Yesterday, the U.K. government published a report entitled "Developing effective resolution arrangements for investment banks" which sets forth, primarily in response to the September 2008 collapse of Lehman Brothers Holding, Inc. (in particular its U.K. arm, Lehman Brothers International (Europe)), the U.K. government’s initial thinking as to the reforms which may need to be considered in developing effective resolution arrangements for future investment bank failures. Specifically, the report focuses on reforms attributable to "[t]he treatment of investment banking clients after default, the future of their assets, and the treatment of their open or un-reconciled trading positions, as well as examining what can be done to make the process of insolvency itself more effective and limit the damage that may be done by a failing investment bank."
Briefly, the report recommends exploring reform in three primary ways:
- Client Assets and Monies - The effects on a failing investment bank's client assets during insolvency proceedings are "significant" and there is "[a] need to ensure that where clients have proprietary rights in assets or monies held on their behalf, such assets and monies will be returned promptly following insolvency proceedings." Possible legislative, regulatory and market reforms would need to:
- Ensure clarity with respect to "the way client assets and monies are treated in insolvency, and addressing misconceptions as to the protections in place";
- Improve "transparency by facilitating the identification and legal categorization of client assets and monies following the commencement of insolvency proceedings and the legal categorization of a client’s rights in respect of those assets and monies";
- Speed investors' access to assets that are held in trust; and
- Ensure that "sufficient flexibility is maintained in order to enable investors and brokers to arrive at mutually acceptable outcomes."
- Trading, Clearing and Settlement - The handling of open trading positions upon an investment bank's insolvency is "critical to a well-ordered and effective financial system." To address this challenge, the report recommends:
- Protecting the diversity and choice of trading, clearing and settlement methods for market participants;
- Ensuring clarity, and "building an environment in which the reasonable expectations of market participants with regard to trading, clearing and settlement are consistently matched with outcomes";
- Ensuring that "clear and flexible contractual arrangements can be applied consistently in a manner which secures legal certainty with regard to trading, clearing and settlement"; and
- Developing appropriate market and regulatory responses to the "technical challenges surrounding uncertainty with regard to the trading, clearing and settlement of trades not executed on recognized exchanges in the event of insolvency proceedings."
- Achieving Effective Resolution - U.K. insolvency law and practice might merit change in certain respects to "[e]nable a more timely and effective response" in the event of any future investment bank failures. Possible changes include:
- Continuity of service obligations;
- Changes to the process for initiating insolvency proceedings;
- Greater freedom for insolvency practitioners and a special insolvency regime; and
- Special insolvency officeholders.
Separately, last Thursday, the Financial Services Global Competitiveness Group, co-chaired by U.K. Chancellor Alistair Darling and former Citigroup Inc. Chairman Sir Winfried Bischoff, published a report entitled "UK international financial services - the future" representing the views of several of the U.K.'s financial services leaders who undertook, at the government's request, to examine the competitiveness of financial services globally and to develop a proposed framework on which to base policy and initiatives to keep U.K. financial services competitive over the next 10 to 15 years. The report outlined several considerations and recommendations to "provide general policy guidance for the longer term" with the central theme being that "the UK’s future success must be based on partnership" between the financial services industry, the wider domestic economy, emerging economies and their financial centers.
A brief summary of the report's considerations and recommendations is as follows:
- Establish a clear direction for the U.K. international financial services industry in partnership with the wider economy and overseas markets. This would involve ensuring that "the benefits obtained through the UK’s position as an international financial center continue to accrue across the UK domestic economy, and further recognize that the UK’s status as an international financial center depends on the maintenance of an open economy and cooperation with other financial centers." To meet this goal, the Report recommends that the U.K. government and financial services industry should, among other things:
- Engage in public debate on the role of financial services in the economy to explain the depth and breadth of the sector and its existing and potential contributions to the wider economy;
- Collaborate to maintain and expand the U.K.'s role as a financial portal for the rest of Europe and the world;
- Support financial markets infrastructure initiatives, especially clearing and central counterparties for traded products; and
- Intensify work with emerging market economies, through strengthened economic and financial policy dialogue, the creation of joint ventures, co-investment and training and shadowing schemes to support building local capabilities, sharing expertise on regulation, business models, structure and risk management.
