Back in January I wrote about the update which the independent panel reviewing the UK ring-fencing regime (the "Panel") had given about the progress of its work and its initial findings. Just over two months later the Panel has now published its Final Report, which makes interesting reading.
The Panel's headline finding is that there is still a place for ring-fencing, but that the scope of the regime should be revised so that it applies only to the largest and most complex banks, given that the UK resolution regime is fast overtaking the ring-fencing regime in tackling entities "too-big-to-fail".
The ring-fencing regime's entry threshold
It had been relatively widely reported that some banks had been lobbying for an increase to the threshold at which the ring-fencing regime starts to apply, which is currently set at £25 billion of deposits. This would have enabled banks at or just below the threshold to increase the level of deposits held without becoming subject to the ring-fencing regime (thus opening up further relatively cheap funding). However, the Panel has not recommended such an increase.
Rather, it has recommended removing from the regime entirely those banks with deposits above £25 billion which conduct "excluded activity" (i.e. activities which must not be conducted by the ring-fenced bank, such as dealing as principal), below a de minimis level (the Panel recommends 10% of tier 1 capital). Any excluded activity above this level would bring such a bank into the ring-fencing regime and would have to be conducted in a non-ring-fenced bank. It has been suggested that, for example, such a change would mean the complete removal of some of the more retail-focused banking groups from the ring-fencing regime.
Discretionary exclusion from the regime
Another significant proposal is that banks deemed by resolvable by the Bank of England could be removed from the ring-fencing regime by their regulators (the Bank of England in conjunction with the Prudential Regulation Authority (PRA) and, possibly the Financial Conduct Authority (FCA). This would recognise that the resolution regime can, in certain circumstances, address too-big-to-fail risk more effectively than the ring-fencing regime.
Effect on M&A
One recommendation which, if implemented, is likely to give ring-fenced banking groups considerably more flexibility in respect of their M&A activities, is that there should be a a transitionary period for compliance with relevant requirements, applicable where an entity in a group subject to ring-fencing requirements acquires or merges with a bank which is not subject to the ring-fencing regime. This is potentially significant because, at present, businesses not subject to ring-fencing requirements immediately become subject to such requirements when acquired into a group subject to ring-fencing; this can pose issues because such businesses are unlikely ever to have even assessed their compliance with ring-fencing rules. A transitionary measure of the type proposed could therefore make inter-bank M&A simpler for banking groups over the ring-fencing threshold.
The Panel's other recommendations are likely to increase the operational flexibility afforded to ring-fenced banks/groups and include:
- easing the prohibitions on exposures to "relevant financial institutions" ("RFIs"). At present the prohibitions on such exposures are absolute - the Panel has recommended allowing ring-fenced banks to provide banking services to SME RFIs, moving the relevant definition to regulatory rules (from legislation) and introducing a grace period in which to transition a customer which becomes an RFI from a ring-fenced bank to a non-ring-fenced bank, which would avoid unwelcome and unnecessary cliff-edges;
- clarifying the status of trustees and insolvency practitioners;
- removing the need to issue a notice to customers onboarding to a non-ring-fenced bank (which effectively tells such customers they have been deemed eligible to bank outside the ring-fence); and
- removing the blanket restriction on ring-fenced banks having operations or branches outside the EEA.
Many of these recommendations will be welcomed by ring-fenced groups, as they address a number of issues which arise from the drafting of the current regime, and which can cause such groups significant operational issues without bringing obvious policy benefits. For example, the clarification of the status of trustees and insolvency practitioners would address uncertainty which has existed since the relevant legislation was first passed.
Overall the Panel appears to have done a thorough job and taken a proportionate approach to its task. The context is a vastly changed UK to that in 2013 when the current regime was first introduced. In particular, recognising the development of the resolution regime in addressing too-big-to-fail is a significant step. It's not much of a leap to suggest that the direction of travel of the recommendations is the ultimate removal of the ring-fencing regime completely, but we're not there yet. In the meantime, making the regime more adaptable, simpler and more coherent with wider legislation should only be welcomed.
Based on the evidence, the Panel concluded that the ring-fencing regime is worth retaining at present but needs to be more adaptable to better serve customers and address future risks. The recommendations focus on providing regulatory authorities with more flexibility in applying the ring-fencing regime, while also proposing options to better align ring-fencing with the UK resolution regime. This recognises that resolution is overtaking ring-fencing in providing a more comprehensive solution for tackling "too-big-to-fail".