BUSINESS AND PROPERTY COURTS
OF ENGLAND AND WALES
BUSINESS LIST (Ch D)
Financial Services and Regulatory
IN THE MATTER OF LLOYDS BANK PLC
IN THE MATTER OF BANK OF SCOTLAND PLC
IN THE MATTER OF LLOYDS BANK CORPORATE MARKETS PLC
IN THE MATTER OF THE FINANCIAL SERVICES AND MARKETS ACT 2000
B e f o r e :
|LLOYDS BANK PLC|
|BANK OF SCOTLAND PLC|
|LLOYDS BANK CORPORATE MARKETS PLC|
Rory Phillips QC and Robert Purves (instructed by PRA & FCA) for the Regulators
Javan Herberg QC (instructed by Deloitte) for the Skilled Person
Hearing dates: 27th & 28th March 2018
Crown Copyright ©
MR JUSTICE HILDYARD :
Introduction and scope of this Judgment
"Implementation is a highly complex project of national importance. It will be relevant to millions of retail banking customers in the UK."
Structure of this judgment
[A] The ring-fencing regime introduced as Part 9B of FSMA;
[B] The implementation of ring-fencing by a ring-fencing scheme under Part VII of FSMA;
[C] Basic design of the Lloyds RFTS;
[D] Rationale for the design of the Lloyds RFTS;
[E] The Lloyds Group's parallel reorganisation;
[F] The principal features of the Scheme;
[G] Procedural history of the application and previous hearings;
[H] The Transferors' Communications Plan and its implementation;
[I] Amendments to the Scheme proposed before sanction;
[J] Jurisdictional pre-conditions and their satisfaction;
[K] The Court's role and discretion: the guidance in the Barclays Judgment;
[L] The Skilled Person's Report and conclusions on the Statutory Question;
[M] Objections and representations;
[N] Effective Date: preferred and contingency;
[O] Determination whether the Court should sanction the Scheme;
[P] Form of Order sought: sections 111, 112 and 112A of FSMA.
[A] The ring-fencing regime: Part 9B of FSMA
[B] Ring-Fencing Transfer Schemes
"(1) A scheme is a ring-fencing transfer scheme if it— (a) is one under which the whole or part of the business carried on— (i) by a UK authorised person, or (ii) by a qualifying body—is to be transferred to another body (the transferee), (b) is to be made for one or more of the purposes mentioned in subsection 3, and (c) is not an excluded scheme or an insurance business transfer scheme …
(3) The purposes are (a) enabling a UK authorised person to carry on core activities as a ring-fenced body in compliance with the ring-fencing provisions; (b) enabling the transferee to carry on core activities as a ringfenced body in compliance with the ring-fencing provisions; (c) making provision in connection with the implementation of proposals that would involve a body corporate whose group includes the body corporate to whose business the scheme relates becoming a ring-fenced body while one or more other members of its group are not ring-fenced bodies; (d) making provision in connection with the implementation of proposals that would involve a body corporate whose group includes the transferee becoming a ring-fenced body while one or more other members of the transferee's group are not ring-fenced bodies …
(5) For the purposes of subsection 1(a) it is immaterial whether or not the business to be transferred is carried on in the United Kingdom.
(6) 'UK authorised person' has the same meaning as in section 105 …
(8) 'The ring-fencing provisions' means ring-fencing rules and the duty imposed as a result of section 142G".
(1) A UK entity obtains 'authorisation' under FSMA 2000 by a successful application for 'a Part 4A permission' to carry on one or more 'regulated activities' by way of business in the UK. A person that has such a permission is an 'authorised person';
(2) 'The regulated activity of accepting deposits' (the principal regulated activity of a bank) is specified as a 'PRA-regulated activity'. An application for a permission that includes a PRA-regulated activity must be made to the PRA. A firm with permission to carry on a PRA-regulated activity is a 'PRA-authorised person';
(3) It follows that a UK-authorised bank (for example, Lloyds Bank plc) is both (a) an 'authorised person'; and (b) a 'PRA-authorised person';
(4) The result is that UK-authorised banks are dual-regulated: that is, they are subject to (a) prudential regulation by the PRA; and (b) conduct of business regulation by the FCA;
(5) Other authorised persons (for example most investment businesses) which do not carry out deposit-taking activity or any other PRA-regulated activity, apply to the FCA for authorisation and are solo-regulated by the FCA: that is subject to both (a) prudential regulation by the FCA; and (b) conduct of business regulation by the FCA.
(1) Each of the Transferors and the Transferee are PRA-authorised persons, dual-regulated by the FCA and the PRA, with permission to carry on deposit-taking activities, amongst other regulated activities;
(2) Lloyds Bank Corporate Markets plc (the Transferee) is newly authorised under FSMA 2000; and
(3) As is common for newly authorised banking entities, LBCM was authorised with 'mobilisation restrictions' imposed by the PRA, with the consent of the FCA. These are restrictions on LBCM's activities, pending the PRA's decision, with the consent of the FCA, that the bank is fully ready for operation. I return to an issue as to the lifting of these restrictions later.
"(1) An application may be made to the court for an order sanctioning an insurance business transfer scheme or banking business transfer scheme, a reclaim fund business transfer schemes or a ring-fencing transfer scheme.
(2) An application may be made by— (a) the transferor concerned (b) the transferee, or (c) both.
(2A) An application relating to a ring-fencing transfer scheme may be made only with the consent of the PRA.
