The Banking Act 2009: An Overview
On Thursday 12 February, the Banking Act 2009 received Royal Assent. The Act is a major piece of legislation aimed at giving significant new powers to the Financial Services Authority (FSA), the Bank of England (BofE) and Her Majesty’s Treasury (HMT) so that they may deal with failing banks. The Act represents only a part of the measures being taken by the relevant authorities – HMT, the BofE and the FSA – the remainder of which are outside of the scope of this article.
The current problems with the UK banking system originated across the ocean and in the US sub-prime mortgage sector. Mounting levels of personal debt led to increased levels of default, and financial institutions in the UK were exposed to those defaults through securitised debt and other complex instruments. The markets started to lose confidence in the banking system, leading to a plunge in share prices and liquidity funding problems. One only has to consider the problems that have befallen the Northern Rock, Bradford & Bingley, The Royal Bank of Scotland and the Lloyds Banking Group (the merged entity followed by the merger of Lloyds TSB and HBOS) to see how serious the concerns are.
Due to the threat to the financial system and the stability of the banking system, the relevant authorities started working together in the autumn of 2007 to revise the regulatory framework. As a result, they published an initial discussion paper in October 2007 followed by three consultation papers: one in January 2008 and two in July 2008. Certain proposals set out in these consultation papers form the basis of the provisions of the Act. The Act has been rushed through Parliament, as it replaces the Banking (Special Provisions) Act 2008, which was put in place to enable HMT to nationalise Northern Rock and had a limited shelf life.
The Act comprises eight parts. The first three parts deal with the ‘special resolution regime’ (SRR), which consists of three stabilisation options, a bank insolvency procedure and a bank administration procedure (SRR tools). The remaining parts cover changes to the Financial Services Compensation Scheme (FSCS) arrangements, formalisation of the BofE’s role overseeing inter-bank payment systems; banknotes issued in Scotland and Northern Ireland; strengthening the role of the BofE and other miscellaneous provisions.
The three stabilisation options give the relevant authorities (in relation to a failing bank) the power to transfer:
Should the relevant authorities seek to exercise either the bridge bank or public ownership powers, they would only do so to stabilise the bank before selling it on to a private sector buyer.
When considering using the SRR tools discussed above, the relevant authorities must have regard to the special resolution objectives contained in Section 4 of the Act:
Section 5 of the Act requires HMT to issue a Code of Practice about the use of the SRR tools. The Code will provide guidance on various issues, such as how the objectives can be achieved and how to determine whether the test for the use of the ‘private sector purchaser’ or ‘bridge bank’ has been passed.
Each of the relevant authorities has a role in how the SRR functions. Under the Act, the stabilisation options can only be used once the SRR has been triggered. This can only happen if, under Section 5 of the Act, the FSA is satisfied that:
The threshold conditions represent the minimum conditions a firm must continue to satisfy in order to remain authorised by the FSA. Not all of the threshold conditions relate to a firm’s financial resources, so it is conceivable that the FSA could consent to the use of the stabilisation options in relation to a bank which is not insolvent and which has a positive value. In the event that a potential buyer wishes to consider purchasing a failing bank, it is very important that it enters into a dialogue with the FSA to determine the specific reasons for the bank’s failure to meet the threshold conditions.
Once the SRR has been triggered by the FSA, the BofE can transfer all or part of the failing bank to a private sector purchaser or to a ‘bridge bank’ (a bridge bank is a company which is wholly owned by the BofE). While either the shares or business can be transferred to a private sector purchaser, only the business of a failing bank can be transferred to a bridge bank. Before the BofE can exercise either of these powers, it has to be satisfied (having consulted the FSA and HMT) that Condition A of Section 8 of the Act is met. The condition is that exercise of the power is necessary having regard to the public interest in:
In its Impact Assessment Document published in October 2008, HMT expected that its preferred option would be to transfer a failing bank to a private sector purchaser. Otherwise, a transfer of assets to a bridge bank would be the next preferred option, the intention being that the shares in the bridge bank would eventually be sold to a private sector buyer. The last resort would be for HMT to take a failing bank into public ownership. This can only happen if one of the following conditions is met:
As stated above, the Act permits the BofE to make a partial transfer of property, therefore giving the flexibility to split a bank. This option would most likely be used for the purposes of transferring the ‘good’ part of a failing bank’s business to either a private sector purchaser or bridge bank. Residual assets would be left behind in the remainder of the bank, which may be wound up or put into administration (see below). This partial transfer option has raised several concerns about potentially negative effects of the partial transfer mechanisms. There have been concerns that partial transfers could lead to higher funding costs and higher requirements for regulatory capital, ultimately resulting in a loss of competitiveness. These potential consequences flow from possible disruption to set-off and netting agreements and security interests, and the possibility that creditors of a failed bank find themselves worse off after a partial transfer than they would have been under had the whole bank gone into an insolvency procedure.
The Government has sought to assuage these concerns by making provision in the Act for a range of safeguards that would be put in place through secondary legislation. These are:
Nevertheless, there are still concerns about the operation and effectiveness of the secondary legislation to be used to implement the partial restriction provisions. Conservative peer Baroness Stokes has recently stated that any uncertainty about how the secondary legislation would affect contracts would impact the overall attractiveness of London as a financial services centre. She said:
“If counterparties cannot get legal certainty, transactions simply will not happen. The lack of watertight set off and netting arrangements also affects non-bank counterparties and could disrupt conventional treasury cash management techniques. It could also impact on what goes into the annual accounts, not only of banks but of ordinary commercial businesses.”
As well as the stabilisation tools introduced in Part 1 of the Act, the SRR provides for a new bank insolvency procedure (BIP) and a new bank administration procedure (BAP), which are contained in Parts 2 and 3 of the Act respectively.
The BIP is based largely on the existing liquidation provisions of the Insolvency Act 1986. Section 103(6) of the Act sets out a table showing how certain provisions of the Insolvency Act are to be modified for the purposes of the BIP.
The BIP is designed to enable quick compensation payments to depositors under the FSCS without giving them a preference over other bank creditors. Therefore, the new procedure can only be used where a bank has depositors who are eligible for compensation under the FSCS.
The BIP can only be commenced by an application for a bank insolvency order by either the BofE, the FSA or the Secretary of State. The application must nominate a person to be appointed as the bank liquidator.
The BAP is based largely on existing administration provisions of the Insolvency Act 1986 (as amended). Section 145(6) sets out a table showing how the relevant provisions of the Insolvency Act 1986 have been modified for the purposes of the BAP.
The BAP can only commence upon an application made by the BofE to the court for a bank administration order. The application must nominate a person to be appointed as the bank administrator.
The BAP is to be used where there has been a partial transfer to either a private sector purchaser or a bridge bank, leaving an insolvent residual bank (although the BAP will not always be used in these circumstances). Where the BAP is to be used, the bank administrator is appointed to administer the affairs of the insolvent residual bank. The bank administrator would be required to ensure that the residual bank provides services and facilities required to enable the private purchaser or bridge bank to operate effectively. In achieving this aim, the bank administrator has to cooperate with the BofE. Once the objective is achieved, the procedure continues in a similar way to an ordinary administration.
There are a number of concerns that the rush to push the Act through Parliament means that there has been insufficient time for proper scrutiny and debate of the key issues contained within it. Some in the market have questioned whether the new legislation will in fact prevent a repeat of the events at Northern Rock and Bradford & Bingley, and that any rushed legislation may only compound the problems that the relevant authorities are attempting to address in the Act. At this stage it is impossible to tell what the impact of the Act will be and whether or not the fears that have been put forward are well founded.