Banking StandardsWritten evidence from HSBC Holdings

General Comments

1.1 You have asked us to consider whether the draft Bill will successfully give effect to, and is the most efficient and effective means of delivering, the main objectives set out in the policy document accompanying the draft Bill (Sound banking: delivering reform):

(a)making banks better able to absorb losses;

(b)making it easier and less costly to sort out banks that still get into trouble; and

(c)curbing incentives for excessive risk taking.

Our detailed comments on the specific questions are set out below but, as requested we have the following high level comments.

1.2 We acknowledge that HM Government is fully committed to a policy of ring-fencing retail and SME banking and we are likewise committed to taking all the steps necessary to implement that policy decision. We are wary however of overstating the incremental impact that ring-fencing operations within a single jurisdiction will have in terms of delivering the main objectives set out in the draft Bill. It is also somewhat hypothetical to estimate whether ring fencing is the most efficient and effective way of achieving the objectives set out in the draft Bill, as the cost/benefit analyses of both ring-fencing and its alternatives are highly subjective. On top of this, determining the incremental contribution of ring-fencing to the aggregate benefit from all the other structural and regulatory changes in train would be conjecture.

1.3 Accepting that HM Government wishes to pursue a form of ring-fencing which insulates banking services to individuals and SMEs from shocks elsewhere in the financial system and has a further continuity objective around uninterrupted provision of vital banking services in the UK, we would however urge it to consider carefully developments in both Europe and the US. It is important as far as possible to agree a globally consistent approach to structural reform, if we are to reduce the risk of both regulatory arbitrage and excessive complexity and therefore cost in delivering structural reform. We believe there are a number of actual and potential inconsistencies between the approach proposed by the Liikanen Group and the ICB (as developed by HM Government) which would need to be “ironed-out” to achieve this.

1.4 There have been welcome modifications made to the ICB’s original recommendations necessary to address issues which arose in the detailed consideration. Importantly, changes to the Group PLAC requirements reinforce the Government’s position that the UK should not be considered financially responsible for overseas subsidiaries, and the reversion to the international leverage ratio of 3% is both consistent with the views of the Basel Committee and consistent with the narrower focus and lower risk profile of the proposed ring-fenced bank.

1.5 We believe that the timetable for implementing a structural change of this magnitude must reflect the significant legal, financial and operational challenges in creating these new financial institutions. It is important that an ambitious timetable does not divert resources and put the continuity of customer services at risk or limit capacity to support the Government’s growth agenda.

1.6 From an HSBC perspective, we do not believe that separation of retail and wholesale banking will have a material impact on the culture of the firm as neither side was dominant; there are undeniably distinctive characteristics of retail and investment banking and these will endure in the two new banks. The most senior management that sat astride both parts of the firm would regard themselves as universal bankers, not advocates of one particular business line and that too will remain in the new configuration. We do, however, believe that the separation will have an impact on investors’ appetite for UK wholesale banking—and this must have been an objective of the structural reform—when compared to investment opportunities elsewhere in a universal banking model. Government should keep a watching brief over time as to whether contraction in the UK based wholesale banking sector creates longer term vulnerability to the actions of foreign firms with broader capabilities to serve UK based multinational companies.

1.7 The draft Bill necessarily gives many delegated powers to the supervisory authorities to adjust the scope and parameters of the ring-fence once it has been established. We think this provides essential flexibility and trust that these delegated powers will be exercised with sufficient consultation, within an appropriate implementation timetable, and subject to due scrutiny by and accountability to Parliament.

1.8 On the specific proposals presented in the draft Bill and White Paper, we believe that the de minimis limit for firms which has been suggested to identify firms to be excluded from the ring-fence requirements may be too high. We look forward to seeing more clarity on the Core Activities of the ring-fenced bank and the Excluded or Prohibited Activities as soon as possible so that we can make decisions on where our ring-fence should be positioned to best serve our customers. We support HM Government’s proposal that the ring-fenced bank should be able to offer simple derivatives given the potential consequences of concentrating all risk management activities for the real economy into a limited number of non-ring fenced banks and foreign firms.

1.9 There is a strong case for depositor preference but this would create a subordination of other creditors and the impact of this on funding markets needs to be understood. Furthermore, this would seem to be inconsistent with existing European proposals. More thought is needed on this issue.

1.10 In our opinion, the majority of the benefits in terms of improving financial stability (as set out in the objectives above) are derived from regulatory initiatives other than ring-fencing, making it difficult to assess the incremental impact of the ring-fencing structural reform. Improved loss absorbency has been achieved by the introduction of bail-in powers on non-common equity capital and other creditors, and we believe this should also be extended to deposit guarantee schemes. Curbing incentives to take risks has been achieved, inter alia, through the introduction of private sector bail-in and changes to remuneration structures. It is difficult to show how ring-fencing has incrementally improved the ability to “sort out” a failing bank given the resolution options available and the likely timetable over which these will be applied but we accept that the public policy benefits of making the separation, in terms of helping to restore public trust in the industry, are undeniable.

Responses to Specific Questions

Objectives and general approach

Q1. 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?

1.11 Loss Absorbency: The draft Bill (and the stated intentions for secondary legislation) reinforces the resolution framework established under the Special Resolution Regime and should ensure that banks will be better able to absorb losses in the event of a further crisis through the introduction of Primary Loss-Absorbing Capacity (PLAC) or bail-inable term unsecured debt. However, it is difficult to say whether this is the most efficient and effective means of achieving this objective as the incremental impact of the structural reform on top of other regulatory changes is impossible to measure. Given that other jurisdictions are adopting different approaches it is possible that experience will, in due course, show that one structural solution is more successful than another, but hopefully all the other reform measures will prevent future crises arising in the first place.

1.12 In terms of detail, we would favour a broader definition of bail-inable liabilities along the lines suggested by the European Commission in their proposed Recovery and Resolution Directive, without the specific focus on PLAC. Covering a wider range of creditors gives greater flexibility and avoids creating what is de facto another class of capital. Within this broader range, we also believe that HM Government should consider establishing a framework for the bail-in of the deposit guarantee scheme in the UK. This would restore its role in bearing losses in the event of the failure of a firm, even if that firm has been resolved by the Authorities rather than entering into liquidation.