(2B) In deciding whether to give consent the PRA must have regard to the scheme report prepared under section 109A in relation to the ring-fencing transfer scheme".
"(1) An application under section 106B in respect of a ring-fencing transfer scheme must be accompanied by a report on the terms of the scheme ('a scheme report').
(2) A scheme report may be made only by a person— (a) appearing to the PRA to have the skills necessary to enable the person to make a proper report, and (b) nominated or approved for the purpose by the PRA.
(3) A scheme report must be made in a form approved by the PRA.
(4) A scheme report must state— (a) whether persons other than the transferor concerned are likely to be adversely affected by the scheme, and (b) if so, whether the adverse effect is likely to be greater than is reasonably necessary in order to achieve whichever of the purposes mentioned in section 106B(3) is relevant.
(5) The PRA must consult the FCA before— (a) nominating or approving a person under subsection 2(b), or (b) approving a form under subsection (3)".
"(3) Subsections 4 and 5 apply when an application under section 107 relates to a ring-fencing transfer scheme.
(4) The following are also entitled to be heard— (a) the PRA (b) where the transferee is an authorised person the FCA, and (c) any person ('P') (including an employee of the transferor concerned or of the transferee) who alleges that P would be adversely affected by the carrying out of the scheme.
(5) P is not entitled to be heard by virtue of subsection 4(c) unless before the hearing P has— (a) filed … with the court a written statement of the representations that P wishes the court to consider, and (b) served copies of the statement on the PRA and the transferor concerned".
"(1) This section sets out the conditions which must be satisfied before the court may make an order under this section sanctioning an insurance business transfer scheme, a banking business transfer scheme or a reclaim fund business transfer scheme, or a ring-fencing transfer scheme.
(2) The court must be satisfied that … (ab) in the case of a ring-fencing transfer scheme the appropriate certificates have been obtained (as to which see Parts 2B of [Schedule 12]); (b) the transferee has the authorisation required (if any) to enable the business, or part, which is to be transferred to be carried on in the place to which it is to be transferred (or will have it before the scheme takes effect).
(3) The court must consider that, in all the circumstances of the case, it is appropriate to sanction the scheme."
"(1) For the purposes of section 111(2) the appropriate certificates, in relation to a ring-fencing transfer scheme, are—
(a) a certificate given by the PRA certifying its approval of the application,
(b) a certificate under paragraph 9C …".
"(1) A certificate under this paragraph is one given by the relevant authority and certifying that, taking the proposed transfer into account, the transferee possesses, or will possess before the scheme takes effect, adequate financial resources.
(2) "Relevant authority" means—
(a) if the transferee is a PRA-authorised person with a Part 4A permission or with permission under Schedule 4, the PRA;
(b) if the transferee is an EEA firm falling within paragraph 5(a) or (b) of Schedule 3, its home state regulator;
(c) if the transferee does not fall within paragraph (a) or (b) but is subject to regulation in a country or territory outside the United Kingdom, the authority responsible for the supervision of the transferee's business in the place in which the transferee has its head office;
(d) in any other case, the FCA.
(3) In sub-paragraph (2), any reference to a transferee of a particular description includes a reference to a transferee who will be of that description if the proposed ring-fencing transfer scheme takes effect."
[C] Basic design of Lloyds RFTS; transferring and non-transferring business
(1) transfer the core activities to a ring-fenced body, leaving the transferor to conduct Excluded Activities and other business which would breach the Prohibitions; or
(2) transfer the Excluded Activities and business which would breach the Prohibitions to another entity, leaving the transferor to carry on the core activities as a ring-fenced body.
(1) certain derivative transactions (mainly complex derivatives);
(2) certain loan facilities which incorporate a complex derivative within the loan (e.g. an interest rate based on an index such as the RPI);
(3) certain other transactions which directly or indirectly result in the Transferor having a prohibited exposure to a RFI, such as loan and liquidity facilities to which an RFI is a party.
[D] Rationale for the design of the Lloyds RFTS/Scheme
[E] The parallel reorganisation in the Lloyds Group
(1) transferring the insurance sub-group (Scottish Widows Group Limited and its subsidiaries) from Lloyds Bank plc to the Parent;
(2) transferring various companies and certain other strategic and minority investments that are currently held directly or indirectly by the Transferors (or other entities in the Group) to a new intermediate holding company, LBG Equity Investments Limited, which is a direct wholly-owned subsidiary of the Parent, to form the equity investments sub-group; and
(3) transferring various entities incorporated outside the EEA, which carry on banking business and which are currently held directly or indirectly by the Transferors, to the Transferee, to form the non-ring-fenced bank sub-group.
[F] The Scheme in more detail
The Transferring Business
(1) The manner in which it is identified is by: (a) a USB drive which lists the identification number of trades, transactions and contracts at a cut-off date of 16 March 2018; and (b) a data base, which will be compiled by the Transferors, listing the identification numbers of trades, transactions and contracts booked or entered into after the cut-off date for the USB drive, provided in each case they have not been terminated or novated or transferred by the relevant Transferor prior to the Relevant Date (as defined in paragraph . The USB drive and the data base are identified in Schedule 2 to the Scheme. The USB drive is to be held by Linklaters, the Transferors' solicitors, to the order of the Court. This is in my experience unusual; but I do not think it objectionable and it is certainly logistically rational and sensible.
