The Financial Services (Banking Reform) Bill 2 nd Reading Monday 11 th March 2013 This briefing paper provides the British Bankers Association s (BBA) position on the Financial Services (Banking Reform) Bill. The BBA supports the objectives of the Financial Services (Banking Reform) Bill and sees it as an integral part of the banking reform programme currently underway. The Bill implements a number of the recommendations of the Independent Commission on Banking, most notably retail ring-fencing, as well as other policies. Contents: Introduction The Reform Programme Ring-fencing The planned use of revised Part VII FSMA transfer provisions Depositor Preference and bail-in Further information Annex: Clause-by-clause guide to the Bill Introduction As the Bill begins its formal passage through Parliament, we provide this initial brief to outline the following: Place the Bill into the context of other reform measures taken or currently being put in place Support in principle the objectives of the Bill Underline the vital importance of the secondary legislation and supporting regulation to ensuring that the arrangements work as envisaged and that ring-fenced banks can continue to provide appropriate services to their customers. Explain practical concerns about the proposed reliance upon revised of Part VII FSMA transfer powers to bring about the ring-fence. Support the bail-in provisions as a key component of addressing too big to fail and stress the importance of the UK arrangements working within the regime to be created by the proposed EU Recovery and Resolution Directive. Provide a brief clause-by-clause guide to the Bill. The final building blocks in the international banking reform programme are now being put in place and UK banks and their regulators are being subjected to structural change and reorientation. The BBA has been working constructively with the authorities to help bring about the ring-fencing to be introduced by the Bill and has also given evidence to the Parliamentary Commission on Banking Standards. Both the international programme and these UK initiatives will redefine substantially the environment in which banks operate and their nature.
The Reform Programme 2 Putting aside the 2008 emergency powers bill designed to cope with the collapse of Northern Rock, the Financial Services (Banking Reform) Bill is the fourth banking-related statute to be introduced to Parliament in recent years. It builds upon: The Banking Act 2009, which put in place a permanent Special Resolution Regime, providing the Bank of England with new powers to enable the orderly resolution of a banking group in irresolvable financial difficulty. The Financial Services Act 2010, which conferred a number of new duties and powers upon the Financial Services Authority (FSA), including a requirement for banks to draw up recovery and resolution plans, significant new disciplinary powers for the FSA and new provision for financial education. The Financial Services Act 2012, which provided statutory underpinning for a Financial Policy Committee within the Bank of England charged with responsibility for financial stability, including the deployment of sectoral capital requirements to calm asset bubbles, and the replacement of the FSA by the Prudential Regulatory Authority (PRA) and the Financial Conduct Authority (FCA). It is also the case that banking is a regulated activity subject to not only domestic legislation and regulation, but international convention and European legislative and regulatory requirements. Other significant requirements upon banks devised since the onset of the financial crisis include: A fundamental revision to the international capital accord (Basel III), as implemented by the EU Capital Requirements Directives and Regulation (CRD III and IV and CRR), requiring banks to hold a minimum of 7% Tier 1 capital, supplemented by a surcharge up to 3.5% for large, global banks and an additional Countercyclical Capital Buffer of up to 2.5%; the introduction of a Leverage Ratio as a backstop and a greater emphasis on stress testing; and the introduction of two new liquidity standards in the form of a Liquidity Coverage Ratio (LCR) and a Net Stable Funding Ratio (NSFR). A review of capital within the trading book is currently underway. Activity following on from the first two Acts listed above, including the FSA s Proactive Intervention Framework (PIF) and the preparation of Recovery and Resolution Plans by individual institutions; also the planned introduction of measures aimed at further enhancing primary loss absorbing capacity, including through the introduction of a statutory bail-in regime for bondholders and senior creditors as a result of the Bill (and the overlapping EU Recovery and Resolution Directive). Raising of deposit guarantee limits substantially in many jurisdictions, including the UK under EU requirements, additionally removing co-insurance on the part of the depositor, and improvement in the efficiency with which deposit guarantee schemes can make compensation payments. More intensive banking supervision in many jurisdictions than had been the case in the period directly preceding the financial crisis. This includes the adoption of a more judgement-led, strategic approach and a strengthening of cross-border cooperation. At an EU level this has been supported by the formation of the European system of supervisors and this will be underpinned by the adoption of a single rulebook to be drawn up by the recently-formed European Banking Authority. Banks substantially strengthening their corporate governance arrangements and in some jurisdictions, including the UK, placing greater emphasis on risk management through measures such as the establishment of a Board-level risk committee and the appointment or elevation of a senior, independent Chief Risk Officer (CRO); others have strengthened their reporting lines to the centre. Substantial improvements in market infrastructure and transparency through requiring derivative trades to be centrally reported and/or cleared through central counterparties. These measures will reduce counterparty risk and interconnectedness between financial institutions.
