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Understanding UK Ringfencing
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What is ring-fencing and why is it happening?
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Introduction
Following the 2008 Financial Crisis, the UK Government established the Independent Commission on Banking (ICB) chaired by Sir John Vickers which proposed several measures to tackle the idea that banks were “too big to fail” and prevent the costs of banks failing falling on taxpayers.
The ICB proposals were implemented through the Financial Services (Banking) Reform Act 2013 and are known as ring-fencing. Ring-fencing separates and protects core retail services from other activities such as investment and international banking.
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Estelle KadjoTCLA Writer
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Many banking groups offer a wide range of services including payments processing, corporate lending, mortgage lending, trading in financial markets, and retail banking for individuals and businesses. The risks associated with these activities vary significantly and ring-fencing is designed to separate vital banking functions from potentially more volatile business activities such as investment and international banking.
By 1 January 2019, banking groups must reclassify services; those inside the ring-fence will be administered through Ring-fenced Bodies (RFBs), and those outside through Non-Ring-fenced Bodies (NRFBs). NRFBs will house the more volatile business activities so that if they run into trouble, those entities can be wound down by regulators without affecting other retail banking services.
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Who will be affected?
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Ring-fencing will affect a range of market players including the banks, consumers, and businesses and corporates.
Banks
Implementing the ring-fencing requirements is a complex and costly task “spanning legal, operational, governance, technological and management issues” as pointed out by Marcus Hughes, Director of Business Development at Bottomline Technologies. HSBC estimated the cost of ring-fencing at £2.5bn and Barclays reportedly spent more than £1bn to satisfy the requirements. As ring-fencing requires the separation of core banking retail services from other volatile activities, many banking groups established new separate legal entities to provide those services. For instance, HSBC announced that HSBC UK is its RFB, RBS rebranded NatWest Markets for its NRFB, and Barclays UK will offer day-to-day products and services to individuals and businesses (with a turnover of less than £6.5m).
Consumers
Many consumers must have their sort codes changed to satisfy ring-fencing and the Bank of England estimates that over one million customers could be required to change their sort codes. New sort codes also mean that customers’ International Bank Account Number (IBAN) will change. Ring-fencing has led to customers experiencing restricted access to online, phone and mobile banking services over the course of several months as banks implemented the changes. The disruption is likely to continue and affect day-to-day retail activities as new group structures and ways of operating are introduced. More significantly, Stuart Gulliver, former CEO at HSBC argued that the ring-fencing rules will trigger a surge in fraud widely affecting customers. Currently, millions of customers across the UK are being contacted about changes to their bank account details and this creates opportunities for fraudsters to persuade consumers to reveal their credentials by posing as a bank and making fraudulent payments.
Businesses and corporates
Businesses and corporates are likely to deal with both RFBs and NRFBs as they offer simple derivatives, deposit-taking, lending, payments processing and trade finance. These activities can sit on either side of the ring-fence. This will further complicate the relationships between banking groups and their clients as businesses and corporates must deal with both RFBs and NRFBs after the 2019 deadline.
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Is ring-fencing necessary?
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The collapse of Lehman Brothers and Fortis Bank in 2008, the run on Northern Rock in 2007 and the support packages offered to Lloyds Banking Group after its acquisition of HBOS and the Royal Bank of Scotland exposed the fragility of the global banking system. The Crisis demonstrated that banks could fail, therefore much stronger foundations were required to support them.
However, ten years post-Crisis a multitude of financial reforms have been introduced including MiFID II, Basel III and IV, and the FCA changes to LIBOR. Pauline Lambert, Analyst at Scope argues that the recovery frameworks adopted on a global scale have “enhanced the safety and sustainability of the UK banking sector compared to the pre-crisis period”. Therefore, ring-fencing may be less necessary in 2018 as there are several mechanisms in place to ensure that banks are better able to absorb shocks. Her argument is supported by Wilson Ervin who believes that ring-fencing will increase by 5 times or even 15 the likelihood of banks failing as there will be less capital and liquidity flowing through the new banking group structures.
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Conclusion
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The UK banking system is undergoing a significant restructuring due to the ring-fencing requirements. The change will affect the banking groups, consumers, businesses and corporates. Ring-fencing is a crucial response to the Financial Crisis as it aims to dispel the myth that banks are ‘too big to fail’. However, considering the multitude of financial reforms adopted post-Crisis, ring-fencing may be less necessary.
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Introduction
Estelle is a member of TCLA’s writing team. She graduated from the University of Bristol in 2016 with a Law degree. She now works as a Banking and Finance paralegal at Addleshaw Goddard LLP, while studying the Legal Practice Course (LPC) LLM part-time study programme at BPP Law School.
You can reach out to Estelle in our forums by clicking here.
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