10 key points coming out of the stabilisation of Silicon Valley Bank UK Limited
Corporate customers of Silicon Valley Bank UK Limited (SVBUK) faced an anxious weekend as the possibility of SVBUK going into a bank insolvency process threatened uninsured deposits and could have impacted on customers’ ability to draw on their credit lines and access other key banking services. We are delighted that the Bank of England's decision to stabilise SVBUK through a sale to HSBC UK Bank PLC appears to mean those concerns have now abated.
Here are ten key takeaways coming out of the weekend’s events.
1. Resolution tools are there in the toolbox, but they might not be used
For anyone who has followed the development of bail-in and other resolution powers through the Credit Crisis, the Banking Act 2009 and two iterations of the Bank Recovery and Resolution Directive (BRRD), it would be easy to think that banks in financial difficulty can be simply and easily bailed-in without cost to the taxpayer, and commercial life goes on largely as before. However, whilst bail-in is an important power for resolution authorities to have in the toolbox, it remains the exception rather than the rule. As the Bank of England itself states on its use of resolution powers, [most] UK firms would be put into insolvency if they failed, because that wouldn’t disrupt the economy or financial system.” Large banks that are ‘too-big-to-fail' and could have a systemic impact on the wider financial system may still be bailed in, as may those who provide critical services such as clearing, but others may not be. For most of the weekend, it appeared from the outside at least that SVBUK was heading in a similar direction; in its statement on 10 March 2023, the Bank of England made clear that “absent any meaningful further information, [it] intends to apply to the Court to place [SVBUK] into a Bank Insolvency Procedure.”
2. Limited deposit protection doesn't prevent a bank run
Large companies have benefitted from deposit protection in the event of a failure of a UK bank since the implementation of the second Deposit Guarantee Schemes Directive (DGSD II) in July 2015. However, companies are eligible for deposit protection up to the same GBP85,000 limit as retail and SME depositors. For companies with tens of millions on deposit with a bank at risk of insolvency, this is a (very) limited incentive to leave their money where it is. In addition, regulated firms are carved out of deposit protection under the Financial Services Compensation Scheme (FSCS). In circumstances in which cash placed with a failing bank remains beneficially owned by end customers who are eligible claimants under the FSCS, they may still benefit from deposit protection; however, in the case of funds, the money used to subscribe for fund units invariably becomes the property of the fund and ceases to be beneficially owned by the unitholders and therefore ceases to attract deposit protection. For these and other reasons, banks with significant corporate and institutional customers are still likely to come under pressure from a flight of deposits if they get into financial difficulty. Deposit protection may still play a prudential role in mitigating against bank runs where retail depositors are involved, but for corporate and institutional depositors with larger deposits, the effect is limited.
3. Depositors are expected to diligence the banks they place their money with
Deposit protection is capped for a few different reasons. An obvious reason is affordability, particularly for the portion of deposit protection that is funded after the fact through contributions from other deposit protection scheme members that remain standing. Another key reason that deposit protection is capped is to avoid “moral hazard.” If deposits were protected in full, depositors would have no incentive to diligence the institutions that they place their money with or to spread their deposits. Corporate clients who concentrate their deposits with a single bank may now be considering the benefits of diversifying.
4. In any scenario analysis, it helps to understand depositor preference
The UK has had a form of depositor protection in place based on the requirements of Article 108 of BRRD, which it has retained post-Brexit. Amongst other things, this requires that “that part of deposits from natural persons and micro, small and medium-sized enterprises which exceeds the coverage level provided for in” DGSD II shall have a higher ranking that the claims of ordinary unsecured creditors, e.g. holders of senior unsecured debt. However, as secondary preferential creditors, retail and SME depositors will still rank behind fixed charge realisations, the insolvency practitioners’ remuneration and expenses; and ordinary preferential creditors, which includes the FSCS for any compensation payments it makes. In addition, large companies do not benefit from depositor preference, in the UK at least. Depositors who may have been considering the possibility of selling their SVBUK deposits, and institutional investors who may have been considering buying them, will have wanted to understand where they sit in the insolvency hierarchy. Companies above the SME threshold do not benefit from this similar secondary preferential status.
While a Bank Insolvency Process does prioritise ensuring eligible depositors receive their limited compensation speedily, any distribution to preferential creditors (including secondary preferential creditors) may take many months. This will not help those eligible to receive such distributions with short term liquidity issues. Whether classed as a potential secondary preferential creditor or not, the boards of any companies with deposits in the affected bank upon which they rely for short term liquidity will need to consider their own ability to make payments (including, for example, payroll) in the short term and may need to seek additional support. We would recommend that boards finding themselves in this position seek immediate restructuring focussed advice.
There are options available including equity support, private sector liquidity funding, and of course the possibility of targeted sectoral support (as was suggested by the Chancellor on Saturday for the technology sector), but this kind of support needs to be made available in a timely manner to be effective.
5. Becoming a “large company” is a meaningful step from a regulatory and insolvency perspective, not just a commercial perspective
The legal tests for when a company is a microenterprise or a small, medium or a large company are technical, to the extent that the European Commission has published a sixty page User Guide to the SME Definition. This remains relevant and persuasive in the UK context as well since, at the time of writing, the UK still uses the EU small, medium and large company definitions post-Brexit, right down to the use of €-denominated thresholds. This might sound dry, but it can have a real practical impact on the protections a company benefits from. As a company grows in scale, some – but crucially, not all – regulatory protections start to fall away and (as noted in point 4 above) a company will cease to benefit from depositor preference once it becomes a large company. This may have a number of different ramifications. PRA expectations on the quality of depositor data is high, but classifications are dynamic, and they may have real impact in the case of an insolvency, resolution or administration. Timing considerations around the size of a company may also be relevant depending on the process that the Bank of England ultimately chooses to follow. In this, we can see how small factors can have a large impact.
