The FSA, HM Treasury and the Bank of England (Authorities) have been criticised over the last few months for their handling of the recent turbulence in the financial markets. In response, the Authorities published a discussion paper, Financial stability and depositor protection: strengthening the framework on 30 January 2008 (Paper).

Discussion paper

The Paper builds on the responses to the discussion paper that the Authorities published last October(Banking reform – protecting depositors)and takes into account the House of Commons Treasury Select Committee report, The Run on the Rock which was published on 26 January 2008.The Paper sets out the Authorities proposals for reform which aim to achieve five key objectives:

  1. Strengthening the stability and resilience of the financial system in the UK and internationally
  2. Reducing the likelihood of individual banks facing difficulties including regulatory interventions and liquidity assistance
  3. Reducing the impact if, nevertheless, a bank gets into difficulties including a new ‘special resolution regime’
  4. Providing effective compensation arrangements in which consumers have confidence
  5. Strengthening the Bank of England, and ensuring effective coordinated actions by authorities, both in the UK – including through reforms to the tripartite arrangements – and internationally.

The publication of the Paper has already prompted comment. In particular, some commentators have said that they fear that the proposals are a ‘knee­jerk reaction’ to a unique and special set of market conditions and that it would have been better to let the markets adjust themselves to the lessons learnt in respect of recent events. The accusation here is that the Authorities are trying to solve the last crisis rather than preventing the next. However, some have commented that the consequences of such a failure are so severe for the markets that one has to face­up to and address the risks, even if it is a remote prospect, while others have said that the odds of having an identical situation in the future are high and that the next crisis could be triggered by, for example, credit risk or computer systems rather than liquidity.

The Paper contains numerous proposals of which there are too many to look at in an article of this length. Instead the remainder of this article focuses on the key proposal of the special resolution regime.

Special resolution regime

The special resolution regime (SRR) would be used to assist a failing bank, prior to insolvency, while the bank retained some net worth. Under the proposals a failing bank would be placed into the SRR when the FSA, after consultation with the other Authorities, considered that its normal regulatory powers would be insufficient and a more radical approach was needed to protect the stability of the financial system or the interests of depositors. The Authorities are seeking views on the criteria and process for triggering the SRR which would be set out in the FSA Handbook.

The SRR would have a number of tools and it is proposed that these include:

  • Powers to allow the Authorities to direct and accelerate transfers of banking business to a third party, in order to facilitate a private sector solution
  • Powers to allow the Authorities to take control of all or part of a bank (or of its assets and liabilities) through a ‘bridge bank’
  • Powers to allow the Authorities to appoint a ‘restructuring officer' to carry out the SRR
  • Should it become apparent that the pre­insolvency resolution is not feasible, or that immediate closure of the bank was appropriate, a ‘bank insolvency procedure’ to facilitate fast and orderly payment of depositors' claims under the Financial Services Compensation Scheme (FSCS).

Accelerated business transfers

In relation to the first tool, this power would not replace the conventional mechanism in Part VII of the Financial Services and Markets Act 2000 (FSMA). It would be used where the Authorities have concluded that the bank should enter the SRR and that this is the most appropriate tool to use to ensure a rapid transfer of part or all of the bank’s business. There would be no application to the court as is the case in the Part VII FSMA procedure although there would be mechanisms for challenge to the use of the power and the calculation of value or its distribution.

Bridge bank

In relation to the second tool, the Authorities would have the power to take control of all or part of a bank (or of its assets and liabilities) through a bridge bank. This involves a bridge bank acquiring some or all of the failing bank’s assets and assuming some or all of its liabilities. The Government would arrange for the establishment of the bridge bank, appoint suitable persons as its directors, and arrange for its financial support so that it could obtain FSA authorisation to enable it to take over all or part of the business of the failing bank. The bridge bank would be permitted to carry on business for a limited period of time (initially 12 months but this could be extended). The bridge bank’s new management would draw up a business plan, to be approved by the Authorities, to run the bank. The aim would be to preserve as much value as possible, pending the eventual sale of the bridge bank to a bidder. While in operation, the bridge bank would maintain continuity of services for customers with respect to the assets, deposits and other liabilities transferred. It would also have the authorisation to conduct new business in line with the business plan submitted to the Authorities. This would assure continuity of banking services and ongoing performance of obligations for liabilities transferred into the bridge bank. 02 Norton Rose LLP February 2008

Bank insolvency procedure

In relation to the fourth tool, the Authorities propose a modified insolvency procedure for banks. This would be a stand­alone insolvency regime for banks based on existing insolvency provisions and practices. The primary objective of the new procedure would be to facilitate fast FSCS payout or to effect a transfer of accounts to a third party and provide the Authorities with control over entry to the procedure once they have determined that other SRR tools are not appropriate. Without prejudicing this primary objective, the bank liquidator would be obliged to manage the resolution of the affairs of the bank in a way that best satisfies the interests of the general body of creditors. It is proposed that where there are monies readily available in the bank insolvency procedure, they may be used to fund the repayment of deposits that would otherwise have been made by the FSCS (in full or in part), subject to an indemnity from the FSCS to the insolvency practitioner to make good any shortfall against future recoveries. The bank liquidator would work with the FSCS in reaching such a decision.

The claims of the FSCS and depositors (whose claims are not settled by the FSCS) would continue to rank alongside the claims of other ordinary unsecured creditors. While a bank liquidator will have a duty to assist the FSCS to effect a repaid payout (i.e. to process depositor information at an early stage), the funding for any payout to depositors would be provided by the FSCS.

In a similar vein to other ‘special’ insolvency regimes (for example, in the railway sector), it is proposed that there would be a short notice period whereby creditors would be prevented from placing the bank into a normal insolvency procedure or enforcing security in order to afford a breathing space to consider whether the bank insolvency procedure should be deployed or another tool under the SRR used.

Restructuring officer

In line with the increased use of chief restructuring officers or ‘CROs’ in other restructuring arenas the Authorities are also proposing to have the power to appoint a ‘restructuring officer’ to carry out the SRR. The Authority overseeing the implementation of the SRR would set the objectives of the restructuring officer. The restructuring officer would report to the Authorities and, significantly, would not be treated as a director for the purposes of the Companies Act 2006. The restructuring officer would be immune from claims for which a director could normally be liable in the period leading up to the commencement of insolvency proceedings.

The directors would be able to do only what the restructuring officer agreed or required them to do. It is likely that the normal rights and powers of shareholders would be limited in a range of ways. Shareholders could, for example, be wholly or partly prevented from passing resolutions, which have legal effect.

Deadline for comments on the Paper

The Paper will attract much comment and it will be interesting to see the detailed proposals when they emerge. The deadline for comments on the Paper is 23 April 2008.