In
the main, the legislation is intended to implement the recommendations of the UK
Independent Commission on Banking, the Vickers Commission, which proposed a sweeping
structural change for organizations engaged in commercial banking. In essence,
within a single organization the range of ordinary banking operations, such as
deposit taking, lending, and payments, would be segregated in a retail bank,
which would be overseen by its own independent board of directors and ring-fenced
to greatly reduce relations with the rest of the organization. While
proprietary trading and investments in hedge funds would not be prohibited,
these activities would be outside the ring-fence and thus isolated from retail
banking.
The
Government believes that accepting deposits from individuals and small and medium-sized
enterprises should be a core activity of ring-fenced banks. This means that,
under the legislation, the only UK
banks which will be able to undertake this activity will be ring-fenced banks,
and banks which have been exempted from the definition of a ring-fenced bank,
such as building societies.
The
draft prohibits ring-fenced banks from undertaking
certain excluded activities and will grant Treasury the power to designate an
activity as an excluded activity. The Treasury has broad power to exclude
activities, and most will be detailed in secondary legislation. However, the
draft provides that dealing in investments as principal is an excluded activity,
which would exclude most of the derivatives and trading activities currently undertaken
by wholesale and investment banks.
There may be circumstances in which it may be necessary or desirable
to permit a ring-fenced bank to undertake an excluded activity. So the draft gives
the Treasury flexibility in this area. For example, ring-fenced
banks could be permitted to provide some risk management products to customers
provided that they did not require the bank to hold capital against market
risk, give rise to trading book treatment, or did not threaten resolvability.
There
is concern that a total ban on investment products would mean ring-fenced banks
would not be able to provide clients with important hedging and risk management
services. The Chancellor has specifically asked the Parliamentary Commission to
look specifically at the question of whether ring-fenced banks should be able
to offer simple derivatives to their customers and provide its views to
Government in the December 18 report. Following receipt of the Commission’s
advice, the Government, as with other matters, will consider the implications
for subsequent secondary legislation.
The draft requires regulations ensuring that the ring-fenced bank
is able to act independently of the rest of its group while carrying on its
business. In relation to ring-fenced banks that are members of a group, it
specifies the areas in which rules should be made, including holding shares in
other corporate entities, entering into contracts with other members of the
group, governance of the ring-fenced bank, restricting payments that a
ring-fenced bank may make to other members of the group and disclosure. These
provisions do not limit regulators’ power to, but rather are designed to ensure
that a ring-fenced bank interacts with the rest of its group on a third party
basis, and that it remains legally, economically and operationally independent.
The
draft Bill provides for a continuity objective for regulators that will give
them a duty, when dealing with matters related to ring-fencing, to protect the
uninterrupted provision of vital and core banking services. The draft sets out
how the regulators are required to advance this objective. The objective means
that, for example, the new Prudential Regulatory Authority should take steps to
ensure that ring-fenced banks are insulated from shocks that could cause a
disruption to the continuity of core services, but also that, in the event of
failure, either of a ring-fenced bank, or another part of its group, those core
services can be maintained.
This
does not mean that there should be a zero failure regime for ring-fenced banks,
assured the Government. On the contrary, ring-fenced banks should be allowed to
fail, but in an orderly way, with the use of special resolution tools by the
authorities where necessary. Ring-fencing will make it easier for the
authorities to let them fail, as it will ensure that the core services being
provided can be separated and can continue to operate independently from the rest
of the group. For example, said the Government, the best resolution approach
for a failing banking group containing a ring-fenced bank may be a private
sector sale of part or all of the core services, thereby maintaining continuity
for depositors, while allowing the rest of the bank to go through an orderly
administration process.