Why this regulation?
In response to the financial crisis, a number of domestic and international reforms to bank regulation have been introduced or are currently being implemented. Many of these reforms seek to improve the resilience and resolvability of banks, including through making changes to their structure. In the United Kingdom, the PRA is required to make rules to implement the ring-fencing of core UK financial services and facilities.
In October 2015, the Bank of England published two consultation papers; one on ring-fencing and the other on operational continuity. Together these proposals sought to ensure that ring-fenced bodies (RFBs) are protected from shocks originating on other parts of their group as well as broader financial system and can be easily separated from their groups in event of failures.
Well-capitalised, resilient firms mean that when problems occur, critical economic functions, including retail banking, can be maintained and economic growth can be supported through ongoing banking activity.
The proposals sought to ensure that ring-fenced banks have sufficient capital resources on a standalone basis, sheltering them from risks originating in other parts of their groups. The proposed rules also mean that a ring-fenced bank can be more easily detached from the wider group by ensuring intragroup arrangements operate on an arm’s length basis – helping ensure important services remain available in the event of a failure of other parts of the group.
The proposals sought to ensure that ring-fenced banks have sufficient capital resources on a standalone basis, sheltering them from risks originating in other parts of their groups. The proposed rules also mean that a ring-fenced bank can be more easily detached from the wider group by ensuring intragroup arrangements operate on an arm’s length basis – helping ensure important services remain available in the event of a failure of other parts of the group.
What is being sought?
The changes are intended to ensure that ring-fenced bodies (RFBs) are protected from shocks that originate in the rest of their banking group or the financial system in order to minimise disruption to the continuity of the provision of core services. They are also intended to ensure that RFBs, and groups containing RFBs, can be resolved in an orderly manner with minimal disruption to the provision of core services. The Act defines three ‘core services’:
a. facilities for the accepting of deposits or other payments into an account which is provided in the course of carrying on the core activity of accepting deposits;
b. facilities for withdrawing money or making payments from such an account; and
c. overdraft facilities in connection with such an account.
The RFBs are required to assure the PRA that:
a. a ring-fenced bank has sufficient financial resources and liquidity;
b. intragroup exposures and arrangements between the ring-fenced bank and the rest of the group are managed in a prudent manner, at arm’s length;
c. the ring-fenced bank is clear on the PRA’s expectations on the use of financial market infrastructures; and
d. the ring-fenced bank can demonstrate the ability to continue to provide critical economic functions during resolution.
Who is impacted?
a. Firms which have core deposits in excess of the threshold of £25 billion
b. Firms with growth plans which indicate they are likely to meet this threshold by January 1, 2019
What is the process?
An application for RTFS has to be made to the court. The application has to detail
a. The type and number of all transfers the applicant proposes to take as part of its RTFS application. The details of the proposed transferor(s) and transferee(s) needs to be provided along with the respective firm reference number.
b. A detailed summary of what is being transferred (either wholly or in part) through each transfer. This can be (a) transfer of core activities to be moved across to a RFB, or (b) transfer of ‘excluded’ activities moves from RFB into other authorised entities or transferred to non-authorised entities such as service companies.
c. Details of any exclusions that are being sought and justification for seeking exclusion.
d. Provisional timeline for RTFS including milestones, identification of critical path and key dependencies.
e. Any ancillary and/or complementary transfers being carried out in close proximity to the RTFS
The PRA must approve the (a) form of the scheme report; (b) the skilled person; and (c) the RFTS application to the court. The approval from the PRA is in the form of certificates certifying
a. PRA’s consent to the RTFS application.
b. That the transferee will possess adequate financial resources
If the applicant is an EEA firm, the PRA will also issue an additional certificate certifying that
c. The home state regulator of the transferee has been notified of the proposed scheme; and
d. A period of three months has elapsed from the notification date.
At high level process for RFTS is as below:
Ring fencing transfer scheme – approval of a skilled person
Part VII of FSMA 2000 provides for a process for approval of transfers of insurance or banking business. Under an amendment (2013), an additional process for transfer of business known as ring-fencing transfer scheme (RFTS) has been legislated which will enable firms to restructure their businesses in order to comply with the ring-fencing requirements that will apply from January 1, 2019.
As part of RTFS process, firms must appoint a skilled person to prepare a scheme report. The person preparing the scheme report should be:
Appearing to the PRA to have skills necessary to enable the person to make the report, and
Nominated and approved for the purpose by the PRA. The PRA is also required to consult the FCA before making its decision.
Who can be nominated as a skilled person?
The skilled person being nominated should ideally be one whose knowledge, skills and experience directly correlates to the type of business being transacted. The applicant will be required to convince the PRA on the suitability of the skilled person being nominated. Typical evidence required to substantiate a nominee skilled person’s qualifications may be his/her professional qualifications, theoretical and practical knowledge, membership of professional bodies, publications and experience.
In turn, the PRA, in consultation with the FCA, will assess the application for authorization on the following criteria:
a. How the knowledge and expertise of the nominee directly correlates to the business being transacted. This will include an assessment of the evidence submitted in support of the nominee’s knowledge and skills. A key weightage is likely to be there for evidence of preparation of sec 166 report for PRA and FCA.
b. The methodology being adopted to ensure the quality and independence of the making of the Scheme Report, and
c. How the nominee will ensure that the ultimate responsibility of effecting the transfer rests with them.
Firms who have recently completed Part VII within their business would find this process familiar.
Interbank payment system
Article 13 of the Order prohibits a RFB from entering into any transaction that requires the use of services provided through an inter-bank payment system unless it is a direct participant in the system. Where the RFB is not a direct participant in the system, at least one of the conditions set out in Article 13(2) of the Order should be satisfied.
