Restructuring

Contributed by Sally Willcock
On September 12, the UK Independent Commission on Banking (ICB) published its Final Report on and recommendations for reforms to improve financial stability and competition in UK banking.  The Final Report follows on from an Interim Report published by the ICB in April, which had been the subject of wide consultation.  The ICB is chaired by Sir John Vickers and its report is widely referred to in the City of London as the Vickers Report.
The key aims of the ICB’s recommendations are to create a more resilient banking sector better able to withstand future financial crises and to remove the risks posed by banks to the public finances, whilst safeguarding retail deposits.  The reforms are to be implemented alongside and by way of addition to pending reforms required by Basel III and by other European initiatives.  The UK Government has endorsed the Vickers Report and has expressed its intention to put the recommendations into law by the end of the current parliament in 2015.  Like Basel III, the Vickers provisions will not be required to be fully implemented until early 2019.
Much of the detail of the measures has yet to be finalized by relevant regulatory bodies, but in overview, the ICB recommends the following:
(1) UK retail banking activities should be ring-fenced into separate subsidiaries distinct from a bank’s investment banking operations.  Retail and small business deposits and overdrafts for businesses and customers within the European Economic Area will be required to be held within the ring-fence, and investment banking activities — such as derivatives, investing and trading in securities and debt and equity underwriting — must fall outside the ring-fence.  Banks can choose where to place other activities, such as deposits and loans of large corporate customers.  These measures apply to UK banks and UK branches of non-EEA banks, but significantly, do not apply to UK branches of EEA banks.
(2) Ring-fenced parts of banks should be required to hold equity capital of an amount ranging between 7 and 10% and calculated by reference to the ratio of the bank’s risk weighted assets to UK GDP.  All banks should additionally be required to have total loss-absorbing capital of at least 17-20%.  To the extent that bank regulators require long-term unsecured debt to bear losses in a bank resolution – the so-called “bail in bonds,” such bondholder components would fall within the required capital cushion.  The increases in the capital requirements are intended to improve banks’ ability to absorb losses and also to make them less vulnerable to liquidity problems.
(3) Deposits currently insured by the Financial Services Compensation Scheme (broadly covering deposits (capped at £85,000) in a failed bank, authorized by the UK Financial Services Authority) should enjoy an enhanced ranking, ahead of both other unsecured debt and holders of floating charge security, should the bank be wound up.
(4) The final tranche of recommendations consists of provisions intended to improve access to bank accounts for retail and small business customers and other provisions focused on improving competition in retail banking.
Impact of the Recommendations and Initial Reactions in the City of London
The Vickers Report stretches to some 363 pages, and significant further rounds of consultation on the further detail of the recommendations is pending, before the legislation can be finalized.  Initial reactions to the report and whether in particular the proposals will prevent a future financial crisis are mixed.
In terms of the medium-term impact of the proposals, currently a number of UK banks combine domestic retail services with global wholesale and investment banking operations so that the reforms will require significant structural changes for these banks.  Inevitably, this will involve very significant costs, which the ICB estimates at up to £7 billion.
There is also a tension in the proposals arising as the capital requirements recommended by the ICB exceed those required by Basel III (due to be implemented on a maximum harmonization within the EU by the Capital Requirements Directive IV.)  |It is not yet clear how this mismatch of capital requirements will be resolved, but this position has led to concern in the banking sector that enhanced capital requirements in the UK could significantly increase the cost of lending for UK business and make UK banks less competitive globally.
The Vickers Report follows hard on the heels of a separate consultation and discussion document issued by the Financial Services Authority in August concerning proposals for recovery and resolution plans required of financial institutions (the “R&R Requirements“)
The R&R Requirements contemplate that UK financial institutions must manage their business in a way that reduces the impact that their own insolvency would have on their clients’ money and custody asset holdings and that avoids the need for the government to provide a taxpayer bail in.  Under the Financial Services Act 2010, all UK deposit-takers are required to have resolution and recovery plans in place; for systemically important firms, these plans are required to be completed by the end of 2012.   The R&R Requirements put in place a process for implementing these provisions.