Impact of the Recast DGSD upon UK Banks Part 1
Recast DGSD means significant changes for Banks already supporting the UK FSCS scheme
This article is relevant to banks which are already members of the FSCS Deposit Guarantee Scheme. For information on ‘wholesale-only’ banks, many of whom were not previously members, please see Part 2 here.
The PRA Consultation Paper (CP20/14) implements the recast EU Deposit Guarantee Schemes Directive (DGSD), and it seems to carry numerous substantial additions to the current reporting process. It also makes proposals on how the DGS will work in operation, as well as in cooperation with the EU Bank Recovery and Resolution Directive (BRRD). This article discusses the impacts of these changes for banks.
UK Banks have until 6th January 2015 in which to respond to the PRA’s proposals set out in the Consultation Paper, a tight deadline in which to scale plans for a large amount of work. Thereafter, two deadlines have been outlined for the delivery of these requirements, one for those to be enacted by July 2015 and another for those to be enacted by H2 2016.
The DGSD has been created in order to better “harmonise” the various national level deposit guarantee schemes (DGS) already established across Europe into an EU scheme, providing a degree of homogeneity to the schemes. This will in turn give clarity and confidence to depositors, particularly those holding accounts in several countries across Europe.
A key short-term consequence of this harmonisation is that companies “of all sizes” are now eligible for deposit protection, significantly extending the scope of depositors to be covered, and thus to be reported upon by banks. Another is that EEA branches are now also eligible for protection. This article aims to highlight the most significant subsequent actions facing the banks already supporting the UK DGS rules (referred to as ‘already reporting’ in this article), as a result of this harmonisation.
- Key Changes by Date
- Key Changes to be effected by July 2015
- Account Marking
- SCV Additions Part I
- Funding Requirements
- Key Changes to be effected by 2016 H2
- SCV Additions Part II
- Exclusions File
- ‘Continuity of Access’
- Transition State
Key Changes by Date
Additions to the existing DGS are several. The “headline” proposed changes required are listed in the table below, by delivery deadline date. These are discussed in detail later in the article.
Key Changes to be effected by July 2015
There are a number of new rules around Account Marking to be implemented by 3rd July 2015.
The abovementioned three rules therefore replace previous rule Comp 17.2.3, which states, “A firm must be able to identify which accounts are held by eligible claimants and which accounts (including client accounts and trust accounts) are held on behalf of beneficiaries who are or who may be eligible claimants.”
The words “immediate identification” create two potential challenges for Banks already reporting:
- Many banks do not “mark” accounts as eligible or not. Rather they have created an MI database which lists the eligible accounts as part of the process of creating the SCV file. This database is not necessarily accessible to allow the immediate identification of eligibility of a particular account (e.g. eligibility cannot be established by branch staff nor online via customers). To create markers on all the accounts along with maintenance processes would be a major piece of engineering.
- Even if a bank has got eligibility markers in place, these would have to be updated in line with the harmonisation of eligibility categories (including large enterprises and accounts in EU branches). This would appear to require quite a lot of IT re-engineering and the establishment of business processes for the data maintenance of these markers.
Rule 11.3 means that accounts that would not flow into the SCV file (because they are not eligible accounts because they are not in the EU) need to be marked as “Eligible by customer/ product type but not eligible because of geography”. This is a different type of marker that will not exist in any bank system. Thus IT work to establish such markers and the business process for maintaining them needs to be created.
SCV Additions Part I
Firms already submitting Single Customer View (SCV) files in a compliant way will need to make some changes to their SCV processes and systems.
COMP 17 compliant institutions must ensure by 3rd July 2015 that:
- Their SCV file’s scope in terms of customers matches that defined by the DGSD
- The SCV system automatically identifies the amount of compensation payable to each depositor
This therefore means that banks’ SCV files need to be upgraded to include reporting on Wholesale customer deposits, as well as deposits held in EU branches, each not previously reported on the SCV.
Article 16 of the recast DGSD sets out new disclosure requirements intended to help with awareness of DGS arrangements. Below are the requirements to be met prior to July 2015:
- A prescribed template of information, referred to as the ‘information sheet’ must be provided to the depositor before entering into a contract of deposit-taking, then at least annually thereafter. Receipt of this must be acknowledged in the case of the former.