(2) The nature of the Transferring Business is defined as including, to the extent governed by the laws of England and Wales, Scotland or Northern Ireland:
(a) certain long-dated derivatives with a maturity date on or after 1st January 2021;
(b) certain short-dated derivatives with a maturity date before 1st January 2021;
(c) RFI Loan Facilities, being in broad terms loan and liquidity facilities (and certain sub-participations entered into in connection with such facilities), which at the Effective Date remain outstanding (including those that are undrawn) and which involve an exposure to an RFI, but excluding Permitted RFI Exposures;
(d) Trade Finance Transactions which have a maturity date that falls on or after 1st January 2019 and in relation to which at least one of the Transferors is the beneficiary of a counter-indemnity issued by an RFI or which otherwise creates a prohibited exposure to an RFI, but excluding Permitted RFI Exposures;
(e) RPI Loan Facilities (not falling within (c) above), being in broad terms loan facilities which have an interest rate linked to the retail price index, such that the relevant Transferor would be prohibited from holding the loan under the ring-fencing regime, and which have a contractual maturity date that falls on or after 1st January 2021, but excluding Permitted RFI Exposures.
(1) Transferring Ancillary RFI Exposures, being broadly any receivables due under certain closed-out derivatives agreements to a Transferor and which involve an exposure to an RFI;
(2) the Business Assets, being broadly other assets relating to the transferring transactions and contracts, including, among other things, associated agreements entered into by the Transferors with customers, rights and benefits of the Transferors under Transferring Guarantees / Security, rights and claims of the Transferors, data, receivables and pipeline business;
(3) the Assumed Liabilities, being broadly the liabilities of the Transferors relating to the transferring transactions and contracts, to the extent that those liabilities arise on or after the Effective Date (excluding the Excluded Liabilities).
The effect of the Scheme
(1) Paragraph 5.9 contains the usual provision that the transfer takes effect notwithstanding any provision to the contrary in any contract or arrangement with any customer or other person and as if there were no requirement upon either of the Transferors of any other person to obtain the consent of any other person or comply with any other contractual provision which could have the effect of restricting or prohibiting the transfer.
(2) Paragraph 12 provides that the transfer and other matters effected by the Scheme shall not give rise to other consequences, such as invalidating or discharging any contract; or requiring compliance by a Transferor and/ or the Transferee with a number of possible contractual provisions, which might otherwise be triggered by the transfer; or allow any party to terminate any contract, if that party would not otherwise have been entitled to terminate it.
Treatment of security
Duplication of Master Agreements and ancillary documents
(1) the existing Master Agreement remains in force between the relevant Transferor and the customer and continues to govern transactions under it which do not form part of the Transferring Business; and
(2) a new Master Agreement on identical terms will come into effect between the Transferee and the customer. Any derivative transactions forming part of the Transferring Business will cease to be governed by and form part of the existing Master Agreement and instead be governed by and form part of the duplicated Master Agreement (paragraphs 9.1 and 4.2).
Treatment of Collateral
Residual Assets and Liabilities
(1) certain liquidity facilities with customers that are RFIs, which support the credit ratings of the debt securities issued by the RFI, where upon the transfer of the facility to the Transferee, the customer or other transaction parties (acting on its behalf) may be obliged to make a standby drawing as a result of the Transferee's credit rating falling below a contractually stipulated level, and the interest and other fees payable on the sum drawn-down are greater than the commitment fee payable whilst the facility remains undrawn;
(2) certain swaps entered into with the Transferors to hedge securitisation structures, where the swap would otherwise transfer under the Scheme on the Effective Date, but the securitisation structure includes certain documents governed by laws of a foreign jurisdiction (i.e. any laws other than those of England and Wales, Scotland and Northern Ireland);
(3) certain derivatives with a maturity date which falls between 28th May 2018 (being the targeted Effective Date) and 11th June 2018;
(4) certain Business Assets in relation to which the counterparty has granted security governed by the law of a foreign jurisdiction where the security cannot be transferred simultaneously with the Business Assets.
Changes to agreements and mandates
Conduct of Proceedings
Confidentiality, Data Protection, Access to Records, Marketing Preferences and Subject Access Requests
Another feature of the ring-fencing arrangements curtailed products
A detail concerning two derivatives
[G] Procedural chronology
[H] The Communications Plan and its implementation
[I] Amendments to the Scheme prior to sanction
[J] Satisfaction of jurisdictional requirements
(1) The Scheme satisfies the definition of a ring-fencing transfer scheme within the meaning of section 106B of FSMA. Part of the business carried on by each of Lloyds Bank plc and Bank of Scotland plc is to be transferred to Lloyds Bank Corporate Markets plc, the Transferee. Both Lloyds Bank plc and the Bank of Scotland plc are UK authorised persons within the meaning of section 105 of FSMA, i.e. bodies incorporated in the UK with Part 4A permissions to carry on one or more regulated activities.
(2) The Scheme is for purposes set out in s. 106B(3)(a) and (c) FSMA in that:
(a) the transfer is for the purpose of enabling the Transferors to carry on core activities as ring-fenced bodies in compliance with the ring-fencing provisions: s. 106B(3)(a); and
(b) in addition, the Scheme is made for the purpose of making provision in connection with the implementation of proposals that involve the Transferors (as body corporates of the Group) becoming ring-fenced bodies, while the Transferee (as another member of the Group) is not a ring-fenced body: s. 106(3)(c).
(3) the Scheme is not an "excluded scheme" (within the meaning given to that term in s. 106B(4)); nor is it an insurance business transfer scheme, so that s.106B(1)(c) does not apply.