3 The purpose of the Banking Reform Bill is principally to make appropriate statutory provision for the introduction of retail ring-fencing as recommended by the Independent Commission on Banking (ICB). The Bill has been redrafted in light of the pre-legislative scrutiny report prepared by the Parliamentary Commission on into Banking Standards and will be amended to include provision giving the regulator the power to enforce full separation between retail and wholesale banking in a specified group subject to statutory conditions and tests - the Government s response to the call for the ring-fence to be electrified. The structural reform resulting from ring-fencing reinforces the above reforms, in particular recovery and resolution planning, and can be seen as the final step in financial stability orientated measures. When viewed in combination with other reforms it should achieve the objective of no bank being 'too big to fail' and in the process insulate the UK taxpayer in the event of future bank failure. The Bill is also being introduced to Parliament at a time when the Parliamentary Commission on Banking Standards is completing its investigations into a breakdown in ethical and professional standards in banking contributing to a series of high profile compliance failures. The BBA and others responded to the initial call for evidence and provided supplementary evidence on the core topic of professional standards and on issues as diverse as director sanctions and accounting, audit and tax. The Parliamentary Commission, we understand, is due to report this spring and can be expected to recommend the inclusion of additional conduct related provisions in the Bill and actions to be taken by others, including the regulatory authorities, notably the new conduct regulator. Ring-fencing The cornerstone of the Bill is its provision for retail ring-fencing, which is being introduced following two reports by the Independent Commission on Banking, two Government consultations and a pre-legislative scrutiny exercise undertaken by the Parliamentary Commission on Banking Standards. The BBA has made it clear throughout this process that the banking industry fully supports the underlying objectives identified by the ICB for banking reform: a reduction in the probability and impact of systemic financial crisis; the maintenance of an efficient flow of credit to households and businesses over time; and ensuring a continuity of core banking services in the event of failure without capital support from the taxpayer. The ring-fencing provisions are relatively high level as the intention is that most provisions governing ringfencing will be set out in secondary legislation and regulation. While we would not disagree with this approach, given both the complexity and innovative nature of ring-fencing, we would underline the need for full technical scrutiny in order to ensure that the secondary legislation and regulation achieves what it sets out to achieve, does not add unnecessary burden and is consistent with ring-fenced banks being able to provide banking and financial services to their core household and business client group. The secondary legislation will be pivotal in determining whether a ring-fenced bank can be organised in an orderly and effective manner and whether it will be capable of providing a suite of services to households and businesses consistent with the principles originally set out by the ICB. Notwithstanding the need to ensure that the ring-fence is suitably robust, there is also a need to ensure that banking services in support of business such as simple hedging and trade finance can be provided in a cost effective manner. We therefore welcome the Government commitment to open consultation on the principal secondary legislation in time for the Bill s Commons Committee stage. Much of the detail will also rest in PRA (and FCA as relevant) regulation. Whilst sight of this is not necessary in order to make an assessment of the suitability of the primary legislation, progress clearly needs to be made in order for banking groups to be placed in a position to begin to make detailed plans for the implementation of the ring-fencing arrangements. Regulatory authorisation will also be needed in many instances and this will also take time. The planned use of revised Part VII FSMA transfer provisions The structural reorganisation of a banking group to bring about ring-fencing is likely to involve relying upon the banking business transfer regime under revised Part VII of FSMA for the transfer of tens of millions of accounts and contracts. Key to this is ensuring that the revised provisions are suitably scoped and that the procedures involved are compatible with an orderly transition to ring-fencing within the envisaged 2019 timescale. While the provisions have been modified in light of industry and legal profession input based upon the pre-legislative scrutiny draft legislation, some quite significant concerns remain about whether the
