On 18 December 2013 the UK Banking Reform Act 2013 (the Act) was enacted following over 12 months of consultation and negotiation. This important legislation brings into law requirements for a diverse range of reforms in the financial services sector.
These include the introduction of: a retail ringfence for banks; a preference for certain depositors on insolvency; a new bail-in tool; a new licensing regime; a new payment systems regulator; and a cap on the cost of payday loans. The provisions in the Act are due to come in to force on various dates between now and 1 January 2019.
The Act is much broader than the original Bill, as the Government has added provisions to address various policy initiatives in recent months. The final amendments, made in the House of Lords:
– will require the Prudential Regulation Authority (PRA) to carry out a review of proprietary trading activity within one year of the implementation of the retail ringfence; a further independent review is then to be commissioned by HM Treasury;
– allow for the application of the bail-in tool to building societies and include a power for the Bank of England to convert a building society to a company in order to apply the bail-in tool, exercising relevant powers;
– require the PRA to raise standards of professionalism in financial services by imposing a training and competence-based licensing regime; and
– include a range of amendments to the provisions regarding senior managers and the certification of individuals.
The provisions regarding building societies (except those allowing societies to issue floating charges) will come in to force on 18 February 2014; all other substantive provisions of the Act are subject to an order being made by either HM Treasury or the Secretary of State.
Key provisions of the Act
As noted above, the Act covers a diverse array of policy objectives. An overview of the key aspects of the Act is set out below:
1. Ring-fencing requirements
The ring-fencing regime is intended to implement the core recommendation of the Independent Commission on Banking (ICB) that UK banks should ring-fence their retail and small and medium-sized enterprise (SME) and deposit-taking businesses in legal entities which are separate to, and financially independent from, those entities undertaking riskier, wholesale and investment banking activities. The Act provides for amendments to Part VII of the Financial Services and Markets Act 2000 (FSMA), to allow scope for transfer schemes which are designed to implement the ringfence, and otherwise functions as enabling legislation, providing for the detail of the ring-fencing regime to be set out in secondary legislation and PRA rules.
Draft secondary legislation was published by HM Treasury for consultation earlier this year.1 The Government has said that all such secondary legislation will be in place by May 2015.
2. Loss-absorbency requirements
In order to ensure that the losses from a failure of a bank need not fall on the taxpayer, but instead can be imposed on the shareholders and unsecured creditors of the bank, the Act introduces a mechanism that may require systemically important UK banks and building societies to hold primary loss-absorbing capacity (PLAC) in addition to required regulatory capital. Section 142Y of FSMA will grant HM Treasury the power to set out the framework for PLAC requirements in a statutory instrument; a draft Banking Reform (Loss Absorbency Requirements) Order was consulted on in conjunction with other ring-fencing related secondary legislation in the summer (see above).
The Government intends that these requirements for PLAC be used to implement the requirements for firms that maintain a minimum amount of "eligible liabilities" (ie liabilities that may be bailed in) under the proposed European Recovery and Resolution Directive (RRD).
3. Depositor preference
The Act amends the Insolvency Act 1986 to provide that, with effect from 1 January 2019, deposits which are eligible for compensation by the Financial Services Compensation Scheme (FSCS), up to the extent of the coverage limit (ie covered deposits), are to be preferential debts and will therefore rank ahead of the claims of unsecured creditors in any bank insolvency. The preference will therefore reduce the losses incurred by the FSCS and, consequently, will ensure that the FSCS levy imposed on the industry is minimised. However, this benefit to the industry will lead to decreased distributions to other creditors – including counterparties, bond holders and trade creditors.
The RRD is presently expected to mandate that all deposits made by persons who are eligible for compensation by the FSCS shall be preferred, with covered deposits given a "super-priority" ranking. Further amendments to the Insolvency Act 1986 are therefore likely to be required in order to implement the RRD.
4. FSCS governance
The Act will amend Part 15 of FSMA to: (a) impose new statutory duties on the manager of the FSCS to ensure efficiency and effectiveness and to minimise public expenditure attributable to financial assistance given to the FSCS; and (b) enhance information sharing between the FSCS and HM Treasury, ensuring that HM Treasury has access to the information necessary for its Principal Accounting Officer "to be assured of high standards of regularity and propriety at FSCS".
