Bank structural reform

Introduction

Following the financial crisis of 2009 regulators around the world considered the introduction of measures intended to resolve the systemic and moral hazard risks associated with the failure of systemically important financial institutions (SIFIs).

One of the most significant of those risks was "too-big-to-fail" (TBTF). This arises when the threatened failure of a SIFI leaves a government with little practical alternative but to bail it out using taxpayer money.

Regulators have implemented a number of reforms which are intended to diminish, if not eradicate, TBTF. The Financial Stability Board (FSB) outlined the benefits that structural reform would bring when it observed in a paper published in September 2013 that:

"Structural reform measures (including separation of activities, intra-group exposure limits, local capital and liquidity requirements, etc.) seek to put restraints on excessive risk-taking by SIFIs and thus help promote financial stability. They can also contribute to improving the resolvability of SIFIs at a jurisdictional level, thus reducing the moral hazard of TBTF."

The FSB provided a useful overview of the various global initiatives and made the point that the proposals for the implementation of structural reform vary from country to country:

"Several models for structural reforms have emerged: one places an outright prohibition on certain combinations of financial activity (e.g. the Volcker Rule contained in section 619 of the Dodd-Frank Act). Alternative approaches, associated with the UK’s Independent Commission on Banking (the ICB or "Vickers Commission"), the High-Level Expert Group on Reforming the Structure of the EU Banking Sector chaired by Bank of Finland Governor Erkki Liikanen and recent legislation in Germany and legislative initiative in France, emphasise instead a requirement for different types of financial activity to be conducted by separately capitalised subsidiaries. Approaches for structural regulation differ in scope and content reflecting the different institutional characteristics of the jurisdictions for which they have been developed."

This article focuses on the structural reform measures which have been introduced, or are proposed to be introduced, in Europe and the UK.

Key proposed measures

Europe

The High-level Expert Group was appointed by EU Commissioner Michel Barnier in February 2012 under the chairmanship of Erkki Liikanen (the Governor of the Bank of Finland). The Group’s task was to assess whether additional reforms directly targeted at the structure of individual banks would further reduce the probability and impact of failure, ensure the continuation of vital economic functions upon failure and protect vulnerable retail clients.

The Group published its report on 02 October 2012. The key recommendation was that certain particularly risky financial activities of universal banks should be separated from their deposit-taking activities.

Shortly after the publication of the Group’s report, the European Commission launched a consultation on the Group’s recommendations. It published a summary of responses on 21 December 2012. This was followed by a further consultation paper in May 2013 which focused on the different policy options that would underpin structural separation. On 17 October 2013, the European Commission summarised the responses to the consultation paper.

The European Commission then issued its Proposal for a Regulation on structural measures improving the resilience of EU credit institutions (2014/0020) on 29 January 2014 which proposed a ban on proprietary trading in financial instruments and commodities (i.e. trading on own account for the sole purpose of making profit) by systemically important EU credit institutions and their subsidiaries and branches.

In a speech delivered at a financial symposium in August 2014, Erkki Liikanen provided an overview of the original aim of his group and how its recommendations had been interpreted by the European Commission:

“The Expert Group that I chaired saw the need to simplify the structure of large and complex banks to shield the deposit-taking bank from an excessive risk-taking in trading activity, to facilitate monitoring and supervision of these banks and to make the recovery and resolution measures easier to impose. At the same time, we wanted to preserve the universal banking model that, by and large, has well served the European economy.

Given these starting points, we proposed a mandatory separation of a deposit entity and a trading entity within a banking group. Based on this recommendation, the European Commission presented its proposal for the Regulation on structural measures [in] January this year. The objectives of the Commission´s proposal are similar to ours. However, the Commission´s proposal leaves more discretion to the authorities concerning the separation process. In addition, the Commission´s proposal includes an outright ban on organised proprietary trading as in the Volcker reform.”

The European Central Bank issued an opinion (CON/2014/83) on the proposed Regulation on 19 November 2014 in which it welcomed the proposed Regulation.

The proposed Regulation was first considered by the Economic and Monetary Affairs Committee (ECON) of the European Parliament on Tuesday, 04 November 2014. The British Bankers' Association (BBA) produced a report which briefly summarised the speech on the proposed Regulation given to ECON by its Rapporteur, the Swedish MEP, Gunnar Hökmark and the subsequent discussions.

