Banks in the UK are subject to ‘ring-fencing’ rules which were introduced as part of the transformational Financial Services (Banking Reform) Act 2013. Under these rules, banks in the UK which meet the applicable thresholds have to structurally separate their ‘core banking services’ (e.g. provision of deposits and withdrawals) from their riskier investment banking operations.

These rules are now under review by an independent panel – to be led by Keith Skeoch (former Standard Life Aberdeen CEO) – appointed by HM Treasury earlier this month. The focus of the panel’s review will be on whether the rules have any unintended consequences on competition in UK banking markets and whether they stifle the competitiveness of the UK banking sector in international markets.

Regardless of whether banks are subject to the rules now, or could be in the future, the panel’s review will be closely watched given its potential to fundamentally reshape retail banking rules in a post-Brexit Britain. Between now and then, we expect plenty of jostling between the banks, regulators and other industry stakeholders to advance their respective agendas.

In this post, we consider this development from a competition law perspective, focusing on the issues which we expect to dominate the debate. We’ve also identified some areas where we think there is scope for the rules to be amended, such as increasing the core deposits threshold and introducing a tiered system of regulation.

Does the fence need fixing?

The UK ring-fencing regime has applied since January 2019, but only kicks in once a bank holds a three-year average of more than £25 billion in 'core deposits' (broadly from individuals and small to medium-sized businesses). The overarching intention of the rules is to ensure the financial stability of the UK retail banking system and minimise risks to public finances by structurally separating core banking services from riskier investment banking operations.

If it ain’t broke, don’t fix it

There are parts of the industry that strongly support the ring-fencing rules (such as the Bank of England), including because:

• structurally separating retail and investment banking activities insulates a retail arm from shocks to the investment arm;
• as the UK Government experienced during the global financial crisis, this separation makes it easier for the authorities to resolve issues if wider corporate groups fail; and
• at its most fundamental, the ring-fencing rules should reduce the likelihood of the Government being forced to bail out a failing bank using public tax-payer funds.

The response from the other side of the fence

While there is support for the rules in some corners, many other industry participants staunchly oppose them. In particular, because:

• for established domestic banks, complying with the rules is costly. It requires the establishment of an independent board and a variety of compliance and liquidity measures. This naturally puts ring-fenced banks at a disadvantage relative to their offshore peers not subject to such restrictions;
• for foreign banks, the additional regulatory cost disincentivises entry or expansion in the UK;
• for challenger and digital banks, the rules inhibit their ability to build sufficient scale to compete effectively with larger incumbents (something recognised previously by the Bank of England in relation to retail mortgages); and
• the measures do not eliminate the risk of banks failing altogether. The banking sector is critically important to the UK economy and is a significant employer. A careful balancing is therefore required to ensure that the competitiveness of the UK banking sector, particularly in a post-Brexit world, is not undermined.

Let’s take a look at what’s in the toolbox…

It seems unlikely that the panel will be persuaded to do away with the rules altogether, particularly given the significant investments already made to comply with the rules. However, there appears to be scope for amending the rules to offset some of the unintended consequences for competition in the banking sector, including, for example:

• increasing the current £25 billion core deposits threshold and then reviewing the threshold at periodic intervals going forward;
• relaxing some of the rules which contribute to the higher compliance costs;
• introducing a tiered system where the rules progressively ratchet up as core deposits reach certain prescribed threshold levels;
• deferring the application of the rules to new businesses for a pre-defined period;
• allowing ring-fenced banks to establish siloed wholesale divisions which can access cheaper internally sourced funding up to an annual cap.

Some detail on the panel and its task

In early February, the HM Treasury published the Terms of Reference for an independent panel review of the operation of the UK’s ring-fencing legislation. The panel (which will also separately review potential risks in banks’ proprietary trading activities) has been directed to assess the impact of the ring-fencing legislation on the following areas:

• competition in the banking sector, examining both any benefits from ring-fencing and the extent to which it may have acted as a barrier to growth for smaller and digital banks;
• competition in the UK mortgage market, including the impact on the price of mortgages and any risk-taking incentives the regime may have created for certain banks;
• the international competitiveness of the UK banking sector;
• the provision of finance and related financial services to the economy, considering in particular the impact on lending conditions to small and medium-sized enterprises; and
• any other unintended consequences of the ring-fencing legislation.

What’s next?

The panel has one year to submit a report to the Treasury, which will then be tabled before Parliament. Between now and then, we expect to see banks and other stakeholders increasingly mobilise efforts to assert their views. Watch this space for further updates as the review progresses.