This is an abridged version of an article that I have written for the Society for Computers and Law.
The Independent Commission on Banking (“ICB”) published its Final Report on 12 September, setting out recommendations on structural and non-structural reforms to improve stability and competition in UK banking.
The recommendations broadly suggest that:
- Banks need to improve their loss absorbency, by achieving more equity relative to their assets;
- Competition needs to be encouraged; and
- Retail banks should be ring-fenced from any wider corporate group and/or financial organisation of which they form part.
Earlier this month my Banking colleague Derek Arnott and I delivered presentations in Brodies’ Glasgow, Edinburgh and Aberdeen offices discussing the recommendations.
Derek (a lawyer of formidable experience in this field, and a former Head of Group Legal Services at The Royal Bank of Scotland Group) discussed the recommendations from the perspective of a banking solicitor, while I focused on the implications of the retail ring-fence from the perspective of an IT/outsourcing/commercial contracts lawyer.
Recommendations of most significance to the IT/outsourcing/commercial contracts lawyer
I believe that the retail ring-fencing recommendations will have a direct impact on any lawyer who advises on corporate governance or commercial contracts.
The particular recommendations which are of most direct significance to the IT/IP/commercial contracts lawyer are broadly summarised in the following list:
- Ring-fenced banks should be separate legal entities.
- Ring-fenced banks should be prohibited from offering certain services and/or carrying out certain activities.
- Any financial organisation owned or partly owned by a ring-fenced bank should conduct only activities permitted within a ring-fenced bank. Such a financial organisation’s balance sheet should also contain only assets and liabilities arising from these services and activities.
- The wider corporate group should be required to put in place arrangements to ensure that the ring-fenced bank has continuous access to the entire infrastructure required to continue provision of its services and activities, irrespective of the financial health of the rest of the group.
- All transactions (including secured lending and asset sales) between a ring-fenced bank and all other entities forming part of a wider corporate group should be conducted on a commercial arm’s-length basis.
These recommendations, and the overall concept of a ring-fence, are directly at odds with the present day corporate structures of many large banks and financial institutions.
Most financial institutions operate some form of shared service model, with one group entity contracting with suppliers on a basis that allows other group members to benefit from that contract.
The ring-fenced bank will either have to possess its own infrastructure or, if it is shared, then such infrastructure will have to be identified (which may be by no means a straightforward task) and then made available formally to the ring-fenced bank, via:
- direct agreement with the supplier;
- direct agreement with another member of the group; and/or
- a member of the wider group, which contracts with suppliers, but is “bankruptcy-remote”.
Infrastructure separation of the type that is likely to be required by the ICB recommendations may feasibly involve:
- drafting agreements to formalise supply of infrastructure services to the ring-fenced bank;
- renegotiation of existing agreements to separate provision of infrastructure services;
- novation or assignation of agreements to a well-capitalised, bankruptcy-remote shared service subsidiary (without assets or liabilities) to provide infrastructure services on behalf of the separated entities; and/or
- partial or wholesale outsourcing of infrastructure provision.
There are many questions still to be answered regarding the ICB recommendations.
The deadline that the ICB has set for implementation of its’ recommendations is 2019. George Osborne, the Chancellor of the Exchequer, has indicated that he intends to implement the recommendations and will “seek a legislative slot” in the 2012-13 parliamentary session.
What seems certain is that some sort of separation or segregation of retail banks is inevitable and, in this context, the deadline of 2019 is not that far away. Whether acting for financial institutions or their suppliers, from now on the IT/IP/commercial contracts lawyer should keep in mind what is on the horizon when negotiating or renegotiating agreements.
On November 29, 2011