HM Government’s 'ring fencing' reforms came in as a response to the financial crisis that began in 2007/8. Various big banks are now in the middle of a flurry of reorganisation, with the end in sight in 2019.

The reforms oblige large British banks to separate retail banking activity – which includes HNW wealth management activity – from everything else, especially investment and international banking activities, by 1 January 2019. Ring-fencing requirements apply to banks with a three-year average of more than £25 billion in retail deposits, measured on a rolling average of three years. The first article in our ring-fencing series came out in 2013, before the rules were clear. This and the next article will describe actual progress.

The idea behind the policy is to reduce the likelihood of disruption to what the Government calls “core banking service” from risks arising elsewhere in a banking group or the wider financial system. The words that the Government has been using most frequently since 2008 to describe its aim here are ‘resilience’ (a word it often applies to IT systems as well) and ‘resolution’ (the way in which a bank collapses). Its overall aim is to improve financial stability.

The ring-fencing timeline

The Government set up the Independent Commission on Banking in 2010 and this body produced its final report the next year. In December 2013, the month of our first article, it passed the Banking Reform Act which enshrined the ICB's recommendations in statutory form. Secondary legislation followed in July 2014 and February 2015. Then came a great deal of policy development and rule-making on the part of the Prudential Regulation Authority and Financial Conduct Authority.

‘Implementation planning’ began in January 2015, by which time the firms had sent in their initial plans. By January last year they had submitted plans that the regulators described as ‘near final.’ The task of actual implementation has been at full throttle since the beginning of the year and will remain so until the middle of next year.

What does ring-fencing mean to the regulators?

The Banking Reform Act obliges each large British bank to separate ‘core’ retail banking activities from everything else by putting them in a so-called ring-fenced body. Such a body cannot:

• deal in investments as principal;
• deal in commodities;
• access payment schemes indirectly;
• hold exposures to “relevant financial institutions”; and/or
• operate outside the European Economic Area.

No regulator knows whether the phrase "outside the EEA" will turn into "outside the UK" once Parliament has passed the Great Repeal Bill to embed the laws of the European Union on the Statute Book. HM Treasury is likely to take this decision.

What are “relevant financial institutions”? In its information pack from June, NatWest Markets describes them as large banks, funds and globally systematically important insurers. Regulators have told Compliance Matters that a ring-fenced bank can hold an exposure to a building society.

This does not preclude a ring-fenced bank from providing payment services to another bank or acting as a correspondent bank. Ring-fenced bodies must be ‘sufficiently’ separate from entities outside their fences financially, operationally and organisationally. The PRA’s ring-fencing rules and supervisory statements set out:

• legal structures, governance arrangements and the continuity of services for ring-fenced bodies;
• prudential standards, intra-group arrangements and access to payment schemes; and
• reporting requirements.

A ring-fenced bank, or a group that includes one, will have to have its own capital resources and its own “liquidity resources,” a PRA term. It cannot rely on the resources of the rest of the group and must have these resources exclusively for its own use.

On the subject of access to payment schemes, ring-fenced banks should generally connect to such schemes directly and not through another institution. There is an exception to this rule: if it is dealing in euros with an overseas bank, it might be exempt.

What does ring-fencing involve?

When we look at the things that are inside the ring-fence and compare them with the things that lie outside it, the picture becomes fuzzier. The regulators are allowing banks a good deal of latitude in the restructuring of their businesses. Some are placing most of their activities inside the ring-fence; others are placing as much as possible outside. Some of the main things that have taken up the regulators’ efforts (and will continue to do so up until the deadline of 1 January) are listed below.

• They have ‘authorised’ three banks – Barclays, HSBC and Lloyds.
• Some existing banks are being restructured.
• Financial and operational dependencies are being unwound.
• Both regulators and banks are ‘plumbing in’ direct access to payment schemes on behalf of their ring-fenced bodies.
• Banks are reconfiguring IT systems. These tend to be antiquated and complex systems. One regulator told Compliance Matters: “they must now have separate systems that they can use on either side of the ring-fence.”
• Banks and regulators are negotiating “arms’-length terms” for services to be provided across the fence. This includes human resources, property management, IT and data management. In line with such an agreement, a service company might be expected to provide these services on an “arms’-length basis” to the rest of the group so that the regulators can see the nuts and bolts of the infrastructure that is supporting the ring-fenced bank in question.
• Some customer sort codes and bank account numbers are being changed.
• Banks are preparing several major transfers of business that the courts will then have to sanction. These banks are having to do this with assets, liabilities, relationships with customers that are linked to the assets, and other things as well. In the case of one firm, the Scottish courts will decide on what ends up where; in the other cases, it will be the High Court (actually a system of 25 courts) of England and Wales.

In the next instalment of this series we shall look at ways in which HNW customers are likely to be affected; the aim is to disturb them as little as possible.