Banking StandardsWritten evidence from Standard Chartered Bank

The responses below set out Standard Chartered’s response to the call for evidence on the pre-legislative scrutiny of the Banking Reform Bill. Since it is unlikely we will need to create an ICB ring-fence we have focused our responses on the Primary Loss Absorbency Capacity (“PLAC”) questions but have provided some comments on ring-fencing to the extent we think this would be helpful.

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

There is considerable uncertainty about how the Liikanen recommendations will be implemented. The scope of the ring-fence and the extra-territorial application are key issues on which there is currently a lack of clarity. Until these issues are clear it will be difficult to understand the interplay with the ICB regime, therefore, although we appreciate the need to make steady progress on the ICB legislation, the interaction with Liikanen will be key.

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

The timelines for implementing ICB and any of the recommendations from Liikanen need to be aligned because they will represent such significant structural change that bank funding models will need time to adjust to avoid a negative economic impact. It will also be important to understand the linkages and possible conflicts between the two regimes and how they will interact with Capital Requirements Directive IV (“CRD IV”) and Capital Requirements Regulation (“CRR”) plus the Recovery and Resolution Directive (“RRD”).

Delegated powers and accountability

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?

Yes. Given the uncertainty of the current EU legislative landscape it is necessary for the UK authorities to have a degree of flexibility so legislation can be implemented in a coherent way. The publication of Liikanen adds considerable uncertainty about how the ICB and Liikanen regimes will interact. This will also be partly driven by interactions with other EU legislation already in train including the RRD, CRD IV and CRR.

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?

This will partly depend on the implementation timetable for Liikanen and what the final conclusions are from the European Commission. We appreciate the need for quick implementation but this has to be done in such a way to ensure the smooth creation of the new regimes.

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?

Yes. The focus of the review should be on the impact of the ring-fence on the financing needs of businesses and consumers. Given the possibility of EU legislation with the implementation of the Liikanen recommendations, it will also be helpful to ensure similar provisions are included with EU legislation and the UK effectively feeds into any EU process.

The ring-fence

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

Yes. The de minimis approach provides for a proportionate regime based on the impact that the failure of an institution may have on financial stability. Setting the de minimis requirement at a lower level may act as a barrier to entry given the increased costs of creating a retail ring-fence. This is a crucial example of striking the right balance between financial stability and creating an effective competitive landscape.

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

Using a de minimis approach will help to ensure the ring-fence regime is proportionate and that it does not prevent market entry which is key for ensuring a competitive landscape. We also agree with HMT that there should be an exemption for high net worth individuals because their needs will be different to those of high street customers.

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?

Standard Chartered is unlikely to be required to create a retail ring-fence because of the small amount of mandated deposits we hold. However, we believe that there are benefits for small and medium businesses being able to access risk management products from within the ring-fence. These are essential services that are particularly important for medium-sized corporates seeking to enter export markets. We appreciate the concerns that have been raised by the misselling of Interest Rate Swaps but conduct and financial stability issues need to be considered separately. Regardless of whether derivatives are in or out of the ring-fence there will be the need for an effective conduct regime to be developed for the sale of these products. However, if SMEs are unable to access derivatives their ability to effectively manage their foreign currency and interest rate risk will be limited.

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

ICB (and possibly Liikanen) will lead to fundamental shifts in the way in which banks fund themselves and the relationship between different parts of the bank. They will pose significant challenges and could inadvertently lead to a greater reliance on wholesale funding, which seems a perverse outcome. The requirements for a third party relationship between the ring-fenced and non-ring-fenced bank is likely to increase the costs of funding for banks and will ultimately be borne by clients and customers. We also think policymakers need to consider why adopting a third party approach is appropriate given that a bank will have a much greater understanding of the risks inherent in activities it has generated, as opposed to third party banks. These arrangements are likely to make it more difficult for banks to comply with the liquidity requirements set out in Basel III or indeed the Financial Service Authority’s current liquidity regime. As with our view on structural reform generally, we have concerns that these extra intra-group requirements will actually make banking groups more brittle and unable to deal with relatively minor funding problems. We believe that such issues would be better dealt with through effective Recovery and Resolution Plans (“RRPs”) and challenging oversight by supervisors.

Depositor preference

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

No. The effect of the policy really is only to push the Financial Services Compensation Scheme (“FSCS”) further up the insolvency hierarchy. There will be no difference for depositors that hold deposits with a failed bank. Therefore, all of those with deposits up to £85,000 and eligible for protection under the FSCS, will continue to have their deposits protected. We do not believe there is a compelling case for increasing the scope of depositor preference and note that any further increase could increase the costs of funding, which would in turn increase the costs of borrowing. It will also make a bank’s deposit base increasingly fragile as customers will no longer make a conscious decision about the quality of a bank with which they place their money. Since we only have limited protected deposits in the UK, the policy does not have a material impact on our funding costs.

Capital Levels

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

Yes. The draft Bill is consistent with the recommendations of the ICB on loss absorbency. The Bill is relatively clear on the qualifying instruments that would be made loss absorbing, although the key issue here will be the shape of the regime that is developed with the implementation of the RRD and the decisions on the implementation of the Liikanen recommendations. Much will also depend on the methodology used in setting PLAC.

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?

