Financial Sector Briefing

Outlines the possible impact of the Financial services (Banking Reform) Bill on bank pensions schemes.

In this Briefing:

Banking: Financial Services (Banking Reform)

In October 2012, the Government published the draft Financial Services (Banking Reform) Bill (the “Bill”).  The Bill was introduced into Parliament in February 2013 along with a paper which included responses to the Parliamentary Commission on Banking Reform1 recommendations.

The Bill is designed to provide the Government with the necessary powers to implement the recommendations of the ICB2. With a few exceptions, this means the majority of the detail will be set out in future secondary legislation and regulatory rules.

Effect on Pension Schemes

The areas that are likely to be of most interest to trustees of bank sponsored defined benefit pension schemes are:

  • restructuring of schemes in order to comply with ring-fencing;
  • depositor preference; and
  • the introduction of a bail-in tool3.


UK institutions4 which carry on “core activities” (accepting deposits from individuals and small and medium enterprises) will be required to ring-fence those activities from the rest of their business.  This is often referred to as ring-fencing “retail” activities while “non-retail” or “wholesale” activities continue outside the ring-fence.

The following UK institutions are exempt from the Bill:

  • building societies – though changes will be made to the Building Societies Act 1986 to bring it into line with the ring-fencing provisions in the Bill; and
  • institutions that are exempted pursuant to an order made by the Treasury. An order may only be made “if the Treasury is of the opinion that the exemption conferred by the order would not be likely to have a significant adverse effect on the continuity of the provision in the UK of core services”.5

Ring-fencing is likely to affect pension schemes in the following key areas:

  • impact on employer covenant – the Government anticipates that the covenant of each ring-fenced bank (“RFB”) and non-RFB is likely to weaken as each scheme is backed by fewer employers and as a result of the demotion of employer debts6 upon a bank insolvency, due to depositor preference;
  • sponsor support – the estimated cost of implementing the Bill;7 and
  • contingent assets – changes may be required to current contingent assets which currently support all liabilities of bank pension schemes.

Restructuring of pension schemes

As part of ring-fencing, pension schemes must be restructured so that a RFB cannot be liable for pension liabilities of other members of its banking group (or, to the extent that is not possible, to minimise any such liability).

The Bill contains an enabling power which will allow the Treasury to introduce Regulations to achieve this objective.  The Government intends “to give as much flexibility as possible to banks and trustees to undertake such restructuring” and expects them to “determine the optimal solution” for their schemes.

The Bill recognises that restructuring bank pension schemes for this purpose may take the form of splitting an existing scheme, establishing a new scheme or segregating the scheme into two or more sections.

The Bill suggests8 that:

  • ultimate responsibility for ensuring implementation of the restructuring of scheme liabilities lies with the RFB rather than pension trustees;
  • restructuring of schemes will be a collaborative process between the RFB and the trustees, with the trustees retaining any existing consent rights under the scheme rules in relation to such restructuring; and
  • the courts will be the final arbiter in any dispute between the RFB and the trustees if the RFB believes that the trustees are unreasonably refusing consent to the scheme restructuring.

Although ring-fencing will come into effect in 2019, the Government does not currently intend for the restructuring of pension liabilities to be fully effective until 2026.

There are a large number of issues arising in this area:

  • timing – ring-fencing is due to become effective in 2019 while restructuring of schemes is not due to become effective until 2026. Governance of schemes during the transitional period may, therefore, be extremely difficult;
  • the basis for restructuring -whether this should be effected on the basis of historic or future liabilities, active or all members is not yet clear;
  • availability of historic data -if restructuring is undertaken on an historic basis, banks and trustees may not have the necessary data available to them to determine whether liabilities are “retail” or “non-retail”;
  • switching between roles -some members will have moved, or will in the future move, between retail and non-retail roles. Clarification is needed on how these should be dealt with;
  • ‘orphan’ liabilities9 -clarification is also needed on how to deal with these. Current pensions legislation on this issue is highly technical and does not readily sit with imposing a ring-fence;
  • time and cost – restructuring of schemes may be a major task and will have cost implications for sponsors, including potential section 75 debts10;
  • ‘electrification’ of the ring-fence – the Government will provide the banking regulator with a power to force individual banks to implement full separation (as opposed to ring-fencing) of retail and non-retail activities if a bank seeks to undermine the ring-fence. An explanation is required on what would happen to bank pension schemes if this power were exercised prior to restructuring of such schemes in 2026;
  • materiality – currently there is no materiality level which means that schemes which only have a relatively small amount of non-retail liabilities would have to undertake a scheme restructuring;
  • swap contracts – any existing swap contracts that schemes have in place are highly unlikely to distinguish between retail and non-retail liabilities. It is not clear if trustees would be expected to unwind such contracts and put in new separate arrangements for retail and non-retail liabilities;
  • trustee protection – there is no statutory protection for trustees against claims from members in relation to restructuring of schemes; and
  • role of TPR11 – it is not clear what role TPR would have in relation to scheme restructurings and whether its current powers will be curtailed so that an RFB cannot be required to provide support to schemes outside the ring-fence.

Depositor Preference

Under the Bill all deposits which are eligible for compensation under the FSCS12 (“insured deposits”) will be preferential debts13, which will be paid out ahead of pension liabilities14 in the event of a bank insolvency.

