Banking StandardsWritten evidence from Allen & Overy LLP

1. Introduction

We are grateful for the opportunity to provide written evidence to the Parliamentary Commission on Banking Standards (the Commission) in relation to its pre-legislative scrutiny of the UK Government’s draft Financial Services (Banking Reform) Bill (the Draft Bill).

As a law firm, our principal concerns with the Draft Bill are issues raised by the proposals which go to legal and regulatory certainty. Accordingly, this response primarily focuses on legal and regulatory issues raised by the Draft Bill. Other market participants are better placed to address the policy and economic consequences of the proposals.

We would be delighted to provide the Commission with further details on any aspects of this response.

About Allen & Overy LLP

Allen & Overy is one of the world’s leading law firms, with around 5,000 staff and 500 partners worldwide. Since opening its first office in London in 1930, the firm has grown into a global organisation with 42 offices in 29 countries across Europe, Asia, the US, South America, the Middle East and Africa. Allen & Overy LLP acts for many, if not all, of the systemic financial institutions in Europe.

2. Key comments

Generally we are supportive of the proposals set out in the Draft Bill. Our key comments are as follows.

(a)The implementation of the ring-fencing proposals represents by far the most substantial change to the structure of the UK banking sector in living memory. Others are better placed to comment on the economic ramifications of ring-fencing: we would emphasise that the transition to ring-fencing will be complex, commercially sensitive and resource intensive, and that a poorly designed ring-fence could deliver some outcomes whose costs exceed their benefits. It is hard to overstate the importance of getting the legislation and regulation, and transition and implementation processes, right.

Transition: moving to a clear and workable regime

(b)It is in the interests of banks, their stakeholders and regulators that the legislative and regulatory process enables transition to ring-fencing in as orderly a manner as possible. In order to create an environment for an orderly transition, there is a need to recognise that financial institutions have a legitimate need for certainty as early as possible in order to facilitate planning and execution of the transition and implementation processes.

(c)The ICB report raised a large number of highly material policy issues. Over a year since the report was produced, there has been little progress on clarifying these. This is not in itself a criticism of the efforts made by the Government to date in seeking to move the ICB process forwards, as the issues are complex. But our perception is that the very large number of outstanding questions on application of the ring-fencing proposals, and on the scope of mandated and prohibited services and ancillary activities in particular, have left market participants unable to prepare for transition. There is simply insufficient detail on even the major elements of the regime’s architecture to enable meaningful planning. Some of the more fundamental examples of that uncertainty are:

(i)whether fund management, investment management or custody are permitted within the ring-fence;

(ii)whether loan servicing and administration are permitted within the ring-fence;

(iii)to what extent a ring-fenced bank may provide credit enhancement or derivatives to a securitisation it originates;

(iv)whether macro hedging will be permitted as an ancillary activity;

(v)whether retail structured products may be issued by ring-fenced banks;

(vi)whether trade finance will be allowable within the ring-fence.

We would be happy to share further examples of important unresolved issues.

(d)Equally, in some of the areas where there has been a lot of consultative focus (such as the question of what amounts to a financial institution) some significant questions arise around how the proposals can be “operationalised” within banks. There seems to have been insufficient focus on the workability of the detail of the new regime to date.

(e)Lastly, there is a host of implementation issues—including tax and pensions impacts—which are still to be worked through.

(f)Whilst the uncertainties associated with the ring-fencing proposals are well known to the larger UK financial institutions, they are less well understood by other stakeholders. The Government has consulted reasonably extensively on some of the issues, but on others (such as the scope of allowable ancillary activities within the ring-fence) there has been very little consultation or dialogue. We are also unclear as to how far the FSA has been involved in the process to date.

(g)These issues need to be resolved in order to enable transition and implementation. They are complex, often interrelated, and in some cases highly technical.