- On a depositor’s ‘statement of accounts’ there must be confirmation the deposit is protected, information about exclusions to protection and the contact details of the deposit-taker.
- Inside branches and on websites, FCSC stickers, posters and informative adverts must be displayed detailing particular DGS-centric information.
- If a deposit-taker for any reason withdraws from the DGS or in the case of a merger/ conversion of subsidiaries into branches/transfer or similar occurrence, it must inform depositors at least one month before it legally takes effect and give depositors three months to withdraw their eligible deposits, including any accrued interest or benefits (which may exceed the maximum compensation sum payable) without penalty.
The banks will have to examine their account opening processes to incorporate the information sheet and statement of accounts. Since there are multiple account opening processes (branch, online, telephone etc.) this could be an onerous change.
The Consultation Paper also provides the PRA’s proposals around the new funding requirements in the DGSD.
The government intends to use the existing levy of the Finance Act 2011 to create an ex-ante fund, which is required by the DGSD. The total amount required by the fund is the equivalent of 0.8% of the amount of covered deposits of its members, so it is expected that each member will pay roughly in this proportion. However, the recast DGSD intends to implement risk-based levies which would mean the amount paid by a given bank would vary depending on their level of risk.
The EBA is in the process deciding on how to best calculate these risk-based levies.
The ex-ante fund will only be used if the PRA determines that firms cannot be levied to pay compensation at the time it is need. Under the new system, banks must therefore not only be able to pay into this ex-ante fund, but also in the event of the FSCS needing to call on contributions from DGS members, they will be expected to pay. If any amount of the bank levy is accessed by the FSCS, then firms will be expected to replenish the funds in subsequent years.
Deposit-takers will be expected to comply with the new funding rules (Rules 30-47) by 3rd July 2015.
The Banks will therefore need to come up with a new mechanism for calculating the levy based on two new parameters:
- The formula will have to change based on the risk based factors described above
- The volume of eligible deposits will change based on the Categorisation changes (inclusion of EU branches and Corporate deposits)
This is also anticipated to be a complex task for banks to carry out in advance of July 2015.
Key Changes to be effected by 2016 H2
SCV Additions Part II
Rules 11.4 -11.23 outline various changes that banks will need to make to their SCV files in order to be compliant with the new rules. One of the most difficult rules to meet will be 11.17, which requires the SCV file to contain a lot more information than the COMP handbook previously stipulated. The table below shows all the additional information fields SCV files will need to contain:
Collating all this information is likely to be an onerous task for banks. Collecting it from new customers may not be straightforward, as there will be new information required when accounts are being set-up and so account-opening systems will have to change, however it does seem feasible. Yet, for many banks, collecting this required information from existing customers will likely prove arduous.
In light of this challenge, it is advisable that banks establish clarity from the PRA on its expectations around data quality and completeness.
Alongside the maintenance of an SCV file banks will also be required to create and maintain an ‘Exclusions File’. It is not always clear whether deposits are eligible for DGS-protection or exactly who is entitled to the compensation of an eligible deposit. Such deposits are to appear on the exclusions file. The PRA in CP 20/14 breaks up these types of deposits into four categories:
- Deposits where the depositor is not absolutely entitled to the amount in the account:
A possible example here may be the deposit of a small business which has more than one owner. Before compensation is paid out it must be resolved how much each owner is entitled to.
- Where the account is under legal dispute:
This could be exemplified by a joint-account of a married couple getting a divorce. It is unlikely to be straightforward which party has what legal claim to the contents of the account and to prevent the wrong amounts of compensation being paid this issue would first have to be resolved.
- Where the deposit is subject to restrictive measures imposed by national/international bodies or governments:
It may be the case that holdings in a deposit were obtained as a result of criminal activity or a deposit contains laundered money. Such deposits are not eligible for DGS protection and thus it would be necessary to wait for the investigation to be settled before clarifying whether the deposit is or is not eligible for compensation.