(1) is made by both the Transferors and the Transferee in accordance with section 107(2)(c);
(2) was made with the consent of the PRA, which in giving its consent had regard to the Scheme Report in accordance with s.107(2A) and (2B);
(3) is properly made to the High Court in accordance with s. 107(3)(b) and (4), Lloyds Bank plc and the Transferee being registered in England and Wales and Bank of Scotland plc in Scotland.
(1) The appointment of Mr Lloyd as the Skilled Person was approved by the PRA after consulting with the FCA. Mr Lloyd has been a partner in the Banking and Capital Markets practice of Deloitte LLP since 1996. He is a fellow of the Institute of Chartered Accountants of England and Wales ("ICAEW") and a Fellow of the Association of Corporate Treasurers. Amongst other things, he is involved in the ICAEW's role in providing recommendations to policymakers in the UK and internationally on accounting and regulatory matters in relation to financial services' firms, including banks, both as a member of the ICAEW's Financial Services Faculty Board and the Chair of the ICAEW's banking committee.
(2) Mr Lloyd has the requisite independence for the role, as reinforced by (i) the PRA's approval of both his nomination as the Skilled Person and the form of the Scheme Report; (ii) Mr Lloyd's own recognition for the need for his independence from the Group; and (iii) the fact that Mr Lloyd is required to give his opinion on the Statutory Question and has prepared the Scheme Report in accordance with the PRA Statement of Policy and FCA Finalised Guidance on the implementation of RFTSs.
(3) The Scheme Report provided by Mr Lloyd is in a form approved by the PRA, after consulting with the FCA, in accordance with section 109A(3) of FSMA, as shown by a letter from the PRA dated 15th November 2017. Mr Lloyd has produced, in addition to a detailed and comprehensive Scheme Report (24th November 2017), a Summary Report summarising the Scheme Report and a Supplementary Report (19th March 2018) considering developments relevant to the Scheme since his Scheme Report was issued, including any objections received in respect of the Scheme. I discuss these most important documents, and Mr Lloyd's assessment of the Lloyds RFTS, later.
(1) The "appropriate certificates" have been obtained by the Applicants. The PRA has certified its approval of the Applicants' application for sanction. Further, the PRA has given the Transferee a CFR. Counsel for the Regulators took me to the copies of these certificates in the evidence. The PRA is the "relevant authority" to give the certificate, as the Transferee will be a PRA-authorised person with a Part 4A permission if the proposed Scheme takes effect, as to which see below.
(2) With respect to the pre-condition in section 111(2)(b) that the Transferee has the authorisation required, or will have it before the scheme takes effect, to enable the business which is to be transferred to be carried on in the place to which it is to be transferred, the evidence shows that on 25th July 2017 the Transferee was authorised by the PRA under Part 4A FSMA as a credit institution, having permission to carry on certain regulated activities. That permission was subject to restrictions. On 21st December 2017 the Transferee applied to vary its permission by removing the restrictions. On 15th March 2018 the PRA (with the consent of the FCA) made its decision to grant that application to take effect on 24th May 2018 (4 days prior to the target Effective Date of 28th May 2018). The requirements in connection with its mobilisation to be met by the Transferee in advance of the PRA (with the consent of the FCA) removing restrictions on the Transferee's permissions are, and are expected to remain, within the control of the Transferee or the Group and the Transferee intends to make arrangements to fulfil them before the Effective Date. The PRA has informed the Transferee that, if the Effective Date is not 28th May 2018 (as to which see paragraph  below), a further decision of the PRA (with the consent of the FCA) will be required before the Transferee will have the necessary full authorisation to carry on regulated activities. The PRA has stated that the further decision will be "to defer the date that the variation of the Transferee's permission to lift mobilisation restrictions takes effect". I return to this later when addressing the Applicant's desired provision for a later date of 16th July 2018 as a contingency Effective Date.
[K] Court's role and discretion: guidance in the Barclays judgment
"Having chosen to apply the Court's s 111 jurisdiction to ring-fencing transfer schemes, the appropriate inference is that Parliament intended that the Courts would at least have regard to the approach to the exercise of their discretion as had been previously been adopted under s 111(3)…
However, it is only a starting point and an RFTS is categorically different to any other species of transfer under Part VII…"
"(A) substantially increased "going concern" capital and liquidity requirements with detailed rules improving the quality of capital issued and increasing the amount of liquid assets held;
(B) new rules with respect to "minimum requirements for own funds and eligible liabilities" ("MREL"), which require … [affected banks] to issue an amount of equity and subordinated debt equal to circa 30 per cent. of risk weighted assets ("RWAs") in order to effect a recapitalisation via "bail-in" of the relevant entity in a stress [situation] …
(C) broad resolution powers of the Bank of England that (coupled with stabilisation enacted through MREL conversion) enable it to take remedial action to the benefit of critical stakeholders … ;
(D) operational continuity requirements, whereby banks are required to identify and ensure that critical services that support critical economic functions supporting the wider economy can continue operating during a stress [situation]; and
(E) senior manager requirements, whereby senior individuals within banks are individually accountable to the PRA and FCA for the ongoing operation of the bank, including recovery and resolution planning for their respective entities. This regime includes a criminal offence punishable by up to seven years in prison if, broadly, a senior manager is found to be culpable for a bank failure".
