Now is not the ideal time to introduce law reform proposals which have the effect of discouraging counterparties from taking on exposures to
The motivation is a concern for depositors — the idea being that where a bank has both depositors and market creditors, depositors should be paid out first. Various legislative mechanisms are being introduced to ensure that Government will be able to procure this outcome.
From one perspective this is understandable — admirable, even. Unfortunately the SRR proposal fails to take into account the fact that balance sheet accounting is, in the most literal possible sense of the word, a zero-sum game. An institution has a certain value of assets and a certain value of creditors. The more you prefer one group of creditors, the more you subordinate others. Consequently, the regime will be of no benefit to creditors as a whole.
When Government seeks to reallocate risk between creditors, the costs of the reallocation are not necessarily even across the institution. Detriments to some will not necessarily be equally balanced by benefits to others. This is because the creditors who know that they may be subordinated will calculate their risk charge on the basis of the worst possible treatment that could be afforded to them under the new regime. If the system is unclear as to what they can expect, a worse outcome than a zero sum will be produced, as all non-depositor creditors will price in a detriment which only some will actually suffer.
It follows that the only way to minimise the overall damage which the proposals will cause is to circumscribe within the narrowest possible limits a) the detriments that creditors may suffer, and b) the ways in which the powers creating those detriments will be exercised.
It is at this point that the SRR proposal takes on a slightly desperate air. Having suggested the granting of series of powers enabling the rights of any creditor to be extinguished, the government then proposes that its use of these powers should be limited by a voluntary non-binding code of conduct. The proposed code of conduct would apply to Her Majesty’s Treasury, the Bank of England and the Financial Services Authority — none of which would be bound by it in any way.
In the aftermath of Northern Rock, it is understandable that government should be worried by the lack of pre-existing administrative powers exercisable at short or no notice. However, by its proposals the government has embarked on a course of action that runs the risk of seriously damaging UK banks — and ultimately harming the very depositors it is intended to help.
Simon Gleeson is a partner at Clifford Chance.