We support the creation of RRPs and the use of bail-in, however both need to be developed in a manner that ensures the most effective and proportionate resolution of failed banks. We would stress that regulators should have discretion to set the level of PLAC and its composition from the perspective of the risk profile of the individual entity rather than against a uniform, one-size-fits-all, approach. The quality and effectiveness of an individual institution’s RRPs should influence the level and composition of loss absorbency.

24. Is the Government’s stated intention for the design of loss-absorbency requirements workable?

Yes, but it depends significantly on developments outside the UK. There are substantial mechanical issues to work through as the concept of bail-in regime is a material shift from the established creditor hierarchies applied to the non-financial sector with which markets have grown accustomed. It will take investors some time to understand these differences and a sustained period of education will be needed. Some institutional investors will be precluded from investing in senior debt made eligible for bail-in as their constitutions preclude them from either holding equities completely, or only up to a relatively low cap because of investment mandates. This might expose pension funds to reinvestment risk indirectly. Policymakers should consider a statutory approach for handling these issues.

Markets will need to adjust their pricing parameters to accommodate the bail-in regime and this will rightly increase cost differentials between different banks based on the risks they take. Policy is developing quickly on bail-in and it is not clear all the factors have yet been thought through but it will be essential to consider these as the market changes. For example, there will be some complex pricing movements between equity and senior debt as a bank travels closer to the point of non-viability. There may even be some unintended arbitrage opportunities that would attract investors whose interests are not aligned with the wider interests of financial stability.

We strongly urge the government to adopt a statutory regime for the application of bail-in covering all existing senior unsecured debt in issue irrespective of residual maturity. We believe this provides a good foundation for a global regime. The regime developed with the RRD also needs to reflect these options. This is important for a number of reasons:

Maintaining consistency with the likely evolution of bank capital under CRD IV and Capital Requirements Regulation.

Carving out senior debt with less than one year to maturity creates an unnecessary distortion to the market. Perversely it will encourage the issuance of short-term debt at the expense of more stable long-term funding which is precisely opposite to the thrust of much of Basel III.

A statutory regime that embraces all debt in issue avoids the “first issue peril” where the initial issue would carry the entire loss absorbency and would also infer that the rest of the senior debt could not effectively absorb losses. This would create major market disruption given the sporadic access some banks have recently had to unsecured new issuance funding and the dependence that has emerged on official programmes such as the LTRO.

In designing a bail-in and recovery regime it is also clear that short-term liquidity support may be required to ensure effective resolution. This should not come at the expense of the Exchequer. There could be some advantages to the Bank of England giving consideration to a new, broader definition of eligible collateral to be used specifically in the context of liquidity support for resolution planning strategies based around bail-in. This issue has to be given greater consideration but we believe it will be necessary as part of a more holistic approach to resolution.

– In particular, how justified is the intention to allow an exemption for assets held in overseas operations?

The original intent of ICB appeared to be the protection of the UK economy from material disruption caused by the failure of a systemically important entity. Applying that intent does justify the carve out in respect of the calculation of PLAC and therefore we agree with the position set out by HM Treasury in the White Paper. However, there are instances where the application of the exemption renders the orderly wind-down of an international bank’s operations in resolution potentially unworkable. For instance where the exemption has an impact on the UK’s reputation or the ability of the home regulator/resolution authority to discharge its obligations to provide a coordinated resolution of a troubled bank. Our view is that the exemption should be available for application by the resolution authority on a discretionary basis where these issues are addressed.

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?

Yes, we support the idea of a back stop leverage ratio but agree with the approach adopted by HMT. We do not believe that being super-equivalent on this point would be appropriate.


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

Yes, the provisions in the legislation supplement those already available to the authorities in the Banking Act 2009 and those being developed with the RRD. However, it will be essential to ensure effective international co-operation on the development of recovery and resolution regimes. Cooperation between regulators in home and host countries will be an essential step to ensuring these regimes are effective. It is not yet clear how this will work across borders, especially beyond the EU, however we support moves to a global statutory bail-in regime applied to all debt in issuance.

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?

Bail-in should only be at the point of resolution and with a statutory regime without carve outs for minimum maturities. Other options could have a negative impact on the stability of institutions. Regulators are best placed to set the levels of PLAC required by banks and this should reflect the quality and effectiveness of an institution’s RRP as well as their pre-existing levels of resilience in both capital and liquidity terms.

International issues

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

Liikanen appears to be biased towards a contractual regime for bail-in which we do not believe is workable. We remain concerned about the lack of clarity around the purpose and creation of resolution funds and the impact of capital agreements. There is considerable uncertainty about the scope of the Liikanen regime and this will not become clear until the European Commission publishes more details on the scope of the regime.


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

We support the creation of bail-in regimes, however in developing and regulating the regimes policymakers will need to consider the systemic impact the triggering of bail-in might have in a crisis. Losses will be absorbed within the system as a whole and most probably by a combination of institutional and retail investors who may not be in a strong position to absorb them. Regulators will need to be alert to these risks and consider, for instance, the impact a bail-in could have on investment returns for pension funds. However, whilst obviously multiple bail-ins could have second order impacts on market stability, they would, managed well between coordinating regulators, be a less destabilising phenomenon than many of the alternatives.

5 November 2012

Prepared 2nd January 2013