Sir John Vickers’ report was published almost three weeks ago and received a surprise welcome from Bob Diamond, who sees the report as “a welcome step towards the greater clarity that banks need to be able to operate with confidence”. We have also seen some contradictory statements questioning the whole ring-fencing idea and the sentiment that retail banking is less risky than investment banking, brandished “casino banking”.
Regardless of which side of the fence you are on, we, as an industry are about to enter the pre-lobbying phase.
Banks are asking; “should I be doing something about this now?” The answer is an emphatic yes. There are steps banks should take now in order to both get the wheels in motion to comply with the 2019 regulation and, as importantly, to identify areas where they should be focussing their lobbying efforts.
1. Write loss absorbency measures into Basel III programmes
The loss absorbency measures in Vickers’ report are relatively clear and largely an enhancement of the Basel III rules. In terms of implementation, it would make sense to write these into banks’ pre-existing Basel III programmes; particularly in light of the fact that the timelines are consistent and the ICB requirements are dependent on the Basel III capital calculations.
2. Make use of the time
There are almost eight years until the recommendations need to be implemented, but banks will need to be lobbying hard in the years leading to 2015 when the legislation will be brought into force. Already we are seeing this. Santander, whose investment banking arm is relatively small (five to ten per cent of its assets), is asking that this can be included in the ring-fence, thereby avoiding the need to separate its investment banking business from the retail bank. The recommendations of the report as it stands are much more open to interpretation than the legislation will be. A detailed understanding of the recommendations’ implications and the choices that will have to be made is essential for effective lobbying.
Also, by planning operational changes early, banks will be able to reduce costs and disruption to the business – early investment will save future costs.
3. Let the defining begin
Define your markets: Banks will need to define which customers are sold which products and from which side of the ring-fence. While most of this is mandatory, it is not all clear-cut. In particular, trading with non-financial corporates is a grey area and it is up to the banks to decide on which side of the ring-fence the relationship falls. This has obvious implications for customers, as well as for the infrastructure of the bank.
Define the support operating model: Achieving separability of the ring-fenced bank is mandatory, but the report is not prescriptive about how to accomplish this. It is largely being left for banks to decide. The key areas that will be most affected here are operations, payments, treasury, risk, finance and, of course, the omnipresent IT function. For each of these functions the question needs to be asked; will there be replicated functions on each side of the ring-fence, or will banks create a bankruptcy-remote entity within the group?
The size of the functions in question and the implications both financially and for the people involved mean that these decisions cannot be made hastily or with ease. What is the most cost effective way of implementing these changes? Does this provide the opportunity for further organisational improvements? How will this impact current outsourcing arrangements? These are the sort of questions that will need to be asked. They are complex with many variables, and the options need to be thought through and modelled for a legitimate comparison to be made.
Define the future legal structure: The answers to the previous two points will drive the future legal structure. This structure then needs to ripple through the organisation from the contracts written with customers to the contracts under which people are employed.
4. Start making the decisions early, 2012 would be a good start
Everyone now knows ring-fencing must happen, and by when. It is now down to the banks to establish exactly what they are going to do. The sooner the cloud of uncertainty passes, the likelihood that projects will stagnate is reduced, and the better they can be directed to ensure consistency with the target 2019 operating model. The early adopted projects may even help with achieving compliance.
For example, if a bank is considering replacing its ledger system in the next few years, if it is based on the existing legal structure, they may need to tear it up in a few years – this could prove to be a potential multi-million pound mistake. The earlier the new structure is defined, the less risk will be taken in replacing the ledger system, and, in fact, the ledger programme can even help by delivering the finance part of the 2019 target operating model.
5. Avoid big one-off transfers
The easiest way to move from one operating model to another is typically to let business run down in the old model and book new business into the future model, rather than transferring it all in one go. This requires having the new operating model up and running early alongside the existing one. Once you are in this position the transition can be executed gradually over time as contracts are renewed.
This transfer avoids expensive, complex and risky one-off migrations, and, as new business is being written in the new legal structure, existing contracts will not need to be unpicked. It also means that, while temporary project teams will need to be in place to create the new operating model, the transition can be managed by the ‘business as usual’ organisation – saving money and the disruption caused by ‘over the weekend’ transitions.
The timelines faced by banks are not tight. Rather than doing nothing and hoping the problem eventually becomes someone else’s, this should be seen as an opportunity. It is an opportunity to properly understand what the implications of the recommendations are, and to influence the legislative process. It is also an opportunity to think it through and plan the transition properly, minimising costs and minimising the disruption to the business and to other key projects.