Casino and banking are terms that are rarely used in the same breath these days. In fact, you could argue that banking in the UK has become a tad boring compared with the heady days of 2008, when the term “casino trading” was used to describe the business models of those UK banks that used retail customer deposits to fund excessive risk-taking and expansion within their trading operations.
Since the global financial crisis, chief risk officers within banks have been kept busy implementing a swathe of new regulations – Basel III, the Markets in Financial Instruments Directive (MiFID) II, packaged retail and insurance-based investment products, the list goes on – designed to keep casino bankers in check and protect consumers and investors. But the UK went a lot further than most financial markets. In 2011, the Vickers Commission prescribed ringfencing – the legal separation of “core retail banking services from activities such as investment and international banking” – as the best antidote to discouraging banks from thinking they were “too big to fail”.
If that were not gold-plated enough, the UK also wanted the proverbial head on a spike when things went wrong. So, in 2016 the Senior Managers and Certification Regime (SMCR) came into being, which was designed to encourage a healthier culture within banks by making individuals more accountable for their conduct and competence. Some of the toughest measures regarding bankers’ pay with clawback provisions were also introduced to hit senior managers where it hurts the most: in the pocket.
Enough or too much?
For some, however, the UK’s rigorous approach to regulation in the wake of the 2008 financial crisis was a step too far. “For too long, UK regulators have not just gold-plated, but sometimes platinum-plated the approaches put in place in Brussels,” says Miles Celic, CEO of TheCityUK, an industry-led body representing UK-based financial and related professional services. “UK regulators have a long history of diligence and dotting every ‘i’ and crossing every ‘t’. That has sometimes morphed into the view, especially lower down the regulatory ranks, that companies are guilty until proven innocent. That sort of attitude has prevailed for far too long.”
But that was then, and now the question is whether the UK, in its drive for turbocharged economic growth, has swung too far the other way, giving banks a free pass to indulge in some of the risky, casino-style behaviours that caused the financial meltdown more than a decade ago. The Edinburgh reforms announced on December 9 in the Scottish capital, by UK chancellor Jeremy Hunt, are seen as a dialling down some of that tough-on-banks rhetoric – specifically on ringfencing and the SMCR – as well as the hundreds of EU regulations the UK ‘onshored’ when it left the EU. Mr Hunt described the package of 30-odd measures – some new, many expected – as “one of the most ambitious packages of financial services reforms in decades”.
The reforms were intentionally short on detail, which has given political pundits and headline-writers plenty of scope to conclude that UK financial markets could be headed for a Big Bang 2.0-style deregulation. “So Mr Hunt has pitched up in Scotland’s financial centre, Edinburgh, to announce he is reverting to the traditional UK economic model: he is cutting the burden of regulation on banks, insurers, hedge funds and asset managers, and hoping this time it won’t all end in tears,” tweeted political commentator and journalist Robert Peston.
Responding to Mr Peston’s critique of the reforms, Mr Celic of TheCityUK points out that there is nothing that says the 2008 financial services reforms the UK put in place are set in stone. “Industry and customer expectations have moved on, as have the regulatory regimes of other countries,” he says. “It’s like painting the Forth Bridge in Scotland. You keep painting it. It is evolutionary and not Big Bang 2.0 deregulation.”
While critical reforms – ringfencing, SMCR – that were implemented post-2008 have given UK financial services a solid base to work from, Mary O’Connor, CEO at HowdenCAP, a capital advisory business for financial institutions and corporates, says there have since been seismic shifts in financial services, with new entrants such as fintechs, non-banks and digital asset firms. “We now need regulations that are fit for purpose for the next 30 years,” she says.
No regulatory bonfire
David Strachan, head of Deloitte’s Europe, the Middle East and Africa Centre for Regulatory Strategy, says the Edinburgh reforms’ impact could be significant, but he also observes that it is too early to tell at this stage whether this is full-scale deregulation. “We need to wait and see what emerges from the consultations and calls for evidence,” he says. “By the end of this year we will know a lot more, which will give us a sense of what’s in play and the range of possible outcomes.”
In many respects, the Edinburgh reforms are about writing a new chapter in UK financial services, one in which the UK is the lead author, thanks to its newfound post-Brexit freedoms. “Hundreds of pages of burdensome EU-retained laws governing financial services” will be repealed or replaced with UK-friendly regulations, says the UK government, and some in the City certainly will not be sad to see them go. “Some of the [Edinburgh] reforms could make London a better and more attractive place to do business by getting rid of some of the red tape of MiFiD, which doesn’t work or provide value,” says one compliance head at an asset management firm, who asked not to be named. “But I would be concerned about too much divergence with the EU. London is still the biggest financial market in Europe and there has to be almost equivalence because data needs to be shared between Europe and the UK.”
