This guide was published in August 2017.
Following an independent review into the operation of the SAR, the Investment Bank (Amendment of Definition) and Special Administration (Amendment) Regulations 2017 (the 2017 Regs) came into force on 6 April 2017. The 2017 Regs aim to extend and strengthen the existing regime. Despite being an “investment bank” special administration regime, as a result of its focus on protecting client assets, the SAR has also applied to a wide range of other businesses including private client stockbrokers, foreign exchange traders and discretionary fund managers.
It is important for officeholders to understand the regime. Whilst there have been only 15 special administrations under the SAR since its introduction in 2011, including MF Global UK Limited and Worldspreads Limited, the SAR covers a much wider range of investment firms than its name suggests and has a number of notable features, particularly since its recent amendment.
The detailed workings of the SAR are set out in the Investment Bank Special Administration Regulations 2011 (the Regulations) and the Investment Bank Special Administration (England and Wales) Rules 2011 (the Rules). The Regulations and the Rules are not exhaustive, however - the regime interacts closely with the Financial Conduct Authority's (FCA) Client Asset Sourcebook (CASS) which sets out a detailed framework for the segregation and protection of client assets, including money, held by investment banks and CASS includes rules dealing with an investment bank’s failure. Ordinary insolvency principles and other competing regulations will also be relevant. Where specific circumstances of a case do not fit neatly within the regime, flexible and creative solutions may be required and early advice should be sought.
Who does the regime apply to?
The SAR applies to an 'investment bank' - that is an institution incorporated in the UK which holds client assets and is authorised to carry on one of the following regulated activities:
- safeguarding and administering investments,
- dealing in investments as principal,
- dealing in investments as agent; and
- (after the 2017 Regs)managing an alternative investment fund (AIF) or an undertaking for collective investments in transferable securities (UCITS); or
- acting as trustee or depositary of an AIF or a UCITS.
So the SAR applies to a much wider range of investment firms than just 'banks' in the sense of deposit takers. In fact, where an investment bank is a deposit-taking bank, it may not be eligible for special administration: further rules as to its eligibility for the SAR apply, as against other specially designated 'bank' insolvency procedures.
The SAR has applied to a broad range of businesses, including private client stockbrokers, foreign exchange brokers and discretionary fund managers.
SAR appointment process
The appointment of a special administrator must be made by court order. As in a normal administration; the investment bank, its directors and/or creditors have standing to make a special administration application. In addition, the SAR provides the FCA, the Prudential Regulation Authority (PRA) and the secretary of state with the right to make a special administration application, together with a contributory of the investment bank in certain circumstances.
The regulator of the investment bank has the right under the SAR to be heard at the hearing of the special administration application. In practice, it is important to engage with the regulator at an early stage in the contingency planning process. The regulator will expect to be kept updated on the circumstances necessitating the application and will want to be satisfied that the proposed special administrators have the right experience and CASS expertise, either in-house or outsourced, for the appointment.
There is no absolute bar to an investment bank entering into an 'ordinary' administration or liquidation. However, the SAR provides the FCA with a right to two weeks' notice of any preliminary steps taken to place an investment bank into administration or liquidation and the right to apply for a special administration of that investment bank. It will be a rare case where a special administration is not the most appropriate process for an investment bank.
Nature of process
The SAR is modelled on a normal administration, with specific provisions to reflect the regime's aims. The Regulations adopt a number of provisions from the Insolvency Act 1986, including a substantial proportion of Schedule B1, for special administrations, with certain modifications.
The objectives for a special administration are as follows:
- the return of client assets as soon as is reasonably practicable;
- the timely engagement with market infrastructure bodies and the Bank of England, the Treasury, the FCA and the PRA in accordance with the SAR; and
- either the rescue of the investment bank as a going concern or the winding up of the investment bank in the best interests of its creditors.