- Where the account could be dormant:
Dormant accounts (as defined in the Dormant Bank and Building Society Accounts Act 2008) are not eligible for DGS protection. It must therefore be clarified first whether an account is or is not dormant before compensation is paid for that particular account.
The exclusions file is to take a very similar format to the SCV file except there are some changes to the information fields concerning beneficiary accounts. As the two are very similar documents it should not prove overly difficult for banks to produce an exclusions file alongside an SCV.
‘Continuity of Access’
The recast DGSD requires the FSCS to pay compensation to at least the majority of depositors within 7 days of the failure of a deposit-taker. This policy of ensuring ‘fast payout’ and that depositors have continued access to their funds is captured in the ‘Continuity of Access’ rules.
Banks must all the while bear in mind the relationship between the DGSD with the BRRD, due to the interdependence with the execution of the resolution strategy. For example, insured deposits need to be identified in a Bail-In Calculation because if a depositor would be eligible to be bailed in, the Deposit Guarantee scheme would stand in for the depositor and would fund the amount of money to be bailed in. Conversely, if the depositor were not covered, they would be expected to lose the bailed in proportion of their deposit and be offered shares in the bank in exchange. There are other aspects of the insured deposits, such as liquidity planning that need to be taken into account during resolution.
The Continuity of Access requirements can be divided into two key category of rule:
Firms are required to implement systems which allow accounts containing non-eligible deposits to be frozen at the point of resolution whilst leaving eligible deposits accessible. These systems must also be capable of freezing accounts in the exclusions file and where an account exceeds the £85,000 coverage limit, the system must allow the transfer of the uncovered amount into a separate account whilst leaving the covered amount available.
This will likely require substantial systems design-work and the CP 20/14 offers two potential solutions. Either creating multiple ‘shadow accounts’ for each individual depositor into which the excess or not eligible funds are deposited or one large suspense account into which all uncovered funds are transferred.
It would be prudent for banks to consider possible solution designs for this now, in order to present/lobby for these during the consultation process, i.e. before 6th January 2015.
Depositor Prioritisation Hierarchy
Some depositors have both covered and uncovered deposits distributed across various accounts. The PRA rules outline a hierarchy placing different types of accounts into an order of which accounts are to be compensated first and, being consistent with their policy of enabling continuity of access, prioritises accounts which are needed for day-to-day activity over longer-term fixed accounts. The hierarchy is set out below (with 1 being the highest priority):
- Instant Access Accounts (including current accounts)
- Notice accounts
- Fixed term deposits with a term of less than one year
- Fixed term deposits with a term of one year or more but less than two years
- Fixed term deposits with a term of two years or more but less than four years
- Fixed term deposits with a term of four years or more
This rule has potentially very major implications for deposit-takers. For example, it might require them to categorise all the types of accounts they offer into one of the seven categories, which might not be straightforward.
There are some transition state problems likely to arise due to the staggered implementation deadlines. For example, in the Republic of Ireland, it has recently been realised that certain long-term structured accounts which are currently protected under its domestic DGS rules, will no longer be after July 2015. There may be therefore be some equivalent compliance and customer communication issues facing UK banks that would require immediate analysis and attention. It would be worthwhile establishing these issues prior to the consultation deadline 6th January 2015.
The PRA’s Consultation Paper suggests that the recast DGSD will incur only limited change on the part of banks already supporting the FSCS DGS, since several of the processes will already be underway. However, this appears to significantly underestimate the complexity of some of the underlying challenges for banks and the urgency with which action needs to be taken.
Transitional state problems which may arise as a consequence of the staggered directive delivery deadlines should be identified immediately in order to be reported in the PRA response in January 2015 to bring these to its attention. Similarly the second set of deliverables, which although not due until 2016, should also be considered by banks now: a.) to include any issues in the January 2016 consultation b.) as some may be long lead time items and therefore leaving them until after July 2015 may be too late.
Possibly most urgent, the ‘Continuity of Access’ rules requirement of account splitting represents a large and challenging IT engineering project, and in particular for banks with older accounting systems, a potential IT engineering nightmare. Design work for this should therefore begin imminently in order to assess the scale of this challenge.
To read about the implications the recast DGSD will have on wholesale-only banks read Part 2 here.