1.13 Resolution of Banks: The ring-fencing of certain functions considered critical to customers who are unlikely to have access to alternative suppliers (such as individuals and SMEs) is intended to make banks easier and less costly to resolve and facilitate the uninterrupted provision of vital banking services. In a way, ring-fencing contributes to this goal as it allows different resolution approaches to be considered for the two parts of the bank. Indeed, unless different resolution approaches are available, it is difficult to see the additional benefits offered by separation compared to simply requiring UK banks to have (i) more loss absorbing capacity—which could be in the form of Tier 2 capital, bail-in debt, other creditors or the bail-in of the deposit guarantee scheme—and (ii) effective recovery and resolution plans which allow for the ex post dismantling of the failed bank.

1.14 Unfortunately, it is difficult to see, ex ante, the practical difference which would arise from the structural distinction which has been created. We recognise that the objective for resolution of a ring-fenced bank would be a rapid recapitalisation through the bail-in of PLAC with continuous operation of the bank during this period. But a similar bail-in scenario is also likely for the non-ring fenced bank given liquidation is not likely to be seen as a realistic option for a number of reasons:

(a)Unless wholesale banks in London shrink substantially in size (and we believe The City of London’s role would diminish in such circumstances), they will remain a key part of both the UK and international financial systems. The importance of London maintaining its leading international position in financial services has been continuously reinforced by HM Government so we take this to be a foundation of the UK’s economic positioning. While it is essential that there is a mechanism to resolve wholesale banks so that they can be wound down without public sector support, pending completion of an effective cross border resolution framework, which is currently far from complete, any requirement in the meantime for a wholesale bank liquidation would have material issues for other parties such as investors and counterparties (including central clearing counterparties and, through them, ring-fenced banks) and further impacts on other non-ring fenced banks in terms of confidence and funding.

(b)Corporates will in the future be transacting the majority of their risk management activities with a non-ring fenced bank and so be exposed to the credit risk of the failure of that bank; the explicit discipline of this exposure is part of the objectives of regulatory reform but it is also likely to see business increasingly concentrated into the most systemically important counterparty banks. Although channelling most standard activity in due course through central counterparties will alleviate much of the credit risk in the event a systemically significant firm is put into resolution, a myriad of OTC derivative contracts which make loans affordable or foreign transactions bankable, through hedging interest or exchange rate risks, would suddenly be removed with potentially severe consequences.

(c)Given the wide scope allowed for the non-ring fenced bank, this bank will also likely contain the main banking relationships for a significant tranche of UK middle market and larger corporates and these could not be unaffected by the failure of the non-ring fenced bank. Importantly these firms are the customers and suppliers to the SMEs within the ring-fenced bank so any impairment of their financial position, for example because their deposits are caught up in the wind down, would reverberate into the customer base of the ring-fenced bank.

1.15 Realistically, it would seem that the likely resolution options for both portions of the bank include bail-in, so avoiding putting taxpayer monies at risk and forcing private investors to take responsibility for the failure. Both banks would then need to be restructured—it is difficult to envisage a scenario where a bank has failed and this is not required—but the eventual outcomes could be radically different. The ring-fenced bank may largely resume operations whilst the non-ring fenced bank could be subject to transfers of its viable activities to another entity and the solvent wind-down of the remainder. But in this scenario, it would seem that we have not increased the resolution options—just put them into different buckets. This is an expensive solution to achieve this differentiation.

1.16 Contemporaneous with the work of the ICB we note the considerable body of work being undertaken on recovery and resolution under the guidance of the Financial Stability Board (FSB). The Bank of England (BoE) and the Financial Services Authority in the UK (FSA) have been at the forefront of this. Within this work, there appears to be an approach which recognises the impossibility of trying to achieve a full solution and full separation over a weekend. Instead, the required in-depth analysis of businesses and extensive preparation of resolution planning will provide a much wider range of options for the separation of banking operations into their constituent parts as part of a business restructuring once the firm has been put onto a firmer financial footing. The product of this work is a definition of a much broader range of critical economic functions within the UK’s resolution regime, acknowledging the need for continuity in a wide range of banking functions, beyond the sub-set concentrated upon by the ICB.

1.17 We would conclude, therefore, that while ring-fencing adds clarity to different parts of the banking model and makes explicit the risks being borne by creditors to each portion, it has less practical impact on the “sorting out” of failed banks: it is financial bail-in which provides the solvency support to allow for a more considered restructuring of the firms at the necessary granular level using the information from the resolution planning process rather than the structural separation of activities.

1.18 Curbing Risk Taking: A key objective of the reform proposals is that by removing the implicit government support from an organisation which is too big or too complex to fail, funding providers are forced to embrace the riskiness of the business they are supporting. On top of this, reforms should place an effective curb on the instinct of bankers to take risks where the gain is private but the loss is public. We support all steps to achieve these objectives but argue the objectives are not achieved by ring-fencing but by:

(a)the introduction of private sector bail-in, covering a wide range of creditors, including preferably the deposit guarantee scheme—so that these stakeholders have a strong incentive to curtail risks since, in the main, they have fixed rewards; and

(b)reforms to remuneration policies which have ensured that risk-takers are clearly identified within any firm and that their incentives for excess risk are curtailed through deferred payments, payments in shares and clawback arrangements.

Q2. 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?

1.19 Although the Final Report from the ICB was published in September 2011, the Issues Paper on which it was based was published in September 2010 and much of the evidence which it considered was focused on periods before this. During 2011–12, there has been considerable progress in a number of areas.

1.20 Structural Regulation: Both the US and the European Union have considered structural reform to address questions of financial stability through (a) the Volcker Rule within the Dodd-Frank Act and (b) the Report of the Liikanen High Level Expert Group respectively. Given this broadening of interest by the authorities in structural reform, there is considerable merit in ensuring that this is undertaken on a globally consistent basis to reduce the risks of regulatory arbitrage, particularly given that many of the affected businesses are quite geographically mobile. In addition there is a need to ensure that the industry is not burdened with duplicative costs from similar but not identical requirements which will increase unnecessarily the costs of intermediation borne by the real economy.

