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