(h)Given the complexity and sensitivity of ring-fencing, we believe that more could be done to bring transparency and clarity to the process:

(i)it is crucial that a timetable is adopted (whether or not in the draft Bill) to provide certainty on the major open questions in good time to enable banks to plan and prepare for transition;

(ii)a forum is needed to provide an open and transparent dialogue between the private and public sector on the unresolved issues within the proposals. We would recommend the creation of a panel under the Bill, similar to the Banking Liaison Panel under the Banking Act 2009, to provide a forum for stakeholders, the Government and the regulatory authorities to ensure that the detail contained in secondary legislation and/or regulation is properly understood and workable. Such a panel would also be a useful mechanism for providing feedback on the effects of ring-fencing post-implementation.

(i)We believe that the lead time that was proposed by the ICB to implement ring-fencing was a reasonable estimate at the likely timeframe needed given the complexity of the issues raised by the proposals. Given the relative lack of progress on the issues above, we would query whether that timing remains realistic. This also ties in with the question of the legal means by which ring-fencing is achieved—as to which see our comments below on Part VII.

Statutory instrument v regulation

(g)We do not support the proposed approach of providing for the location of the ring-fence in secondary legislation and height of the ring-fence in regulation. The proposed split is arbitrary.

(h)In very simplistic terms, we see two possible avenues for implementation of the regime: low certainty high discretion, or high certainty low discretion. A low certainty high discretion regime is one in which the relevant legislation or regulation provides general rules, which require considerable exercise of judgement on the part of the regulatory authorities to enforce it. A high certainty low discretion regime is one in which there are very detailed rules requiring little by way of supervisory discretion. There are policy advantages and disadvantages to each.

(i)We believe that a low certainty high discretion regime could be provided for by statutory instrument, but not a high certainty low discretion regime. This is because the rules needed to establish the precise location of the ring-fence will be highly technical and run to a matter of hundreds, rather than tens, of pages of requirements (the draft US Volcker Rule is a reasonable precedent here, albeit that it is a far less wide-ranging rulemaking). As is often the case with complex, highly technical regulation, the rules are also likely to need amendment—possibly reasonably frequently—from inception.

(j)If the intention is to provide for a high level of legal certainty, we believe that the detail needs to be made through regulation rather than statutory instrument (albeit guided by principles to be set in statute or statutory instrument), and that the legislation needs to provide for an enhanced process for scrutiny of the ring-fence rules and accountability of the PRA for them.


(g)It is not clear whether the proposed variation of FSMA Part VII is in practice likely to be the most appropriate tool for the transfer of assets and liabilities whilst establishing the ring-fence. One area of weakness is the current scope of the provisions—these do not extend to businesses or assets held by any subsidiary of a UK authorised person who has permission to carry on one or more core activities. This would, for example, preclude the separation and transfer of funding programmes within a subsidiary. Whilst this issue could be resolved by ensuring that the amendments to section 106 FSMA increase the scope of the provisions so that businesses or assets that sit within subsidiaries of ring-fenced banks could also be moved, it is just one example of the weaknesses inherent in the tool when considered in the context of establishing a ring-fence. Further work is needed on how Part VII can be amended to ensure appropriate coverage and provide a transparent, predictable and timely restructuring process.

The following sections consider the detailed questions posed by the Commission.

3. The Commission’s Questions

Objectives and general approach

1. Does the draft Bill successfully give effect to the objectives set out in paragraph 1.3 of Sound banking: delivering reform and is it the most efficient and effective means of delivering those objectives?

We consider that the Draft Bill does give effect to the objectives set out in paragraph 1.3, subject to our comments elsewhere.

2. Do any of the recommendations of the Independent Commission on Banking (ICB), which the draft Bill seeks to implement, need revision as a consequence of developments since the ICB’s report?

We believe that it is important to monitor developments within Europe and to ensure that any UK legislation is in line, so far as possible, with any European reform.

3. Do the powers in the draft Bill and the Government’s stated intentions for their use give effect to the ICB’s recommendations? Are any deviations justified?

Whilst the Draft Bill is clearly intended to give effect to the ICB’s recommendations, it will only be possible to confirm whether this is in fact the case once the secondary legislation has been published.

