Banking StandardsWritten evidence from Santander UK

1.1. Santander UK welcomes the opportunity to respond to this call for evidence.

1.2. Santander UK supported the objectives of the Independent Commission on Banking to make banks better able to absorb losses, make it easier to resolve failing banks and to curb excessive risk taking. The proposals have the potential to protect ring-fenced banks from a degree of interconnectedness risk, making them safer. We support the Government in its efforts to implement these objectives and have enjoyed a constructive relationship with the Treasury.

1.3. Neither Santander UK nor the Santander Group has ever needed a state-funded bailout. Santander UK believes that the taxpayer should never have to bailout troubled financial institutions. To this end, Santander was one of the first banks in the world to agree a recovery and resolution regime with regulators at a Group level and in all its core markets.

1.4. In this response, we have sought to answer the questions which particularly affect Santander UK. Santander UK stands ready to assist the work of the Parliamentary Commission as best it can. Where there are areas where more detail would be helpful, Santander UK encourages the Parliamentary Commission to contact us directly.

2. Design of the ring fence

2.1. Santander UK plc operates a UK ring fence around it and its subsidiaries. This ring fence would been effective in shielding the UK-based businesses of the wider Santander Group from systemic or idiosyncratic risk elsewhere in the wider group. This arrangement has also demonstrated that ring fencing can be guided by clear principles and robustly implemented and maintained through both self-imposed corporate governance arrangements and effective domestic regulatory oversight by the FSA.

2.2. The Santander UK ring fence reflects the subsidiary model operated by the Santander Group. This subsidiary model involves autonomous Santander subsidiaries operating in core markets (such as Santander UK) where each local unit is autonomous as to liquidity and capital, without reliance on Santander as the parent bank.

2.3. Santander UK generates funding and liquidity for the purposes of its UK banking business primarily through UK retail and corporate deposits, as well as in the financial markets through its own debt programmes and facilities. It does this in reliance on the strength of its balance sheet and profitability and maintaining its own network of investors and credit ratings with the major credit ratings agencies. It does not rely on a guarantee from Santander or any other member of the Santander Group to generate this funding or liquidity.

2.4. The Santander UK corporate governance model reinforces the independence of the Santander UK business and ensures that its board and the management make their own decisions on liquidity, funding and capital, having regard to what is appropriate for its business and strategy.

2.5. Santander UK has enhanced the Santander Group subsidiary model by agreeing a regulatory ring fence around its UK activities with its lead regulator, the FSA. The ring fence creates formal firewalls between Santander UK and the rest of Santander Group, thereby reducing systemic risk and the risk of problems in other markets or units impacting Santander UK.

2.6. Specifically, the regulatory ring fence restricts the provision of liquidity and capital by Santander UK to the rest of the Santander Group and limits the extent of exposures to the Santander Group that it can assume. This ring fence is explicitly reported on and monitored by the FSA on a frequent basis.

2.7. This model has demonstrated that the regulator has the tools and the experience to implement a ring-fence which limits the relationship between banking entities in the same group in order to protect the stability and resolvability of that entity.

2.8. Santander UK believes that it represents a practical example of a well-functioning and robust ring fence, firmly rooted in clear principles, which is implemented and policed cooperatively by Santander UK and the FSA.

3. About Santander UK

3.1. Santander UK is mainly a retail and commercial bank: some 90% of profits after tax are derived from retail and commercial banking activities. Santander UK is a wholly owned subsidiary of Banco Santander S.A. As explained above, Santander UK is self-sufficient in capital, funding and liquidity and operates autonomously from its Spanish parent company.

3.2. Santander has invested more than £16 billion into the UK economy through the acquisitions of troubled financial institutions including Abbey National (c.£9 billion, 2005), Alliance & Leicester (£2.3 billion, 2008), and Bradford & Bingley (£612 million) and a recent capital injection of £4.5 billion (2010) to further develop its business in the UK.

3.3. Santander UK is embedded in communities throughout the UK with some 25 million customers, 24,500 employees, 1,350 branches, and 1.6 million UK-based shareholders.

3.4. Santander UK is dedicated to earning and keeping the trust of its customers. Trust is the cornerstone of the Santander business model and the foundation of its corporate values. Santander UK is working to build a full-service, diversified retail bank around the needs and interests of its customers. Santander UK is also making a significant contribution to economic growth by focusing on growing its lending to small and medium-sized enterprises in the UK, which it did by 20% in the first nine months of this year.