"It is important, therefore, to consider also the Scheme against the background of the purpose of ring-fencing, which was described in the PRA's paper "the Ring-Fencing Regime for UK Banks" of 10th February 2017 as being "to isolate retail banking services from the risks of global wholesale and investment banking, to ensure the continuity of deposit taking services, to ensure greater resilience against future financial crises and to remove risks from banks to the public finances."
"It is noteworthy that Part VII of FSMA does not provide for the approach that the court should adopt to a negative answer to the statutory question. In these circumstances (though the matter was not argued before me), it seems to me that it would not be incumbent on the court to refuse to sanction a ring-fencing scheme even if it or the Skilled Person reached the view that a material adverse effect was likely to be greater than was reasonably necessary in order to achieve the statutory purposes."
"It seems to me, therefore, taking into account the authorities and the submissions that I have mentioned, that in exercising its discretion, the court must keep in mind, in addition to the contextual and other matters I have already mentioned, the following main factors:-
(1) The court's discretion is unfettered and genuine and is not to be exercised by way of a rubber stamp.
(2) The design of a ring-fencing transfer scheme is a matter for the board of the bank concerned. There may be many possible approaches to the design of a statutorily-compliant ring-fencing transfer scheme that will affect stakeholders differently. The choice is for the directors of the bank concerned, acting properly in accordance with their duty under section 172(1) of the Companies Act 2006 (which is to act in the way they consider, in good faith, would be most likely to promote the success of the company having regard to matters including those specified in that subsection).
(3) The adverse effects of a ring-fencing transfer scheme must be viewed through the lens of the statutory question, so that the court must consider, with the aid of the Skilled Person, first whether persons other than the transferor are likely to be adversely affected by the scheme, and, if so, whether the adverse effect is likely to be greater than is reasonably necessary in order to achieve the statutory purposes. In considering whether persons are likely to be adversely affected by the scheme, regard need only be had to those adverse effects that are (i) possibilities that cannot sensibly be ignored having regard to the nature and gravity of the feared harm in the particular case, (ii) a consequence of the scheme, and (iii) material in the sense that there is the prospect of real or significant, as opposed to fanciful or insignificant, risk to the position of the stakeholder concerned.
(4) Even if the statutory question is answered negatively, it will not automatically follow that a proposed scheme will be rejected. The court's approach will depend on all the circumstances, including the balance between the chosen design of the scheme, the benefits that will be achieved by the scheme, and the nature of the adverse effects identified, all viewed through the lens of the approach inherent in the statutory question itself.
(5) The court will give weight to the views expressed to it by the Skilled Person and by the Regulators, and will fairly evaluate the weight to be given to views expressed to it in statements of representations made by stakeholders.
[L] The Skilled Person's Report and conclusions on the Statutory Question
(1) "Transferring Customers": i.e. current customers with products transferring from either of the Transferors to the Transferee or with agreements being duplicated under the Scheme (considered in Section 6 of the Scheme Report);
(2) "Non-Transferring Customers": i.e. current customers of the Transferors with products that are not transferring under the Scheme; these are made up of all customers of the Retail Banking division (Section 7) and Consumer Finance sub-division (Section 8), and a portion of customers of the Commercial Banking division (Section 6);
(3) "Other Relevant Persons" who may be directly or indirectly affected by the Scheme (Section 9).
(1) in assessing whether persons other than the transferor are "likely to be adversely affected by" the proposed Scheme, he has had to take a view as to the degree of likelihood of an adverse effect required to meet the test. He has adopted, having consulted multiple sources of possible guidance as to how to interpret the word "likely", including the dictionary, accounting standards and the medical profession, a conservative approach in including not merely those impacts or events where a person is "more likely than not" to be adversely affected.
(2) In other words, for practical purposes, Mr Lloyd can be taken to have applied a conservative standard in fulfilling his task as the Skilled Person. I note that this is consistent with the guidance given in the Barclays judgment, where (at [100(iii)]), the Chancellor indicated that
"in considering whether persons are likely to be adversely affected by the scheme, regard need only be had to those adverse effects that are (i) possibilities that cannot sensibly be ignored having regard to the nature and gravity of the feared harm in the particular case".
However, it should be noted (paragraph 4.13 of the Scheme Report) that in the event Mr Lloyd did not identify any effects of the Scheme where making an assessment of "likely" was a critical factor in itself in enabling him to reach a conclusion on "adverse effect".
(1) paragraph 5.10 of the PRA's Statement of Policy dated March 2016 and entitled 'The implementation of ring-fencing: the PRA's approach to ring-fencing transfer schemes', which states, "Given the breadth of the Statutory Question, the Skilled Person may wish to consider only material adverse effects" and
(2) the Court's guidance in the Barclays judgment, where (at [100(iii)]) the Court noted that regard only need be had to those adverse effects that are
"material in the sense that there is the prospect of real or significant, as opposed to fanciful or insignificant, risk to the position of the stakeholder concerned".
(1) in assessing materiality, Mr Lloyd has considered the potential adverse effect 'net' of any mitigants that the Group has applied or the affected persons could reasonably be expected to apply themselves: Scheme Report, paragraph 4.25.
(2) He has also had regard to the fact that (as noted) materiality can depend upon the context of the individual customer. In many cases, it is not possible to know the precise impact upon an individual (or, practically, to investigate it given the potential numbers of those affected) and hence he has, where appropriate, made an assumption of materiality, and hence of an adverse effect, and moved on to consider Part B of the Statutory Question.
