David Strachan, head of Deloitte’s EMEA centre for regulatory strategy, comments on the deadline for near-final ring-fencing submissions
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On 15 October 2015, the Prudential Regulation Authority (PRA) asked the UK’s six major banks that are subject to ring-fencing to submit near-final plans for the creation of ‘ring-fenced banks’ (RFBs). Outlined in CP47/15, the deadline to submit to their PRA and Financial Conduct Authority (FCA) supervisors has recently elapsed. These plans build on initial thinking that was sent a year ago and include project arrangements, operating and governance structures and financial proposals.
As the implementation deadline of 1 January 2019 approaches, there has been greater focus on what ring-fencing means for certain business lines within the six banks. Those impacted are in the process of rolling out their new legal structures. Some with larger investment banking operations have publicly announced they are creating new RFBs which will require depositors to be migrated. Private banking is a business where the bank (in the main) has a degree of flexibility over the side of the fence on which the customer sits, and in some cases they are likely to be on both.
Ring-fencing rules will have a number of implications for private banking customers. For example:
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By GlobalData– Only individuals with £250,000 of deposits and/or transferable securities (held over a period of at least twelve months) are eligible to deposit with the non-ring fenced bank (NRFB). Where banking groups decide to offer deposits to this customer segment from the NRFB, the FCA requires the bank to provide customer information regarding the impact of depositing on the non-ringfenced side.
– A stipulation of the RFB and its subsidiaries is that it cannot offer deposit accounts outside of the European Economic Area (EEA). This also means that the RFB cannot offer deposits in the Channel Islands or Isle of Man. High net worth, multi-national individuals often require deposit accounts in some or all of these jurisdictions. By virtue of this rule, the ease of service for customers could be hindered as they will be required to deal with both sides of the ring-fence.
– Ring-fencing regulations also only allow the RFB to sell ‘simple’ derivative products to customers, such as referencing currencies, interest rates or commodities. The level of market risk that the RFB can accept is limited, thereby constraining the range of structured deposit products that can be provided. For example, deposits which offer a return linked to equities are not permissible to private customers.
– The RFB is permitted to sell products manufactured by the NRFB on an ‘arms-length’ agency basis1 . However, the revenue that can be generated from cross-sales between the RFB and NRFB is also subject to monitoring to ensure neither side becomes too dependent on revenues generated from such activity.
– From a compliance perspective, the product governance mechanism will be more complex post ring-fencing. For example, the non-ringfenced side will need to consider the suitability of products to a target distribution market which will include customers from both sides of the ring-fence.
In theory, this leaves banking groups subject to ring-fencing with two possible models to serve their private banking customers. When making this decision, banks need to consider, amongst other elements, profitability, return on capital and the impact on customer value and satisfaction.
Model 1: Segment existing private banking customers between RFB and NRFB – This option makes it possible for more sophisticated private banking customers to have access to a range of products and jurisdictions that the bank can offer. Under such a model, customers with deposits under the £250,000 threshold of investable assets are likely to be offered a more limited range of deposit products. To the extent that the needs of the majority of each customer segment can be served respectively by the RFB and NRFB, it should be possible to retain a single banking relationship in most cases. Where a customer of the RFB requires a prohibited product (manufactured by the NRFB), they can receive this on an agency basis from the RFB. As some customers’ financial circumstances change, they may ‘transition’ from one side to the other. Segmentation by customer type rather than product may work most efficiently where the banking group has material subsidiaries in jurisdictions mandated to sit outside the NRFB, such as Switzerland.
Model 2: Product split between RFB and NRFB – This option makes it possible for private banking customers to obtain essential banking products like current accounts, credit cards, and deposits from the ring-fenced side. More complex products can also be offered, as well as non-EEA bank accounts, from the NRFB. This model requires having relationships with two different banks, which some may see as disadvantageous.
There are significant uncertainties to be taken into account, which may lead to banks adopting a blend of the two. For example it is still unclear whether the NRFB will have a lower credit rating than the bank or group today, arising from the reduction in diversification of business and funding. Even without rating changes, private banking customers may perceive the RFB to be ‘safer’ than the NRFB and hence prefer to hold deposits with the RFB under model 1. Additionally, under model 2, eligible customers may decide to move elsewhere unless they can opt into the NRFB where for a ‘one stop shop’ service.
In summary, ring-fencing rules pose a number of challenges for the banks concerned, in particular those with material private banking arms. The potential disruption to customers on implementation, together with the prospect of having to deal with both sides of the ring-fence after this may lead high net worth clients elsewhere. For those UK private banks that are not subject to ring-fencing threshold and the UK private banking subsidiaries of the major US and Swiss banking groups, this presents an opportunity to obtain market share.
1The ring fencing regulations allow the ring-fenced bank to hold the FCA permission to ‘deal as agent’ in a more complex products including those prohibited to be ‘dealt as principal’ by the RFB’
David Strachan, Head of Deloitte’s EMEA Centre for Regulatory Strategy