3.5. Santander UK has maintained the strengths of its building society heritage in savings and mortgage products and is growing its presence in the current account market and SME banking. By doing so, Santander UK is bringing significant competition to the UK high street as the first serious challenger to the incumbent “Big Four”.

3.6. Santander UK’s balance sheet is one of the most UK-focused with an exposure of less than 0.5% of assets to eurozone periphery countries. More than 99% of customer assets are UK-related and 85% of its customer loans are prime residential mortgages to UK customers, with the balance being to UK businesses.


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

4.1. While Santander UK strongly supports the Government’s decision to define much of the detail of the ring-fencing rules in secondary legislation and regulation, further clarity on the timeline for implementation would be helpful.

4.2. Once the rules have been finalised, banks will need to make significant strategic decisions on how best to structure their respective organisations. This restructure will come at a high cost and likely with some disruption to customers given the scale and complexity of the task.

4.3. With this in mind, the Government should keep its deadline for implementation under review to ensure that banks have a reasonable amount of time to implement these rules diligently and with as little disruption as possible to customers.

5. Question 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?

5.1. Yes. Santander UK considers that the best way to implement the Banking Reform Bill effectively is to enshrine in legislation clear and robust principles. These should be used to guide the Government and regulators so that they have enough adaptability to ensure that the rules remain relevant and workable in future years.

5.2. The banking market is constantly evolving to adapt to changing customer needs and technological efficiencies. For instance, a significant number of Santander UK’s customers now access their accounts using mobile technology and online services, many of which were not a feature of banking only five years ago. In a market where products and services change so rapidly, effective legislation must retain the adaptability necessary to meet future challenges.

5.3. Furthermore, legislation which avoids a “one-size-fits-all” approach provides customer choice and competition in the market. A degree of regulatory discretion in the implementation of the Banking Reform Bill is the best way of achieving this goal by allowing different banks to pursue different structures while staying within the principles outlined by the Independent Commission on Banking.

5.4. Santander UK considers the principles in the draft Bill to be sufficient to guide the Government and regulator without being overly prescriptive.

6. Question 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?

6.1. Yes. As noted above, regulatory discretion is paramount for the Bill to be effective. Santander UK considers that sufficient accountability is provided through the very clear statement of principles established in the draft Bill.

7. Question 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?

7.1. Santander UK considers that the very clear principles of ring-fencing and securing the continuity of vital banking services provide sufficient clarity to enable public understanding of the proposed changes. There is no need to be familiar with the detail of how banks will be split for this policy to be understood.

7.2. As yet there is not sufficient clarity in the rules for banks to begin preparing for the proposed changes. While the purpose and principles of the Bill have been made clear, the mechanics of a separation are extremely complex and will require further detail from the Government.

7.3. While this detail should properly be provided in secondary legislation and regulation (rather than in primary legislation), Santander UK encourages the Government to publish greater detail as soon as possible. Splitting the UK banking sector into ring-fenced and non-ring-fenced entities will clearly prove to be a significant challenge. The Government must ensure that it gives banks adequate time to implement these rules carefully and with due attention to the possible unintended consequences which might arise.

8. Question 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?

8.1. Yes. Santander UK considers five years to be an appropriate time frame. It provides the necessary balance between continuity in the regulatory environment and the flexibility to ensure the rules remain relevant in a changing market.

9. Question 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?

9.1. Yes. Santander UK considers it essential that ring-fenced banks are able to offer simple risk management products to all its business customers. Simple risk management products are extremely important for many SMEs and mid-caps. Santander UK agrees with the Government that complex derivatives should not be offered from within the ring-fence.

9.2. If businesses are unable to access simple risk management products from ring-fenced banks, Santander UK believes that SMEs and mid-caps will not be able to access them at all, or will only be able to access them from institutions outside the ring fence. These institutions are unlikely to have the same close relationship and long term commitment to the business as the ring-fenced bank. Furthermore, as SMEs will also have to post additional collateral to entities outside the ring fence for these services, they will also be more expensive, and likely prohibitively so. In order to preserve choice for SMEs, it is essential that ring-fenced banks are able to provide simple foreign exchange and interest rate risk management products.

