Banking Reform

November 28, 2011

The Independent Commission on Banking (‘ICB’) published its Final Report on 12 September, setting out recommendations on structural and non-structural reforms to improve stability and competition in UK banking.  

It is unlikely that the ICB’s recommendations in regard to banks improving their loss absorbency (by achieving more equity relative to their assets) will be of direct significance to the IT/IP/commercial contracts lawyer. It is also unlikely that the ICB’s myriad proposals designed to encourage competition will be of great import to the IT/IP/commercial contracts lawyer. However, the same cannot be said for the ICB’s recommendation that UK retail banks should be ring-fenced from any wider corporate group and/or financial organisation of which they form part.  

The retail ring-fence recommendations

Potentially, the retail ring-fencing recommendations will have a direct impact on any lawyer who advises on corporate governance or commercial contracts. The particular recommendations which are of most direct significance to the IT/IP/commercial contracts lawyer are broadly summarised in the following list:

  • ring-fenced banks should be separate legal entities
  • ring-fenced banks should be prohibited from offering certain services and/or carryingout certain activities.
  • any financial organisation owned or partly owned by a ring-fenced bank should conduct only activities permitted within a ring-fenced bank (such a financial organisation’s balance sheet should also contain only assets and liabilities arising from these services and activities)
  • the wider corporate group should be required to put in place arrangements to ensure that the ring-fenced bank has continuous access to the entire infrastructure required to continue provision of its services and activities, irrespective of the financial health of the rest of the group
  • all transactions (including secured lending and asset sales) between a ring-fenced bank and all other entities forming part of a wider corporate group should be conducted on a commercial arm’s-length basis.

Far-reaching consequences 

These recommendations, and the overall concept of a ring-fence, are directly at odds with the present day corporate structures of large banks and financial institutions. Typically, these include tens, hundreds or even thousands of legal entities and are designed to manage capital, economise on taxes, share services and maximise efficiencies.  

These conglomerates of legal entities are not stand-alone in any meaningful way but are linked together through intra-group transactions and joint back offices with shared infrastructure such as technology, data, human resources, payments, treasury, liquidity, risk, accounting, insurance, property, risk and, of course, legal. 

Most financial institutions also operate some form of shared service model, with one group entity contracting with suppliers on a basis that allows other group members to benefit from that contract. In most cases, the entity that contracts for the services actually trades, providing frontline banking or other financial services to customers.

If banks are to set up according to the sort of retail ring-fencing that the ICB report envisages then there will be some far-reaching consequences.

The ring-fenced bank will either have to possess its own infrastructure or, if it is shared, then such infrastructure will have to be identified (which may be by no means a straightforward task) and then made available formally to the ring-fenced bank, via:

  • direct agreement with the supplier;
  • direct agreement with another member of the group; and/or
  • a member of the wider group, which contracts with suppliers, but is ‘bankruptcy-remote’.

Direct agreement with another member of the group may require group-service agreements which set out which services are delivered to which entity within the group (or across the group) and the charge to be attributed for the provision of those services. This discipline is already important for a number of reasons – transfer pricing being an example – but the ICB recommendations will place an even greater focus on making sure that internal risks and responsibilities have been thought through clearly and documented.

If the ‘bankruptcy-remote’ group member option is preferred then it should be a well-capitalised shared service company (without assets or liabilities), similar to a holding company incorporated to hold intellectual property. 

The ease of arranging for provision of the infrastructure services through a ‘bankruptcy-remote’ company will depend on whether the existing agreement allows for intra-group assignations and the relative bargaining strengths of the parties. Any migration of services presents a risk of legal and financial exposure and suppliers will naturally regard enquiries as to renegotiation, novation or assignation as an opportunity to renegotiate the terms of an agreement or to impose conditions on the transfer. 

In summary, infrastructure separation of the type that is likely to be required by the ICB recommendations may feasibly involve:

  • drafting agreements to formalise supply of infrastructure services to the ring-fenced bank;
  • renegotiation of existing agreements to separate provision of infrastructure services;
  • novation or assignation of agreements to a well-capitalised, bankruptcy-remote shared service subsidiary (without assets or liabilities) to provide infrastructure services on behalf of the separated entities; and/or
  • partial or wholesale outsourcing of infrastructure provision.  


There are many questions still to be answered regarding the ICB recommendations. 

The deadline that the ICB has set for implementation of its recommendations is 2019.  George Osborne, the Chancellor of the Exchequer, has indicated that he intends to implement the recommendations as part of a separate programme of legislation to the Financial Services Bill and will ‘seek a legislative slot’ in the 2012-13 parliamentary session to debate reforms.

It has been suggested that UK banks may avoid the ring-fence by relocating to another Member State and branching back into the UK. The ICB speculates that there would be major legal, reputational and practical impediments rendering corporate migration unappealing or unworkable. It has also been suggested that it may be difficult to make ring-fencing applicable to all major banking organisations in the UK within the legal framework of the European single market. Time will tell. 

What seems certain is that some sort of separation or segregation of retail banks is inevitable and, in this context, the deadline of 2019 is not that far away.  Whether acting for financial institutions or their suppliers, from now on the IT/IP/commercial contracts lawyer should keep in mind what is on the horizon when negotiating or renegotiating agreements.   

John D. McGonagle is a Senior Solicitor at Brodies LLP