1.21 EU Recovery and Resolution Directive: The European Commission has published a draft Recovery and Resolution Directive which sets out, inter alia, clear goals for loss-absorbency which would apply to all firms across the European Union. UK proposals for loss-absorbency may need to be modified to fit with this regime, in particular:

(a)the proposals that loss-absorbency requirements are determined on a firm specific basis taking account of a series of criteria set out in the draft Directive (Article 39)—this has the effect of avoiding the cliff and trigger effects which come from the creation of a “hard minimum”, which HM Treasury indicated it was seeking to avoid in its White Paper of June 2012 (Para 3.30); and

(b)depositor preference is not permitted under the European Commission proposals which also include scope for a deposit guarantee scheme (which in the UK would be the Financial Services Compensation Scheme) to be bailed-in—this is discussed further in our response to Question 21 below.

1.22 EU Capital Requirements Directive 4 (CRD4): In addition to incorporating the proposals for the implementation of Basel 3 within the European Union, CRD4 also incorporates further provisions on remuneration and incentives which are relevant to the ICB’s considerations given the focus on “curbing incentives for excessive risk taking”.

1.23 Capital Requirements for Trading Activities: There has also been a significant change in the structure and nature of trading activities with the transfer of OTC derivative trading to central clearing counterparties (CCPs), the collateral requirements with these CCPs and the requirements for much higher margin requirements for trades which are not centrally cleared. These developments have significantly reduced the risk of trading operations to universal banks.

1.24 FSB and Other Developments on Resolution: In the period since the ICB’s work, there have been considerable developments by the FSB in its work on international resolution, including recognition of different approaches to the resolution of a Globally Systemically Important Bank (G-SIB) depending on the structure and nature of its operations—this is discussed further in our response to Question 3 below. As mentioned above, thinking has also advanced on the timetable for resolution, as set out in a speech by Andrew Gracie, Director, Special Resolution Unit, Bank of England on 17 September 2012. This indicates that resolution is not contemplated over a single weekend but over a much longer series of phases which makes the need for ex ante separation of universal banks less obvious.

Q3. 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?

1.25 The Draft Bill and HM Government’s stated intentions do give effect to the broad thrust of the ICB’s recommendations through enabling HM Treasury with the requisite powers to implement the policy underlying the Bill through secondary legislation. This recognises that adjustments will always be required as high level policy making is applied in detail. This has also necessitated a modest number of deviations and developments from the original recommendations in the Final Report of the ICB. We have commented on some which are particularly relevant below.

1.26 Group Primary Loss Absorbing Capacity: The proposals on the application of PLAC requirements to Groups have been modified to recognise the diversity of Group structures and the associated differences applicable in resolution regimes, a point also now acknowledged by the FSB. There is now agreement that, prima facie, it would be inappropriate for PLAC requirements to be applied across an entire Group (such as HSBC) which operates through separately capitalised and funded banks, which would be resolved locally under what the FSB refers to as the “multiple-entry” approach. The original requirement would have forced such groups to migrate towards a “single-entry” or “top-down” model for resolution which would have placed much more responsibility and risk on the home country (i.e. the UK). HM Government has indicated that it does not wish to take on the task of resolving overseas operations of a UK-headquartered Group which pose no threat to the financial stability of the UK; the revisions from the original ICB report are therefore appropriate.

1.27 Resolvability Buffer: The Final Report of the ICB suggested that an additional 3% loss absorbency buffer could be added by supervisors if they had concerns about the resolvability of any firm. We concur with the view from HM Government that this power is unnecessary to make explicit given the other powers with similar impact which supervisors hold with respect to both resolvability and capital.

1.28 Leverage Ratio: The ICB recommended that the leverage ratio for the ring-fenced bank should be increased from 3.0% to 4.06% in line with its proposed increase of the minimum capital ratio from 7% to 10% for the largest ring-fenced banks. HM Government has proposed to restore this to the international standard of 3.0%. We support the decisions of HM Government and note that:

(a)when the proposed increased capital requirements for G-SIBs were announced by the Basel Committee and FSB, they did not recommend any changes to the leverage requirements; and

(b)the original leverage ratio of 3% devised by the Basel Committee was intended to apply across all banks including universal banks. Therefore it was a blended rate recognising that banks hold low risk liquidity pools and mortgages as well as higher risk-weighted corporate and wholesale banking assets. Applying that blended rate to retail ring-fenced banks, with their concentration of lending to lower risk mortgages and with larger tranches of liquid assets, would in and of itself constitute a more onerous standard. To go beyond this would mean that the leverage ratio would becoming a binding capital restriction rather than the backstop measure which the Basel Committee originally intended.

1.29 De Minimis: HM Government has decided to introduce a de minimis level for the implementation of ring-fencing. Whilst we agree that this is prudent, we disagree with the level at which this has been set—this is discussed further in our response to Question 13 below.

Q4. What should be the timetable for implementation of these measures, and should it be set out more clearly?

1.30 HM Government has set out a timetable for the implementation of primary legislation (i.e. by the end of 2013) with the intention that secondary legislation should be in place by May 2015. This timetable seems broadly appropriate although, as we note elsewhere, it is important that HM Government gives due and careful consideration to developments in both Europe and the US to ensure that there is a globally consistent approach to structural reform and regulatory arbitrages do not develop. Depending on progress elsewhere, this may require a modification of that timetable.

1.31 In terms of capital requirements, the ICB Final Report recommended that its proposals should be implemented in line with the timetable for the introduction of higher capital requirements under Basel 3 over a period to 1 January 2019. We concur with this timetable but would note that the British banks affected by the ICB proposals are already operating at capital levels which are above the “glide-path” for achieving Basel 3 compliance. This is, in part, due to the pressure being placed upon them by the Interim Financial Policy Committee, supervisors and market commentators. We note that this acceleration may be having detrimental effects on the ability of some banks to provide incremental credit support to the real economy, although recent Government initiatives such as the Funding for Lending Scheme and guidance from the FSA have sought to ease these pressures.

1.32 In terms of the timing requirements for separation to create the ring-fenced bank, HM Government has indicated that this should occur as soon after 1 January 2019 as is practicable. We recognise that it is important that this step must occur within a reasonable timeframe and be undertaken in a measured manner. Through the process of creating the ring-fenced banks, the major banks in the UK will be transferring the systems and operations resources and capabilities which support their most vulnerable customers (as identified by the ICB) to new entities to be established for this purpose. A huge communication exercise will be required to make customers aware of what is happening to their banking arrangements. They must also be given an opportunity to make choices where these are required and the legal process will need to be undertaken within an agreed protocol designed to avoid disputes and exposure to avoidable claims for compensation. The operational systems and processes to be established will have to be planned and properly implemented and tested thoroughly so that customers will not be affected by any break in service. New boards and governance structures will need to be put in place for the split banks. Much of this can be done in advance and in parallel but it will take care, time and proper planning, all of which is to be done during a period of expected economic fragility in Europe.