6. Netting and set-off may not help borrowers with their deposits
In a pre-insolvency scenario, the negotiated terms of many facility agreements may restrict borrowers’ ability to apply netting and set-off in respect of amounts owed to them by their lenders, which will limit their ability to use self-help methods to mitigate exposures. In a Bank Insolvency Process (“BIP”), as in a traditional UK corporate insolvency, the set-off of debits, credits and other claims between counterparties with sufficient mutuality between them would automatically apply. Other processes may leave companies in a very different position, however, at least in the short term. In a bank administration process (BAP), for example, set-off would not automatically apply until the administrator determines to make a distribution which enables trading of positions with a view to set-off even after the commencement of administration.
7. The first information isn't always the best information
Over the weekend, it was difficult to gauge the possibility of a stabilisation of SVBUK through a third party purchaser coming in to buy the business. The Bank of England’s statement on Friday night was qualified, but may have led many to assume that a BIP was the most likely outcome for SVBUK. Anyone reading the news on Sunday afternoon may have thought that depositors’ best hope was Middle Eastern investors willing to buy the business; as of 1am on Monday morning, the Bank of London had gone public with the fact that they had made a bid and there was press speculation that large banks including HSBC were in discussions with the Bank of England and the HM Treasury. HSBC’s identity as the successful bidder was only confirmed around 7am, with statements from the Bank of England and the Chancellor of the Exchequer confirming what has to be a positive outcome for the UK technology sector. Staff at the Bank of England, His Majesty’s Treasury and others no doubt worked extremely hard over the weekend to achieve this result, and a degree of confidentiality over the bidding process is understandable. The power of social media was a significant factor over the last week moving information (good and bad) quickly and influencing behaviours which may have exacerbated or otherwise distorted positions. The Fourth Estate have an important role to play at times like these, but even they may have only part of the picture.
8. Different jurisdictions may reach different solutions
In the UK, the stabilisation of SVBUK was achieved through a sale to another UK bank that had sufficient liquidity to take on liability for both insured and uninsured deposits, ensuring (in the Bank of England’s words) “the continuity of banking services, minimising disruption to the UK technology sector and supporting confidence in the financial system.” In the United States, the US Treasury Department, Federal Reserve and the Federal Deposit Insurance Corporation (FDIC) also successfully put steps in place designed to protect depositors and allow them to access their money without recourse to taxpayer funds, but without an immediate buyer in place. The solution for SVB therefore looks quite different on either side of the Atlantic. According to the US Treasury, other banks that fund the US deposit insurance system will bear the cost of protecting uninsured depositors through a “special assessment.” There is a precedent in the United States for a willing purchaser to take on liability for uninsured deposits, as happened during the Credit Crisis when JP Morgan Chase acquired the banking operations of Washington Mutual (WaMu). It just didn’t happen this time around.
9. Contagion to the corporate sector is a regulatory consideration
The potential impact of an SVBUK failure on the UK tech industry was a major source of concern, with a potential perfect storm of customers’ deposits being written off, difficulties in accessing credit lines and inability to access core banking services potentially leaving customers unable to run their businesses and (in some cases) in position of technical insolvency. The Bank of England always made clear that the risk of financial sector contagion was a relevant factor to which resolution or other tools would be used (or not). The statements that accompanied HSBC UK Bank Plc’s agreement to purchase SVBUK made clear that the potential impact on the UK tech industry was ultimately a key factor in the ultimate solution that was reached. In the context of the Credit Crisis, US commentators often talked about “Wall St’s impact on Main St.” It is a theme that is just as relevant today. It will be interesting to observe whether there will be any additional scrutiny of concentration risk or competition for banking services to sectors which have been identified as critical (from an economic and/or political perspective) given evidence of the significant exposure of the tech sector to SVBUK.
10. A timely reminder to corporates to check their documentation with their lenders
Facility agreements documented on LMA terms will often have the relevant provisions necessary to allow a borrower to replace an “impaired agent” and/or a “defaulting lender”. Of course, implementing these remedial actions may take time and until a borrower manages to replace the relevant defaulting lender any undrawn commitments (such as revolving facilities or acquisition/capex facilities) may not be available, resulting in liquidity issues or funding gaps.
Of course, not all facility agreements will be drafted on LMA terms and so may not have the relevant defaulting lender and impaired agent provisions in them; for example, smaller bilateral loans may only contemplate a single lender. In that scenario, the solution may require a complete refinancing of the existing lender with the associated time, costs and documentation involved.
Either way, checking the terms of your financing documents now is a sensible step to take so that you know what rights you may have should this happen to your lender.
Policymakers remain focused on containing any systemic risk to the wider financial system and on the real economy. There was marked trading volatility when markets opened in the morning on Monday 13 March, notwithstanding HSBC Bank UK Plc stepping in to purchase SVBUK. On the other side of Atlantic, US regulators had to grapple not just with the failure of SVBUK’s parent company, but with Signature Bank of New York, where again the US Treasury, the Federal Reserve and FDIC took steps to ensure the protection of depositors without recourse to taxpayer funds. With the second and third largest bank failures in US history (after WaMu) coming over the same weekend, it is perhaps unsurprising that the Federal Reserve announced a new Bank Term Funding Program to ensure that banks are able to meet the needs of depositors, borrowing against US Treasuries and other qualifying assets. Whether the UK needs to follow the US’ lead in offering additional liquidity facilities to others in the market remains to be seen.