Banking Standards Joint Committee Contents

4  How the draft Bill proposes to give effect to structural separation


55. The draft Bill and accompanying policy document reflect the Government's intention to implement the form of structural separation and associated measures proposed by the ICB, with five exceptions which were set out in paragraph 7 of this Report. This would place a ring-fence around the core functions of banks. This chapter sets out the mechanism through which the draft Bill gives effect to the ring-fence, focusing in particular on which features are established in primary legislation and which it is proposed be implemented through secondary legislation and regulatory rules.

Setting the location of the ring-fence

56. The ICB recommended that all household and SME deposit-taking and current account provision must take place within a ring-fenced bank, and that ring-fenced banks should be prohibited from carrying out a range of wholesale and investment banking activities. A large proportion of the provisions in the draft Bill relate to the "location" of the ring-fence, together defining, or allowing the Government to define, which activities must or must not be carried out within ring-fenced banks. In summary, the draft Bill gives effect to the ICB recommendations by inserting provisions in the Financial Services and Markets Act 2000 ("FSMA") as follows:

i)  Defining a "ring-fenced body" as one which conducts "core activities" (new section 142A);

ii)  Defining the regulated activity of accepting household and SME deposits as a "core activity" (new section 142B);

iii)  Defining the regulated activity of "dealing in investments as principal" as an "excluded activity" (new section 142D);

iv)  Establishing that any "ring-fenced body" which carries on an "excluded activity" is in breach of its regulatory requirements (new section 142G).

The activity of dealing in investments as principal, which is defined in existing legislation, captures "most of the derivatives and trading activities currently undertaken by wholesale and investment banks".[91] The four proposed new sections therefore together have the broad effect of preventing deposit-taking and investment banking from taking place within the same entity.

57. The draft Bill also provides the Treasury with a range of delegated powers which in summary allow them to do the following, subject to certain conditions:

i)  Define a class of institutions which should not be regarded as "ring-fenced bodies" even if they otherwise meet the definition (new section 142A(2)(b));

ii)  Define circumstances in which accepting deposits is not to be regarded as a "core activity" (new section 142B(2));

iii)  Define circumstances in which a regulated activity other than accepting deposits is to be regarded as a "core activity" (new section 142B(5));

iv)  Define circumstances in which dealing in investments as principal is not to be regarded as an "excluded activity" (new section 142D(2));

v)  Add any other activity to the definition of "excluded activity" (new section 142D(4));

vi)  Impose prohibitions on what a "ring-fenced body" can do in relation to specific categories of transaction, establishing branches in specific countries, or holding shares in companies of a specified type (new section 142E).

58. The provisions described in paragraph 57 allow the Government scope to refine the broad definitions set out in the provisions described in paragraph 56. The delegated powers, taken together, could allow the Government to re-define almost any aspect of the ring-fence location. To illustrate this using extreme hypothetical examples:

  • The delegated power under section 142D(4) could be used to define virtually all bank activities apart from investing in Government bonds as "excluded activities", which would resemble a form of John Kay's "narrow banking" proposal under which banks holding insured deposits would not be permitted to engage in any risky lending;[92]
  • The delegated powers under sections 142A(2)(b) or 142B(2) could be used to exempt most banks or most deposit-taking activity from the requirements of the ring-fence; and
  • The delegated powers under section 142D(2) could be used to permit ring-fenced banks to conduct a wide range of otherwise prohibited trading activities, such as those permitted under the Volcker rule or the Liikanen Group's proposals.

59. The Government's stated intentions for using these powers include the following, some of which will also be considered later in more detail:

i)  Setting a "de minimis" threshold so that banks holding deposits below a certain value are not brought within the ring-fence;[93]

ii)  Providing that deposits from high-net-worth individuals and larger firms do not have to be held within the ring-fenced bank;[94]

iii)  Allowing ring-fenced banks to conduct some trading activities in order to manage their own liquidity and risks;[95]

iv)  Prohibiting / allowing the ring-fenced bank to provide certain types of derivative to customers;[96]

v)  Restricting what exposures ring-fenced banks can have to other financial institutions;[97]

vi)  Prohibiting ring-fenced banks from operating branches or subsidiaries outside the EEA.[98]

60. One important way in which the draft Bill constrains the use of delegated powers is by setting tests in relation to their impact on the continuity of provision of "core services". Such services are defined in proposed new section 142C. These comprise the main facilities for operating bank accounts: making deposits, withdrawing funds and managing overdrafts. The Treasury can add to the definition of core services through a further delegated power. Two examples of how delegated powers are constrained by reference to "core services" are:

  • In order to make an order allowing a ring-fenced bank to do things that would otherwise qualify as "dealing in investments as principal", the Treasury must be of the opinion that this "would not be likely to result in any significant adverse effect on the continuity of the provision in the United Kingdom of core services".
  • To define an additional excluded activity which ring-fenced banks cannot undertake, the Treasury must be of the opinion that it is "necessary or expedient for the purpose of protecting the continuity of the provision in the United Kingdom of core services".

Setting the height of the ring-fence

61. The ICB set out a series of principles to ensure the independence of the ring-fenced bank from the rest of the group. The relevant section of the draft Bill which makes provisions for this question of the "height" of the ring-fence is proposed in a new section of FSMA, 142H. This requires the regulator to make rules for ring-fenced banks with the aim of ensuring that it can act independently of the group, and that ring-fenced banks' core activities (deposit-taking, in the first instance) are not jeopardised by the acts or omissions of other persons. The rules must cover intra-group exposures, independent corporate governance and payment of dividends. The policy document accompanying the draft Bill stated:

The draft Bill requires the regulator to make rules to ensure that the ring-fenced bank is able to act independently of the rest of its group while carrying on its business. In relation to ring-fenced banks that are members of a group, it specifies the areas in which rules should be made, including holding shares in other corporate entities, entering into contracts with other members of the group, governance of the ring-fenced bank, restricting payments that a ring-fenced bank may make to other members of the group and disclosure. These provisions do not limit regulators' power to make general rules. These requirements are designed to ensure that a ring-fenced bank interacts with the rest of its group on a third party basis, and that it remains legally, economically and operationally independent.[99]

62. Proposed section 142H is the only section of the draft Bill which deals with the "height" of the ring-fence. It contains only limited detail about what the rules on the height of the ring-fence must contain; this does not contain some of the elements needed to ensure effective independence for the ring-fenced bank which are considered later in this Report. In contrast to the location of the ring-fence, which will largely be established by the Government in secondary legislation, the height of the ring-fence beyond what is to be set out in primary legislation is proposed to be a matter for the regulator.

91   HM Treasury, Sound banking: delivering reform, Cm 8453, October 2012, para 2.24 Back

92   John Kay, Narrow Banking, 15 September 2009 Back

93   HM Treasury, Sound banking: delivering reform, Cm 8453, October 2012, para 2.16. Back

94   Ibid., paras 2.18 and 2.19. Back

95   HM Treasury, Sound banking: delivering reform, Cm 8453, October 2012, para 2.26. Back

96   Ibid., para 2.27. Back

97   Ibid., paras 2.31 and 2.32. Back

98   Ibid., paras 2.33 and 2.34. Back

99   HM Treasury, Sound banking: delivering reform, Cm 8453, October 2012,paras 2.35 and 2.36 Back

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Prepared 21 December 2012