1.33 Given that the secondary legislation necessary to enable banks to make clear decisions will not be finalised before early 2015, it is difficult to envisage that the structural reform could be completed by 1 January 2019 and it may be some time thereafter depending on how quickly the secondary legislation can be published and rules around it promulgated. The final timetable will ultimately depend upon operational decisions which are made about how the switchover is to be accomplished and we believe it would be dangerous to be too prescriptive at this stage.

Q5. The draft Bill proposes continuity objectives on the PRA and FCA. Are these appropriate and compatible with their other objectives?

1.34 We believe that the continuity objectives which have been set out for the PRA and FCA are consistent with their overall objectives and the goals that they have been pursuing with the development of enhanced recovery and resolution plans.

Banking Standards and Competition

Q6. What will be the impact of the proposed changes in the draft Bill on banking standards in the UK more widely?

1.35 We are unconvinced that the proposed changes in the draft Bill will have any direct impact on banking standards more widely. We do not see either a strong linkage between standards in banking and the degree of mixing of retail and wholesale banking, nor that separation in and of itself changes the behaviour of individuals within the two pieces; this is one aspect of a much more complex issue on which we have commented to the Commission in our submission of 24 August 2012. However we believe the clarification of the different roles of the ring-fenced bank and its non ring-fenced affiliate, delivered through structural reform, may help public understanding of the industry. The intensified scrutiny of banks by debt and other creditors because of the bail-in regime should, however, put pressure on banks to ensure bail-in is a remote risk.

Q7. What will be the impact of the separation of retail and wholesale banking on the culture prevailing within each?

1.36 The HSBC Group operates on the basis of a common culture operating across its global business in both retail and wholesale banking. The principles underlying that culture were approved by the Board of HSBC Holdings plc and there has been a strong process, led by the Group CEO, ensuring that everybody in the firm understands and abides by these principles. As a result, we do not believe that there will be a change in culture as a result of the separation. We are working to have the same culture in parts of the Group outside the UK that will not be subject to ring-fencing so if we thought that structural change was necessary to achieve the right culture we would be making such changes in all our markets.

Q8. What will be the impact of the ring-fence on competition, both in retail and investment banking, and in other areas of financial services?

1.37 Retail financial services in the UK are already highly competitive and there is no reason to believe that ring-fencing will improve this level of competition; indeed there is a danger that the onerous capital and other requirements will act as a barrier to the development of substantial “challenger” banks, or these firms will avoid activities subject to the ring fence to avoid the additional costs of separation, thereby further concentrating the market.

1.38 Ring-fencing of wholesale banks will by design make them much smaller institutions with more volatile cashflows and, as a result, lower credit ratings. This will increase the level of capital which wholesale banks need to hold in order to be able to attract funding and raise the cost of such funding when that is available. In the global marketplace in which wholesale banking operates, if it is not possible for wholesale banks headquartered in the UK to attract the necessary incremental capital because they offer returns to investors which are below those available elsewhere, in particular from universal banks still perceived to have implicit government backing, then activities will migrate over time to these banks. It is not realistic to seek to assume it would be possible to charge customers materially above the rate offered by the competition to compensate.

1.39 Ultimately, therefore, we see a risk of a long term decline in UK-domiciled wholesale banking and a rising dependency amongst UK corporates and other institutions (such as pension funds) on overseas universal banks for their more sophisticated requirements. This could leave The City of London more vulnerable to external competition than it is today. HM Government will need to continue to monitor carefully the overall competitive position of The City within the international banking system and, more importantly, the impact of structural reform on companies based in the UK who depend on the City today for their funding and risk management needs.

Delegated Powers and Accountability

Q9. 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?

1.40 Following the Final Report of the ICB, there have been a series of interactions between the public, the banks and HM Treasury on the proposed implementation of the recommendations. These have led to some necessary adjustments as detailed issues around implementation have become clearer—these are discussed in more detail under Question 3 above. This process is, however, ongoing and will indeed continue throughout the implementation of the ring-fence. We appreciate, therefore, that it is not possible for all of the developments to be reflected in the primary legislation but we do believe that the principles are clear.

1.41 We note, however, that the objectives which HM Treasury must consider before making orders in respect of additional Core Activities, Core Services and Excluded Activities are very broad and the impact of any order could be significant for a bank. As a result, the principles and procedures under which these delegated powers are exercised will be important. For example, the definition of Core Activities and Core Services covers the entire operation of accepting deposits, making payments and providing overdrafts, not just limiting this to individuals and SMEs as recommended by the ICB. This is a crucial distinction for the banks since the reality of implementation of the ring-fence is that banks increasingly operate with a focus on customer segments, rather than products as seen by the ICB. If a bank defines the scope of its ring-fence bank separation largely on a customer basis to comply with the prevailing rules, and then orders from HM Treasury amend that, this could well result in the transfer of customers into (or potentially out of) the ring-fenced bank; a complex, time-consuming and potentially risky process and one very frustrating for customers.

1.42 We note that the scope of the delegated authorities in respect of both Excluded Activities and Prohibitions is also broad and we believe this illustrates the difficulties of giving effect to structural regulation within a country’s banking system. It is recognition that, in a modern financial environment, it is exceptionally difficult to create absolute rules to separate different activities into distinct banks. The result is the need for regulatory and supervisory intervention to maintain the integrity of the separation. But this defeats one of the purposes of structural regulation—to remove some of the discretion from supervisors as existing powers have been shown not to have been exercised effectively before the last financial crisis.

Q10. 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?

1.43 We believe this is achieved. There is a continuing need for flexibility, subject to consultation and scrutiny—see our response to Question 11 below.

Q11. 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?

1.44 The primary legislation is high level but is a necessary first step in the implementation of these proposed banking reforms. We are confident that further details which will be provided in secondary legislation about how HM Government intends to use the delegated powers will give the public a clear understanding of the measures proposed and allow affected banks to prepare appropriately for proposed changes.