On 27 May 2015, ECON rejected by a single vote the report from Gunnar Hökmark on structural reform. The reasons for doing so appear to have been the inability of the two main political groupings within the European Parliament (the centre-left S&D and the centre-right EPP) to agree on a compromise. For details, see the alert issued by the BBA.

On 19 June 2015, the Council of the European Commission agreed its negotiating stance on structural reform and called on the European Parliament to agree on its position as soon as possible. For details, see the press release issued by the Council.

On 03 July 2018, the European Commission formally withdrew 15 pending legislative proposals, one of which was the Proposal for a Regulation on structural measures improving the resilience of EU credit institutions  (2014/0020) (see the relevant page of the European Commission website). The European Commission stated that it could see no foreseeable agreement between the European Parliament and the Council and that the file has not progressed since 2015. In addition, the main financial stability rationale of the proposal has in the meantime been addressed by other regulatory measures in the banking sector and most notably the entry into force of the Banking Union's supervisory and resolution arms.

UK 

The Independent Commission on Banking (ICB) was appointed by the Government in June 2010. Its task was to consider the structure of the UK banking sector and to look at structural and non-structural measures to reform the banking system and promote competition.

The ICB reported on 12 September 2011. Its key recommendation was that the retail activities of UK universal banks should be ring-fenced in a separate legal entity within the wider banking group.

The Government published a White Paper containing its response to the recommendations on 16 June 2012. It adopted the majority of the ICB’s recommendations.

The Parliamentary Commission on Banking Standards (PCBS) was appointed by HM Treasury to subject the draft legislation which would implement the structural reforms to pre-legislative scrutiny. The PCBS made a number of recommendations, several of which were accepted by HM Treasury.

The nature and scope of the ring-fencing regime in the UK is a large and important subject. However, one or two important points can be made.

The legislative regime is created by the Financial Services (Banking Reform) Act 2013 (FSBRA) which received Royal Assent on 18 December 2013. It should be noted that the FSBRA is a far-ranging statute that introduces a number of changes into the financial services regulatory landscape. For example, it creates a senior managers' regime, a criminal offence of reckless misconduct in the management of a bank and a bail-in stabilisation tool as part of the special resolution regime created by the Banking Act 2009. The ring-fencing provisions of the FSBRA are, therefore, but one aspect of those far-ranging reforms to the banking industry. 

The ring-fencing regime is created by:

• the insertion of a new Part 9B into the Financial Services and Markets Act 2000 (FSMA)
• the issue of a number of statutory instruments which set out which entities will be "ring-fenced bodies" and the activities and services which a ring-fenced body can provide to its customers. In particular:
  • The Financial Services and Markets Act 2000 (Ring-fenced Bodies and Core Activities) Order 2014 (SI 2014/1960) was made on 23 July 2014 and came into force on 01 January 2015
  • The Financial Services and Markets Act 2000 (Excluded Activities and Prohibitions) Order 2014 (SI 2014/2080) (the Excluded Activities Order) was made on 23 July 2014. Part of it came into force on 01 January 2015 and the remainder entered into force on 01 January 2019, and
• rules issued by the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA).

The ring-fencing requirements will apply to a "ring-fenced body". A ring-fenced-body will be a "UK institution" which carries on one or more "core activities" in relation to which it has permission under Part 4A of FSMA, unless one of the relevant exemptions applies. A UK institution is defined as being a body corporate incorporated in the UK.

At the date of writing, the only activity designated as a "core activity" under the FSBRA is the regulated activity of accepting deposits (whether carried on in the UK or elsewhere) as set out in article 5 of The Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (SI 2001/544). Certain exemptions will apply to a body in question when:

• it is a type of institution which has been exempted from ring-fencing (such as building societies, insurance firms, registered societies such as credit unions and industrial and provident societies)
• it falls within the exemption for small banks. Broadly, this applies to deposit-takers that are members of a group whose core deposits do not exceed £25 billion or to deposit-takers that are members of a group, where the sum of the average core deposit totals for each deposit-taker in the group do not exceed £25 billion, or
• its deposit-taking activity is deemed not to be a core activity, because it does not relate to "core deposits".

