A 'quirky' attempt at bank reform may be abandoned, but Alex Novarese finds the regulatory war will go on

Given the political charge it had built up, it was inevitable that media reaction to the final report from the Independent Commission on Banking (ICB) would be framed as a win or loss for the banks. Even on that basis, it was a tricky call – the final proposals issued last month proving a little tougher in terms than expected, but with a longer-than-predicted timeframe for implementation of 2019. And on reflection it becomes clear that this awkwardly British process totally defies easy categorisation.

Certainly the commission, chaired by Sir John Vickers, has made few camps happy, introducing measures that will be unpopular among banks but that still fall well short of the brutal reckoning the City's many critics were hoping for. There is widespread agreement that the recommendations – which the Government quickly pledged to enact – will make British banking more onerous and expensive, by the report's own estimate raising funding costs by between £4bn to £7bn a year. Yet it is still hard to say the result is a clear policy victory or defeat for big banks, with a straw poll of finance advisers finding that individual institutions lobbied for different things and, as such, had widely varying reactions to the report.

The core recommendations remain largely as flagged in the interim report in the spring. UK retail banking operations are to be ring-fenced in legally and operationally separate subsidiaries from the rest of the banking groups to which they belong, covering between one sixth and a third of the £6trn balance sheet of the UK's largest banks. Large ring-fenced banks will have to hold equity capital of at least 10% of risk-weighted assets, against 7% under incoming international standards. In addition, the largest UK-based globally-important banks should have at least 7% further of loss-absorbing capital (bonds designed to impose losses on creditors ahead of depositors).

The consensus among City lawyers is that while the ICB's package comes at a considerable cost, it could have been worse for the banks. There is also agreement that the reforms will make the taxpayer less exposed to bailing out banks in future – useful, given that the assets of Britain's largest banks are currently 4.5 times the size of its gross domestic product. Yet it would be a stretch to say the ICB's work has been welcomed, even by the lawyers who support the need for banks to be forcibly rendered more resilient. Many finance advisers find the whole notion of a national solution to banking regulation an oddity at a time when so much of the running is happening in Europe and the G20 – in particular with the looming Basel III capital standards.

And the ICB was always on a sticky wicket in seeking a national solution to an international policy problem. In the wake of the banking crisis, many countries talked tough about ushering in Glass-Steagall-style reforms to split cuddly retail services from evil investment banking. But it soon became apparent that such talk was not turning to action. As such, the core recommendation regarding ring-fencing of retail banks is viewed as a clunky compromise between the full separation the commission wanted and what the dictates of City competitiveness and European competition rules would allow.

Unsurprisingly, it's hard to find passionate advocates for ring-fencing, even among those supporting far higher capital cushions. While some lawyers see it as a logical extension of the creation of living wills to help regulators to wind up banks without hurting depositors – or the banking system – it is both oddly specific, yet irritatingly simon-gleeson-ccvague. "They are saying that they want banks to restructure themselves in a highly specific way, but are not saying how," argues Clifford Chance partner Simon Gleeson (pictured). "It's a charcoal sketch rather than a detailed blueprint. It seems a rather quirky, British response to the issue of resolveability." Given the lack of connection between specific banking models and finance collapses over the last 25 years, it's also hard to argue with the critics who say the ICB should have ditched ring-fencing in favour of simply raising capital requirements for the largest banks, a move that would have gone with the grain of international efforts.

But despite threats from some banks regarding moves to quit the City if the ICB was overly tough, there is little expectation among finance lawyers that the report will seriously impact on London as a financial centre. Indeed, as several lawyers point out, despite all the sabre-rattling from banks about quitting jurisdictions in response to aggressive regulation, the equation has fundamentally changed since the banking crisis, with many jurisdictions wary of taking on large banks. As one banking partner at a magic circle firm puts it: "Banks will be reviewing their operations in London but it is not as simple as just moving to another jurisdiction. You have to look at which regulator will accept you and accept the risk of potentially having to bail you out one day."

So while there are strong critics of the whole ICB endeavour, a more commonly-held view is that the proposals are a workable if inelegant response to the need to stop British banks being too big to save, let alone too big to fail. "I don't see regulation as something that is likely to break the camel's back," says Ashurst partner Rob Moulton (pictured, main). "Tax will drive business – tax instability, that's what people don't like. If someone tries to take a dry run at a Tobin tax in London then that could be the kind of thing where people say, 'We could do this somewhere else.'" In comparison, the ICB proposals to improve competition in banking services – the perennial bane of regulators' lives – are widely viewed as a sideshow unlikely to have any meaningful impact.


Basel III and all that

What the ICB's package does reflect is one part of a much wider global regulatory push that looks set to gradually reduce the banking industry to a somewhat smaller and less lucrative business. Added to which, these initiatives – among them Basel III, the Remuneration Code, the US Dodd-Frank Act, the creation of the Financial Stability Board – are only just starting to have an impact on the finance industry. The combined effect strongly points to a smaller industry that is less focused on using its balance sheet and more intent on advisory work like M&A. And even if the ICB's agenda is watered down – a hope of some bankers given the long implementation date – Basel III alone looks set to force banks to adopt substantially tougher capital standards.

(International banks are expected to mount a fierce lobbying campaign on BASEL III's implementation ahead of the next G20 meeting in Cannes in November. It is also worth noting that the 'surcharge' under BASEL means the largest banks will have to hold as much as 9.5% of equity to risk-weighted-assets, not that far out of line with the ICB's model).

Some of these shifts are not entirely unwelcome for City law firms – which have always generated more lucrative assignments from banks' advisory work rather than their trading and investment activities. This burst of regulatory activity also explains a gradual move by law firms away from overwhelming reliance on transactional work in favour of larger regulatory and contentious practices. Such a sustained push will likely see regulatory issues take an increasingly prominent role in capital markets work, particularly with a new generation of loss-absorbing bonds that will be issued under Basel. Indeed, the biggest challenge for regulatory lawyers these days is just keeping up.

Says Gleeson: "We've got the biggest financial regulation team in the City, and we're stretched to breaking point. I'm not entirely confident that we're keeping up with all this stuff – and if we can't keep up, I'm not sure who can." Even if the ICB's report is ultimately ditched, for advisers it will most likely prove just one battle in a war that will continue to rage for years.