Consultation on Near-Term UK Ring-Fencing Regime Reforms

HM Treasury has launched a consultation on proposed near term reforms to the U.K. ring-fencing regime—"A Smarter Ring-Fencing Regime"—and published its response to its call for evidence on the practicalities of aligning the ring-fencing and resolution regimes for banks. These potential changes to the four-year-old ring-fencing regime were announced in the government's Edinburgh Reforms, which we discuss in our client note: "UK Government Publishes Edinburgh Reforms for Financial Services."

The near-term reform proposals respond to the recommendations of the Independent Review on Ring-fencing and Proprietary Trading conducted by Sir Keith Skeoch. The proposals for near-term reforms would involve:

• Raising the threshold for banks to be within scope of the regime from £25 billion to £35 billion in "core deposits."
• Removing banks that do not have major investment banking operations from the ring-fencing regime entirely. HM Treasury is proposing to exempt retail-focused banks with trading assets of less than 10% of Tier 1 capital, except where they are part of a Global Systemically Important Bank.
• Introducing a de minimis threshold to allow RFBs to incur an exposure of up to £100,000 to a single "relevant financial institution" (e.g., another bank, certain insurers or an investment firm) at any one time, and permitting RFBs to incur exposures to RFIs that qualify as SMEs (determined by reference to certain thresholds) as well as clarifying that RFBs may incur exposures to RFIs when they act as a trustee for minors or charities.
• Revising the list of activities which RFBs are prohibited from undertaking, with a view to allowing RFBs to conduct certain activities, for example, allowing RFBs to deal in investments as principal for the purposes of undertaking test trades, correcting the failure of a securities trade which is due to error or for divesting debentures, and permitting RFBs to undertake a wider range of standard trade finance activities.
• Removing the prohibition on RFBs that prevents them from operating in or servicing customers outside the U.K. and European Economic Area. The U.K. Prudential Regulation Authority is consulting on its proposed rule and policy changes relating to the establishment and maintenance of third-country branches and subsidiaries within RFB groups, responses to which should be submitted by November 27, 2023.
• Improving the operation of the regime with various technical amendments, such as introducing a transitional regime in the event of a merger or acquisition of a bank.
• Facilitating investment by RFBs in small and medium enterprises (SMEs), including allowing RFBs to make direct and indirect equity investments in U.K. SMEs.

The consultation paper is accompanied by draft secondary legislation that would implement the near-term reforms—the draft Ring-fenced Bodies, Core Activities, Excluded Activities and Prohibitions (Amendment) Order. Responses to the consultation, including feedback on the draft Order, may be submitted until November 26, 2023. HM Treasury intends to lay legislation implementing these changes in early 2024.

Regarding the practicalities of aligning the ring-fencing and resolution regimes for banks, the government intends to publish its policy response to the call for evidence and will consult on any further proposals for reform of the ring-fencing regime in the first half of 2024.

A Financial Markets Law Committee paper published in November 2021, to which Shearman & Sterling contributed, set out a series of very detailed potential reforms to make the ring-fencing regime more effective and eliminate uncertainties and difficulties with the regime. For the most part, the current proposals do not address the issues raised in that paper. HM Treasury is however proposing two important changes; the introduction of the de minimis threshold to allow RFBs to incur an exposure of up to £100,000 to a single RFI, and those that will permit RFBs to have exposures to RFIs that qualify as SMEs.

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