Publications

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Michael McKee is the partner who heads our Financial Services Regulatory team in the Finance and Projects department, based in London.

Below is Michael's summary and commentary on the UK Government response to the Vickers Report.

The Main Recommendations

On Monday 19th December the UK Government announced that it was accepting the main recommendations of the report of the Independent Commission on Banking ('the Vickers Report').

The likely outcome had been well trailed in the weekend press but, nonetheless, the decision is still a significant setback for UK banks.

Main elements of the requirements will be:

• The taking of deposits from retail customers and SMEs should only be provided by banks ringfenced from other banking services. It should not be mandatory to include private banking for high net worth individuals or corporate banking within the ring-fence
• Ring-fenced banks should be prohibited from undertaking certain investment banking activities
• The ICB's recommendations on loss absorbency for banks are accepted and will require big UK banks to have a loss-absorbing capital capacity of 17%. This will apply not just to UK assets but also to non-UK operations except where the banking group can demonstrate that the operations do not pose a threat to the UK taxpayer
• The government considers that all UK banks should be subject to normal competitive market forces - and should be able to fail safely without relying on a government guarantee and without putting the provision of critical services at risk
• The government considers that all banks - including non-ring-fenced banks - need to be resolvable without the use of state resources. The Vickers Report recommendations need to be complemented by a tesolution regime that covers investment firms and financial holding companies as well. The government supports bail-in debt as part of this regime
• Increased competition in banking services is supported - as recommended by Vickers - including, in particular, a strong and effective new UK bank challenger to the biggest UK banks. 
• The government supports depositor preference 'on balance' but believes that further analysis and consultation is required

One area where the government does not agree with Vickers is in relation to a de minimis exemption Vickers did not support such an exemption but the government wants to consider exemptions for banks below a certain size, for entities that undertake only a small amount of either mandatorily ring-fenced or prohibited services and for individual transactions under a certain threshold.

In addition the government supports something proposed by the Treasury Select Committee, but not mentioned in the Vickers Report - bringing the Payments Council within the scope of UK regulation. It plans to consult on options for enhancing the regulatory framework for payment systems in the New Year.

Costs

The government estimates the aggregate private costs to UK banks of implementing the recommendations as £3.5 to £8 billion leading to a gross reduction in UK GDP of £0.8 billion to £1.8 billion. The banks however, estimate the costs as higher - roughly £11 billion or so. The government believe  that there will be a consequential economic benefit to the UK of £9.5 billion per annum which would in their view, justify the expense to the banks.

A particular concern of course, is to reduce the risks to the public finances of the failure of a bank. This concern appears to be shared by politicians of all hues. Similar concerns about risks to the public finances are expressed in the recently published report of the Draft Financial Services Bill Joint Committee ('the Joint Committee') - the Parliamentary Committee made up of politicians from all parties and from both the House of Lords and the House of Commons which is reviewing the proposed new financial services legislation.

Implementation

The government intends to publish a White Paper during Spring 2012 with a view to legislation related to the ring-fence being completed by the end of the current Parliament in May 2015. Banks will be expected to be compliant "as soon as practically possible thereafter."

The capital and loss-bearing requirements will have to be implemented in line with the international timetable for implementation for Basel III which means that they will come in on a phased timetable and are to be fully in force by no later than the start of 2019.

Commentary

The government's full support for the main recommendations of the Vickers Report represents a lobbying defeat for the banks - but is not particularly surprising given the need for political balance within the coalition and the concerns of the general public and the media about the bailing out of banks during the financial crisis.

The government retains the Vickers approach of giving a reasonable amount of flexibility to the banks in deciding what assets will be included within the ring-fence. This means that the banks will now have to think hard, and strategically, about how they split up their groups.

It should not be assumed, however, that this flexibility will be retained in the text of the ring-fencing legislation. The Joint Committee report has already called for Parliament, rather than the banks or the regulators, to have responsibility for the content of the ring-fence. This indicates the Committee favours more tightly drawn legislation defining the ring-fence.

In general the anticipated removal of the 'state guarantee' for investment banking, together with the new capital rules from Basel III, means UK banks are already cutting back their investment banking operations significantly.

The government has also held firm on the 17% loss-bearing capital requirement for large banks despite pressure from those banks who mainly operate outside the UK to have this taken into account. The concession is that "if a bank can show that its non-UK operations do not pose a risk to UK financial stability and thus to the UK taxpayer, this requirement should not apply to those operations."

This concession leaves room for further discussion, and also for banks in this position to reorganise themselves so that their non-UK operations will not pose a risk to the UK taxpayer. Overall, however, the announcement leaves the banks with a major restructuring exercise which must start sooner, rather than later, if the ring-fence is to be in place by 2015.

If you have any questions about the response, implications for your business or would like to find out more about our Financial Services Regulatory experience, please contact:

Michael McKee, Partner

+44 (0)20 7153 7468