Angus Canvin, director of international affairs at UK Finance, the trade association for the banking and financial services industry, says the repealing of EU financial services directives is pretty uncontentious. “It was always understood this was temporary legislation and that the UK would need to go back and take a look at the EU laws it inherited to assess whether they were fit for purpose for the UK,” he explains. But he insists this is not a deregulatory race to the bottom. “Big Bang 2.0 misses the mark,” he says. “The major reforms made through Basel III, all the reforms around bank capital, too big to fail, no taxpayer money at risk, big reforms in relation to markets – the Edinburgh reforms are not knocking down these foundations.” Mr Celic adds that even the EU is reviewing directives such as Solvency II and making changes, but when the UK does it, it’s seen as a “regulatory bonfire”.
The Edinburgh reforms will also see the government review its much-prized gold-plated reforms – ringfencing and SMCR – which has nothing to do with post-Brexit freedoms. It talks about “freeing retail-focused banks from the ringfencing regime”. But what does that actually mean? Will it simply raise the £25bn deposit threshold at which the regime applies, or could it be watered down further, or even dismantled? Mr Canvin of UK Finance says there is no suggestion the UK is shedding its gold-plated armour. “The UK has a justified reputation for a rigorous regulatory regime, high standards of supervision, appropriate certification, and rule of law, which is key to its success as a major financial centre. No one wants to undo that,” he says.
A question of rules
So if the UK’s gold-plated armour is firmly intact, what is in store for ringfencing? Huseyin Sevinc, director of financial institutions and banks at Fitch Ratings, does not expect ringfencing rules to be relaxed for the UK’s largest banking groups, Barclays, HSBC, Lloyds and NatWest, given their relatively large trading and investment banking operations and international businesses. “However, the potential changes could benefit medium-sized or challenger banks without large investment banking operations,” he says. “Such banks would no longer be constrained by the £25bn deposit limit that triggers ringfencing requirements, or the associated costs and complexity of staying compliant.”
While most challenger banks’ deposit bases are believed to be well below the existing £25bn threshold, Goldman Sachs’ Marcus paused taking on more customer deposits in 2020 to avoid hitting the threshold. The bank is currently on around £23bn of deposits with approximately 750,000 customers. A spokesperson for Goldman Sachs told The Banker that it is not commenting on the Edinburgh reforms until it knows the full details. But the bank has stated publicly that it would welcome an increase in the ringfencing threshold so it can continue to serve its UK customers. Revolut’s global head of government affairs, Adam Gagen, says the Edinburgh reforms will bring real-world benefits to UK consumers and businesses by boosting competition.
By relaxing the ringfencing rules, Mr Sevinc says medium-sized banks would be able to compete more strongly in the mortgage or consumer finance market. But increased competition could also see funding costs increase, ultimately putting more pressure on banks’ margins. He says the other banks currently subject to ringfencing rules – Santander UK, TSB and Virgin Money – may also stand to benefit from any relaxation given their lack of large investment banking, trading or international operations, as could foreign banks that would have needed to hold separate capital for their UK operations in a ringfenced bank.
Past its sell-by date?
Ringfencing, at least for now, seems to be here to stay. But opinions are divided as to the regime’s success. Ms O’Connor of HowdenCAP maintains there is broad agreement within financial services that ringfencing works. “It hasn’t been that problematic,” she says. “UK banks have thrived, and have the most robust business models of any banks in the world.” Others, however, feel it may have passed its sell-by date.
Sarah Hall, professor of economic geography at the University of Nottingham, says ringfencing probably did its job in the immediate aftermath of the 2008 financial crisis, by signalling regulators’ interest in banks’ affairs. But the focus on ringfencing today may miss the point. “Ringfencing isn’t perhaps the best way to go about assessing bank stability,” she says. “Systemically, financial risks may emerge in areas that haven’t been a key area of regulatory scrutiny.”
Systemically, financial risks may emerge in areas that haven’t been a key area of regulatory scrutiny
One prudential supervisor who implemented ringfencing at a UK bank says he would like to see the regime dismantled. “Ringfencing has to be one of the worst regulations I’ve come across,” says the supervisor, who did not wish to be named. “It was drafted by politicians and lawyers, but it didn’t do its job. Banks have spent billions of pounds implementing the regime, but it hasn’t reduced risk at all. It’s based on a complete fallacy that universal banks were the source of the problem, which is total nonsense.”