Ring-fenced bodies will be prevented from undertaking those activities which regulators believe lie outside the scope of those which a retail bank should undertake. Accordingly, the FSBRA amends FSMA by introducing a new section 142D. This refers to the concept of "excluded activity" and specifically includes dealing in investments as principal. Other excluded activities are specified in the Excluded Activities Order.

Banks became subject to the full regime with effect from 01 January 2019.

On 27 May 2015, the PRA issued its policy statement (PS10/15) which set out its detailed guidance on the implementation of the ring fence for UK retail banks. The BBA welcomed the policy statement saying that it cleared up potential ambiguities and gaps in understanding the proposed arrangements and would enable banks to make progress. It also pointed out that much more detail was needed before banks could implement the major restructuring of their businesses which the legislation will require. The BBA's response is available on its website.

On 16 October 2015, Paul Chisnall, the BBA’s Executive Director for Financial Policy and Operations, published a useful summary of the ring-fencing position to that date and considered what the BoE's proposals would mean for the banks affected.

Further policy statements were also published in 2016.

On 04 March 2016, the PRA published its policy statement entitled The implementation of ring-fencing: The PRA’s approach to ring-fencing transfer schemes (PS10/16) which responds to feedback on its previous Consultation Paper 33/15 of the same name.

On 18 March 2016, the FCA published its policy statement entitled Ring-fencing: Disclosures to consumers by non-ring-fenced bodies (PS16/9). This contains the information to be communicated by a non-ring-fenced bank (namely, a deposit taker that is not a ring-fenced-bank but is part of a corporate group that contains one) to eligible individuals (namely, individuals with financial assets of at least £250,000) who elect to continue to hold or to open an account with a non-ring-fenced bank.

On 07 July 2016, the PRA published two policy statements. The first policy statement, entitled The implementation of ring-fencing: prudential requirements, intragroup arrangements and use of financial market infrastructures (PS20/16), was published with various appendices which set out the final rules. Alongside this first policy statement, the PRA has also published a further consultation on its proposed ring-fencing policy, entitled The implementation of ring-fencing: reporting and residual matters (CP25/16), which sets out the PRA’s proposals in relation to the data it intends to collect in support of its obligations under the Act in respect of ring-fencing. The consultation closes on 07 October 2016. The second policy statement, entitled Ensuring operational continuity in resolution (PS21/16), responds to feedback on its previous Consultation paper CP38/15 of the same name.

On 11 October 2016, the PRA published a consultation paper entitled Occasional Consultation Paper (CP36/16). Chapter 5 of the consultation paper covers amendments to the ring-fencing rules and reporting requirements that the PRA is proposing following HM Treasury’s publication of amendments to the ring-fencing secondary legislation. The consultation closed on 12 December 2016.

On 20 October 2016, the House of Commons Treasury Select Committee (Treasury Select Committee) published a press release, together with an exchange of letters with HM Treasury, concerning proposed amendments to the bank ring-fencing rules. At the same time, the Treasury Select Committee published an undated memorandum entitled Minor and technical amendments to strengthen the effectiveness of the ring-fencing legislation which provides a summary of the proposed amendments.

On 28 October 2016, the Financial Services and Markets Act 2000 (Ring-fenced Bodies, Core Activities, Excluded Activities and Prohibitions) (Amendment) Order 2016 (SI 2016/1032) was made. The Order makes certain technical amendments to the UK's bank ring-fencing regime, which entered into force on 01 January 2019. It amends the Financial Services and Markets Act 2000 (Ring-fenced Bodies and Core Activities) Order 2014 (SI 2014/1960) and the Financial Services and Markets Act 2000 (Excluded Activities and Prohibitions) Order 2014 (SI 2014/2080). The Order entered into force on 01 December 2016.

The PRA website contains a useful table which lists the various policy developments since 06 October 2014 and is a useful overview of the evolution of policy in relation to bank structural reform. An entry in the table confirms that the near-final rules and near final supervisory statement are both contained in PS10/15 (referred to above). HM Treasury previously issued a useful policy paper in May 2015 which summarises government policy in relation to bank regulation during the Coalition Administration of 2010-2015.