1.45 As discussed above, there is the need for continued flexibility for further measures to be introduced. However, at present, we do not understand the process by which such orders will be determined and implemented including (a) consultation with banking supervisors, the affected banks, their customers and other relevant bodies as well as scope for appropriate Parliamentary oversight of significant developments; and (b) the timetable for complying with such orders. We believe that this is an area where further discussion is required.

Q12. 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?

1.46 The provisions in the draft Bill on the PRA review do not give any details as to the scope and objectives of proposed review; we assume that these will be set out in secondary legislation and/or agreed with HM Treasury when the review is initiated. We assume that if HM Treasury is to lay the report before Parliament, it will be subject to scrutiny on that report both by MPs directly and through appropriate committees such as the Treasury Select Committee and that representatives of the PRA could also be called to answer questions. If this is the case, there would seem to be opportunity for sufficient scrutiny and accountability if Parliament chooses to exercise it. The five year review period seems appropriate in general, although we would suggest that the first review might usefully be done after two or three years in case early remediation steps are required.

The ring-fence

Q13. 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?

1.47 At present, we understand that HM Government intends that the ring-fencing requirements will not apply to firms where the deposits which would otherwise need to be held within a ring-fenced bank (i.e. from individuals who are not High Net Worth Individuals or smaller SMEs) would be less than £25 billion.

1.48 We believe that it is appropriate for there to be a de minimis level at which firms are not required to introduce a ring fence. We are, however, unconvinced that the threshold of £25 billion of mandated deposits which has been proposed by HM Government is appropriate or sufficient on its own. Recent crises in the UK and elsewhere have demonstrated that even smaller deposit-holding firms have been shown to be systemically important, in part because of the risk of contagion to similar firms, as in the case of the savings and loans companies in the US, the former building societies in the UK and the cajas in Spain. This contagion effect will be exacerbated if the firm has a concentration of deposits in any market sector, either by geography or customer type. Careful consideration, therefore, needs to be paid to the regulation and resilience of these firms at this level.

1.49 Although the threshold is intended to be based upon a ceiling of £25 billion of mandated deposits, an exempted firm could hold deposits in excess of this, for example from middle market corporates or from individuals in excess of the personal free and investable asset threshold. Grossing-up the balance sheet for this effect would mean that these could be sizeable operations in the context of the UK economy not subject to ring-fencing rules and capital requirements. There may be communication challenges in explaining to consumers and small firms the differential protection they would receive in these smaller institutions.

1.50 By putting personal and SME deposits into a ring-fenced bank, the Government has effectively created an ancillary deposit support scheme, mandating higher capital levels and creating the option of a bail-in restructuring which should in most circumstances leave all deposit holders (not just those insured or preferred) unaffected by the failure of the bank. This also creates the potential problem that all deposit holders may want to benefit—and, more importantly, may expect to benefit—from this kind of protection.

1.51 There might then be a case where a firm is outside the scope of ring-fencing due to its modest deposit base, but remains a material risk to (part of) the economy and financial system due to activities on the asset side of its balance sheet. In these circumstances, there could be considerable moral pressure on the Government to ensure that the depositors in such firms were, in some sense, protected, when the scope of the Financial Services Compensation Scheme would not cover all of the depositors. This could be a considerable gap for the Government to bridge and would suggest that either the deposit threshold should be set lower or that a threshold should be similarly defined with respect to total balance sheet size.

Q14. 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?

1.52 Core Activities: As discussed above, the definition of Core Activities and Core Services currently covers the entire operation of accepting deposits, making payments and providing overdrafts, not necessarily limiting this to individuals and SMEs as recommended by the ICB, unless the additional activities and services are carried on in circumstances specified by order made by HM Treasury. It will be important that Core Activities is quickly defined so that banks can apply this definition effectively to their own customer bases when designing the necessary separation.

1.53 Excluded Activities: At present, HM Government has only defined the regulated activity of dealing in investments as principal as an excluded activity, a small sub-set of the activities envisaged by the ICB and in subsequent consultations. We understand that most excluded activities will be addressed in the secondary legislation. We hope that this will give HM Government an opportunity to (a) develop more detailed definitions of excluded activities so that banks can make firmer plans for separation, and (b) consider developments on structural separation in the European Union and US so that requirements and definitions can be, so far as is possible, harmonised and conformed to facilitate the smooth operation of the global financial system.

Q15. Which categories, if any, of customer should be permitted to deposit with a non ring-fenced bank?

1.54 The current proposal from HM Government is that insured personal depositors (excluding High Net Worth Individuals) and SMEs should be required to place their deposits with a ring-fenced bank; others including High Net Worth Individuals can become direct customers of the non-ring fenced bank if they so choose or can be customers of the ring-fenced bank. Overall, we concur with this position. At some point, customers must be considered eligible to choose how to invest their savings and accept the risks of decisions regarding the firm with which they choose to transact.

1.55 The level of personal deposit insurance has already established this threshold of responsibility for individuals. It is right that HM Government has extended this to the smaller companies and we believe that this criteria should be set at the lower end of the size range proposed, namely turnover of £6.5 million per year.

Q16. 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?

1.56 We believe that it is important, from both a risk management perspective and customer service perspective, that ring-fenced banks should be able to offer simple derivatives to their customers. It is important to recognise that where a bank offers basic financial products such as fixed rate mortgages or loans or simple principal guaranteed investments, it is effectively providing a derivative, albeit built into the terms of the loan or other service. Indeed, they are already part and parcel of routine activity and most customers simply see the product they choose to take rather than unbundling the elements that went into its construction. There would in our view be customer push back if routine products were not available because there is an embedded derivative in the product construction. Allowing these to be sold separately and clearly identified will help ensure that customers, banks and supervisors are all fully aware of the risks which are being underwritten and can check that appropriate risk management is in place for the bank as a whole.

1.57 The customers of the ring-fenced bank can include larger corporates with much more sophisticated risk management needs than SMEs. If ring-fenced banks were not permitted to offer derivatives, it would force these businesses to choose between either (a) undertaking the entire transaction with a non-ring fenced bank, or (b) splitting the transaction so that the vanilla element (say, the loan) was with the ring-fenced bank and the hedge (say, a fixed interest of exchange rate) was obtained from a non-ring fenced bank. For the customer, this could mean that a loan made affordable by fixing interest or FX rates may not remain so because of having to deal with two counterparties with incremental operational complexity

1.58 HM Government has proposed that the only derivatives which can be offered would be standardised contracts for interest rates and FX. Since the customers of the ring-fenced bank can include larger corporates and given the scenario outlined above, we do believe that these restrictions are less efficient than they might be. Not all risk hedges will be capable of being put in place using standardised derivatives contracts and scope, within limits, should be created for non-standardised transactions, under standardised ISDA documentation and with collateral posted.

