On 28 September 2023, HM Treasury launched a consultation on draft secondary legislation to implement near-term reforms to the ring-fencing regime for UK banks, based on recommendations set out in an independent review published in March 2022. The government plans to introduce legislation in Parliament in early 2024, subject to parliamentary time. The government also intends to make an announcement in 2024 regarding its plans for longer-term reforms to the ring-fencing regime.
The ring-fencing regime was introduced following the global financial crisis of 2007-08, in order to promote financial stability and competition within the UK banking market. It was set out in the Financial Services (Banking Reform) Act 2013 (FSBRA) and came into effect on 1 January 2019. The regime requires UK banks with core deposits in excess of £25 billion to separate their retail banking services from non-retail activities such as investment and international banking. Ring-fenced banks (RFBs) are prohibited from having exposures to relevant financial institutions (RFIs), which includes all banks (apart from other RFBs), investment firms, globally systemic insurers, and funds, subject to limited exceptions.
FSBRA required the government to commission an independent review of the ring-fencing regime within two years of it coming into force, together with a review of proprietary trading by banks. The Ring-fencing and Proprietary Trading (RFPT) Review was launched in February 2021 and carried out by a panel of independent experts chaired by Sir Keith Skeoch. In its final report, issued in March 2022, the panel made a number of near-term recommendations, including changes to the scope of the regime and allowing RFBs to provide services outside the European Economic Area (EEA). The panel also called on the government to consider aligning the ring-fencing regime with the resolution regime, with a view to giving authorities the power to remove banks from the ring-fencing regime if they are deemed to be resolvable.
The government’s proposals for near-term reforms
HM Treasury published its response to the RFPT Review in December 2022 as part of the Edinburgh Reforms. The government broadly accepted the panel’s recommendations and committed to consult on a number of changes to the regime in 2023. These proposals are set out in the recent consultation. In summary, the government is proposing to:
- increase the ring-fencing deposit threshold from £25 billion to £35 billion of core deposits;
- exempt retail-focused banks with trading assets of less than 10% of tier 1 capital from the ring-fencing regime, unless they are part of a global systemically important bank (G-SIB);
- introduce a de minimis threshold that would allow RFBs to incur an exposure of up to £100,000 to a single RFI at any one time;
- allow RFBs to operate branches and subsidiaries outside the UK or EEA;
- allow ring-fenced banking groups a transitional period of four years to comply with the ring-fencing regime when they acquire a bank that is not subject to ring-fencing;
- permit RFBs to carry out a broader range of activities, such as making direct and indirect equity investments in small and medium-sized enterprises (SMEs) and incurring exposures to RFIs that qualify as SMEs; and
- make a number of other technical amendments and changes to definitions as recommended by the RFPT Review
The government is also seeking preliminary views on several other recommendations made by the panel.
Alongside the HM Treasury consultation, the Prudential Regulation Authority (PRA) has published a consultation paper (CP20/23) setting out proposed rule and policy updates in respect of the establishment and maintenance of third-country branches and subsidiaries within RFB sub-consolidation groups pursuant to the government’s amended regime. The PRA is proposing to:
- require RFBs to ensure that any third-country branches or subsidiaries within the RFB sub-consolidation group do not present a material risk to the provision of core services in the UK by the RFB; and
- introduce a set of supervisory expectations that the PRA will consider when determining if a third-country branch or subsidiary of an RFB or ring-fenced affiliate poses a material risk to the provision of core services in the UK by the RFB.
The government’s consultation closes on 26 November 2023, and the PRA’s consultation closes the following day.
Longer-term reforms to the ring-fencing regime
On 2 March 2023, HM Treasury launched a call for evidence seeking views on the practicalities of aligning the ring-fencing and resolution regimes for banks and long-term options for reform as recommended by the RFPT Review panel. The call for evidence closed on 7 May 2023.
The government published an overview of responses to the call for evidence on the same day as its consultation on near-term reforms. According to the government, respondents provided a range of views on the benefits of ring-fencing, with some respondents arguing that ring-fencing supports resolution planning, while others suggested that ring-fencing could make resolution processes more complex and less effective. There was a consensus, however, that the panel’s proposal to disapply ring-fencing where banks are deemed resolvable would be difficult to operationalise.
The government says it will continue to explore all the options, with a view to publishing its policy response to the call for evidence in the first half of 2024, together with any proposals for further reform regarding the longer-term future of ring-fencing.
Implications of the government’s proposals
The government’s proposed changes to the ring-fencing regime are intended to increase competition in the UK banking sector and boost the competitiveness of UK banks, as well as support the growth of UK SMEs by facilitating the provision of finance to these firms. Both the RFPT Review panel and the government are of the view that the regime is working well overall but should be recalibrated to capture only those firms where there is a clear financial stability benefit.
Increasing the threshold of core deposits and exempting retail banks that undertake only a small amount of excluded activities will be welcomed by banks whose activities are constrained by the current threshold. As noted by the panel, these changes could give challenger banks and new entrants room to grow without becoming subject to ring-fencing requirements. Furthermore, lifting the geographical restrictions on RFBs will enable them to service the global needs of existing customers with operations outside the EEA.
The impact on the competitiveness of UK banks is harder to gauge. The panel concluded that it was hard to measure the impact of the ring-fencing regime because it has only been in place for a few years and there have been other significant drivers for the banking sector during that time. UK investment banks were already losing market share to US competitors before ring-fencing was introduced, and EU banks have experienced slower growth than UK banks even without a ring-fencing regime.
In the panel’s view, ring-fencing has not increased the resilience of less complex banks within the regime, and progress in ending too-big-to-fail has been attributable to the UK resolution regime rather than ring-fencing. It pointed out that the ring-fencing and resolution regimes are increasingly not aligned, adding complexity to UK regulation for banks. According to the panel, the resolution regime embodies a more dynamic approach that is preferable to the structural separation imposed by the ring-fencing legislation. It remains to be seen whether the government will take steps to address this disparity and align the two regimes.
Whatever the outcome, the recent experience of the failure of Silicon Valley Bank (SVB) and the acquisition of its UK subsidiary by HSBC Bank UK plc is a good example of how the ring-fencing and resolution regimes can work together in a crisis situation. In that case, the Bank of England, as the resolution authority, decided that using the private sector purchaser tool produced the best outcome in light of the special resolution objectives. The government introduced statutory instruments which modified specific ring-fencing requirements in relation to the acquisition, including allowing SVB UK to remain permanently exempt from the ring-fencing regime, subject to certain conditions.