On 26 May 2016, the Financial Policy Committee (FPC) published its Framework for the Systemic Risk Buffer (SRB), which applies to ring-fenced banks and large building societies. The SRB will be applied to individual institutions by the PRA and will be introduced at the same time ring-fencing entered into force on 01 January 2019.

On 29 July 2016, the PRA published a consultation on Ensuring operational continuity in resolution: reporting requirements (CP28/16) which sets out proposals for firms to report on the activities and financial resources of their group provider(s). The consultation closed on 28 October 2016.

On 01 February 2017, the PRA issued a policy statement entitled The implementation of ring-fencing: reporting and residual matters – responses to CP25/16 and Chapter 5 of CP36/16 (PS3/17). The appendices to this policy statement set out the final rules (see Appendix 1) and supporting policy documents (see Appendices 2-6) to implement the proposals consulted on in CP25/16. The relevant appendices items (1, 2 and 6) include links to final reporting templates and instructions.

On 16 February 2017, the PRA published a consultation paper entitled Occasional Consultation Paper (CP2/17), which sets out proposed changes to the PRA rules and existing supervisory statements, including proposals on reporting requirements for ring-fenced bodies. The consultation closes on 16 May 2017.

On 24 March 2017, HM Treasury published a policy paper explaining the concept of ring-fencing. The paper details how banks’ customers will be affected and provides links to relevant legislation and providers of further information.

On 16 June 2017, the Bank of England (BoE) published a speech on ring-fencing by James Proudman (the Executive Director for UK Deposit Takers Supervision). He reminded banks that ring-fencing was coming soon, with implementation due by 01 January 2019. He provided an overview of the implementation of the new regime and said that the BoE would require “full and prompt implementation” by the deadline. He warned that the ring-fencing project faces a “high degree of delivery risk” with “some potential for disruption to everyday activities” as banks move to new group structures and ways of operating.

On 03 July 2018, the PRA published a consultation paper entitled UK leverage ratio: Applying the framework to systemic ring-fenced bodies and reflecting the systemic risk buffer (CP14/18), in which the PRA proposes to apply the systemic risk buffer (SRB) framework into the UK leverage ratio by:

• applying the UK leverage ratio framework on a sub-consolidated basis to ring-fenced bodies in scope
• amending the additional leverage ratio buffer to reflect the SRB, and
• where applicable, expecting firms to hold capital on a group consolidated basis to address ring-fenced bodies group risk (the ‘Leverage Ratio Group Add-on’).

On 14 November 2018, the PRA finalised its proposals in Policy Statement PS28/18. The PRA made no changes to the proposals set out in CP14/18.

And so, in conclusion, the overall legislative structure is in place and most of the detailed rules regarding implementation have been formulated.

Judicial applications

The Courts have given directions on administrative and procedural issues associated with the ring fence transfer schemes of affected banks. For example, in its judgment in the case of In the Matter of Barclays Bank PLC and Others [2017] EWHC 1482 (Ch) (26 May 2017), the High Court gave guidance to the claimant banks on communicating the details of schemes to customers and the timetable for the future conduct of applications. In the case of In the Matter of Lloyds Bank Plc (Chancery Division, unreported) (25 September 2017), the High Court gave preliminary directions on how Lloyds Bank Plc should communicate to customers.

On 09.03.18, in In the Matter of Barclays Bank PLC [2018] EWHC 472 (Ch), the High Court sanctioned the ring-fencing scheme of Barclays Bank PLC (Barclays) and Woolwich Plan Managers Limited pursuant to Part VII of the Financial Services and Markets Act 2000 (FSMA 2000). The Judgment contains a clear explanation of the regulatory background to the statutory ring-fencing scheme which implements one of the key recommendations of the Independent Commission on Banking which was appointed in the aftermath of the financial crisis of 2008-2009. Further details of the ring-fencing scheme is available on the website of Barclays Bank Plc.

On 29.10.18, in In the Matter of Barclays Bank PLC [2018] EWHC 2868 (Ch), the High Court sanctioned a banking business transfer scheme by which parts of the banking business of Barclays Bank PLC and Barclays Capital Services Limited were transferred to Barclays Bank Ireland PLC.

