With all eyes on the impending introduction of the complex web of joy that is MIFID II, another less discussed regulation is fast approaching and this article seeks to highlight just what that regulation is, who it impacts and how.

With all eyes on the impending introduction of the complex web of joy that is MIFID II, another less discussed regulation is fast approaching and this article seeks to highlight just what that regulation is, who it impacts and how.

The ring fencing requirements emerged from the Sir John Vickers led 2011 Independent Commission on Banking. The purpose of which is to prevent a group’s investment banking arm from bringing down its commercial bank in any future crises. Applicable from January 2019 the regulation captures all UK banks that have a 3 year average of more than £25bn core deposits.

As a result of this regulation Barclays, HSBC, Lloyds, RBS, and Santander (UK) are required to legally separate their ‘essential banking services’ from the rest of the banking group. Examples of such services are as follows:

• Accepting deposits or other payments into an account
• Offering facilities for withdrawing money or making payments from an account
• Overdraft facilities

Affected banks will split themselves into separate entities, one being the ‘ring fenced bank’ (RFB) which is not allowed to incur financial exposures to any ‘Relevant Financial Institutions’ (RFI), such exposures will sit instead within the ‘non ring fenced bank’. (NRFB)

‘Relevant Financial Institutions’ are defined as follows:

• Credit Institutions (Banks)
• Investment Firms (security companies / broker dealers)
• Globally Systemically Important Insurers (GSII’s)
• Undertakings for Collective Investments in Transferable Securities (UCITS)
• Management Companies (collective portfolio management)
• Alternative Investment Funds (AIF’s)
• Alternative Investment Fund Managers (AIFM’s)
• Financial Holdco’s
• Mixed Financial Holdco’s
• Structured Finance Vehicles (SFV’s)

The RFB needs to be sufficiently financially, operationally and organisationally separate from the NRFB. This of course means both banks will need their own capital and pools of liquid assets along with their own credit ratings, the latest of which I have taken directly from the Bank’s own websites and put into Table 1.

Essentially any investment banking business will need to be transferred to the NRFB. A glance at each banks website reveals a compelling message of comfort to the retail client, new sort codes and account numbers may well be required but such things will be handled in a seamless manner, by the banks themselves therefore the impact to the person on the street ‘should’ be minimal.

What of the ‘Relevant Financial Institutions’? What might the impact there look like? We shall take the case of an asset manager and look at the possible ramifications of the aforementioned bank restructuring.

In the event that the non-ring fenced bank requires a change of legal entity, as is the case of Lloyds which will transition all RFI exposures to ‘Lloyds Bank Corporate Markets PLC’ then new legal documentation will be required. These might include depending upon the bank, ISDA’s, GMRA’s, CDEA’s, and clearing agreements to name but a few.

I envisage that Part 7 transfers, or other such court approved schemes, may well be used to transition the RFI exposures but this is something I would urge the buy side to address with its counterparties sooner rather than later. A typical asset manager may have thousands of such agreements in place which may require some renegotiation.

In any case a change of legal entity will require new counterparty approvals to be processed by the asset manager, we know this can be a lengthy and time consuming process. Each NRFB will need to be capitalised in its own right and therefore given its own credit rating by the various agencies. This of course means that its counterparty risk profile may look very different to that of the current entity the manager faces.

Much like the retail clients requiring new account details so will the buy side, new standard settlement instructions will have to be recorded in hundreds of systems across tens of thousands of accounts across multiple businesses.

These five banks play a large part in the derivative and repo trading ecosystem, already challenged significantly by balance sheet limitations we have seen contractions in the repo market particularly by some of the traditional houses, could this place further strain?

Lloyds for example trade 25% of the Gilt repo market, with just 5% of their current balance sheet exposed to investment banking activities will their participation continue to that extent post restructuring?

I hope that you have found this short piece informative and that it at the very least puts the topic on your radar in the event that you have exposure to any of the banks mentioned herein. I am aware that some of them may have an outreach program in place but with so much on the mind of the buy side right now, it pays to be safe rather than sorry.

This article was first published in edition 10 of Rocket, our magazine. Download available Rocket editions here, and save your up to date address in your profile to to indicate your interest in receiving a printed copy of the magazine. Copies are also available to purchase and subscribe to via the shop.

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