Others say they would like to see ringfencing remain for the large investment banks, to protect retail investors, but that the deposit threshold should be raised to help the likes of Marcus and Starling. “Dismantling the regime, however, is probably a step too far,” says one compliance expert.
There have also been developments in other areas that could see ringfencing, over time, become less relevant. One such area is ensuring banks are ‘resolvable’, that is, able to continue operating in the event of a financial shock, with investors and shareholders bearing the cost, not taxpayers. Given that UK banks have now been deemed ‘resolvable’, Simon Hills, director of prudential regulation – financial and risk policy at UK Finance, says its members, particularly those banks that are ringfenced, feel ringfencing no longer serves any purpose. “Things have moved on,” he says. “Banks now have more capital, better liquidity and better oversight and governance. Realistically, however, permitting some currently prohibited activities to be carried on within the ringfence, as well as streamlining operational processes, would be a satisfactory more immediate outcome of the review,” he says.
The March 2022 Ringfencing and Proprietary Trading Independent Review, led by Keith Skeoch, the former chief executive of Standard Life Aberdeen, concluded that with time, the resolution regime will overtake ringfencing in providing “a more comprehensive solution for tackling too-big-to-fail”. But we are not there yet, says Deloitte’s Mr Strachan. For now, he says the ringfencing and the resolution framework will operate in parallel, providing a ‘belt-and-braces’ approach which some policy-makers appear to favour. “There may well come a time when we know resolvability works better than ringfencing or vice versa, but at this point we don’t,” he says.
Other gold-plated reforms such as SMCR are also up for review. But unlike many of the reforms which were expected, that element was new, says Mr Strachan. He says the Prudential Regulation Authority (PRA) and Financial Conduct Authority (FCA) both recently reviewed SMCR and concluded that it was generally working as intended. One compliance head says the authorities will need to be careful how far they go in reforming it, adding that SMCR can be a useful tool for changing management mindsets and behaviours. “There is a risk they may go too far. The devil will be in the details,” the compliance head told The Banker.
UK Finance says its members are largely supportive of SMCR, which it says has been game-changing for senior people who clearly understand they are individually accountable for failures within the functions they manage. But the hoops smaller firms have to jump through are not insignificant, says Mr Hills. “You could retain the core of the Senior Managers Regime, but I would look at the Certification Regime and registration requirements,” he says. “But the quickest win for industry would be more timely processing by the FCA, which is still bogged down in getting approvals through.”
Mr Celic of TheCityUK says it is encouraging the FCA to go further and faster with steps to improve the process, as it is essential for the UK’s competitiveness.
Growth at any cost
The Edinburgh reforms will also see the PRA and FCA take on new remits such as promoting “growth” and “international competitiveness”. However, Kate Troup, a financial services regulatory lawyer with Fladgate, says the FCA is already stretched. “Asking the FCA to be mindful of international competitiveness and inward trade, on top of its existing obligations, is just another thing for it to have to deal with. If it is not given additional resources or guidance, it could just add to existing delays,” she says.
My fear is that people will say, ‘I need to drive growth so I’m going to ignore risk management
But one of the most significant aspects of the Edinburgh reforms, says Ms Hall, is that financial services are being used to drive growth in a way that was not made as explicit under previous UK government ambitions. But in the race to turbocharge economic growth, could financial services companies easily revert to old behaviours? “My fear is that people will say, ‘I need to drive growth so I’m going to ignore risk management,’” says Ms O’Connor. “We need to be really firm that you need to lean into it. We’re not in a 2008 system. Rather than thinking about it as a risk/reward trade-off, you need to make compliance/regulation easy for people to do.”
The EU is also likely to be watching closely how this new chapter in UK financial services regulation plays out. In areas such as green finance, for example, which is also mentioned in the Edinburgh reforms, Ms Hall says it would be ideal if the UK fell into line with the EU’s taxonomy, which is world-leading.
“But if the UK goes too far with regulatory divergence it will attract interest from the EU,” she says. “Europe is in an unusual position in that its major financial centre is now offshore and not subject to the same regulatory regime, and with green finance there is a risk of additional regulatory burden. They’ll want to align for both sides, but politically Brexit was about taking back control and sovereignty, which doesn’t naturally fit with collaboration.”