4 revisions to the FSMA provisions are adequate to facilitate transfers of the scale and type envisaged to achieve ring-fencing. On scope, we see a case for broadening the entities within a banking group to which business can be transferred; on process, we are not convinced that the revised provisions suitably clarify the inclusion of permitted activities and believe that statutory provision should be made ensuring that Court decisions are taken firmly within the context of the wider societal benefits of the structural reorganisation required to bring about ring fencing in order to avoid specific parties impeding the ring-fencing process. This is a matter upon which we will comment in more detail at Committee Stage. Depositor Preference and bail-in We support the bail-in provisions as a key component of addressing too big to fail and stress the importance of the UK arrangements working within the regime to be created by the proposed EU Recovery and Resolution Directive. In legislating in favour of depositor preference the Government appears to be preempting final discussions on the EU Recovery and Resolution Directive. In the event that the EU Directive is struck on a different basis, depositor preference introduced on a national basis could be expected to impact upon the pricing of UK bank debt and investor appetite. We would there see grounds for a review of this approach should the EU Directive be concluded on different terms. It should be noted that depositor preference has no bearing on depositor protection as far as an individual depositor is concerned, but instead concerns whether in insolvency the deposit base of a bank should be supported by the Financial Services Compensation Scheme or funded through a further deduction from the interests of other creditors through the new bail-in regime. Further information The BBA is happy to provide further information on the issues above or on any of the topics covered by Financial Services (Banking Reform) Bill. Please contact Mark Cazaly (mark.cazaly@bba.org.uk), Ben Andersen-Tuffnell (Ben.andersen-tuffnell@bba.org.uk) or Paul Chisnall (Paul.Chisnall@bba.org.uk) for further information. An annex which provides a clause-by-clause guide to the Bill can be found overleaf. British Bankers Association March 2013
5 Annex: clause-by-clause guide to the Financial Services (Banking Reform) Bill Clause 1: Objectives of Prudential Regulatory Authority As explained in the accompanying HM Treasury/BIS policy document Banking reform: a new structure for stability and growth, the continuity objective of ring-fencing has been included to act upon the Parliamentary Commission recommendation that such an objective be built into the PRA s general objective and reflected fully on the face of the Bill. The proposed legislative provision is in keeping with the ICB s original objectives for ring-fencing and consistent with the PRA s statutory responsibilities. Clause 2: Modification of objectives of Financial Conduct Authority The same considerations apply in respect of the continuity objective applying to the FCA. Clause 3: Amendment of PRA powers of direction The proposed power of direction would also appear consistent with giving priority to the continuity of core services as envisaged by the ICB. Clause 4: Ring-fencing of certain activities Clause 4 comprises the core provisions related to ring-fencing of certain activities of larger UK banks. Proposed FSMA Part 9B includes the following key provisions: - 142A: ring-fenced body : establishing that building societies will be dealt with separately, that the exemption limit for banks will be determined by secondary legislation and that the scope of the regime will extend only to UK incorporated institutions. - 142B: core activities: identifies the regulated activity of accepting deposits as a core activity unless carried on in circumstances specified by Treasury order. Treasury may provide by order that other activities are core activities based on financial stability grounds and protection of continuity of those activities. - 142C: core services: identifies core services connected to core activities as being facilities for the accepting of deposits or other payments, facilities for withdrawing money or making payments, overdraft facilities and other services to be determined by Treasury order on financial stability grounds. - 142D: excluded activities: identifies dealing in investments as principal as an excluded activity unless carried on in circumstances specified by Treasury order. Such an order can only be made in circumstances not likely to result in any significant adverse affect on the continuity of the provision of core services. Other activities can be specified as an excluded activity by Treasury order subject to specified tests. - 142E: power of the Treasury to impose prohibitions: subject to specific tests, enables ring-fenced bodies to be prohibited by Treasury order from: entering into transactions of a specified kind or with persons falling within a specified class; establishing or maintaining a branch in a specified country or territory; or holding in specified circumstances shares or voting power in companies of a specified description. - 142F: orders under the above sections: provides that Treasury Orders may authorise or require a regulator to make rules on ring-fencing or refer to publications issued by a regulator, another UK body or an international organisation; also that orders may impose conditions on the exercise of regulatory power, stipulate consultation requirements or make the exercise of regulatory power subject to regulatory consent - 142G: ring-fenced bodies not to carry on excluded activities or contravene prohibitions: provides that a ring-fenced body which carries on an excluded activity or purports to do so or contravenes any
