Banking Act 2009 and Failing Banks

BANKING ACT 2009 AND FAILING BANKS

The Banking Act 2009 is the Government’s main legislative response to the current banking crisis affecting us all – there had earlier been the Banking (Special Provisions) Act 2008.  The 2009 Act, which comprises 265 sections, was passed on 12th February, 2009, with most provisions being brought into force soon afterwards under the Banking Act 2009 (Commencement No 1) Order (SI 2009 No 296).  Various provisions of Part 7 were brought into force on 1st June, 2009 by the Banking Act 2009 (Commencement No 2) Order (SI 2009 No 1296)

The Act has subsequently been followed by a Government White Paper, entitled “Reforming financial markets”, on 8th July, 2009.  This White paper has a consultation period running until 30th September, 2009, and can be accessed at the following URL:
www.hm-treasury.gov.uk/d/reforming_financial_markets080709.pdf

There has been a further report, this one commissioned by HM Treasury, dealing with corporate governance of banks.  The report by Sir David Walker, is entitled, “A review of corporate governance in UK banks and other financial industry entities”, and was delivered on 16th July, 2009.  It is available on:
www.hm-treasury.gov.uk/d/walker_review_consultation_160709.pdf

In addition, the Financial Services Authority, has published two earlier papers.  First, “The Turner Report” (real name, “A regulatory response to the global banking crisis”, March, 2009), which is available at www.fsa.gov.uk/pubs/other/turner_review.pdf .  Secondly, there is the FSA’s Discussion Paper 09/2, “A regulatory response to the global banking crisis”, available at www.fsa.gov.uk/pubs/discussion/dp09_02.pdf

The main aim of this blog is to highlight some of the key points regarding how failing banks will be dealt with, or rescued, under Part 1 of the 2009 legislation.  Given the size of the Act, it will not be possible to go into any great detail – with some key points being highlighted.

PARTS OF THE 2009 ACT NOT DEALING WITH BANK RESCUES

However, before doing so, it is worth noting that the 2009 Act also deals with a range of banking related matters (not just regulation), as set out below:
(i) “The Financial Services Compensation Scheme” – Part 4 (ss 169-183 BA 2009), which amends various provisions of the Financial Services and Markets Act 2000 concerning the Scheme).

(ii) “Inter-bank Payments” – Part 5 (ss 181-206 BA 2009) – this part has not yet been brought into force.

(iii) “Scottish Bank Notes” – Part 6 (ss 207-227 BA 2009) – this part is also not yet in force, but will effectively replace the “permissions” under s 1 of the Bank Notes (Scotland) Act 1845, with a requirement that a bank is “authorised to issue bank notes”: see ss 207, 210- 214 BA 2009.  There is power for the Treasury to “make regulations” concerning ‘“backing assets”’ which banks issuing Scottish bank notes will be required to have: see ss 215, 217 BA 2009.  Such “assets” would include “bank notes issued by the Bank of England”, “current” “United Kingdom” “coins” and “funds in a specified kind of account held with the Bank of England”: see s 217(2) BA 2009.

(iv) “Bank of England” – “Financial Stability” – “Miscellaneous “ Part 7 (ss 228 – 247 BA 2009) – included in the “Miscellaneous” proposals, under Pt 7 of the BA 2009, is an amendment to the Bank of England Act 1998 by including provisions on “financial stability” as an “objective” of the Bank: s 238 BA 2009, adding new ss 2A-2C of the Bank of England Act 1998, amongst other changes to the 1998 Act.

(v) Floating Charges in Scotland – Pt 7 (s 253 BA 2009) – this provision, which came into force, makes minor amendments to s 38 of the Diligence and Bankruptcy (Scotland) Act 2008 (colloquially known as “the BAD Act”), concerning floating charges granted to a ‘“central institution”’ (being “the Bank of England”, a foreign “central bank”, or “the European Central Bank”: s 253(7) BA 2009).  This is an interesting example of primary Westminster legislation (the BA 2009) amending primary Holyrood legislation (the BAD Act).