Unlike a normal administration, there is no hierarchy between these objectives. A special administrator must commence work on each objective immediately on their appointment, prioritising the objectives as they think fit in order to achieve the best result overall for clients and creditors. The Regulations include detailed provisions in respect of the objectives, particularly the first, and we discuss some of these below.
Features of the special administration regime
Perhaps most significantly, the SAR and the Rules make clear that the special administrators will take control of effectively two separate sets of assets and money, the treatment of which is separate but related. These are: client money and client assets held for clients on their behalf in accordance with the CASS rules; and firm money and assets, which are the property of the firm.
Features of the SAR include that:
- it is the special administrators who have control of the distribution or transfer of client assets, and they are required to prioritise dealing with those assets;
- the special administrators are required 'immediately after being appointed' to carry out a client money reconciliation, and – if the amount does not reconcile – to transfer from the office account to the client account (or vice versa) any amount required to make up the difference, as described in regulation 10H of the Regulations.
- the appointment of special administrators triggers a primary pooling event under the CASS rules, which creates a pool of client money that falls outside of the insolvency regime. The return of such client money to clients is determined on the basis of the reconciliation, the client money in fact available, and is subject to deduction for costs properly attributable to its return.
- the special administrators may set a bar date for claims to be submitted as to ownership or security over client assets. After that date, assets which have been returned are not affected by any later claims. The 2017 Regs now allow the special administrators in certain circumstances to return client assets without the need to first obtain court approval where a bar date has been set. It also provides for a hard bar date, after which the administrators may transfer unclaimed assets to the general estate.
- the special administrators are required to prepare a distribution plan which deals with the return of client assets, and how expenses of the special administration may be allocated. It must be approved by the creditors' committee and the court, and distributions may be made only after three months have elapsed from the bar date.
- the 2017 Regs have modified the distribution process to deal with issues which arose in the MF Global case. In that case, certain claimants in respect of client money had sought to maximise their returns by - instead of claiming for the return of client money (on which interest is not payable) - claiming as an unsecured creditor, including for interest. As a result of the 2017 Regs, a claimant is no longer permitted to claim for interest as an unsecured client where it has a client money claim, other than if there is a shortfall on such client money claim;
- to ensure the return of client assets as soon as is reasonably possible, only costs, including remuneration and disbursements, which are 'properly incurred by the administrator in pursuing Objective 1', may be deducted from client assets. Any costs which do not relate to the pursuit of Objective 1 are recoverable only from the investment bank's own assets;
- a creditors' committee may be composed of both creditors and clients. Its composition should reflect the interests in the outcome of the special administration. So if there is unlikely to be any or any significant return to unsecured creditors, then the committee should be composed of primarily clients. Additionally, the FCA is entitled to attend and make representations at any such committee meetings;
- certain key suppliers to the investment bank, in particular suppliers of critical IT services, may not terminate supply, provided that the special administrators pay for the supply incurred after the commencement of the special administration.
What special administrators should look out for
The FCA will certainly expect regular and timely updates both pre and post appointment. Additional regulatory or other statutory entities should be kept informed where they have a potential interest in the outcome of the special administration. This may include: The Financial Services Compensation Scheme, HMRC, and The Pension Regulator.
The obligation to undertake a reconciliation immediately on appointment creates a potential issue where such a reconciliation is not possible: for example where access to critical IT infrastructure is removed prior to the commencement of the special administration. In that circumstance, it is necessary to obtain as part of the special administration order a direction that the special administrators will prioritise taking steps with a view to enabling them to carry out the reconciliation, and that it is carried out as soon as it becomes possible.
Even though an investment bank may have significant client assets under its control, its own assets, at least those immediately available to the special administrators, may be minimal.
The special administrators may be left with significant obligations, but only minimal funds available to pay their costs in circumstances where there may be a significant amount of work to be done which cannot be recovered from client assets (because it does not relate to Objective 1), including potentially pre-appointment work; or as a result of the obligation to transfer from firm assets an amount to make up a shortfall in client money.