5. Introduction of bail-in as a stabilisation option
The special resolution regime under the Banking Act 2009 will be amended under Part 3 of the Act to introduce bail-in as a new stabilisation option, available to the Bank of England in circumstances where a bank, investment firm, central counterparty or group company is failing. The powers provided for regarding bail-in include the ability to cancel or modify liabilities of institutions in resolution or to convert an instrument under which the bank owes a liability from one form or class to another. The Bank of England may appoint a bail-in administrator to hold securities or otherwise perform functions concerning the bail-in. It is presently expected that the RRD will mandate the introduction of a bail-in tool on or before 1 January 2016. However, the fact that HM Treasury moved to add the provisions for the bail-in stabilisation tool to the Bill in the autumn (when the Bill was at a late stage of its progression through Parliament) suggests that they will bring into force Part 3 of the Act quite soon, and certainly during the course of 2014.
6. Conduct regime
Following recommendations made by the Parliamentary Commission on Banking Standards,2 the Act introduces a new framework under FSMA for oversight of individuals within banking consisting of a Senior Manager Regime, Certification Regime and Banking Standards Rule.
The Senior Manager Regime: this was originally intended to ensure that the key responsibilities within banks are assigned to specific individuals over whom the regulator has oversight. This regime will mandate the inclusion of a statement of responsibilities in applications for regulatory approvals of persons who will perform designated senior management functions. Such persons will be subject to a new criminal offence relating to the taking of, or agreeing to take, a decision causing a financial institution to fail. In order to be liable, the senior manager must have actual knowledge of the cause of failure, and must have exhibited conduct that "falls far below what could reasonably be expected of a person in [their] position"; in order to avoid liability, a senior manager will need to be able to "demonstrate [that] they took all reasonable steps to prevent the contravention occurring or continuing". The maximum sentence for the new offence will be seven years in prison and/or a fine, for which no limit is set. The Government-stated intention with the Senior Manager Regime is to ensure that financial institutions are managed in a way that does not affect the economy or taxpayers.
The scope of the Senior Manager Regime has been extended to include systemically important investment firms that do not take deposits but that are regulated by the PRA. Power to further extend the scope to cover UK branches of foreign banks and investment firms is also provided. The Certification Regime: will apply to other bank staff (ie those who are not senior managers) whose actions or behaviour could seriously harm the bank, its reputation or its customers. This regime will provide enhanced scope for regulatory enforcement action where an individual has breached the banking standards rules or is knowingly concerned in a breach of regulatory requirements by their institution.
Banking Standards Rules: these rules will, when introduced by the regulators, replace the existing Statements of Principle for Approved Persons and associated codes of practice and may apply to any individual employed by a financial institution authorised under FSMA.
7. Payment systems regulator
As foreshadowed in its March 2013 consultation "Opening up UK Payments", and response thereto, the Act provides for the establishment of a new payments systems regulator which will have oversight of designated payment systems, expected to be primarily retail payment systems. The new regulator will be a subsidiary of the Financial Conduct Authority (FCA), whose objectives will be to promote competition in the usage of the designated systems, the interests of users of such systems generally, and innovation and development for the benefit of their users. The new regulator will have broad powers to:
(a) give "directions" to participants in a designated payment system requiring or prohibiting the taking of specified actions or setting standards to be met;
(b) require the operator of a designated system to establish or change rules for the operation of a designated payment system (or require any change in rules to be subject to the regulator's consent);
(c) vary agreements governing direct or indirect access to a designated payment system;
(d) vary agreements on fees and charges for participation in a designated payment system or for the use of services provided by such a system. This includes the power to specify a maximum fee or charge; and
(e) require the disposal of an interest in an operator of a designated payment system if – broadly speaking – the regulator believes that this is necessary to remedy a restriction or distortion of competition in the market for payment systems or for services provided by payment systems (exercise of this power is subject to consent of HM Treasury).
As a "competition-focused" utility-style regulator, the new regulator will have concurrent competition law powers, meaning that it will be able to enforce Competition Act 1998 prohibitions against anti-competitive agreements and abuse of dominance, and to make market investigation references to the Competition and Markets Authority in respect of all payment systems, not just those that are designated.
8. Financial market infrastructure administration regime
The Act establishes a special administration regime, modelled on the Investment Bank Special Administration Regulations 2011, which will apply to the operators of systemically important inter-bank payment systems and securities settlement systems in the event of their insolvency.
