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Banking Act 2009 (Third Party Compensation Arrangements for Partial Property Transfers) Regulations 2009

Noble Lords will recall that partial property transfers attracted significant interest in debates during the passage of the Banking Act. These statutory instruments provide legislative safeguards for creditors and counterparties of UK banks by directly responding to concerns that partial property transfers made under the Banking Act 2009 could negatively affect their rights and interests. Although the debate should not be difficult, it is unlikely to involve simply going through the motions. Overall, the policy issues involved are complicated. Noble Lords will recall that there was close consultation with stakeholders in connection with the Banking Act 2009. I believe that these regulations provide strong legislative safeguards for creditors and counterparties of UK banks in the event of a partial transfer. They address the concerns put to the authorities that partial property transfers could negatively affect creditors’ and counterparties’ rights and interests. If counterparties and creditors of UK banks do not have legal certainty as to how partial property transfers may affect their contractual interests and their position as creditors of a failed bank, negative market consequences are likely. The contractual interests that could be affected include risk reduction arrangements, such as set-off and netting arrangements, and financial collateral arrangements. The possible negative market consequences of a lack of legal certainty in this area could include higher regulatory capital requirements and cost of funding for UK banks. As stated in the consultation stages for the SRR and during the parliamentary stages of the Act, the Treasury's aim in providing these legislative safeguards has always been to avoid damaging negative financial market consequences as a result of taking partial property transfer powers. I believe that this aim will be delivered by these instruments, which provide legal certainty to the market and an assurance that the Government would have to have regard to leaving creditors no worse off after a partial property transfer. As well as running a full public consultation process, with the publishing of a dedicated consultation document on 6 November 2008, the Treasury has worked extensively with industry stakeholders, particularly with the expert liaison group, presently being replaced by the statutory Banking Liaison Panel, to reach an outcome acceptable to both the market and the authorities. As the Committee may be aware, during this process, the Government listened to the concerns raised by noble Lords and others and moved their policy significantly towards providing the market with greater legal certainty. I now turn to the safeguards order in more detail. The safeguards order is made under Sections 47 and 48 of the Act. In summary, it provides legislative protection against possible disruption under a partial property transfer for important risk management arrangements and other financial arrangements in use in the markets today. These arrangements include set-off and netting arrangements, financial collateral arrangements and structured finance arrangements. The Committee will be aware that the Government have provided broad protection for set-off and netting. The order provides that property included under a counterparty’s set-off and netting arrangement with a bank may not be split up under a partial transfer. The possibility of damaging cherry-picking of a counterparty's relationship with a failing bank is therefore avoided, and the ability to obtain clean legal opinions in relation to the effectiveness of set-off and netting should not be compromised. However, to allow the authorities necessary flexibility to carry out partial transfers in the interests of financial stability and depositor protection, the order features a number of carve outs from the protection provided. The most notable of these is property belonging to a Financial Services Compensation Scheme eligible person, which is not covered by the set-off and netting safeguard. This particular carve out from the set-off and netting safeguard will allow the authorities to transfer, for example, the retail deposit book of a failing institution to a solvent new company in a short time-frame, which is important to allow the authorities to provide continuity of service, which was an interest of a number of noble Lords who spoke in the debates during the passage of the Bill, and to protect public confidence. I now turn to an important point on the practical effect of the order. Property that is not covered by the set-off and netting safeguard under the order is referred to as "excluded rights" or "excluded liabilities". Under the order, the authorities may choose to, for example, transfer only the excluded rights and liabilities and leave the remaining rights and liabilities in place in the original entity, regardless of any wider set-off and netting arrangement that the authorities would otherwise have needed to have kept whole. However, it is not the Government's policy intention that the presence of excluded rights or liabilities under a wider set-off and netting arrangement should render that entire arrangement unprotected by the order. I would like to make it clear that, in the Government's view, the drafting of the safeguards order does not yield this legal effect. I am aware that some market participants are concerned that the scope of the safeguards order is not wide enough, in particular with regard to the