Simmons' James Bresslaw outlines the UK Government's response to the ICB's recommendations for a banking system reform

The Independent Commission on Banking (ICB) published its final recommendations on the reform of the UK banking system in September last year. The Government issued its formal response shortly before Christmas. The scale of the proposed reforms is immediately apparent from the first page of the Government's response, which begins: "This Government is proposing the most far-reaching reform of British banking in our modern history".

The recommendations of the ICB, and the manner in which they will be implemented, raise important commercial issues for the affected UK banks, as well as legal issues for their advisers. Here, we consider a number of these and focus on what lies ahead in 2012 in terms of implementation.

The ICB was appointed after the 2010 election to consider the structure of the UK banking sector and to look at both structural and non-structural measures to reform the banking system and to promote competition.

On structural reform, the ICB recommended ring-fencing UK retail banking from investment banking and imposing stricter capital and leverage ratios to strengthen banks' capacity to absorb losses. On competition, the ICB recommended that the divestment required of Lloyds Banking Group be enhanced to ensure that any emerging entity can compete effectively, and 
also recommended a range of 
other measures to promote competition, such as an easier method for switching personal current accounts.

The Government broadly welcomes the recommendations of the ICB. It declares that the ICB provides a compelling answer to the "British dilemma", namely how Britain can be the home of some of the world's leading banks without exposing British taxpayers to the costs of those banks failing. Inherent in this statement lies one of the themes that runs throughout the ICB's recommendations on structural reform: how to deal with the issue of a bank being considered "too big to fail".

From a commercial perspective, the cost of implementing the reforms remains a central concern for affected banks. The ICB estimated that the annual pre-tax costs to UK banks of the proposed reforms would range from £4bn-£7bn. The Government has broadly accepted that estimate, although it has adjusted the cost range, setting the range from £3.5bn-£8bn.

In evidence before the Select Committee on Economic Affairs of the House of Lords in October last year, some banks expressed the view that the uncertainties over how the reform package would be implemented precluded reliable costing. Later, written submissions to the committee revealed diverging opinions.

Lloyds Banking Group assessed that, if implemented well, the benefits to the wider economy could outweigh the costs. Barclays believed that the broad range of costs set out by the ICB was a reasonable estimate. HSBC believed that ICB had underestimated extra funding costs. The Royal Bank of Scotland estimated that the actual costs of the reforms would be higher than those estimated by the ICB. Santander believed that the ICB had underestimated all-in costs. The quantification of the costs was, and remains, a vexed issue for affected banks.

From a legal perspective, the Government's response to the ICB's proposals raises a number of different issues across a range of practice areas. A primary area of regulatory concern is how the ICB's recommendations will fit in with domestic, European and international regulatory initiatives. This concern was neatly summed up in evidence given by Peter Sands, chief executive of Standard Chartered Bank, before the Treasury Select Committee of the House of Commons on 14 December last year. He expressed concern that the sheer complexity of having so many different overlapping initiatives brings with it a risk of unintended consequences because it is difficult for one set of regulators to see through the complex mix of changes that are being implemented.

The Government's response notes the close link between the ICB's recommendations and the current proposals emanating from a range of international bodies for dealing satisfactorily with bank failure. Banks are already keenly aware of this linkage. In his evidence before the Select Committee on Economic Affairs of the House of Lords on 11 October last year, Barclays Bank chief executive Bob Diamond stated that no taxpayer money should ever be at risk from bank failure and pointed out that the critical component in achieving this was having resolution and recovery plans (or living wills) in place.

The Government confirms its commitment to fostering a competitive banking sector and agrees that the emergence of a strong and effective challenger bank from the Lloyds Banking Group divestment would contribute to enhancing competition. The Government accepts the ICB's recommendations to make switching current accounts easier for customers and small businesses and has agreed with the banking industry that by September 2013, a system of switching within seven days, with direct debits and credits being redirected automatically at no cost to the consumer, will be in place.

The response further raises the prospect of requiring 'full account portability' should the measures not deliver the expected consumer benefits. The Government also agrees that the Prudential Regulation Authority and Office of Fair Trading should work together to consider what further improvements could be made to the Financial Services Authority's authorisation process and prudential requirements. It is also considering a number of reforms to bring the Payments Council within the scope of financial regulation. A consultation will take place this year.

Banks are, of course, already well able to manage the employment aspects of major restructuring exercises. There may have to be significant changes to central terms and conditions such as duties, reporting lines, remuneration and reward practices, particularly for senior staff, and renegotiation of existing arrangements for protecting business interests. The differences facing banks under the proposed legislation will be of scale and complexity, in terms of numbers of people involved and the timeframe for transferring employees between entities and, possibly, jurisdictions. One issue that will involve careful planning is the restructuring of pension liabilities across the different legal entities to avoid unintended and untimely cash calls to fund deficits in occupational defined benefit schemes.

The Government's response to the ICB's proposals on the height of the ring-fence in terms of legal and operational links has been positive. It agrees that the ring-fenced banks need to be able to demonstrate operational separability. One key issue that remains is the preferred structural solution to ensuring that the ring-fenced bank can demonstrate such separability.

While the ICB outlined three possible structures to achieve this, the Government response mentions only two: the ring-fenced bank directly owning its own separate operational infrastructure or the relevant infrastructure being hived down to a separate subsidiary. The Government may have rejected the third option (the relevant infrastructure being provided independently of the ring-fenced bank either by other group companies or third parties) on the basis that this will not enable the ring-fenced group to demonstrate it is operationally separate.

The ICB recommended that the necessary legislation and rules to implement the proposals be put in place by no later than the beginning of 2019. However, the Government's response states that it intends to implement the proposed reforms in stages, with the final changes being those relating to loss-absorbency.

In the shorter term, the Government promises to bring forward a white paper setting out in detail how the ICB's recommendations will be implemented in the spring of this year. A three-month consultation will follow, after which the Government will introduce primary legislation into Parliament.

All the legislation necessary to introduce the ring-fence is intended to be in place by the end of the current Parliament, namely May 2015, and banks will be expected to comply as soon as practically possible after that.

An important caveat in terms of the timetable for implementation of the reforms is the Government's recognition that implementation cannot take place in isolation from European and international developments. In particular, the Government mentions amendments to the Capital Requirements Directive, the introduction of a Capital Requirements Regulation and proposals to develop a European crisis management framework.

In conclusion, 2012 will provide numerous commercial and legal issues for consideration by UK banks and their advisers insofar as the implementation of the ICB's recommendations are concerned.

James Bresslaw (pictured above) is a partner and head of the banking group at Simmons & Simmons.

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