1.59 If the ring-fenced bank is to provide effective risk management products, it is critical that products can be tailored to mitigate client specific risk profiles. The proposed definition of “standardised” products may be overly restrictive to deliver this result. Instead, we believe that the focus should be on ensuring that the market for these contracts should be liquid and that these should be documented under standard ISDA agreements. In some cases, contracts could comprise two or more standardised products but it is not clear if this approach would be acceptable.

1.60 Having proposed that the ring-fenced banks should be able to offer derivatives to its customers, we recognise that it is important that there are safeguards in place to ensure that this power is not abused and that there is not an undue build-up of risk within the ring-fenced bank. We believe there should be two levels of safeguards: (a) a purpose test and (b) a limit on overall derivative exposure.

1.61 Purpose Test: The current Building Society Act sets out a “purpose test” which, with suitable modifications, could be applied to the ring-fence bank to prevent speculative activity. Attention is focused on transactions directly linked only to loans but some customers do not borrow money, instead making investments from their cash resources and these customers still want to manage their risks. In order to address this, a revised definition might limit the derivative risks which can be taken on by a ring-fenced bank to those where:

(a)the derivative is directly linked to reducing risks arising from the provision of credit, holding of deposits or making and receiving of payments; or

(b)the customer is a user, producer or consumer of the hedged asset (or a near equivalent, if the specific asset is not available), in appropriate quantities.

1.62 Limit on Overall Derivative Exposures: One of the safeguards that HM Government has proposed in the White Paper of June 2012 is that the residual market exposure from such derivatives should be capped at a percentage of capital which is as operationally close to zero as possible. This is unrealistic. Eliminating all market risk could potentially be prohibitively expensive since there will always be residual exposures, for example, on timing as expected (and actual) durations of thousands of underlying loans (such as mortgages) will not match the corresponding market-side hedge. We recognise that the residual market exposure for ring-fenced banks should be less than in the current universal bank and suggest that it would need to fall within a pre-defined risk framework which is subject to regulatory approval and periodic monitoring. The capital associated with any pre-defined risk framework would be agreed within Basel 2 Pillar 2 for each bank.

Q17. 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?

1.63 We recognise that having created a separate ring-fenced bank, it will need its own board and that body will also have a degree of independence; HSBC operates on this basis with its separate legal entities around the world and separate independent boards. HSBC has already installed an independent Chairman in its UK bank. It is also essential, however, that the ring-fenced bank remains clearly a part of the HSBC Group, adhering to the Group Standards which have been established.

1.64 It is intended that directors will have an additional duty to maintain the integrity of ring-fence alongside their other duties. Whilst it is feasible for directors to be required to manage a number of different objectives, this does make their role increasingly complicated and means that maintaining a high standard of directors will be essential. There will also need to be a clear regulatory definition of what is meant by the “integrity of the ring-fence”.

1.65 We support the position of HM Government on a separate committee for Risk—this is the practice with the majority of our locally incorporated entities in any event. We are unconvinced on the question of a Nominations Committee given that there will be an independent Chairman, but we would be happy to put this in place if required. We also believe that while the ring-fenced bank has input to and oversight of remuneration for its employees it is also important that the remuneration policy is closely linked to the Group, given that:

(a)a considerable portion of the remuneration for directors and senior management will be in the form of shares in HSBC Holdings plc, and these must be issued on a common basis across the Group; and

(b)senior management within the ring-fenced bank will often have served, or expect to serve in other parts of the HSBC Group, and the remuneration policies need to be consistent so that postings to the ring-fenced bank are not unduly penalised or favoured.

Q18. 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?

1.66 We understand that the proposed restrictions on exposures and operational dependencies between the ring-fenced bank and the rest of the group are to be designed to ensure that the ring-fenced bank can continue to operate despite the failure of other banks within the Group. These are the principles on which HSBC is developing its approach to the resolution of the Group and we believe that these will provide a sufficient degree of independence and resilience.

1.67 It will, however, be important that the UK authorities are not super-equivalent in requiring additional separation of exposures and services for ring-fenced banks beyond internationally agreed standards. This would set a precedent for national ring-fencing of finances and operations and prejudice the ability of UK-based banks to operate internationally on a competitive basis and so gain the benefits of economies of scale and best practice in global operations. We believe the continuity of services can be adequately protected in other ways.

Q19. Will it be possible to effectively monitor and police the ring-fence, given the degree of regulatory discretion the draft Bill proposes?

1.68 The monitoring of the ring-fence by supervisors should be aligned to the continuing analysis of resolution plans in the UK which require an annual update of the status of each of the Critical Economic Functions within the UK bank. These processes are still under development but, on this basis, we anticipate that the ring-fence can be effectively monitored.

1.69 In terms of the level of regulatory discretion, it will be important that the supervisors are clear in how their discretion is being exercised both across the industry and as applied to individual firms, and sufficiently far in advance of the implementation date so that firms are able to move efficiently to comply.

Q20. 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?

1.70 We do not believe that the provisions on corporate governance for ring-fenced banks will promote improved standards within the HSBC Group as, in the main, these are standards to which we already operate. The sharper focus on directors’ responsibilities will however reinforce the standards expected of directors. We do not believe that other measures are required.

Depositor Preference

Q21. 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?

1.71 There is a strong case for insured depositor preference in the event of bank insolvency; however this would create a subordination of other creditors beyond that which exists today and care would need to be taken to understand the impact of this on funding markets. Depositor preference is also inconsistent with the scope for deposit guarantee scheme bail-in included in the European Commission’s proposed Recovery and Resolution Directive and we believe there should be consistency around a single position.

1.72 There is also a case in terms of public policy to broaden the scope of deposits covered. We would not advocate extending this beyond personal deposits but it seems iniquitous to (a) punish, for example less sophisticated savers who do not open multiple accounts, all within the protection limits or (b) catch transitory monies from, for example, a house sale, a pension lump sum, insurance recoveries or life policy receipts that default into a bank account. Such monies should be protected as a matter of public policy in our view.