9.3. Santander UK believes that safeguards would be necessary and has previously proposed a set of principles (see paragraph 9.16) to ensure that these products can be offered without threatening the stability or resolvability of a ring-fenced bank, thereby ensuring that their provision does not impede the continuity of core banking services.

9.4. Santander UK is mindful that products similar to those which we argue should be inside the ring-fence have been missold to SMEs in the past. However, most of these products (structured interest rate collars) were complex and would likely not be included in the ring-fence under the principles outlined in the Government’s White Paper. In this submission, Santander UK proposes further principles to inform conduct regulation in order to ensure that these products are always sold in a transparent and fair manner (see paragraphs 9.17–9.23 below).

Scope of simple risk management products

9.5. As per the Government’s White Paper, Santander UK proposes that only simple hedging products necessary to manage interest rate and foreign exchange rate risk should be sold to customers by a ring-fenced bank.

The importance of simple risk management products to SMEs

9.6. Interest rate and foreign exchange risk management products are essential for businesses of all size, including very small business.

9.7. Foreign exchange risk management products allow importing and exporting businesses which need to make and accept payments in foreign currencies to have certainty as to the sterling value of those payments when they are made. Without access to these products SMEs would be less likely to begin exporting or to make investments in overseas markets.

9.8. Interest rate risk management products are also important to business as they allow them to manage their financing costs while also providing flexibility which cannot be found in a fixed rate loan. It is clear that some businesses prefer to take a floating rate loan and then manage a part or all of that risk with a separate risk management product. This is a legitimate and positive choice for some SMEs. Santander UK believes that the Government should not act to close off this financing option for those SMEs which choose to use it.

SME access to simple risk management products

9.9. If SMEs cannot access simple risk management products from a ring-fenced bank, Santander UK is extremely concerned that they will not be able to access them at all due to the relatively small size of the contract they will be seeking and the increased cost which they are likely to incur.

9.10. Non-ring-fenced banks will deal with very large corporate clients and other financial institutions. It is therefore unlikely that they will be inclined to offer these products to SMEs given the relatively small scale on which they will be required. Furthermore, it is unlikely that a non-ring-fenced bank will take the time to get to know their clients in the same way that the primary relationship bank is able to, or be able to provide the network of support and advice which a ring-fenced bank can provide through branch networks and local business managers. SMEs right up to the very highest end (£150 million annual turnover by Santander UK’s estimates) rely upon this local relationship approach for doing this kind of businesses. Santander UK would consider pushing small and relatively unsophisticated SMEs to investment banks for simple derivative products to be an unintended outcome of banking reform.

9.11. Even if non-ring-fenced banks do offer these products to SMEs, it is likely that they will be considerably more expensive than if offered by the primary relationship bank (which Santander UK expects will be the ring-fenced bank) due to a lack of common security in the non-ring-fenced bank.

9.12. For instance, when the ring-fenced bank provides FX execution and hedging, it does so alongside other credit lines which the customer has open (e.g. a loan facility). This enables the ring-fenced bank to offer longer term foreign exchange hedges without requiring any additional security from the customer. If an SME was forced to access foreign exchange hedges from a third party provider (i.e. a non-ring-fenced bank or an internet provider) then they would be very unlikely to be offered the same secured credit lines. In this case, the only option for the SME would be a shorter term or unsecured derivative which would be less effective for cash management and, in many cases, unaffordable.

9.13. The challenges with interest rate hedges are very similar. Without access to common security, non-ring-fenced banks would require cash backed or carved out security packages—both of which an SME would be unlikely to be able to offer. In particular, requiring an SME to post cash collateral would expose its cash position and day-to-day operations to short-term movements in financial markets; something which is clearly highly undesirable for most SMEs. Where ring-fenced banks can’t offer these products, most SMEs would be forced to take fixed rate loans which do not offer the flexibility provided by simple interest rate risk management products.

Principles to protect the stability and resolvability of ring-fenced banks

9.14. Santander UK considers that the key question is whether ring-fenced banks can provide these products while preserving the principles and objectives of resilience and resolvability set out by Sir John Vickers. Santander UK believes that they can.

9.15. Santander UK considers that simple derivative products can be offered by ring-fenced banks without significantly increasing the interconnectedness risk to which the bank is exposed or complicating the resolvability of the bank, thereby causing no impediment to the continuity of core banking services.

9.16. In March 2012, Santander UK proposed the principles below for the regulator to use to restrict the provision of simple risk management products by ring-fenced banks to business customers to ensure that resolvability and stability are protected.