6 provision of a prohibition order under 142E is a contravention of requirements imposed on the ring-fenced body. Treasury orders may be issued determining that the contravention is actionable at the suit of a person suffering loss. - 142H: ring-fencing rules: establishes that the PRA and/or FCA must make: a) rules requiring the ringfenced body to make arrangements ensuring the effective provision of services and facilities required to carry out a core activity and b) rules required for group ring-fencing purposes. Group ring-fencing purposes include ensuring as far as reasonably practicable that: the carrying on of core activities is not adversely affected by the acts or omissions of other members of the group; the ring-fenced body is able to take decisions independently of other members of the group; the ring-fenced body does not depend on resources provided by others in the group; and, the ring-fenced body would be able to continue to carry on core activities in the event of the insolvency of one or more other members of the group. Ring-fencing rules for the group ring-fencing purposes must cover: Restrictions on contracts between the ring-fenced body and others in the group otherwise than on arm s length terms Payment restrictions from the ring-fenced body to others in the group Regulatory disclosure requirements relating to transactions between a ring-fenced body and other members of its group Constitution of a ring-fenced body s board A ring-fenced body s compliance with of a remuneration policy meeting specified requirements A ring-fenced body s compliance with a human resources policy meeting specified requirements Arrangements required made by a ring-fenced body for the identification, monitoring and management of risk to meet specified requirements Other provisions as considered necessary or expedient for group ring-fencing purposes - 142I: powers of the Treasury in relation to ring-fencing rules: enables the Treasury to require the PRA and/or FCA to make (or not make) the above provisions within the ring-fencing rules. - 142J: review of the ring-fencing rules: provides that the PRA (or FCA as relevant) must undertake a review of the ring-fencing rules every 5 years and provide the report to the Treasury, Parliament and the public. - 142K&L: pension liabilities: provides the Treasury with the ability to make regulations related to the treatment of pension liabilities within a ring-fencing group. - 142M: power of the Treasury in relation to loss-absorbency requirements: Treasury may by order provide that the regulator should require the issue of debt instruments and that the regulator may stipulate that the debt instruments be of a particular kind. This provides the means by which ring-fenced banks and banking groups can be subject to additional primary loss-absorbing capital requirements and was also a key recommendation of the ICB. - 142O: interpretation of Part 9B: makes further consequential technical changes to FSMA Clause 5: Directors of ring-fenced bodies to be approved persons Acting as a director of a ring-fenced entity s board (or similar function) will be a significant influence function and a controlled function. This is intended to underscore the specific obligations of such directors to the ringfence and ensure that they can be subject to the full range of the regulators disciplinary powers. This provision may be augmented in light of any subsequent recommendations by the Parliamentary Commission and is in keeping with the public policy priority given to maintaining the integrity of ring-fencing. Clause 6: PRA annual report The public reporting proposed is consistent with the Government supporting the Parliamentary Commission s recommendation that the PRA conduct an annual review of the operation of the ring-fence.
7 Clause 7: Ring-fencing transfer schemes Clause 7 introduces a schedule amending Part VII of FSMA 2000 and is intended to make suitable legislative provision for the transfer of business bank accounts and other contracts from one part of a banking group to another in order to achieve an appropriate ring-fence/non ring-fence divide. These provisions are important to enabling the transition to the ring-fenced structure. We have indicated a couple of suggestions above and will brief further at Committee Stage. Clause 8: Building societies: power to make provision about ring-fencing Treasury may make ring-fencing regulations for building societies. There is logic in seeking to protect the continuity of core services provided by building societies through an equivalent application of ring-fencing. Clause 9: depositor preference As explained above, introduces depositor preference as part of the resolution and insolvency arrangements, which may prove incompatible with the prospective EU Recovery and Resolution Directive. Clauses 10-12: Financial Services Compensation Scheme The legislative provisions set out follow consultation undertaken on the FSCS and are intended to strengthen financial discipline and governance. Clause 13: Fees to meet Treasury expenditure The Government has accepted that the provision, in Clause 13, that industry pays for HM Treasury engagement with international authorities on financial stability or financial services matters generally should be based upon the recovery of subscriptions rather than unidentified expenses. Clause 14: Parliamentary control of statutory instruments under FSMA 2000 Clause 14 governs the use of the affirmative procedure in respect of the secondary legislation, which is welcome given its importance. Clause 15: Bank of England Clause 15 provides the Bank of England with powers to override the provision of Companies Act information by its wholly owned subsidiary companies (excluding the PRA and bridge banks under the Banking Act 2009) if this is necessary in regard to its Financial Stability Objective. The Treasury must be consulted first.