4. What should be the timetable for implementation of these measures, and should it be set out more clearly?

Rather than determining the timetable for implementation, we strongly believe it is crucial to focus on the timetable for drafting and finalising the legislation and regulatory rules to give full effect to the ICB’s recommendations.. Given how complex (and important) these measures are likely to be, the process needs to be transparent and allow for appropriate dialogue between stakeholders in the private and public sectors.

We believe that an expert panel (similar to the panel that HM Treasury is required to have under section 10 of the Banking Act 2009) would be a suitable forum within which the Treasury, the PRA, affected banks and other stakeholders could understand the evolving policy, its implications and the details. They could prioritise and work through the grey areas and ensure that the draft measures can actually be operated in practice.

By imposing a structured timetable for drafting the measures, it would not only ensure that adequate time is built in to allow for meaningful dialogue, it would also reassure the industry that complex topics are being given the appropriate level of focus and thought.

5. The draft Bill proposes continuity objectives on the PRA and FCA. Are these appropriate and compatible with their other objectives?

The continuity objectives imposed on the FCA and PRA in relation to core services appears to be contrary to Article 8 (Provisions on democratic principles) of the Treaty of Lisbon which requires EU citizens to receive equal attention from its institutions, bodies, offices and agencies. The requirement to “prefer” the continuity of services in the UK (ie favouring those clients in the UK over those in the EU) will need to be revisited.

There is also a wider question as to the costs of continuity of core services, and the need to balance continuity with failure. Continuity is not an end of itself, and should not be used as a pretext for a no-failure approach to the regulation of ring-fenced banks.

Banking standards and competition

As discussed in the introduction, other market participants are better placed to address these questions.

Delegated powers and accountability

9. The draft Bill grants a large number of delegated powers to the Government. Are the principles under which delegated powers are to be exercised sufficiently clear?

Whilst such principles as are expressed in the Draft Bill are clear, the rather narrow focus of the Bill on continuity of services presents concerns on the interaction of continuity with other objectives. It also misses some of the nuances of the ICB final report, which sets out three, not one, objectives for the ring-fence. We assume that more detail will be provided in secondary legislation. This will need to be analysed before it is possible to fully understand the powers and how they will be exercised.

10. Does the scope of the delegated powers in the draft Bill represent an appropriate balance between flexibility for the Government to respond to changing conditions and accountability to Parliament and the public?

As discussed in the introduction, other market participants are better placed to address the policy and economic consequences of the Draft Bill.

11. Is there sufficient clarity about the Government’s intended use of delegated powers, both to enable public understanding and to enable affected banks to prepare for the proposed changes?

Broadly, we do not consider that there is presently sufficient clarity about the Government’s intended use of delegated powers. As noted in section 2 of this response, there remain a large number of “grey areas” in respect of the necessary detail as to the scope of the ring fence and how it will work in practice. It is critical that such detail be fleshed out as a matter of priority. Banks will be unable to adequately prepare for the proposed changes until such time as this detail has been clarified.

12. The draft Bill provides for review of the ring-fencing rules by the PRA every five years. Does the proposed review mechanism provide sufficient accountability?

We note the review mechanism contained in new section 142I FSMA—what remains unclear from the Draft Bill is what action the Treasury will take as a result of the PRA’s report. Whilst we appreciate the benefits of a review mechanism, it also generates uncertainty if institutions are unclear as to whether they may have to restructure their group five years after the ring-fencing rules come into force (and every five years thereafter).

The ring-fence


As we have stated above, the implementation of the ring-fencing proposals will be a fundamental change to the structure of the UK banking sector and as a result will generate a swathe of complex and commercially sensitive issues that will be time and labour intensive to work through. In order to ensure that the process enables an orderly transition, financial institutions need to be provided with a clear and certain structure as early as possible to enable appropriate planning and execution of the transition and implementation processes.

The Draft Bill does little to resolve the large number of outstanding questions on the application of the ring-fencing proposals. By providing that the location and height of the ring fence will be determined by secondary legislation and regulation respectively, the Draft Bill fails to provide financial institutions with sufficient detail relating to the key structural elements of the proposed ring-fencing regime that would allow for substantive planning.