protections provided for set-off and netting. I understand that these concerns are primarily related to technical drafting, rather than the property that the order clearly excludes as a result of government policy, and that there are varied legal interpretations on whether some relevant financial contracts have been excluded. Let me say that the Government remain committed to a safeguard regime that is as effective as possible and appreciate these potential concerns. Indeed, the Government have already been clear that the safeguards will be subject to review and, as noble Lords will remember, the Banking Act provides for a Banking Liaison Panel of financial services representatives to keep the ongoing effect of the existence of the special resolution regime under review. As part of the Government's existing commitment to work in partnership with the industry in this area via the panel, I can announce that one of the first orders of business for the panel will be to review the safeguards order. If changes to the order are necessary and are compatible with the authorities' flexibility, the Government will make such changes before the Summer Recess. I hope this will reassure stakeholders on this point. However, I should make clear that while an initial review this summer is appropriate, and while the panel will advise the Government on possible changes needed in the future, perhaps sparked by market innovation, it is not the Government's intention continually to change the safeguards order. Any perception that the order is subject to constant change could itself damage the certainty the order intends to bring to the market. Taking a little more time to review the order should allow a less hurried process for the Government and industry stakeholders definitively to iron out any the outstanding concerns in the medium term. I now turn to the next safeguard featured in the order. This safeguard protects financial collateral and other secured arrangements to which a bank is party. In short, it provides that where either party has a security interest over an asset held by its counterparty, related to a liability owed by that counterparty, the asset may not be split up from the liability under a partial transfer. In this way, counterparties can continue to be confident that they will be able to have recourse to security they have taken. There is also a safeguard for financial arrangements broadly covered by the term "structured finance". These arrangements are referred to as "capital markets arrangements" and refer to, for example, covered bonds and securitised vehicles. The safeguard provides that partial property transfers may not interfere in the operation of such arrangements to which a bank is party by transferring some, but not all of the relevant property, rights or liabilities. Noble Lords may recall from the later stages of the debates on the Act that we discussed issues related to events of default and financial contracts. The statutory instrument provides certainty for counterparties that a partial property transfer will not prevent them from calling events of default in relation to specified financial instruments, or set-off, netting or title transfer financial collateral arrangements. The measure also protects the operations of important central market counterparties, such as clearers and settlement houses from possible disruption under a partial property transfer. For example, clearing house default rules, which are given legal force by Part VII of the Companies Act, are given explicit protection. I now turn to third party compensation arrangements regulations, which are made under Section 60 of the Act. Their purpose is to ensure that, following a partial transfer, no creditor will be worse off than he would have been had the whole bank been put into an insolvency procedure. In summary, the regulations provide that, where certain stabilisation options have been exercised under Part 1 of the Banking Act the, ""compensation scheme order or a resolution fund order"—" must— ""include a third party compensation order"." This compensation order must or may include certain provisions: for example, it must provide for the appointment of an independent valuer; and it must provide for the valuer to assess the treatment that the creditors of the failing bank that was subject to a partial transfer, would have received had the whole failing bank been put into insolvency. The order must also provide for the valuer to assess the treatment which such creditors have received, are receiving or are likely to receive if no compensation or further compensation is paid. If the independent valuer determines that a creditor in such a situation has been made worse off than he would have been had the bank entered insolvency, he must consider the compensation to be paid to that creditor. In assessing the amount of any compensation the valuer would be obliged to follow the principles specified in the regulations. These include the principle that no financial assistance would have been provided to the bank by the Bank of England or the Treasury after the relevant time specified in the regulations. I remind noble Lords of the important protections that these statutory instruments provide to the market. I believe that this legislation, formed in intensive consultation with the industry, meets the vast majority of the market’s concerns. The Government are committed to working with the industry to ensure that the regime is as effective as possible. I thank various stakeholders for their hard work on this subject up to this point. I commend the draft regulations and order to the Committee.