On 29 January 2019, in In the Matter of (1) Barclays Bank PLC (2) Barclays Bank Ireland PLC sub nom Re Barclay Bank PLC (Part VII Transfer Scheme) [2019] EWHC 129 (Ch), the High Court approved, in part, a banking business transfer scheme under Part VII FSMA 2000 to an Irish subsidiary in preparation for a no-deal Brexit. Mr Justice Snowden ruled that there was no reason why the scheme should not be sanctioned to the extent that it related to the transfer of the business of Barclays Bank PLC (BBPLC), which was authorised and regulated to accept deposits. He further held that the position in relation to BBPLC's subsidiary, Barclays Capital Securities Limited (BCSL), which was not authorised to accept deposits, was more complex, and that, in all the circumstances, he was prepared to order the transfer under s112(1)(d) of FSMA 2000 of some, but not all, of BCSL's business to Barclays Bank Ireland.

On 03.05.18, the High Court gave judgment in In the Matter of Lloyds Bank Plc and Others [2018] EWHC 1034 (Ch) and has approved the ring-fencing transfer scheme of Lloyds Bank Plc pursuant to Part VII of the Financial Services and Markets Act 2000.  The proposed effective date for the Lloyds scheme is 28 May 2018 (see para. 260 of the judgment). Further details of the scheme, is available on the website of Lloyds Bank Plc.

On 25 January 2019, in In the Matter of (1) Santander UK PLC (2) Abbey national Treasury Services PLC [2019] EWHC 111 (Ch), the High Court sanctioned a ring-fencing transfer scheme pursuant to FSMA 2000 Part VII which was needed to comply with Part IXB FSMA 2000 in respect of the Santander banking group. Its reasons for sanctioning the scheme included the arrangements it made to cover the position of Santander's London branch in the event of a "no deal" Brexit.

There is a list of approved schemes on the PRA website.

Potential impact

The structural reforms will, when finalised, profoundly affect the shape of banks and their businesses around the world.

On a global level, one of the key issues is how the different local reforms will align with each other and whether they will create jurisdictional arbitrage (for example, by a bank relocating to a country which confers a wider range of permitted services on it). The FSB alluded to this risk in the paper referred to above when it noted that:

"There is, however, a risk that diverging structural measures imposed by different jurisdictions may have an impact on integration across national or regional markets. FSB members should therefore monitor and discuss the potential cross-border spill-over effects that may result from different approaches. They should also take account of progress on cross-border cooperation, and seek to avoid unnecessary constraints on the integration of the global financial system or the creation of incentives for regulatory arbitrage."

The cross-border implications of bank structural reform were considered by the FSB in its report dated 27 October 2014, which was prepared for the G20 leaders ahead their summit in November 2014. The report reached four main findings:

• Jurisdictions implementing structural reform emphasised that the reforms promoted global financial stability by reducing systemic risks as well as the government guarantee implicit in TBTF, resulting in the more efficient market pricing of risk and allocation of capital.  Even in jurisdictions not implementing such reforms, the overall objectives were believed to be consistent with the shared goal of ending TBTF.
• Authorities in other jurisdictions identified a number of potential negative cross-border implications, including possible impacts on the efficiency of cross-border groups and complications to their crisis management and resolvability, decreased liquidity of financial markets, regulatory arbitrage and leakage to the shadow banking system.
• Regulatory restrictions on banking structures in order to provide greater transparency and certainty in resolution scenarios can have implications for the mobility of cross-border capital flows (some of which were deliberate). However, the effect on global financial stability will only became apparent as the reforms are fully implemented.
• It will be important to continue monitoring the potential implications of structural reform as they are being implemented, in particular with respect to the effective functioning and operability of resolution strategies of cross-border groups, and to the liquidity of sovereign and corporate bond markets in jurisdictions where global banks have to date played an important role.

The report also contains, in an annex, a useful comparative table showing the key proposed features of structural reform across the US, the UK and the EU.

On a local level, one of the key commercial issues for banks affected by the proposed structural reforms is the impact they will have on the types of services which can be offered to customers.