(vi) “Funds Attached Rule” in Scotland – Pt 7 (s 254 BA 2009) – under this provision, which came into force on 12th April, 2009 (see s 263(2) BA 2009), the “funds attached rule”, which said that the presentation, to a drawee, of a bill of exchange has effect “as an assignation of the sum” of the bill (or such funds as are available if there are not enough funds available) in the bill holder’s “favour”.  This affects ss 53(2) and 75A of the Bills of Exchange Act 1882 and s 11 of the Law Reform (Miscellaneous Provisions) (Scotland) Act 1985: ss 254(4), (5) BA 2009.

FAILING BANKS AND THE 2009 ACT

The 2009 Act primarily deals with the situation of “failing” or “insolvent banks” and building societies by means of “Special Resolution Regimes” in Pts 1-3.  The focus of this note will be banks.

"SPECIAL REGIMES PROCEDURES"

Essentially, there are three such “procedures”:
(i) “stabilisations options” (ss 1-89 BA 2009 BA 2009) – the focus of this blog;
(ii) a “bank insolvency procedure” (see Pt 2, ss 90-135 BA 2009); and
(iii) a “bank administration procedure” (Pt 3, ss 136-168 BA 2009).
(See s 1(2) of BA 2009).

As readers will be aware, there is currently a tri-partite system of bank regulation in the United Kingdom, with (i) the Financial Services Authority (“FSA”) being involved in “day-to-day” regulation of banks; (ii) the Bank of England now being responsible for preventing “systemic risk” (as well as interest rates); and (iii) the Treasury.  This was the structure effected by the Bank of England Act 1998 and the Financial Services and Markets Act 2000 (“FSMA 2000”), as well as a Memorandum of Understanding, between the three parties; there is also a so-called “tri-partite website”, which is the website of UK Financial Sector Continuity: see www.financialsectorcontinuity.gov.uk

This three party structure, which has been criticised in light of the nationalisation of the Northern Rock bank and subsequent events, continues under the 2009 Act, although the three parties have extra responsibilities and duties: ss 1(5), 2(3) BA 2009.

"STABILISATION OPTIONS"

Of these three “procedures”, it is the former which, through necessities of time and space, that this blog concentrates on, and also because what it deals with is topical, given recent events.

There are three types of “stabilisation procedure”, which are effected by transferring a bank’s shares or its assets to:
(i) “a private sector” buyer (s 11 BA 2009) – this involves the sale of the whole or some of a troubled “bank to a commercial buyer” (11(1));
(ii) “a bridge bank” (s 12 BA 2009) – this involves the transference of the whole or some of a troubled banks to a company which the Bank of England owns completely (s 12(1) BA 2009); and
(iii) “temporary public ownership” – involves the transference of a troubled bank to a Treasury “nominee” or a company which the Treasury owns completely (s 13(2) BA 2009).
(See ss 1(3) (4) BA 2009)

It should be noted that there are separate, but modified, procedures for “building societies”: see ss 2, and 84-88 BA 2009.

"SPECIAL RESOLUTION OBJECTIVES" AND CODE OF PRACTICE

The “special resolution procedures” have five “objectives”, which the Bank of England, the FSA and the Treasury should take into account when using their “stabilisation powers”, or “the bank insolvency procedure” or “the bank administration procedure”: ss 4(1)-(3) BA 2009.  These “objectives” are:
(i) protection and enhancement of “the stability of the” United Kingdom’s “financial systems”;
(ii) protection and enhancement of “public confidence in the banking systems of the United Kingdom”;
(iii) depositor protection;
(iv) protection of “public funds”; and
(v) avoiding the interference “with property rights in contravention of a Convention right” (under “the Human Rights Act 1998”).  See also the “Compensation” regime below (ss 49 – 62 BA 2009).
(Ss 4(4)-(8) BA 2009).

To assist with decisions and interpretation regarding the “special resolution procedures”, “a code of practice”, will be drawn up by the Treasury: s 5 BA 2009.

"CONDITIONS" RE "STABILISATION POWERS"

“Conditions” are attached to the use of the “stabilisation powers”, so the use of these powers is not unfettered.  These “conditions” are both “general” and “specific”: ss 7-9 BA 2009.