"the design of a ring-fencing transfer scheme is a matter for the board of the bank concerned. There may be many possible approaches to the design of a statutorily-compliant ring-fencing transfer scheme that will affect stakeholders differently. The choice is for the directors of the bank concerned, acting properly in accordance with their duties under section 172(1) of the Companies Act 2006 (which is to act in the way they consider, in good faith, would be most likely to promote the success of the company having regard to matters including those specified in that subsection)".
(1) A wide RFB and narrow NRFB model, under which as many products and services would be kept inside the RFB as is permissible under the ring-fencing legislation;
(2) A RFBs-only Group model, under which any products, business or services not permissibly conducted within a RFB would be exited, unwound or allowed to run-off, possibly in conjunction with a partnership arrangement with another bank or institution to enable customers to have access through that partner to such products and services;
(3) A narrow RFB and wide NRFB model, under which all transactions with large Global Corporates with turnovers exceeding £500 million ("GCs"), services to Financial Institutions ("FIs") and other wholesale lending business would be conducted in a NRFB.
"…the choice of ring-fencing structure, by maintaining adverse effects to a relatively small cohort of customers…is reasonable in nature, such that the identified adverse effects arising as a direct result solely of the high-level design of the ring-fencing programme, and the Scheme, will not be greater than reasonably necessary in order to achieve the relevant ring-fencing purpose, as set out in Section 106B(3)(a) of the FSMA."
(1) certain possible financial effects of the Scheme on the NRFB sub-group, which he concludes are a consequence of the design decisions taken by the Group in order to comply with the ring-fencing regime and that, as a result, he is satisfied that the adverse effects will not be greater than is reasonably necessary to achieve the relevant ring-fencing purpose, as set out in s. 106B(3)(a) FSMA.
(2) Possible adverse effects on certain persons, who are not customers, but are connected with customers, may be adversely affected: these include, for example, securitisation noteholders and other secured creditors of an SPV which has entered into a liquidity facility with a Transferor or persons who have granted security or a guarantee to a Transferor. The potential adverse effects for these persons are further considered in section 6: in summary, Mr Lloyd is satisfied that as regards these persons the adverse effect is not greater than is reasonably necessary to achieve the relevant ring-fencing purpose, as set out in section 106B(3)(a) of FSMA.
(1) The first main cause of potential adverse effect is that the Transferee is expected to have a weaker credit rating than either of the Transferors before the Scheme. This may have an impact on the fair value of products moved from the Transferors to the Transferee. It may also have an adverse impact on the regulatory capital levels of customers, such as banks, insurance and asset management entities, which are required to hold minimum capital levels. Further, credit rating clauses in derivatives, liquidity facility agreements and in contracts between a customer of the Group and that customer's own clients, may be triggered by the weaker credit rating of the Transferee, with adverse effects for customers.
(2) The second main cause of potential adverse effect is that the Scheme results in some Commercial Banking customers having a split banking relationship with some financial products in the Transferors and some in the Transferee. Possible adverse financial effects are a loss of set-off rights, the breaking of derivative netting sets, and a reduction in the availability of credit lines. There are also possible adverse product effects as a result of split banking, in relation to so-called "linked products" (for example, a deposit to secure a loan or a derivative transaction, resulting in more favourable pricing for the customer) where such linkage may cease to be possible, because the linked products are in different banks after the Scheme takes effect.
(3) The third main cause is the relatively smaller size of the Transferee compared with the Transferors. This has a potential adverse impact in respect of the large exposures regulatory rules, these being rules which are designed to limit the maximum loss a bank could face in the event of a sudden counterparty failure to a level that does not endanger the bank's solvency. The Scheme is likely to result in the exposure of some Commercial Banking customers exceeding the Transferee's large exposures limits, so that steps will have to be taken to reduce the exposure. This may impact adversely on the customer.
(4) The fourth is the Transferee's funding strategy. The Transferee will be primarily financed by Lloyds Banking Group plc, its parent company, rather than raising the majority of its funding from public markets. Customers will not be able to hedge or monitor their credit exposure to the Transferee by buying or monitoring the price of credit default swaps ("CDS") on the Transferee, as this is only possible if there is an active CDS market on the Transferee, which generally requires the bank to have issued actively traded public bonds. This contrasts with the position in respect of Lloyds Bank plc, where customers who want to manage or monitor their credit risk exposures may do so, as there is an active CDS market on a number of its public issued debt securities. There is no such market against Bank of Scotland plc, so any potential adverse effect is limited to customers who have products transferring from Lloyds Bank plc.
(5) The fifth is the future business model of the Transferee. It will offer a narrower range of products and services than the Group did before the Scheme and will be potentially more susceptible to stress situations. This may impact in the future on interest-rates set by the Transferee, the pricing of products and the availability of credit lines for customers.
(6) The sixth is the transfer of products, which may trigger events which lead to adverse results. For example, the transfer of derivatives might result in the crystallisation of taxable gains or lead to increased margin requirements for US customers or the discontinuation of hedge accounting.
(7) The seventh is the effect of commercial decisions to make some curtailments in the products it offers post-Scheme, which will affect RFI customers.
(1) Section 10: capital, liquidity and funding;
(2) Section 11: governance arrangements and risk management;
(3) Section 12: operational continuity arrangements;
(4) Section 13: recovery and resolution planning;
(5) Section 14: information technology and payment implications;
(6) Section 15: taxation implications;
(7) Section 16: pension arrangements.
"plan, and the actual and draft or template communications I have seen to date, are clear, fair and not misleading."