In addition, the Draft Bill arguably creates a degree of confusion by choosing to change the nomenclature used in the ICB report. The industry has had over a year to digest and work through the mandated, prohibited and permitted services terminology but the Draft Bill refers to these services as “core” and “excluded” activities. This makes the process of mapping the ICB recommendations with the new Draft Bill more challenging.

13. Is the power to be able to exempt certain categories of deposit-taking firms from having to establish a ring-fenced bank appropriate, and on what basis should the conditions for exemption be set?

Please refer to our response in the introductory paragraph above.

14. Is the range of core and excluded activities defined in the draft Bill appropriate and sufficiently broad? Are the Government’s stated intentions for using powers to define further core and excluded activities appropriate?

Please refer to our response in the introductory paragraph above.

15. Which categories, if any, of customer should be permitted to deposit with a non ring-fenced bank?

As discussed in the introduction, other market participants are better placed to address the policy and economic consequences of the Draft Bill.

16. The Government is considering whether to allow ring-fenced banks to offer simple derivatives to their customers. Should they be allowed to? If so, what safeguards would be necessary?

As discussed in the introduction, other market participants are better placed to address the policy and economic consequences of the Draft Bill.

17. Are the proposed corporate governance arrangements between the ring-fenced bank and the wider group sufficient to ensure the independence of the ring-fenced bank? Are these arrangements compatible with directors’ duties and principles of accountability?

There are some potential inconsistencies with the provisions of the Companies Act 2006 which will need to be resolved in order to ensure that there is certainty for the individuals taking up directorships as well as for the shareholders and creditors. We would be happy to talk through these potential inconsistencies if this would be helpful.

18. How appropriate are the proposed restrictions on exposures and operational dependencies between the ring-fenced bank and the rest of the group? Will these result in a sufficient degree of independence and resilience?

As currently set out, the proposals in the Draft Bill simply provide high level principles in relation to the “height” of the ring fence. It will not be possible to comment on the effectiveness or otherwise of such proposals until we have been able to scrutinise the regulatory rules to be drafted by the PRA.

19. Will it be possible to effectively monitor and police the ring-fence, given the degree of regulatory discretion the draft Bill proposes?

Please refer to our response in paragraph 6.6 above.

20. How effective will the provisions on corporate governance for ring-fenced banks be in promoting a wider improvement of standards? Should other measures also be considered?

Please refer to our response in paragraph 6.6 above.

Depositor preference

21. Is the proposal to prefer insured deposits in the event of a bank insolvency justified? Is there a case for broadening the scope of deposits which benefit from this protection?

As discussed in the introduction, other market participants are better placed to address the policy and economic consequences of the Draft Bill.

Capital levels

We believe that other market participants are better placed to address these questions; however, we are concerned that giving the Treasury the right to intervene (pursuant to the new clause 142J FSMA) may cause potential conflicts of interest that would not necessarily arise if this power were controlled by the regulators.


26. Will the UK authorities have the necessary tools and powers (as a result of this legislation and other initiatives) to be able to resolve a large failing ring-fenced or non-ring-fenced bank, while maintaining financial stability and minimising the risk to public funds?

Given the scope and detail of the proposals that have been included, it is too early to respond meaningfully to this question given the limited scope of the Draft Bill.

27. What is your assessment of the Government’s preferred design of “bail-in” powers needed to improve bank resolution? How likely is it that the Recovery and Resolution Directive will deliver effective bail-in powers?

We note the Government’s preferred design of “bail-in” powers and would make the following general comments in relation to the bail-in framework currently being considered as part of the Recovery and Resolution Directive. Bail-in is fraught with legal complexity. Whilst it is conceptually relatively straightforward to haircut creditors by writing down debt and, if desired, converting interests into equity, the legal implications of so doing in the context of a solvent entity are very substantial. This complexity multiplies in respect of bail-in of multi-entity groups and cross border groups raise still further issues.

In order to deliver an effective bail-in tool, there are a number of issues that need to be considered and resolved. We would divide these issues into two types: first order issues to be addressed to make a bail-in framework legally workable, and second order issues dealing with consequential legal and regulatory issues that need to be addressed to ensure that the regime does not unduly disincentivise investment in (and thus damage the market for) bail-inable debt.