Section 7 – General Conditions

The “general conditions”, under s 7 BA 2009, concern the FSA only using “stabilisation powers” where two conditions are “satisfied”:
(i) a “bank failing or likely to fail to satisfy the threshold conditions” for holding a banking licence, set out pursuant to s 41(1) and Sch 6 of FSMA 2000.  Of these “conditions”, the most relevant is likely to be a lack of “adequate resources”: Sch 6, para 4 of FSMA 2000; and
(ii) the “timing and other relevant circumstances” mean “it is not reasonably likely that”, in the absence of the stabilisation powers, the bank in question could “satisfy the threshold conditions”.
These conditions can be regarded “as met” if the FSA is “satisfied that they would be met but for” the Treasury’s or Bank of England’s “financial assistance” (s 7(4) BA 2009).  However, before deciding whether the second condition has been satisfied, there needs to be a consultation by the FSA with “the Bank of England and the Treasury” (s 7(5) BA 2009)

“Special Conditions” are different to “General Conditions”.  There are two types: (i) those dealing with “private sector purchasers and bridge banks” (under s 8), and (iI) those dealing with “temporary public ownership” (under s 9).

Section 8 “Special Conditions” – “Private Sector Purchaser and Bridge Banks” (ss 11(2) and 12(2))

In relation to a “private sector purchaser and bridge banks”, under ss 11(2) and 12(2), there are two such special conditions. (ss 8(1)-(3) and 8(4)-(6)).  The first (“Condition A”) arises where the Bank of England is wanting to exercise a “stabilisation power”. (s 8(1))  To do so, there is a “public interest” condition, concerned with financial stability, maintaining “public confidence in the … banking system …, or depositor “protection”. (s 8(2))  There needs to be prior consultation with “the FSA and the Treasury”.  (s 8(3)).

The second special condition (“Condition B”), under s 8, concerns the Treasury informing the Bank of England that it (the Treasury) has provided “financial assistance” to a troubled bank in order to resolve or reduce “a serious threat to … [financial] stability”, with the Bank of England only being able to “exercise a stabilisation power”, in such circumstances, where there is a Treasury recommendation that the Bank of England needs “to exercise the stabilisation power” for the protection of “the public interest”, and the Bank is of the view that this is the best way to proceed. (ss 8(4), (5)).  This “condition” applies in the place of “Condition A” (s 8(5)).  Conditions A and B are “in addition to” the s 7 “General Conditions” (s 8(7)).

Section 9 “Special Conditions” – “Temporary Public Ownership” (s 13(2))

The second group of “special conditions” apply to the Treasury, where they want to take a bank into “temporary public ownership”, under s13(2): see s 9(1) One of two conditions must be satisfied.  First, the exercising of the Treasury’s “stabilisation power” is needed for the resolution or reduction of “a serious threat” to financial stability; or, second, the exercising of that power is needed for the protection of “the public interest” where “financial assistance” has been provided to a troubled bank by the Treasury in order to resolve or reduce “a serious threat” to financial “stability”. (ss 9(2), (3)).  A prior consultation with the FSA and the Bank of England must occur before the Treasury decides if either condition has been “met”. (s 9(4)).  These “special conditions” are additional to the “general conditions”  (s 9(5)).

EFFECT OF "SPECIAL RESOLUTION REGIME"

A “banking liaison panel” will advise the Treasury of the “Special Resolution Regime’s” effect.  (s 10)

METHODS TO CARRY OUT RESCUE

Without wanting to go into technical detail, there are four main ways by which the “special resolution regime” can be carried out/effected:
(i) “share transfer instruments” (“STIs”) – is “an instrument” providing for the transference of “securities issued by a specified bank”, i.e., the troubled bank (s 15(1)).  The “transfer takes effect by virtue of the instrument”  (s 17(2)).  It is used by the Bank of England for sales to private sector purchases (ss 11(1), (2)).  Under such instruments, directors can be dismissed or appointed, or have their service contracts varied or terminated (s 20(1)).  STIs can allow for “securities” to be converted into different classes or to be delisted (s 19).

(ii) “share transfer orders” (“STOs”) – these are used by the Treasury in relation to transfers of securities in a troubled bank to public ownership temporarily (s 13(2)).  They need to “be made by statutory instrument” (s 25(1)).  The “transfer takes effect by virtue of the … order”  (s 17(2)).  STO’s also can allow for directors to be dismissed or appointed, or have their service contracts varied or terminated (s 20(2)).  STOs can allow for “securities” to be converted into different classes or to be delisted (s 19).

