Finance Alerter: PRA Consultation on supervising international banks in the UK
UK's Prudential Regulation Authority (PRA) consults on its approach to international bank branch supervision. The PRA is currently consulting on its proposed approach to supervising UK branches of international banks. It recently published a consultation paper Supervising international banks: the PRA's approach to branch supervision (CP4/14) (the "Paper"). The consultation is open until 27 May 2014.
International banks in the UK
International banks can either operate in the UK as subsidiaries (i.e. through a separately incorporated subsidiary company) or branches (i.e. an office that is legally a part of the legal entity in the home county jurisdiction) and this consultation relates to the latter. It can be more efficient to operate as a branch - a branch does not require its own capital base in the UK or a separate board and there are therefore savings in costs of capital, governance costs, administration and reporting. As a result, operating through a branch has been a popular means of coming to the UK - the PRA notes that there are currently 145 branches of international banks operating in the UK; accounting for some 31% (£2.4 trillion) of the total assets of the UK banking system. However, for regulators branches can be more problematic as they are more difficult to supervise and the UK regulators have, to a lesser or greater degree, to rely on supervision and regulation in the home state.
The paper discusses the PRA's new approach to regulating such branches, in particular in the light of its concern to safeguard what it defines as critical economic functions ("CEFs" which are broadly retail banking; corporate banking; payments, clearing and settlement; custody; intra-financial system borrowing and lending; and / or investment banking). The new proposals discussed in the Paper are an attempt to strike a balance between welcoming in foreign capital and investment on the one hand, but protecting the UK financial system and the Financial Services Compensation Scheme from imported banking crises on the other.
The PRA's proposals
The proposals in the Paper cover branches of both institutions from within the European Economic Area and branches of financial institutions from outside the European Economic Area (non-EEA branches). It is proposed that all such branches complete a new data collection return. However, the proposals in the Paper are likely to have the biggest impact on the 82 non-EEA branches offering retail and wholesale banking. The PRA's approach will centre on an assessment of 3 aspects: (i) the equivalence (or not) of the home state's supervision ("HSS") of the whole firm; (ii) the activities of the UK branch and in particular whether CEFs are carried out; and (iii) the level of assurance that the PRA gains from the HSS over "resolution" (not defined, but broadly the arrangements in place to allow an orderly succession of the business and minimal disruption to customers and the market in the event of financial failure). The PRA states that it will place most emphasis on resolution and identifies this as a key deciding factor; including addressing concerns over sharing of information by the HSS and certainty that the home state will not put national interests ahead of international objectives. When the PRA has assessed that the HSS is equivalent and has sufficient assurance on resolution, the PRA will require a firm-specific agreement on the responsibilities for prudential supervision on the branch and an appropriate level of information sharing.
The PRA states that it expects new non-EEA branches to focus on wholesale banking and to do so at a level that is not critical to the UK economy. The Paper also makes it clear that the PRA will only be content for non-EEA branches to undertake anything more than minimal retail banking activities if there is a very high level of assurance about their HSS crisis-management plans.
An expected impact of the PRA's new supervisory approach is that some international banks will need either to transfer their UK branches into new, separately capitalised and authorised subsidiaries or cease or reduce their UK retail banking services or other activities that might be regarded as CEFs.
Conversion to a bank subsidiary
For non-EEA international banks considering converting a branch to a subsidiary, there are various routes available for this. This can be effected by a private Act of Parliament or by a contractual transfer of business, involving individual novations of the contracts of every account-holder and contract counterparty. Except in the simplest cases, these methods are likely to be highly impractical and costly.
The most practical way to implement a branch conversion in the UK is to set up a subsidiary and use a Court approved "banking business transfer scheme" under the Financial Services and Markets Act 2000 (FSMA) (a "FSMA Scheme") to transfer the branch's deposits together with the rest of the business from the branch to the new subsidiary. The principal advantage of a FSMA Scheme is that the Court has a wide discretion and can sanction the transfer of contracts and arrangements where consents from customers and contract counterparties would otherwise be required. The Court must be satisfied that no customer or contract counterparty is disadvantaged and may impose conditions; although if the PRA and the Financial Conduct Authority (FCA) have indicated they are satisfied, it will not normally do so.
A FSMA Scheme would entail due diligence on the assets and liabilities of the branch, preparation of the FSMA Scheme document and other steps required for the FSMA Scheme e.g. witness statements, gazette and other advertising, and circulars to bank customers. Although the Court has extensive powers under a FSMA Scheme, it is sometimes more appropriate to transfer some arrangements outside of the FSMA Scheme. Complex derivative arrangements are an example where this can be a better approach. The transfer of bank branch employees to the bank subsidiary will happen automatically under the relevant employment regulations (TUPE) and therefore not be part of the FSMA Scheme. In addition, some of the assets, liabilities and contractual arrangements may be subject to laws of jurisdictions outside England. It is then necessary to consider whether the FSMA Scheme would be recognised and given effect in those jurisdictions.
Other UK-centric issues that need to be considered in the context of a FSMA Scheme include that certain registrations need to be applied for by the new subsidiary as they cannot be transferred, such as its FSMA authorisation, and data protection registration. The relationship of the new subsidiary to the parent also needs to be considered, including the form and structure of the new subsidiary's capital, whether any large exposures to the parent entity would be created by the split and whether there are any service contracts which would need to be split. It is often necessary to update registrations, for example in respect of security granted to the branch at the Land Registry (although in the case of a transfer scheme there is a system of bulk registration which makes this easier) and in local registries where overseas customers have granted security in favour of the branch.
We have advised a number of international (and domestic) financial services clients operating in the UK including banks and insurance companies on such "subsidiarisation", implementing transfer schemes and related issues. If you have any comments or questions on the issues discussed above or about how Fieldfisher could assist in relation to them please contact Oliver Abel Smith, Nicholas Thompsell, Shash Dayal or your regular Fieldfisher contact who would be happy to discuss further.