Out-Law News 3 min. read

Ring-fenced UK banks will be able to deal with other parts of the group on 'arms-length terms', says PRA


UK retail banks that have been 'ring-fenced' from the investment banking operations of the same banking group will still be able to cross-sell products and act as an agent for those parts of the business, provided that they do so on "arms-length terms".

The Prudential Regulation Authority (PRA) has proposed the new rule, which will apply to "contracts, transactions and other arrangements" between the ring-fenced bank and other members of the group, as part of a further consultation paper on structural reform. The proposed rule would also allow intra-group payments between ring-fenced and non-ring fenced parts of the business.

The PRA has also proposed a concession that would allow ring-fenced banks to transfer profits to other companies in the form of dividends in certain circumstances. Ring-fenced banks would be able to do so after giving "reasonable notice" to the PRA, as long as they can show that the ring-fenced bank would remain sufficiently capitalised after the distribution has been made.

A consultation on the latest revisions to the ring-fencing rules closes on 15 January 2016. The new regime, which will require UK banks that take in more than £25 billion in 'core' deposits from individuals and small businesses to formally separate their deposit-taking activities from their riskier investment banking activities, is due to come into force on 1 January 2019.

"Making our firms more resilient has been at the forefront of our post-crisis reform agenda," said Andrew Bailey, chief executive of the PRA and a deputy governor of the Bank of England.

He added that the latest proposals would "enable firms to take substantial steps forward in their preparations for structural reform".

The ring-fencing rules were developed in response to the recommendations of the 2011 Independent Commission on Banking, chaired by Sir John Vickers; and are designed to ensure that retail banks remain resilient in the event that other parts of the group get into difficulty. Affected banks will be required to 'ring-fence' their core functions into a legally and operationally distinct entity, which will not be able to hold or own the capital of entities "associated with trading and financial interconnectedness" of the wider banking group.

In the consultation paper, the PRA said that its approach to ring-fencing "sought to preserve, to the extent possible, the benefits arising from [ring-fenced banks] being part of a wider group".

"For example, the cross-selling of products and services, correspondent banking and agency arrangements between a [ring-fenced bank] and other entities in its group are not restricted provided they are carried out in a way that is not inconsistent with the PRA's amended general safety and soundness objective in relation to ring-fencing or the group ring-fencing purposes," it said.

Intra-group transactions should be "managed appropriately" and should not "result in significant exposures to, or dependence on, entities outside the RFB sub-group which may threaten an RFB's ability to continue to carry on core activities", the PRA said. The new arm's length rule would meet these objectives, and would apply to any transactions between entities in the ring-fenced sub-group and entities outside of the sub-group.

"This is to ensure that an RFB's ability to deliver core activities is not undermined as a result of such transactions being conducted otherwise than on arm's length terms," the consultation paper said.

Ring-fenced entities would also be required to develop "robust processes" to identify products, services and transactions subject to the arm's length rules; pricing and non-pricing policies; and appropriate change management, dispute resolution, policy approval and reporting controls.

The PRA has estimated that the policies specific to the latest consultation paper would increase ring-fenced banks' capital requirements by up to £3.3 billion. It intends to provide an estimate of additional operational costs relating to the new rules as part of a further consultation on reporting requirements, which it intends to publish by mid-2016, according to the paper.

"To the extent that they haven't already, it will be critical that the counterparties of ring-fenced banks - including financial institutions such as insurers, and other banks and building societies, are cognisant of the impact that the banking reform measures will have on their various relationships with ring-fenced banks," said banking expert Tony Anderson of Pinsent Masons, the law firm behind Out-Law.com. "It would be hoped that there is currently a robust dialogue occurring on these issues between the relevant parties."

The regulator is also consulting on new operational continuity rules, applicable to a broader range of banks, building societies and PRA-authorised investment firms. It intends to publish a further paper clarifying the precise scope of these new rules, which it intends to limit to "those firms that receive critical shared services supporting functions that are critical to the economy", and setting a closing date for the consultation, in the near future.

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