(iii) “property transfer instrument” (“PTIs”) – is “an instrument” providing for the transference of a troubled bank’s “property, rights or liabilities” (s 33(1)).  The “transfer takes effect by virtue of the instrument” (s 34(1)).  “Property” here includes property “outside the United Kingdom” (s 35(1)).  A PTI is used for both transfers to “a private sector purchaser” and a transfer to “a bridge bank” (ss 11(2)(b), 12(2)).

(iv) “property transfer orders” (“PTOs”) – these relate to the transference of a troubled bank’s “property, rights or liabilities” to the Treasury “nominee” or company completely owned by the Treasury when the troubled bank is taken into “temporary public ownership” (s 45(3)).  It has to “be made by statutory instrument”. (s 45(5)(a)),  Otherwise, a PTO is the same as a PTI (s 45(5)(b)).

COMPENSATION

Under s 49 of the 2009 Act, “the financial interests of transferors” are protected in three ways:

(i) ‘“Compensation Scheme Order”’ – “an order” which establishes “a scheme” to decide if a transferor should receive compensation, or making provision for a transferor to be paid and a scheme regarding making payment (s 49(2)).  Such a scheme would apply to a sale to a private sector purchaser or a transference to “temporary public ownership” (ss 50 and 51).  Under the order, an “independent valuer to be appointed by a person appointed by the Treasury” (s 54).  The order can also state the “valuation principles” regarding “determining the amount of compensation” (s 57).

(ii) ‘“Resolution Fund Order”’ – “an order” which establishes “a scheme” dealing with the entitlement of “transferors … to the proceeds of disposal of things transferred –
(a) in specified circumstances, and
(b) to a specified extent” (s 49(3)).
Such an order must state: (i) those “entitled to a share of the proceeds on disposal of things transferred”; (ii) how “the proceeds will be calculated”; and (iii) “the way in which shares will be calculated” (s 58).  They can be used in relation to transfers to temporary public ownership” (s 51(2)).

(iii) ‘“Third Party Compensation Order”’ – gives a discretionary “power or duty” to establish “a scheme for paying compensation for persons other than a transferor” (ss 49(4), 59).  It can be “part of a compensation order or a resolution fund order, … or be a separate order” (s 59(2)).  There can be “an independent valuer” with “valuation principles” (s 59(3)).

These compensation provisions make the 2009 Act Human Rights Act 1998: see HRA, s 1 and Pt II, The First Protocol of the European Convention for the Protection of Human Rights and Fundamental Freedoms, Art 1.  See also “Special Resolution Objectives” (v) (above).

CONCLUSION

The 2009 Act sets out a framework to assist with helping failing banks, amongst other things, in the context of the regulatory triumvirate of the FSA, the Bank of England and the Treasury.  We have seen the equivalent provisions used successfully in relation to the Dunfermline Building Society.  However, the real test will come if, “perish the thought”, another “big bank” fails.

PS – RECENT MATTERS IN THE HOUSE OF LORDS

There are two matters, unrelated to the Banking Act 2009, which I would draw readers’ attention to:

(i) Bank Charges Case in the House of Lords – the House of Lords heard the (inevitable) appeal in the much publicised litigation on bank charges, on 23rd-25th June, 2009.  The appeal was heard by a strong panel comprising: Lord Phillips of Worth Matravers (the Senior Law Lord), Lord Walker of Gestingthorpe, Baroness Hale, Lord Mance and Lord Neuberger.  The decision is eagerly awaited.

(ii) Recent Decision of the Lords on Contractual Interpretation – on 1st July, 2009, the House of Lords handed down its decision in Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38, regarding the use of pre-contractual negotiations as an aid to construing contracts.  Their Lordships upheld the traditional view that they should not be used. 

However, in this case, there was a nice Edinburgh Centre for Commercial Law connection, as the Centre’s annual guest speaker for 2009, Lord Hoffmann (who, not surprisingly, gave the leading speech in Chartbrook) referred, at paras 37, 38 and 40 of that case, to the paper presented to the Centre by last year’s annual guest speaker, Lord Bingham of Cornhill, entitled, “A New Thing Under the Sun: The Interpretation of Contract and the ICS Decision”, which is published in the Edinburgh Law Review: see (2008) 12 Edinburgh Law Review 374-390.