Credit Crunch - Banking reform

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14 October 2008

On 7 October 2008, the UK Government published its Banking Reform Proposals – the Banking Bill 2008 (the "Bill"). The Bill will replace and enhance the existing emergency legislation (which expires in February 2009) – the Banking (Special Provisions) Act 2008 (the "Special Provisions Act").

The Bill will provide  the UK authorities with a permanent framework to deal effectively and flexibly with banks who get into difficulties and sets out a new proposed "Special Resolution Regime" or "SRR" for UK authorised deposit taking institutions. The proposed SRR has three limbs:

  • a stabilisation option (for banks which the UK authorities decide should be rescued and kept as going concerns)
  • a new bank insolvency regime (based on the UK Insolvency Act 1986)
  • a new bank administration regime

The stabilisation options are to sell or transfer all or part of the business of the bank to a private sector "commercial purchaser", or to a "bridge bank" (a Bank of England subsidiary) or to take the bank into temporary public ownership. In any case the sale or transfer will be effected through one or more orders under the Bill to transfer securities of the bank or its other property, assets or liabilities and/or to extinguish subscription rights in relation to the bank's securities.

However, the proposed "contractual override" provisions of the Bill are causing concern in the market. A relevant authority making a share or property transfer order under the Bill may "deem" that the transfer of property, assets liabilities or securities of a relevant  bank in difficulties pursuant to that order is to be ignored in determining whether an event of default or right to terminate or replacement arises under any specified contracts (thus preventing potentially a counterparty to a transaction with the bank from accelerating or terminating his contract and crystallising his loss). In addition, an order may be made in relation to part only of a relevant bank's property, assets or liabilities. Thus potentially the authorities can "cherry pick" profitable transactions, transferring them out of the bank and therefore reducing the assets available to the bank for distribution to its remaining creditors and also destroying rights of set off against unprofitable transactions with the same counterparty. This could result in netting and set off  arrangements (for example under ISDA master agreements) and security arrangements which were previously thought to be enforceable being open to attack.

In consultation the Government has said that the (non binding) Code of Conduct it is required to publish under the Bill, will set out how it intends to exercise its powers (and when and how it does not intend to exercise them) and allay concerns. In addition, the Bill gives power for the Treasury to pass secondary legislation to protect certain set off collateral and netting arrangements from the impact of a partial transfer. 

Many of these issues also arise under the existing emergency legislation. For example, the order made in relation to the rescue of Bradford and Bingley in the UK specifically provided that the rights and liabilities of certain dated subordinated notes of Bradford and Bingley would be modified so that a default in payment of principal due in respect of such a note would not constitute an event of default under the note.

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