The Government concluded, when the Bill was published in draft, that there was not a sufficiently strong case for preferring pension liabilities alongside insured deposits as:

  • “pension deficits should not be a permanent feature in the longer term”;
  • depositor preference will not be introduced until 2019 giving banks several years to agree with trustees how to bring deficits down to “mutually acceptable and sustainable levels”; and
  • preferring bank pension schemes could prove distortive as it would put them in a significantly better position than schemes in other industry sectors.

The draft RRD15 does not currently permit depositor preference and the Government has acknowledged that it will need to negotiate changes to the RRD to permit this.

Depositor preference would significantly reduce the amounts (if Potential impact on any) that trustees would be able to recover in respect of pension pension schemes scheme deficits if a bank became insolvent.

This position will be worsened if the FSCS is extended in scope Depositor preference as is currently anticipated in Europe16.

Having said this, banks may be less likely than currently to become insolvent in view of measures being taken under other initiatives, such as the increased capital requirements under Basel III17.

Whether the Government is ultimately successful in implementing depositor preference depends on it being able to negotiate the terms of the RRD with the rest of Europe to allow this18.


The Government accepted the ICB’s recommendation that a bail-in tool should be introduced so that creditors, as opposed to taxpayers, meet the cost of any future bank failure.  A bail-in tool would mean that certain liabilities owed to creditors can be written off or converted into equity in the event of a bank failure.

The Government has previously stated that the bail-in power should cover a broad range of a bank’s unsecured liabilities but that some liabilities may be more appropriate or straightforward to bail-in.  Pension liabilities are generally unsecured liabilities and the Government has not stated that they will be excluded. They could potentially, therefore, be subject to bail-in.

The terms of the bail-in power are not included in the Bill as the Government intends to legislate for this when it transposes the RRD into UK law.  The current draft of the RRD provides that liabilities to “employees in relation to pension benefits” shall not be subject to the bail-in tool.

It is not clear precisely which employees (current, past or all) or pension liabilities would be excluded from the bail-in power under the current draft of the RRD. However, there is at least some scope for some pension liabilities to be excluded.

The Government has not stated that it is seeking to negotiate changes to the draft RRD in this respect.  It is to be hoped that the relevant provision of the RRD survives in its current form as it would then be difficult for the Government to argue that pension liabilities should be subject to bail-in.

The full extent of the bail-in power and whether it applies to any pension liabilities will not become clear until the RRD is incorporated into UK law19.

If pension liabilities were subject to the bail-in power, any equity awarded to bailed-in creditors in the surviving bank entity may run contrary to employer-related investment restrictions and be inappropriate assets for schemes to hold in terms of concentration and correlation of risk.

Next Steps

The Bill is now proceeding through Parliament and may be subject to further amendment. However, the areas likely to be of most interest to trustees of defined benefit bank pension schemes – restructuring of pension schemes, depositor preference and bail-in – are not contained in the Bill.

The Government has stated that it intends for all relevant secondary legislation -which should include the Regulations for restructuring pension schemes -to be completed by May 2015.

The outcome on depositor preference is dependent on the final form of the RRD, which the EU Council hopes will be finalised by June this year. Whether the bail-in power applies to pension liabilities will only become clear when the RRD is transposed into UK law, currently due to occur by 31 December 2014.

1 The Parliamentary Commission on Banking Standards, which was asked by the Government to undertake pre-legislative scrutiny of the draft Bill
2 The Independent Commission on Banking, which was established in June 2010 to consider structural and non-structural reforms to the UK banking sector to promote financial stability and competition. It issued its final report in September 2011
3 A mechanism to impose losses on creditors upon failure of a bank without requiring the bank to go into insolvency
4 Other than those exempt from the Bill
5 The Government has previously suggested that institutions with total deposits from individuals and small and medium enterprises below £25 billion should be exempt from ring-fencing provisions. However, this figure has not been finalised and the exact form and size of the threshold will be confirmed in secondary legislation
6 Section 75 of the Pensions Act 1995
7 According to Government estimates, the total costs to UK banks of the ring-fencing and depositor preference measures in the Bill will be between £2bn to £5bn per year with one-off transitional costs between £1.5bn to £2.5bn
8 These matters will only become clear on publication of the draft Regulations
9 Broadly being liabilities which do not related to employment with any of the current remaining employers in the scheme but to past employers
10 Under Section 75 of the Pensions Act 1995, which could be triggered depending on how the separation of liabilities between the RFB and non-RFB is effected
11 The Pensions Regulator
12 The Financial Services Compensation Scheme
13 Insured depositors will still claim against the FSCS. The FSCS will become a preferred creditor in a bank insolvency for the amount of all insured deposits held by that bank
14 Assuming that such liabilities are either unsecured or secured by ‘floating’ as opposed to ‘fixed’ security
15 The European Recovery and Resolution Directive
16 Negotiations are ongoing at EU level on a revised version of the Deposit Guarantee Scheme Directive aimed at improving depositor preference across the EU. The proposals would extend FSCS coverage to businesses and many other organisations and allow Member States to provide coverage above the current £85,000 limit for temporary high balances
17 Basel III is a sequence of major reforms to the international framework for capital requirements
18 The European Council hopes to reach agreement on the text of the RRD by the end of June 2013, with the proposed deadline for incorporating it into national law being 31 December 2014
19 Currently expected to occur by 31 December 2014, with the bail-in power to become effective from 1 January 2015