Following the financial crisis of 2007 to 2008 and the ensuing banking crisis, the UK’s response, designed to reduce the probability of future occurrences, included the creation of the Independent Commission on Banking (ICB). It made a number of banking reform recommendations, including a ‘ring-fencing’ legislation.
In essence, these require banks to ‘ring-fence’ / separate their high street (retail) businesses from their investment banking arms; ensuring a division of both assets and operational activities. The core driver behind this is to ensure that the ring-fenced bodies (RFBs) are protected from shocks that originate in the rest of their banking group or the financial system in order to minimise disruption to the continuity of the provision of core services, reducing systemic risk.
Banks must comply with ring-fencing legislation by 1 January 2019, and the regulatory requirements are still to be fully defined through a consultative process with the affected banks and relevant regulatory bodies (i.e. the Prudential Regulation Authority and the Financial Conduct Authority). So are banks ready?
Where do banks draw the line?
However, implementing this regulation is no simple task. Before we even consider the operational implications, simply developing the distinction between ‘ring-fence’ and ‘non-ring-fence’ activities is not clear cut and there is no single test which can be applied. Banks are able to work off of a set of parameters to distinguish this, for example:
- Timing: transactions which complete prior to 2019 and any investments which mature before 2021 can stay within the RFB (ring-fence bank).
- Products: no products which deal in investments as principle can stay within the RFB. Only very ‘simple’ derivative products can remain in the RFB
- Geography: all non-EEA (European Economic Area) activity cannot stay within the RFB.
Although this is by no means exhaustive, it should provide a flavour of the factors which can be considered when defining the perimeter of the ‘fence’, while also highlighting the complexity involved. Particularly in relation to the separation of products and their associated risk / complexity, one can think of an analogy with the risk associated with a knife.
A sharper knife does not always mean a more dangerous knife, just as a more complex derivative does not always mean a riskier product, and vice-versa. There can be just as much, if not more, risk associated with a butter knife and a simple forward spot currency contract, as there is with a samurai sword and an extremely complex derivative product linked to multiple indexes!
A coordinated approach to regulatory change
If we move on to the challenges faced by banks in the implementation of the required changes to ensure compliance, one of the key issues faced by banks relates to the successful alignment of delivery with in-flight projects, working to similar delivery dates. Banks have already mobilised their ‘ring-fencing’ change programmes, with the January 2019 deadline ever approaching and it is becoming evident that there are clear overlaps with existing regulatory change programmes.
The Senior Managers Regime (SMR) and Fundamental Review of the Trading Book (FRTB), for example, both have an impact on ring-fencing in relation to the accountability of ‘non-ring-fence’ senior manager accountability and feasibility in a shared services model (i.e. RFB senior managers providing a service to both entities), as well as the associated capital requirements when using standardised methods of market risk calculation, respectively.
These issues, too often, are only identified as a reaction (once an issue has developed) rather than proactively identified as part of broad planning activities. This requires a lot of re-work and provides a challenge as people often look to map dependencies too late into a process. The lack of an overarching strategy, or a framework, for regulatory change which takes a holistic view of the disparate regulatory requirements banks face can put real pressure on delivery.
Owners of respective regulatory programmes are typically the most affected areas, which seems intuitive, but this is not always optimal. This model means that the accountable parties do not always have sight of interdependencies. Banks need to develop central Regulatory Change strategies, frameworks for regulatory compliance and forums for collaboration and alignment. This more central approach, even if this is only in the form of oversight or governance, will ensure better coordination and ultimately successful delivery.