First order issues to consider are likely to include conflicts of law issues, cross-border recognition issues, inter-relationship with insolvency law, applicable listing and exchange requirements, and numerous company law issues. Second order legal and regulatory issues include whether bail-inable debt merits changes to the legal, accounting and regulatory framework for investors in and issuers of such debt. Plenty of analysis has been undertaken on first order issues; insufficient thought has been given to second order issues. These are equally important as they will determine the pricing and availability of bail-inable debt following implementation.

Impact assessment

As discussed in the introduction, other market participants are better placed to address these questions.

International issues

30. What will be the impact of the proposals on the international competitiveness of UK banks?

As discussed in the introduction, other market participants are better placed to address questions relating to the policy and economic consequences of the Draft Bill.

31. Are the proposals consistent with existing and forthcoming international and EU regulatory initiatives, for example the recent Liikanen Report? To what extent are they likely to be superseded or generate conflicts?

We believe that the Draft Bill is consistent with the recent Liikanen Report; however, that report was only published on 2 October 2012 and it is now being considered by the European Commission. It will be necessary to monitor future developments (including any legislative proposals) to identify and mitigate potential conflicts.


32. What other matters should the Commission take into account?

(a) Subsidiarisation

Footnote 4 of the Treasury’s white paper entitled Sound banking: delivering reform (accompanying the Draft Bill) states that a branch of a non-EEA bank that has significant deposit taking business will be required by regulators to become a subsidiary. This policy position may have a very significant impact on non-EEA banks operating through UK branches. More detail is required in order to provide clarity on what is meant by “significant” as well as when and how this will be mandated.

(b) Part VII of FSMA 2000

We are considering whether the proposed variation of FSMA Part VII is in practice likely to be the most appropriate tool for the transfer of assets and liabilities with ring-fencing in mind. Our primary concern is the level of uncertainty introduced for all stakeholders by a procedure that provides a forum for counterparties to object and ultimately gives discretion to the court. We have considered some of the areas of potential weakness in more detail below and where appropriate suggested possible solutions or areas that could be improved:

(i)Scope: the current scope of part VII does not extend to businesses or assets held by any subsidiaries of a UK authorised person who has permission to carry on one or more core activities. For example, this could preclude the separation and transfer of funding programmes within a subsidiary. In order to over come this hurdle, the amendments to section 106 FSMA could ensure that the scope of the provisions is extended to allow the movement of businesses and assets that sit within subsidiaries of ring-fenced banks;

(ii)Part VII requires the court to balance the interests of the different classes of persons affected by the transfer prior to sanctioning the scheme—this approach relies on case law and introduces an element of discretion and therefore uncertainty. An example of this is in relation to the court’s ancillary powers. There is no guarantee as to how the court will use these powers to deal with issues such as overriding change of control consents or termination clauses. Part VII could be modified by introducing statutory objectives that the court needs to consider when deciding whether or not to approve the transfer—this would remove the inherent uncertainty that would be detrimental to the ring-fencing procedure;

(iii)as alluded to above, another area of uncertainty relates to the ability of counterparties to object to the scheme on the day of the second court hearing to sanction the transfer. To reduce this uncertainty, Part VII could be amended to ensure that any objections are submitted in writing prior to the second court hearing. Whilst it may not be possible to predict all objections, this would go some way to ensuring that objections raised on the day are only heard in exceptional circumstances; and

(iv)Part VII is unlikely to be recognised in foreign jurisdictions—as a result, non-EEA deposits within the branches of UK banks are likely to require another mechanism.

We will taking part in a working group organised by the BBA to review the proposed business transfer provisions in light of their expected use and consider whether there is a need for further amendment to FSMA Part VII or bespoke enabling legislation or equivalent (for example, additional transfer powers and creditor safeguards that provide greater certainty for all stakeholders). We will be happy to share our thoughts in this regard.

31 October 2012

Prepared 2nd January 2013