Scheme Report: overall conclusion
Supplementary Report by the Skilled Person
(1) Delay to the legal transfer of the liquidity facilities for securitisations that are exposed to potential higher cost implications arising from the ratings trigger being exercised, from the Effective Date to later in the year, using the expanded Retained Assets/Liabilities mechanisms described above; and
(2) Changing the contractual terms with the customer to suppress any margin "step-up" for liquidity facilities, if drawn due to the impact of the Scheme and where the margin changes due to the facility being drawn (this mitigant being proposed as a change to the contractual terms with the customer rather than a change to the Scheme itself).
Conclusion as to the Skilled Person's assessments
[M] Objections and representations
Mr Brown's concerns and objections
Mr Rowe's concerns and objections
[N] Effective Date
"The potential problem is that during the ongoing operational assurance testing of IT systems and processes an issue could possibly be identified which might cause the Transferors and the Transferee to re-assess if a smooth migration of the business can take place on 28 May 2018. The necessary testing is due to be completed in early April 2018. The Applicants have not, to date, identified any reason to think that 28 May 2018 will not be achievable. The Applicants expect to be in a position to be able to determine whether it is safe or not to go ahead with the transfer on 28 May 2018 by or during the week commencing 16 April 2018.
Given there is a potential risk that it may not be practicable to proceed with the transfer on 28 May 2018 the Applicants have identified 16 July 2018 as a suitable alternative and later date for the transfer to take place. Earlier dates have been ruled out as clashing with the Group's financial half-year end, as there is a risk that the major changes to the Group's IT systems involved in the migration of the Transferring Business to the Transferee might disrupt the Group's ability to gather the necessary financial data needed for the half-year results."
"Any change in the Effective Date due to implementing the contingency plan, if required, may result in some additional planning work for customers, i.e. to prepare for the operational transfer of business and duplication of agreements pursuant to the Scheme. Based on discussions held with the Group, and my review of information received from the Group, I do not expect a change in the Effective Date due to implementing the contingency plan to impact my overall conclusions set out in Section 2 of this Supplementary Report."
[O] In all the circumstances, should the Court sanction the Scheme?
[P] Form of Order
"(1) If the court makes an order under section 111(1), it may by that or any subsequent order make such provision (if any) as it thinks fit—
(a) for the transfer to the transferee of the whole or any part of the undertaking concerned and of any property or liabilities of the authorised person concerned;
(b) for the allotment or appropriation by the transferee of any shares, debentures, policies or other similar interests in the transferee which under the scheme are to be allotted or appropriated to or for any other person;
(c) for the continuation by (or against) the transferee of any pending legal proceedings by (or against) the authorised person concerned;
(d) with respect to such incidental, consequential and supplementary matters as are, in its opinion, necessary to secure that the scheme is fully and effectively carried out.
(2) An order under subsection (1)(a) may—
(a) transfer property or liabilities whether or not the authorised person concerned otherwise has the capacity to effect the transfer in question;
(b) make provision in relation to property which was held by the authorised person concerned as trustee;
(c) make provision as to future or contingent rights or liabilities of the authorised person concerned, including provision as to the construction of instruments (including wills) under which such rights or liabilities may arise;
(d) make provision as to the consequences of the transfer in relation to any occupational pension scheme (within the meaning of section 150(5) of the Finance Act 2004) operated by or on behalf of the authorised person concerned.
(2A) Subsection (2)(a) is to be taken to include power to make provision in an order—
(a) for the transfer of property or liabilities which would not otherwise be capable of being transferred or assigned;
(b) for a transfer of property or liabilities to take effect as if there were—
(i) no such requirement to obtain a person's consent or concurrence, and
(ii) no such contravention, liability or interference with any interest or right,
as there would otherwise be (in the case of a transfer apart from this section) by reason of any provision falling within subsection (2B).
(2B) A provision falls within this subsection to the extent that it has effect (whether under an enactment or agreement or otherwise) in relation to the terms on which the authorised person concerned is entitled to the property or subject to the liabilities in question.
(2C) Nothing in subsection (2A) or (2B) is to be read as limiting the scope of subsection (1)."
"(1) Subsection (2) applies where (apart from that subsection) a person would be entitled, in consequence of anything done or likely to be done by or under this Part with an insurance business transfer scheme, a banking business transfer scheme or a ring-fencing transfer scheme-
(a) to terminate, modify or acquire or claim an interest or right; or
(b) to treat an interest or right as terminated or modified.
(2) The entitlement-
(a) is not enforceable in relation to that interest or right until after an order has been made under section 112(1) in relation to the scheme; and
(b) is then enforceable in relation to that interest or right only insofar as the order contains provisions to that effect.
(3) Nothing in subsection(1) or (2) is to be read as limiting the scope of section 112(1)."
"For my part, I would thus start from a position in which it is no necessary requirement of an IBTS that, whilst effecting a transfer of the kind provided for in s.105, it should do nothing else. Indeed, I see the line (if there is one) between that which, incidental or supplementary to or consequential upon the transfer in the scheme, may be within the scheme itself and what, at the time of the scheme or later, can only be authorised under s.112, as being unclear. This is not to say that the contents of an IBTS are boundless; its predominant purpose must be to result in one or more transfers of the described kind. Moreover, it may be (though I do not need to decide and do not decide this issue) that only such supplemental provisions can be within an IBTS as could be authorised under the more liberal view taken of what is "necessary" under s.112(2)(d). However, there are good reasons, if the proponents of a scheme from the outset see the need for a given supplemental provision, that it should be included within the scheme itself. That is what has been done in the case at hand. In that way policyholders have a four-fold protection; the supplemental provision comes within the purview of the FSA, it is reported on by the appointed Independent Expert, is explained to members and is required to obtain the sanction of the court as being "appropriate". By contrast, a subject dealt with only outside the scheme under s.112(1)(d) (but at the same time as the scheme or later), as it requires only the sanction of the court under s.112 , leaves those who might be affected by it unprotected in the other three ways. If the proponents of the scheme are in doubt as to which jurisdiction, s.111(1) or s.112(1)(d), is relevant they can, again as was done here, in effect invoke both."