The Act confers competition-related powers on the FCA and will give the PRA a new statutory, secondary objective on competition, through amendments to FSMA.
The Act also permits the regulators to make rules applying to certain parent undertakings for the purposes of (a) supporting group ring-fencing; and (b) facilitation of group resolution. While the regulators were granted power of direction over qualifying parent undertakings, under the Financial Service Act 2013, the powers under the Act are the first powers that the regulators have had to impose rules on parent undertakings.
"In the longer term, ring-fencing looks likely to redraw the competitive landscape for the UK banking industry. In that respect, the Act represents the beginning of a lengthy journey to an uncertain future."
10. "Payday" loans
The Act will amend the FCA's duties to make rules regarding credit agreements under section 137C of FSMA by requiring the introduction of a cap on the cost of "payday" loans.
11. Claims management regulation
The Government revised the Act in November 2013, amending the Compensation Act 2006 to allow the claims management regulator (CMR) the power to impose penalties on claims management companies (CMCs). The Act includes a diverse array of changes to the regulation of the financial sector. The twin aims of the changes – improvements to stability and culture – are undeniably laudable. The question of whether reform will achieve those aims – and indeed whether legal reform is the right way of generating cultural change – remains largely open. What is certain is that the reforms will heighten legal and regulatory risk (and complexity) for senior bank management in the short to medium term.
In the longer term, ring-fencing looks likely to redraw the competitive landscape for the UK banking industry. In that respect, the Act represents the beginning of a lengthy journey to an uncertain future.
1 See our eAlert "Designing the shackles: draft secondary ring-fencing legislation published for consultation" dated 31 July 2013 (https://www.aohub.com/aoos/viewContent.action?key=Ec8teaJ9Varf5QrAw5Cy7F7eOOGbnAEFKCLORG72fHz0%2BNbpi2jDfaB8lgiEyY1JAvAvaah9lF3d%0D%0AzoxprWhI6w%3D%3D&nav=FRbANEucS95NMLRN47z%2BeeOgEFCt8EGQTBTrTXtG0BY%3D&uid=JAI3emRuMU4%3D&popup=HxapDW%2FMKd4%3D&freeviewlink=true&emailtofriendview=true) and our response to the consultation "HMT/BIS consultation paper – Banking reform bill draft secondary legislation: Allen & Overy LLP response" dated 11 October 2013 (https://aohub.com/aoos/dispatchContent.action?key=BcJlhLtdCv6%2FJTDZxvL23TQa3JHL2AIGr93BnQjo2SkGJpG9xDX7S2thDpAQsCconWHAwe6cJTmk%0D%0ALv%2FbwAqK9mxaD%2BHibKrZ&nav=FRbANEucS95NMLRN47z%2BeeOgEFCt8EGQTBTrTXtG0BY%3D&uid=JAI3emRuMU4%3D&emkey=UkuXj%2Ba2KF48eSKGowRrSE9DNQmQtq%2FvhXC1Rn1IsNo%3D).
2 As to which, see our eAlerts: "Parliamentary Commission on Banking Standards Fifth Report: Changing banking for good" (https://aohub.com/aoos/dispatchContent.action?key=BcJlhLtdCv6%2FJTDZxvL23TQa3JHL2AIGr93BnQjo2SkGJpG9xDX7S2thDpAQsCconWHAwe6cJTn2%0D%0A4CinjKQQOU%2FhiGaiTfdw&nav=FRbANEucS95NMLRN47z%2BeeOgEFCt8EGQTBTrTXtG0BY%3D&uid=JAI3emRuMU4%3D&emkey=UkuXj%2Ba2KF48eSKGowRrSE9DNQmQtq%2FvhXC1Rn1IsNo%3D) and "Electrifying: the First Report of the Parliamentary Commission on Banking Standards" (https://aohub.com/aoos/dispatchContent.action?key=BcJlhLtdCv6%2FJTDZxvL23TQa3JHL2AIGr93BnQjo2SkGJpG9xDX7S2thDpAQsCconWHAwe6cJTk7%0D%0AhzHCfeUYtE%2FhiGaiTfdw&nav=FRbANEucS95NMLRN47z%2BeeOgEFCt8EGQTBTrTXtG0BY%3D&uid=JAI3emRuMU4%3D&emkey=UkuXj%2Ba2KF48eSKGowRrSE9DNQmQtq%2FvhXC1Rn1IsNo%3D).