Principles for the Regulation of the Provision of Simple Risk Management Products by Ring-Fenced Banks

1. Ring-fenced banks may provide a limited set of vanilla risk management and trade finance products and services where they meet the following conditions:

(i)The product or service is required by customers to manage risks to which they are exposed as a result of their business operations.

(ii)The product or service does not expose the ring-fenced bank to categories of counterparty and market risk to which it is not already exposed as a result of its day-to-day risk and liquidity management activities.

(iii)The product or service uses financial instruments traded in deep and liquid markets where there is evidence of this liquidity being maintained under periods of extreme stress.

(iv)The product or service is not provided to a financial institution.

2. In the delivery of the products specified in (1), ring-fenced banks may be exposed to market risk where the capital requirement for this exposure (as calculated for regulatory purposes) does not exceed 5% of total capital requirements

3. In the delivery of the products specified in (1), ring-fenced banks may be exposed to counterparty risk where this exposure is restricted to 5% of total capital requirements (as calculated for regulatory purposes) excluding where a transaction is conducted with a central counterparty regulated by or equivalent to the provisions of the European Markets Infrastructure Regulation1

Principles to Protect Customers

9.17. In addition to ensuring that simple risk management products can be provided by ring-fenced banks without compromising the objectives of the ICB report, Santander UK also considers it important that regulators are confident the products can be sold to SMEs appropriately.

9.18. Santander UK is keen to work with regulators to demonstrate that best practice principles for the selling of risk management product can ensure that they are always sold transparently, fairly and in the best interest of the customer.

9.19. Santander UK’s sales process for risk management products is dictated by a set of principles which we believe protect the customer from the risk of misselling. We believe that these principles can be used to guide the provision of risk management products from within the ring-fenced bank.

9.20. Santander UK believes that the fundamental purpose of these products should always be to enable customers to reduce or remove exposure to variable rate linked interest costs associated with their borrowings from Santander UK. The following principles reflect this:

Santander UK proposed conduct principles for the selling of interest rate risk management products to non-sophisticated clients

(i)Compliance oversight: The principles for selling interest rate risk management products must be overseen by the company’s Compliance division.

(ii)Appropriate persons: All advise to clients must be provided by staff who are FSA registered and deemed competent under Santander UK’s internal policies.

(iii)Restricted products: Only simple risk management products may be offered and sold.

(iv)Speculation: Products provided must not allow clients to “speculate” on interest rate risk2.

(v)Limited terms: The term of the risk management product must not be longer than the term of the loan.

(vi)Limited value: The notional value of the risk management product must not be greater than the loan.

(vii)Limited rate: The underlying rate of the risk management product must be the same as the loan.

(viii)Review and enforcement: Compliance division must undertake a quarterly review of a sample of advice provided to clients to ensure that these principles are being adhered to.

(ix)Client strategy: Santander UK advisers are required to send clients a “Strategy Letter”3.

(x)Legal and tax advice: Clients are encouraged to seek their own legal and tax advice in addition to that provided by Santander UK.

9.21. The sales process of these products to non-sophisticated clients is always “advised” and Santander UK staff must follow a sales process dictated by the principles above to ensure that the product is always in the client’s interest and only used to manage the risk arising from floating interest rates.

9.22. With principles to protect the ring-fenced bank from interconnectedness risk, and principles to protect customers from the risk of misselling, Santander UK believes that removing access from these products entirely for SMEs would be disproportionate and unjustified.

10. Question 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?

10.1. The draft Bill does not provide any detail on the governance arrangements between the ring-fenced bank and the wider group. The details of these measures will be for the regulator to define.

10.2. Santander UK strongly endorses this position. We do not believe that prescriptive rules on the nature of board composition would be desirable or necessary in primary or secondary legislation. A “one size fits all” approach embodied by prescriptive rules is likely to result in counter-intuitive and unintended consequences. For instance, one set of rules would have a very different impact on a listed UK banking group than on a wholly owned independent subsidiary of an EEA headquartered banking group, such as Santander UK.

10.3. There are a variety of tested and proven mechanisms available to regulators which ensure the independence of a board and board functions from the rest of a banking group which do not require overly prescriptive and “one size fits all” rules on board membership.