1.73 We will write separately on this subject as it is complex and we are still finalising our position.

Capital Levels

Q22. Does the draft Bill adequately implement the ICB’s recommendations on loss absorbency requirements?

1.74 As discussed in our response to Q3 above, HM Government’s proposals for loss-absorbency differ from the final recommendations in a number of respects and we believe that those variations are justified.

Q23. 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?

1.75 The power is sufficiently broad to allow considerable scope and flexibility for HM Treasury to meet its overriding objectives of protecting core activities and its continuity objective.

1.76 The approach to applying the loss-absorbency requirements has important ramifications for HM Government as identified in the White Paper in June 2012. In relation to the application of PLAC across an entire Group it stated:

“if the UK authorities were to impose such requirements, it may risk creating a perception that the UK holds or retains responsibility for providing bail-out financial support for such overseas operations.” [para 3.26]

1.77 Given these potential implications, it is justifiable that HM Government remains able to direct the overall policy framework for loss absorbency requirements. It is also important that there is full transparency as to how this power is exercised and there should be clarity around how changes in approach might be flagged and consulted upon.

Q24. Is the Government’s stated intention for the design of loss-absorbency requirements workable? Will it provide a sufficiently well-capitalised banking system? In particular, how justified is the intention to allow an exemption for assets held in overseas operations?

1.78 Increasing the loss-absorbency of the UK banking system will be achieved through the proposals set out by HM Government but this is being done simply by shifting the burden of loss absorption to society, ex ante, through the savings and pensions market rather than ex post through taxation. The key success of the regulatory reforms will be in avoiding future systemically significant losses or mitigating the impact of tail risk events rather than allocating such losses in a different way; society still bears the burden of whatever losses occur. The role of debt providers will change under the bail-in regime: their responsibilities to monitor those to whom they have provided long term funding will increase, fiduciary risk and accountabilities will have to be revisited and consideration given to whether the incentive structures within the fixed income investor community are aligned with the objectives of the draft Bill.

1.79 In summary, we believe there will as a consequence of all of this be additional costs and some contraction in the aggregate supply of credit. This flows through to higher costs for customers whose financing is intermediated by the formal banking sector, particularly SMEs who have less opportunity to seek alternative forms of finance. We therefore expect there to be a modest contraction in funding provided through the banking sector as the level of credit supply adjusts to available funding. One way of mitigating the burden of bail-in on debt providers would be to consider the option of bail-in of the deposit guarantee scheme (as an alternative to depositor preference) for expanding the overall loss-absorbency of the banking sector by spreading the burden more widely.

1.80 In respect of the proposed exemption for overseas operations we support the qualified exemption for assets held in overseas operations; see the response to Question 3 above.

Q25. Is the Government justified in its decision not to implement the ICB recommendation for a higher leverage ratio than is required by Basel III?

1.81 Yes—see the response to Question 3 above.

Resolvability

Q26. 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?

1.82 Since the introduction of the Special Resolution Regime, the UK authorities have had the ability to resolve a large failing firm through options such as the creation of a bridge bank or the bail-in of creditors. These powers are constantly being refined and added to as international debate in this area advances and it is likely that the UK powers will also be amended in the coming years, but the essential elements within the UK are already in place. Progress on handling cross border resolution is less well advanced although the principles have been set out. In summary, the tools are in place to handle a domestic failing bank but not yet in place globally for the failure of a large internationally active bank.

1.83 For the avoidance of doubt, however, we should be clear that in the event that a large bank fails, this will not occur without significant pressure on financial stability. As it restructures, the affected bank would undoubtedly reduce its provision of credit to the UK economy and the overall lack of confidence may well affect other firms’ appetite for lending at pre-crisis levels. Funders and investors will pause to scrutinise the cause of failure, reducing appetite to the sector while the market assesses whether the failure is idiosyncratic or systemic. Other banks may well be forced or choose to take risk off and raise liquidity levels because of demands from both equity and debt investors who will be keen to see that (a) there has been no contagion between the failed bank and the rest of the industry and (b) that other banks are not operating on a similar business model and risk appetite to the failed firm. We have seen a number of examples where a series of smaller banks have all failed in succession, despite being separate institutions, for these very reasons. In essence the sector is substantially correlated in terms of risk profile, so until it is established that the failing bank has a particular problem not shared by others, the whole sector will be under intense scrutiny. This can be seen in recent months where the JPMorgan “London whale” incident hardly caused a ripple as it was seen to be institution specific, whereas the Spanish property weakness within the cajas cast a shadow across the whole sector.

1.84 Furthermore, since it is likely that markets will be unwilling to provide wholesale funding to restructured banks until confidence and transparency are restored fully, we anticipate that the UK authorities will need to provide significant amounts of special liquidity to the UK banking system; taxpayer monies should however not be at risk from this given the bail-in recapitalisation of the banks and the use of collateral for such facilities.

Q27. 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?

1.85 See the response to Question 3 above.

1.86 The Recovery and Resolution Directive (“RRD”) is still subject to amendments from both the European Parliament and the European Council (representing the Member States). As a result, we have yet to see the final terms but the RRD as drafted has been described as consistent with the Key Attributes of an Effective Resolution as set out by the Financial Stability Board. Provided that these Key Attributes are retained, we believe firmly that the directive will deliver effective bail-in powers for application across the European Union.

Impact Assessment

Q28. Is the impact assessment of the costs and benefits credible and balanced?

1.87 The Impact Assessment accompanying the draft Bill is the development of a series of impact assessments undertaken in the UK and overseas to support banking reform which have become progressively more stylised in terms of presenting the case to support banking reform. It is difficult to comment in reality as the base case is set against the unacceptable cost of a future crisis so almost any cost can be justified. What is not attempted is to distinguish the benefits delivered by this draft Bill which are incremental to all those delivered from the EU/Basel/FSB reforms and from the regulatory regime change underway in the UK. What is clear is that all the benefits do not accrue from the UK’s distinctive ring-fencing approach. We also offer below some more detailed comments.

