Summary: Many banks and other credit institutions will be subject to the PRA’s new operational continuity rules effective from 1 January 2019. These new rules are part of the response to the last financial crisis, designed to avoid disorderly failures creating systemic problems in the financial markets. In this article, we look at what these Firms need to do in respect of their real estate assets.
Affected firms must now ensure continued access to critical services in the event of their failure. These Firms will operate from offices and use data centres therefore they are likely to own real estate assets supporting critical services. What do these Firms need to do in respect of real estate?
How do the rules apply?
Properties, whether freehold or leasehold, are likely to be categorised as “operational assets supporting critical services”. The PRA’s guidance specifically includes “premises” and “leases” in its examples of the types of operational assets meeting the expectations applying to operational assets. Firms must ensure that access to their operational assets are not disrupted in the event of a group member being restructured or becoming subject to resolution. Access to relevant properties for Firms must remain available both (i) at the point the PRA steps in to impose resolution on a failing Firm and (ii) during and after any restructuring of that Firm.
In many cases the PRA rules will only apply to parts of Firms’ groups. In these cases Firms need to identify the regulated parts of their businesses and the parts of their businesses that own the relevant operational assets. The practical issues to be considered in such group structures are:
- which group company owns the premises from which critical services are provided?
- which group company would need to occupy the relevant premises at the point of a resolution event and during and after any restructuring?
- if the group company that owns the relevant premises is different from the group company that needs to occupy the relevant premises, what needs to be done?
- if the relevant premises are held under a lease can the landlord forfeit the lease on the occurrence of a resolution event?
We consider these questions further below. Many Firms already have, or are setting up, service companies to provide critical services to the relevant parts of their group. In these cases the Firms needs to ensure that their service companies also have the necessary rights.
Freehold Properties – Ensuring ongoing access
In respect of freehold properties owned by another member of its group, a Firm and its service company will need to demonstrate that they will have an independent right to continue to occupy the property both before and after a resolution event. Otherwise there is a risk that critical services provided by a service company or received by the Firm could be disrupted if its group member suffers financial distress. For freehold properties title to the relevant property could be transferred to the Firm or the service company or separate intragroup leases granting service company and/or the Firm rights to occupy the property may be put in place.
Leasehold Properties – Ensuring ongoing access
Leasehold properties are more tricky because the solutions that can be applied may require a third party landlord’s consent.
The simple solution would be to assign the lease of relevant premises to the Firm or service company. This would most likely require the landlord’s consent and its acceptability will very much depend on the proposed assignee’s covenant strength. Leases tend to prohibit group company assignments and its unlikely that a landlord will consent to such assignment unless the Firm or service company has an equal or greater covenant strength to the outgoing group company. Assignment may also not be appropriate if the Firm or service company only needs to occupy a small part of a larger property.
For the reasons given above an intragroup sub-lease of just the area required by the Firm or service company may be most appropriate. If the lease is excluded from the protection of security of tenant under the Landlord & Tenant 1954 Act and disregarded for the purposes of rent review landlords are less likely to object. A sub-lease also has the benefit of allowing the Firm and / or the service company to just occupy the areas it requires. In some cases, ahead of a resolution event the Firm’s and the service company’s employees may not all be located within the area they will need post resolution. In those cases both the headlease and the underlease are likely to include group sharing provisions which means that that separation will not need to happen until the occurrence of a resolution event.
Leasehold Properties - Landlord’s forfeiture rights
The forfeiture rights typically reserved for landlords in commercial leases raise some uncertainty as to whether a landlord would be entitled to forfeit the relevant lease on the lessee entering into resolution. Specifically, commercial leases can include forfeiture rights for landlords on the entering into an arrangement, scheme, compromise, moratorium or composition with any of the lessee’s creditors. A landlord may seek to argue that as part of the actual resolution process certain steps taken by the Bank of England which effect a bail-in and the suspension of rights of creditors trigger such forfeiture rights. To mitigate against this risk, further protection could be achieved by agreeing amendments to the relevant lease so that the leases expressly state that a resolution event in of itself is not a forfeiture ground. This is not an area that most landlords will be familiar with so the success of this approach will require persuasion.