlement, CREST, LCH Clearnet Ltd, Faster Payments Service and ICE Clear Europe), operators of securities settlement systems (CREST being the only example in the UK) and key service providers to these firms (e.g. IT and telecommunications providers). Responses are requested by Wednesday 19 June 2013.
The SAR would be a variant of a normal corporate administration and would be modelled on the special administration framework used in the utilities industries and the investment bank SAR. However, it would be modified to allow the Bank of England to exercise control of the SAR process, to enable a special administrator to transfer all or part of the business to an aquirer on an expedited basis, and to facilitate the enforcement of restrictions on early termination of third party contracts. Under the SAR, the special administrator would have the overarching objective of maintaining the continuity of critical payment and settlement services in the interest of UK financial stability. “Non-CCP FMI”, such as exchanges and trade repositories, and entities already covered by resolution powers for central counterparties (such as LCH and ICE) would be excluded from the regime.
On 25 April 2013, HM Treasury also published a statement confirming the fact that, before the end of the summer, it will consult on the extension of the special resolution regime (SRR) established under the Banking Act 2009 to group companies, investment firms and UK clearing houses.
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 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.
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
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).
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.
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.
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.
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
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.
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. 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:
- 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.
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.
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.
4.1 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.
 Directive 2006/49/EC