Ring-Fencing and its Impacts on the UK Banking System
Monday 6 August 2018
Since the 2007-08 financial crisis which exposed significant weaknesses and vulnerabilities within the the UK banking system, there have been efforts from regulators to reform the structure of the banking system so that leading institutions can withstand similar shocks and are better equipped to deal with them in the future. To this end, the Independent Commission on Banking (ICB) was formed in June 2010, and in September 2011, it put forward its proposals to the government to reform the banking system and promote financial stability. The headline recommendation presented by the Commission was the introduction of “Ring-Fencing” regulations, due to come into force by January 1, 2019. 
What is Ring-Fencing?
Ring-Fencing is predicated on the idea that the activities of banks can be split into the categories of retail banking, e.g. deposit-taking, payment and loan services to individuals etc; or investment banking, which includes provision of services to large corporations, financial institutions or governments. Typically, banks operate as a group of separate but related entities, known as a “banking group”, and in the past, the same entity could engage in both retail and investment banking business. The purpose of Ring-Fencing is to ensure separation between these two categories so that the retail banking sector isn’t exposed to the same level of risk as the investment banking sector, by mandating that ring-fenced bodies (RFBs) which provide core retail services must not engage in any investment banking activities or any other activities outside the ring-fence. 
The separation of retail and investment banking is not without precedent; In response to the 1929 Stock Market Crash, the US Banking Act (also known as the Glass-Steagall Act) was introduced in 1933, separating retail banking from investment banking. The Glass-Steagall Act was eventually repealed in 1999 by the Gramm-Leach-Bliley Act, effectively removing the separation between Wall Street and commercial banks.  Some theorists argue that the removal of this separation was a major contributing factor in causing the 2007-08 Financial Crisis. Economics Nobel prize winner Joseph Stiglitz claimed "When repeal of Glass-Steagall brought investment and commercial banks together, the investment-bank culture came out on top". 
Policy and Objectives
The main regulating body implementing ring-fencing is the Prudential Regulation Authority (PRA), whose main objective is to promote safety and soundness of the firms it regulates. To this end, the PRA seeks to ensure that the business of any regulated entity will not have any adverse effect on the stability of the UK financial system, and in the event that a regulated entity does fail, this will have a minimal adverse effect on the stability of the financial system . The Ring-Fencing legislation aims to help the PRA achieve these objectives by ensuring that the ring-fenced bodies conduct business in a way that does not interfere with the continuity of core services which are vital to the UK financial system, and that the RFBs are sufficiently protected from any outside risks, or the failure of any banks within the same banking group, so that they can continue to provide these core services to customers.
The PRA’s policies that banks must satisfy in their implementation of ring-fencing include:
1. That RFBs do not own, nor are owned by investment banks; if they exist within the same banking group, they must be sibling entities owned by the same parent company.
2. The RFB must meet its own separate capital and liquidity requirements in addition to the banking group’s own requirements.
3. Any transactions between the RFB and any other members of the banking group must be on strictly third-party terms.
4. The RFB must be able to make decisions independently of the rest of the banking group.
5. RFBs must not outsource to investment banks. 
Who will this affect?
The new Ring-Fencing regulations apply to banks which have over £25 billion in core retail deposits. In effect, this only applies to six of the UK’s largest banks: HSBC, Barclays, Lloyds Banking Group, RBS, Santander UK and the Co-operative Bank . However, this amounts to around 75% of UK retail deposits which will be held within these ring-fenced banks post-implementation, and the effects of implementation will be felt outside of these six banks.
The process of ring-fencing these banks is an extremely complex and costly one. All of the banks’ assets; leases, buildings, IT systems etc. need to be divided up. All of the relationships the banks currently have will need to be assigned to one side of the ring-fence or another, which will also require the identification and mass repapering of all contracts binding these relationships. They will also need to make sure that there is no dependence between the entities on opposite sides of the ring-fence which could allow potential contagion from one to another . Even after it is implemented, the banks will need to pay the cost of monitoring and compliance of these regulations.
Barclays, being the first bank in the UK to implement its ring-fence, has spent an estimated £1 billion on the process so far, ring-fencing 24 million customers and £250 billion in assets .
The impact on customers is initially expected to be minor, but will vary depending on the bank and their individual approach to implementation. For example, customers’ sort codes or account numbers may be subject to change.
Ring Fencing Transfer Schemes
Because of the complexity of the reforms, some banks need to use a legal process in the restructuring of their business called a “Ring-fencing Transfer Scheme” or “RFTS”. This scheme allows the banks to transfer accounts across different parts of their business without the consent of every individual customer (which could otherwise be tricky to obtain from 24 million customers). As part of the process, the banks must first attend a court hearing and explain their planned communication about the RFTS to their customer, and the court decides if the bank can go ahead with their RFTS. If a customer thinks they will be adversely affected by the RFTS, they can also file an objection in the form of a written statement to the court and the PRA, and have their objection heard by the court. 
Timeline of Ring-fencing Implementation 
Although it will bring about big changes and significant challenges in the coming months, the banks are working to ensure the transition is managed as smoothly as possible. What remains to be seen is, whether these new reforms will be enough to adequately protect customers from future shocks to the banking system. One of the most important and hardest learned lessons from the 2007-08 Financial Crisis is the danger of allowing an institution to become “Too Big to Fail”. Despite the many challenges, I believe that the ICB’s approach of Ring-Fencing represents a sensible response to this lesson, as it rightly identifies that risk is inherent to our financial system, and so the possibility that a bank may fail again in future can not be removed entirely; and nor does it attempt to. Instead, it focuses on ensuring that in the event that a bank does fail, it will not have such a catastrophic effect.
Aodhán joined FinTrU in October 2016 through our fourth Financial Services Academy after graduating from Queen’s University with a BA in Politics, Philosophy & Economics.
Upon joining FinTrU, Aodhán was assigned to a client outreach project for a tier 1 investment bank as part a global regulatory repapering exercise. After familiarising himself with reviewing and drafting various documents he transitioned into our legal team, where he has held a variety of roles including a BAU function dealing with documents for Prime Brokerage clients and, currently, preparing documents for a mass repapering exercise in preparation for Brexit.
While at FinTrU, Aodhán has completed two modules of his Investment Operations Certificate with the CISI, studying an Introduction to Securities and Investments, UK Financial Regulation, and is preparing to complete his third module in Derivative Operations.