This presents a sizeable issue for the RFBs who will have to either prove that conditions of ‘exceptional circumstances’ exist or make an application for approval of the use of indirect access to inter-bank payment system. The application process asks for a lot of details on the proposed intermediary. Firms intending to apply for RFB would need to get this sorted out quickly as any delay on this part can lead to delay in the court order.
How are you likely to be impacted and how should you proceed?
The key considerations for PRA while deciding on a RTFS application are:
a. The quality of operational continuity arrangements of the entities to which those persons are exposed or connected and the ability of the entities to continue to provide core services to those persons;
b. the capital position of the entities to which those persons are exposed or connected on a risk weighted and leveraged basis;
c. the liquidity and funding position of the entities to which those persons are exposed or connected;
d. the business-model viability and sustainability of the entities to which those persons are exposed or connected;
e. the quality of the governance arrangements of the entities to which those persons are exposed or connected;
f. the ability of the group to be resolved and the strength of resolution planning in place;
g. the quality of the risk management and the systems and controls of the entities to which those persons are exposed or connected.
The skilled person is required to provide evidence that the transfer will not result in material deterioration in any of the above.
As evident from above, the applicants would need to perform a detailed analysis of their current operating model to assess the impact of the proposed transfer. This impact would include, among others, an assessment of their key business components. Some of the areas which they need to include are:
Customers: What is the likely impact of the transfer on their customers? How would they be impacted? Would it result in a material deterioration of services? How would the transferor and the transferee ensure continued (if not better) level of customer experience?
Products and Services: What is the likely impact? Will the transfer result in unavailability of certain products/services? What is the extent of impact? What options do the firms have to mitigate this impact?
Business Capabilities: RFTS is expected to impact the current capabilities in a significant way. The transfer would entail building new capabilities in transferor and transferee firms to demonstrate their capability to manage the operations independently. Ring-fencing presents an excellent opportunity for the firms to assess the maturity of their business capabilities and create plans to strengthen their core capabilities. A good way to do is through building an enterprise capability model for the firm and for the proposed entities.
Organisation structure: How will the transfer impact the current organisational hierarchies? Which new structures, bodies are required to ensure adequate governance of the proposed entities? Which existing structures/hierarchies are no longer required and hence, can be dispensed with?
People/Employees: What skill sets are currently present in your workforce? How will it be impacted by the proposed transfer? Which additional skills/people capabilities do you need to build to ensure continuity of service levels? Are there opportunities to outsource some skills to service companies? In addition, this is also a good opportunity to assess key person(s) dependencies in your organisation.
Data: What will be the impact on data in the future operating model? Which key data needs to be shared between the ring-fenced and excluded bodies? What additional risk does that bring to the firms and how will that be managed. If data needs to be shared between the transferor and transferee, this provides a good opportunity to get your data and reporting in order. It is likely that there will be new reporting requirements in the post Brexit world and getting your house in order would prove beneficial in the long run.
Technology: Legacy technologies have continued to live in the firms. Maintaining them has been an expensive proposition. Ring-fencing presents an ideal opportunity to review your existing stack and explore options about them. You may not want to get rid of them altogether, but this provides a wonderful opportunity to take a stock and rationalise it to contain your costs and improve customer experience.
Location: RFTS presents a good opportunity to rationalise your locations. Locating the transferor or transferee in separate location(s) would be a good move.
Suppliers/Partners: Over a period of time, firms have continued to add suppliers and partners to their business. There was never a good time to rationalise them. And there can never be a better opportunity than this.
The above are, by no means, a complete list of the components that you need to explore. Some other key elements that you also need to consider are governance, audit, risk and legal which are key components in providing evidence to the skilled person, and through him to the regulators.
Some other aspects that you also need to consider are (a) the magnitude and complexity of the project necessary to comply with Structural Reforms; (b) Which regulatory and/or tax drivers will impact the ring-fenced and the excluded bodies? How are they inter-related? How would the structural reforms impact your five year business plan, especially profitability and customer outcomes?
The key point which I want to make here is this: if you do not have a documented model of your business, this is the best time to have one. An operating model will provide you with a good starting point and would help you prioritise your activities, and hence prepare the timetable for transfer. It will also help you answer key questions on your business model, its viability, your business planning and strategy. In my previous experience, where I was involved in a Part VII transfer, the absence of an operating model proved extremely expensive to the client in the long run. Be aware and avoid that.
Ring-fencing vis-à-vis Brexit
Firms are gearing up to the harsh reality of Brexit. And they will continue to live in this dilemma for a while, before the new department is operational. Brexit will also impact your operating model. The structural reforms could not have come at a better time. The timelines for the structural reforms and (hopefully) for Brexit are likely to coincide. This presents a good opportunity to focus on your governance, data and reporting. At the minimal, these three components of your operating model are definitely going to be impacted by Brexit. At the cost of repetition, there can be never a good time to invest in business architecture capabilities for your business. Business architecture will help you map your key business components and your business capabilities which would provide a cross-functional vocabulary for decisions on operational continuity, capital, risk and business model viability. It is advisable to make the most of this opportunity and broaden your horizon to include structural reforms as well as the post Brexit scenarios. Your options for ring-fencing and Brexit may be aligned and you can save a lot of resources by doing it together.
The above view is based on the available information on the regulators’ websites and from discussions with a number of colleagues and practitioners who have been involved in legal entity amalgamation/divestment before. While, the requirements for structural reforms have just been released (on July 7th, 2016), there exists a lot of speculation about Brexit.
I would welcome your thoughts on this. Please use the comments section below or mail me at depak.mohan@deepakmohan.net