"AND IT IS ORDERED that all the terms of the Scheme shall as and from the dates and times therein provided take effect under section 112 of FSMA without further act or instrument as if each were separately set out in this Order. Without prejudice to the generality of the foregoing (1) the transfers of the Transferring Business provided for by paragraph 4 of the Scheme and the transfers of property and liabilities (as defined by ss 112(12) and (13) of FSMA respectively) provided for by paragraphs 5 and 25 of the Scheme take effect pursuant to s.112(1)(a) of FSMA and transfer and vest as provided for by s.112(3) of FSMA as a result of this Order, (2) for the purposes of s.112A(2)(b) of FSMA the terms of the Scheme shall not prevent the exercise and enforcement of any Preserved Rights as therein defined, (3) the provisions in paragraph 13 of the Scheme relating to the continuation of proceedings take effect pursuant to s.112(1)(c) of FSMA and (4) the provisions of Part B and C of the Scheme, to the extent not already mentioned, take effect pursuant to s.112(1)(d) of FSMA."
Note 1 An institution of the type defined in article 2 of EAPO, including (and subject to exceptions) credit institutions (other than RFBs), investment firms, structured finance vehicles, global systemically important insurers, UCITS, managers of UCITS and alternative investment fund managers. [Back] Note 2 Though these estimates above do not account for: (i) multiple fund entities within a customer group that may, or do have the option to participate within lending facilities where the Group data recognises only a single entity as the principal borrower; and (ii) approximately 257 customers (across all divisions of the Group) whose products may be curtailed by the Group, as a result of the ring-fencing regime and the manner in which the Group has chosen to organise its business in the future to comply with that regime. [Back] Note 3 All derivatives products, including Permitted Derivatives, with FI Customers or GC Customers will be transferred to the Transferee in order (a) to ensure that the Transferors comply with the limits placed by EAPO on the volume of derivative transactions that each Transferor may enter into with its account holders, calculated by reference to the aggregate relevant risk requirements attributable to such derivative transactions; (b) to maintain netting sets for those customers: (c) to allow headroom to enable Transferors to offer simple derivatives to their customers on an ongoing basis; and (d) to treat all similar customers as consistently as possible. [Back] Note 4 Lloyds Bank plc has branches in the following non-EEA jurisdictions: Jersey, Singapore and New York, all of which provide Commercial Banking services. Bank of Scotland plc has a branch in New York, providing Commercial Banking services and one in the Isle of Man, providing Retail and Commercial Banking services. [Back] Note 5 As regards 16th July 2018 (‘the contingency date’) this confirmation (a) does not pre-judge the Regulators’ decision to lift (or not) mobilisation restrictions in time for the Scheme to take effect on contingency date; and (b) is given on the basis that, as the Draft Order anticipates, if the mobilisation restrictions are not lifted, the Scheme will not take effect on the contingency date because the Transferee will not have the necessary permission under FSMA 2000. [Back]
Note 1 An institution of the type defined in article 2 of EAPO, including (and subject to exceptions) credit institutions (other than RFBs), investment firms, structured finance vehicles, global systemically important insurers, UCITS, managers of UCITS and alternative investment fund managers. [Back]
Note 2 Though these estimates above do not account for: (i) multiple fund entities within a customer group that may, or do have the option to participate within lending facilities where the Group data recognises only a single entity as the principal borrower; and (ii) approximately 257 customers (across all divisions of the Group) whose products may be curtailed by the Group, as a result of the ring-fencing regime and the manner in which the Group has chosen to organise its business in the future to comply with that regime. [Back]
Note 3 All derivatives products, including Permitted Derivatives, with FI Customers or GC Customers will be transferred to the Transferee in order (a) to ensure that the Transferors comply with the limits placed by EAPO on the volume of derivative transactions that each Transferor may enter into with its account holders, calculated by reference to the aggregate relevant risk requirements attributable to such derivative transactions; (b) to maintain netting sets for those customers: (c) to allow headroom to enable Transferors to offer simple derivatives to their customers on an ongoing basis; and (d) to treat all similar customers as consistently as possible. [Back]
Note 4 Lloyds Bank plc has branches in the following non-EEA jurisdictions: Jersey, Singapore and New York, all of which provide Commercial Banking services. Bank of Scotland plc has a branch in New York, providing Commercial Banking services and one in the Isle of Man, providing Retail and Commercial Banking services. [Back]
Note 5 As regards 16th July 2018 (‘the contingency date’) this confirmation (a) does not pre-judge the Regulators’ decision to lift (or not) mobilisation restrictions in time for the Scheme to take effect on contingency date; and (b) is given on the basis that, as the Draft Order anticipates, if the mobilisation restrictions are not lifted, the Scheme will not take effect on the contingency date because the Transferee will not have the necessary permission under FSMA 2000. [Back]