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

11.1. As noted above, Santander UK believes that the degree of regulatory discretion in the draft Bill will enhance the effective monitoring and policing of the ring fence. The core principles of resilience, resolvability and competition can and should be enshrined in primary legislation. However, the evolving nature of the banking market in terms of technology, practice and customer preference mean that overly detailed rules which take a “one-size-fits-all” approach risk becoming obsolete and unenforceable.

11.2. Santander UK believes that the key to successfully implementing the Banking Reform Bill lies in strong and effective regulators with the scope to work with banks to ensure that the principles of the legislation are met in a way that reflects the particular circumstances of each institution.

12. Question 22: Does the draft Bill adequately implement the ICB’s recommendations on loss absorbency requirements?

12.1. Yes. The draft Bill provides the framework to implement the loss absorbency measures agreed in the Recovery and Resolution Directive of the European Union (RRD).

12.2. This section necessarily provides for a degree of flexibility as the RRD has yet to be agreed. Santander UK maintains that the Government must seek to implement loss-absorbency measures in line with the rest of the European Union.

12.3. While we appreciate that a strong and predictable regulatory environment in the UK is in the interest of all parties, there nevertheless remains a risk of regulatory arbitrage and a very serious threat of damaging UK banks’ ability to raise funds if these rules are not harmonised across Europe and, to as high a degree as possible, with the major financial jurisdictions across the world.

13. Question 23: The draft Bill gives the Government power to direct the way in which the regulators can implement loss-absorbency requirements. How appropriate and well-designed is this power?

13.1. As noted above, this power is necessary to allow the Government to achieve maximum harmonisation with the EU and other financial jurisdictions. Following the global financial crisis of 2008–9, the importance of internationally agreed and implemented financial regulation is well understood.

14. Question 25: Is the Government justified in its decision not to implement the ICB recommendation for a higher leverage ratio than is required by Basel III?

14.1. Yes. Santander UK agrees with the Government that to apply a higher leverage ratio than that agreed by the Basel Committee on Banking Supervision (BCBS) would be inconsistent with international standards and the methods underpinning those standards.

15. Question 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?

15.1. Santander UK strongly welcomes the Government’s commitment to implement bail-in rules through the Recovery and Resolution Directive of the European Union, rather than unilaterally.

15.2. Like other UK banks, Santander UK raises its funding in international markets. Therefore, a UK-only statutory bail-in power would not give clarity to market participants, many of whom would be operating outside of the UK’s jurisdiction. A bail-in instrument of the kind described in the Government’s White Paper can only be viable if it is internationally agreed and implemented.

15.3. In order to promote a sustainable market for bail-inable debt, clarity of legal and contractual arrangements and clarity on the events which would trigger a bail-in are essential. Given the cross-border nature of bank debt, Santander UK believes that these will be best achieved as part of an international agreement on bail-in.

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

16.1. Santander UK is concerned that the current legislative framework for the transfer of a deposit taking business is ill suited to achieve a ring-fenced bank. Santander UK therefore strongly recommends that the Government amend the current FSMA Part VII process or, instead, puts in place bespoke (primary or secondary) legislation.

16.2. Part VII of the Financial Services and Markets Act (2000) (“FSMA Part VII”) deals with banking and insurance portfolio transfers from one bank or insurer to another.

16.3. FSMA Part VII enables such transfers to take place through a Court approved process. This means that assets, liabilities and certain third party contracts can be transferred from one bank to another without the consent of each individual customer or contractual counterparty having to be obtained.

16.4. Currently, the only feasible way to implement the ring-fencing rules is to use the FSMA Part VII process. In this context, we consider this process to be problematic due to the tensions which could arise between the role of the Court and the object of the FSMA Part VII process, the Court time and resource that would be taken up and confusion this process could create for customers. Santander UK would be happy to provide more information on this point on the Commission’s request.

1 November 2012

1 REGULATION (EU) No 648/2012.

2 This is to mean that the product provided is only to be used to manage the financial risks the client faces in their day to day business, not as a means of potentially generating greater returns.

3 A Strategy Letter is produced following a face to face meeting where a full fact find has been undertaken. It confirms the advisors understanding of the client’s financial exposures and requirements, the agreed or potential course/s of action and indicative pricing. The relevant Product Fact Sheets are attached. Compliance and legal issues are also discussed in relation to their FSA classification and ISDA documentation. The provision of this letter is not a formal regulatory requirement.

Prepared 2nd January 2013