Reforming the UK ring-fencing regime

As trailed in the 2022 Edinburgh Reforms, the government and PRA have issued a three-part package of proposals and recommendations aimed at reforming the UK ring-fencing regime. The package seeks to make the regime more flexible, proportionate and internationally competitive, while still safeguarding the safety and soundness of the UK banking system.

HM Treasury (HMT) has issued a consultation specifying amendments to the current ring-fencing regime. In parallel, the PRA is consulting on changes to its rules that would integrate with HMT's amendments, particularly around managing the risks of establishing and maintaining third-country branches and subsidiaries. And finally, HMT has published a response to its Call for Evidence on aligning the ring-fencing regime with the UK's resolution framework.

The UK's ring-fencing regime was legislated for in the Financial Services (Banking Reform) Act 2013 (FSBRA) and came into full effect on 1 January 2019, with UK banks holding more than £25 billion of "core deposits" required to legally separate their retail banking services.

The FSBRA included a requirement for the government to commission an independent review of the regime within two years of it coming into full effect. The final review report (2.17 MB), delivered in March 2022, made seven key recommendations which sought to make the regime more flexible and proportionate, whilst maintaining appropriate financial stability safeguards and minimising risks to public funds. In December 2022, as part of the Edinburgh Reforms, the government announced its intention to consult on a series of near-term reforms to the ring-fencing regime — broadly taking forward the recommendations of the independent review.

HMT's September 2023 consultation (514 KB) on near-term reforms to the regime includes proposals to:

• Increase the ring-fencing deposit threshold from £25 billion to £35 billion of 'core deposits'.
• Exempt from the ring-fencing regime retail-focused banks with trading assets of less than 10% of tier 1 capital, except where they are part of a G-SIB.
• Allow ring-fenced bodies (RFBs) to incur an exposure of up to £100,000 to a single relevant financial institution (RFI) at any one time.
• Allow RFBs to establish operations outside the UK or EEA.
• Introduce a four-year transition period for complying with the ring-fencing regime for ring-fenced banking groups that acquire a bank not subject to the ring-fencing regime.
• Permit RFBs, subject to limits, to:
  • Make direct minority equity investments in UK SMEs;
  • Make investments in funds which invest predominantly in UK SMEs; and
  • Acquire equity warrants when providing loans to UK SMEs.

•  Permit RFBs to:
  • Incur exposures to RFIs that qualify as SMEs.
  • Undertake a wider range of standard trade finance activities.
  • Offer inflation swap derivatives.
  • Hedge mortality risk.
  • Deal in investments as principal for the purpose of correcting the failure of a securities trade which is due to error.
  • Deal in investments as principal for the purpose of undertaking test trades.
  • Deal in investments as principal where they are divesting debentures.
• Clarify that RFBs:
  • May incur exposures to RFIs when they act as a trustee for minors or charitable incorporated organisations.
  • Are permitted to offer certain collars.
  • Are permitted to incur exposures to RFIs where the exposure arises from correspondent banking arrangements, which involve more than two credit institutions.
• Broaden the scope of the existing exemption that permits RFBs to engage in "debt for equity swaps".
• Permit non-ring-fenced banks (NRFBs) to service central banks outside the UK.
• Provide that a structured finance vehicle (SFV) qualifies as a sponsored SFV of an RFB where its assets were created or acquired by that RFB or another RFB in the same group.
• Introduce a 12-month grace period for NRFBs to move customers that are no longer classified as an RFI to RFBs.

HMT's consultation closes on 26 November 2023, with the government planning to introduce legislation in parliament in early 2024 (subject to parliamentary time).

The PRA's consultation (CP20/23) puts forward changes that would enable HMT's proposals to be incorporated into its Rulebook. In particular, CP20/23 addresses policy updates regarding the establishment and maintenance of third-country branches and subsidiaries within RFB sub-consolidation groups. The proposals would:

• Introduce a rule whereby RFBs must ensure that any third-country branch or third-country subsidiary within the RFB sub-consolidation group does not present a material risk to the provision of core services in the UK by the RFB; and
• Set out a non-exhaustive set of supervisory expectations that the PRA will consider when determining if a third-country branch or third-country subsidiary of an RFB or ring-fenced affiliate poses a material risk to the provision of core services in the UK by the RFB.

Overall, the PRA proposals seek to ensure that the benefits of the amendments proposed by HMT, i.e. allowing RFBs to compete with international and domestic banking groups, can be realised in a way that supports the safety and soundness of these banks.

The PRA consultation closes on 27 November 2023.

As the third piece of the package of reforms, HMT also published a response to its Call for Evidence on aligning the ring-fencing and resolution regimes. The Call for Evidence was issued in March 2023, in response to the independent review's recommendation on the longer-term future of the ring-fencing regime. 

HMT found that respondents provided limited evidence and a broad, mixed range of views on:

• The ongoing benefits that ring-fencing provides to financial stability not found elsewhere in the regulatory framework; and 
• The options for aligning the ring fencing and resolution regimes. 

The government will continue to work with the Bank of England (BoE) and PRA, through the joint ring-fencing task force, to consider the benefits of ring-fencing that should be retained and will set out publicly its policy response and any proposals for further reform in the first half of 2024.

HMT intends this package of reforms to improve outcomes for banks and their customers as well as benefitting competition and the competitiveness of the UK banking sector. 

However, if taken forward, RFBs will need to re-examine their structure and controls around thresholds. This is likely to have particular impact on the most significant UK banks which are set to begin their second Resolvability Assessment in October.

HMT, working with the BoE and other relevant authorities, has also noted that lessons learned from recent failures in the banking sector should be considered as part of any case for further reform.