1.88 Costs: The impact assessment attached to the draft Bill notes that there is a potential capital requirement from pension funds when universal banks are split and the joint and several liability which is currently available is no longer applied. This cost is ignored in the cost benefit calculation but we have not seen developments from HM Government which give us confidence that this can be resolved without either (a) a considerable capital injection or (b) a material compromise in the effectiveness of the ring-fence. The current proposal would entail delaying revoking the joint and several liability until 2025. We do not believe that this will be effective in reducing the effects as any schedule of payments agreed with the Trustees will be an immediate capital deduction from capital under current FSA and proposed EU rules. Additionally, the full protection of the ring-fence is not achieved until this joint and several liability is removed and this is not recognised in the analysis.

1.89 HM Government also assumes that the additional capital requirements necessary to enable banks to comply with the ring-fencing regime will be available through a range of options. Given the lower returns which the market is discounting in UK retail and wholesale banking and the opportunities for investors to invest in other jurisdictions and sectors, we do not believe that this assumption is valid.

1.90 Benefits: HM Government has set out a case which justifies the private and public costs of ring-fencing because it will materially reduce the probability of a future financial crisis and the impact of that crisis if it should occur. However, it is not clear how ring-fencing achieves this:

(a)Reducing the Probability of a Crisis: This would seem to be driven by two assertions independent of structural reform (a) the higher loss absorbency which has been required would delay the point at which resolution would be required and therefore give time to implement recovery options, and (b) changes in incentives to take risks driven by the introduction of private sector bail-in and the changes to remuneration structure will deliver better governance and behaviour (see Question 1 above).

(b)Reducing the Impact of a Crisis: The major GDP effects from a financial crisis arise from the withdrawal of credit as banks restructure their operations and adjust to new funding and capital constraints. There is no reason to believe that these adjustments would not be as severe within two banks as within a single universal bank—indeed, they may be more severe because of difficulties in attracting replacement funding and capital to firms with more narrowly defined business models.

1.91 In summary any cost-benefit analysis is subjective, particularly when set against the cost of an unacceptable systemic event, but it would be helpful if there was a better argued case for the incremental benefits of ring-fencing (as opposed to taking account also of all the other regulatory developments) so that incurring the clear and certain costs can be justified, based on a greater probability that true benefits will be achieved.

Q29. Might there be any other unintended consequences which have not been considered?

1.92 Undoubtedly; we anticipate that there will be a myriad of unforeseen developments and consequences as all the stakeholders in the banking system (banks, customers, equity and debt investors) get to grips with the very profound changes which are being proposed. One clear risk is the complexity in explaining the changes to customers and their reaction.

International Issues

Q30. What will be the impact of the proposals on the international competitiveness of UK banks?

1.93 Concerns around international competitiveness relate primarily to the non-ring fenced banks or “wholesale banks” which will result from ring-fencing. In providing services to the international corporates operating both in the UK and other jurisdictions, these banks will continue to compete with other wholesale banks aiming to serve the same customer base, most of whom will not be subject to the UK’s ring-fence requirements. This will include many international banks operating in The City of London, only some of whom may be affected by similar proposals to those proposed by HM Government (see response on the Liikanen Report below). However, many other banks will not be subject to these restrictions, particularly banks from the United States (which will instead be subject to the Volcker Rule) and from emerging markets such as China, India and Brazil.

1.94 UK wholesale banks will operate with a number of disadvantages compared to their foreign rivals. The first will be capital requirements which we anticipate that UK wholesale banks will be required to hold in order to be able to continue in operation. Without the broad base of funding which is available to a universal bank, wholesale banks will need to obtain all of their funding from wholesale markets. This will need a proper blend of short, medium and long term funding in order to satisfy the requirements of the net stable funding ratio which is incorporated in the Basel 3 Accord. This will create two main disadvantages: (a) we anticipate that any wholesale bank will need to hold higher capital ratios, and (b) UK wholesale banks will lose the benefit of the lower cost of funding which comes from the universal banking model and a much broader mix of funding. Of course, the benefit if investors see a lower risk profile arising from the ring fencing arrangements may offset the higher capital requirements. Indeed it will be interesting to observe market reaction to the distinctive business and structural models that will emerge post regulatory reform. Capital will flow to the preferred model.

Q31. 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?

1.95 The proposals set out in the recent Liikanen report would appear to have many of the same characteristics as the ICB’s recommendations although they approach the issue of ring-fencing or separation from two different angles:

(a)the ICB proposes the ring-fencing of a small number of essential services which need to be protected; and

(b)the Liikanen Group proposes that a small number of potentially higher risk activities should be separated from the rest of the bank.

1.96 In general, we believe that the UK should work towards having a single proposal, applicable as widely as possible where separation is considered. However, whilst these approaches are not incompatible, there are a number of areas of potential conflict:

(a)Whilst the UK regime has been specifically targeted at UK banks and will not apply to entities incorporated outside of the UK, it is not clear whether the Liikanen proposals are intended to apply on an EEA basis or a fully consolidated basis as well as at EEA subsidiary level. It is not clear if this would imply extra-territorial application covering, for example, the non-EU incorporated subsidiaries of an EU-headquartered group. This would add further complexity to decisions around the optimal location for the headquarters of an international banking group.

(b)The proposal for a clearly identified layer of bail-inable debt differs from the proposal from the European Commission for a wide bail-in regime (including the potential bail-in of deposit guarantee schemes).

(c)Under the ICB proposals, a universal bank could be split into a narrowly defined ring-fenced bank incorporating just those customers and activities required within the ring-fence and a wider non-ring fenced bank with a correspondingly broader product and customer range. This may be preferred by some banks because of the scale and rating which would be applied to the larger non-ring fenced bank, but it is not clear that this flexibility would be available under the Liikanen proposals; the wider non-ring fenced bank available under UK proposals might still fall within the rules relating to the allowable proportion of trading assets, necessitating a further split or a redrawing of the boundaries for the scope of the ring-fenced bank.

1.97 We note, however, that the Liikanen proposals have not been officially adopted by the European Commission and/or the European Union and are subject to consultation. Furthermore, they are significantly less advanced than the UK proposals in terms of detail and further issues may emerge as that detail is filled in.

1.98 At least two other important sets of proposals will also emerge over the coming months:

(a)Proposals from France for some form of separation within its local banks. HSBC has a locally incorporated subsidiary in France.

(b)Revised proposals from the US for the implementation of structural separation under the Dodd-Frank Act (the Volcker and swaps push-out rules).

Other

Q32. What other matters should the Commission take into account?

1.99 We have no further matters to add at this time.

5 November 2012