- Reaffirm the U.K.’s reputation for competence, responsibility and trustworthiness. To meet this goal, government and the industry should "restore public trust by addressing the deficiencies which have been revealed by the banking crisis, and rebuild the reputation of banking." The U.K. should play an "active role in regulatory leadership," creating and adhering to "high standards." The U.K. should also "[p]roactively share regulatory insights with other countries and regions as well as encourage collaboration among financial practitioners to ensure critical initiatives are not missed." In addition, the U.K.’s reputation and the economic and social value of financial services depend on following four primary undertakings for success:
- Taking a leading role in the formulation and implementation of global and European Union regulation and further reinforce the attractions of the U.K. as a home for international financial firms and investors;
- Generating "strong and purposeful engagement" between the U.K. government and the financial services industry to ensure that the U.K. tax system "remains stable, sustainable and competitive";
- Supporting flexible labor markets, with enhanced skills and training; and
- Innovating responsibly with effective oversight to meet the challenges of the next 10 to 15 years.
- Ensure effective delivery of the above recommendations. This would involve "[b]uilding on and enhancing the close and productive dialogue between the UK government and the industry, and effectively promoting the UK’s international financial and professional services capabilities." To meet this goal, the UK government should:
- Develop a "leaner" forum led by the U.K. government that focuses on the overall strategic direction of the U.K. financial services industry, with links to bodies that can play a role in implementing the strategy;
- Take an "outward-facing" approach to the strategies presented by the Report and take account of concurrent initiatives in other markets and jurisdictions, including the U.S. and E.U.;
- Support work under way to "establish an independent body that is permanent, practitioner-led, politically neutral, strategic and cross-sectoral, which will demonstrate the importance of the financial services industry to a broader domestic audience and explain and market the strengths of the UK-based financial services industry to an oversees audience"; and
- Work closely with trade associations and others interested in E.U. developments.
The Financial Services Global Competitiveness Group report follows the March 18 report entitled "The Turner Review - A regulatory response to the global banking crisis," prepared by Lord Adair Turner, Chairman of the Financial Services Authority. The focus of the Turner Review was on how the U.K. can "[c]reate a future banking system which is more stable and better able to serve the needs of businesses and households," and further identified three underlying causes of the recent banking crisis – macro-economic imbalances, financial innovation of little social value, and important deficiencies in key bank capital and liquidity regulations.
Briefly, the Turner Review recommended "profound" changes to the U.K. banking system, including:
- Fundamental changes to bank capital and liquidity regulations;
- More and higher quality bank capital, with substantially higher capital requirements for risky trading activity;
- Counter-cyclical capital buffers, building up capital in good economic times so it they can be drawn on in downturns, and reflected in published account estimates of future potential losses;
- Regulation of "shadow banking" activities on the basis of economic substance not legal form: increased reporting requirements for unregulated financial institutions such as hedge funds; and regulatory power to extend capital regulation to such institutions;
- Regulation of credit rating agencies to limit conflicts of interest and "inappropriate application of rating techniques";
- National and international action to "ensure that remuneration policies are designed to discourage excessive risk-taking";
- Major changes in the Financial Services Authority's supervisory approach, building on the existing Supervisory Enhancement Programme, with a "focus on business strategies and system wide risks, rather than internal processes and structures"; and
- Major reforms in the regulation of the European banking market, combining a new European regulatory authority and increased national powers to constrain risky cross-border activity.
Published alongside the Turner Review was an FSA discussion paper which provided more detail regarding specific policy proposals to be made to "enable supervisory authorities around the world both to deal decisively with the problems of the past and to equip them to react swiftly and effectively to any future developments that may, once the current crisis is over, again threaten to undermine financial stability."