Financial services overview | Autumn 2016
Days after the August bank holiday weekend, the former head of the
British Civil Service, Gus O’Donnell, returned to Whitehall to catch up with former colleagues and host a live broadcast titled The Leavocrats on Radio 4.
The group included the former head of the Government Legal Service, Sir Paul Jenkins and former EU Commissioner Jonathan Hill. The topic of debate: making Brexit happen – a feat considered the civil service’s greatest challenge since the Second World War.
Jenkins noted the enormous legal and administrative burden that could potentially take a decade to complete, while Hill commented that the government should devise a broad strategic plan before triggering Article 50. Rounding on the financial services sector – which arguably faces the biggest headache of the UK’s most lucrative industries – O’Donnell emphasised how the much-maligned banking industry will play a key role in shaping the future of UK plc.
As such, a post-Brexit landscape is set to pose undoubted challenges for London’s financial services sector, and present in-house lawyers with the chance to demonstrate their worth to their boards. Recent months have seen a fall in transactional activity prior to the vote, yet there remains healthy competition between banks and alternative lenders vying to invest in the best deals. Such activity has been increasingly met by onerous levels of regulation post-Lehman, including higher capital adequacy requirements levied against banks. As the most seasoned lawyers will attest, it is a great time to be specialised in financial services both in private practice and in-house, with high-profile clients demanding strategic and sophisticated advice for navigating challenges in the sector.
The more the UK moves away from the Single Market and the adoption of European laws, the more extreme conversations become.
Kevin Ingram – Clifford Chance
James McRobbie, GC of risk management and asset management firm CF Partners, says: ‘More than ever, as legal and political developments unfold, in-house lawyers have greater scope to prove their worth internally, rather than just provide standard legal advice on day-to-day commercial deals.’
The Royal Bank of Scotland’s (RBS’s) group general counsel Michael Shaw, who is tasked with managing major legal hurdles including ring-fencing reforms and the return of RBS to private ownership following its £45bn government bailout in 2008, adds: ‘Lawyers should be part of crisis management. Different organisations do it differently – banks tend to be so large and sophisticated there’s normally a specialist for everything. We’re no different. The GC would be expected virtually in every organisation to be at the top table.’
In your court: The Financial List
Introduced by the Lord Chief Justice Thomas of Cwmgiedd and launched in the autumn of 2015, London’s new financial court constituted the first of its kind in the City. It aims to ensure cases requiring financial markets expertise or issues of importance to those markets are managed by judges with appropriate expertise. The initiative aims to further cement London’s status as a market-leading hub for complex dispute resolution.
Financial services-related disputes worth over £50m, or disputes that set a precedent for behaviour in the industry, are eligible to go through the Financial List. The selection process is assessed by a small group of expert judges.
Litigants seeking remedy over derivatives, FX and commodities markets, high-level banking transactions and sovereign debt, will find solace in the new financial court. Lobbyists also market the court as the go-to venue for legal precedent on new financial products.
So far the court has been warmly received by the profession, as well as the deputy governor of the Bank of England, Nemat Shafik, who said the Financial List would contribute to financial stability both domestically and abroad. Additional evidence of the court’s popularity has been a speedy uptake of its use; at present there are 13 cases listed, of which three have been tried. The first judgment was delivered in late January on a dispute over the meaning of terms in documentation from the Loan Market Association.
Speaking at Legal Business’ second annual Commercial Litigation conference in June, One Essex Court’s Laurence Rabinowitz QC said: ‘The beauty of the Financial List is that, although it is a new thing, it probably does not require you to learn any new skills at all. It is something that is strongly supported by the judiciary, and there is a huge advantage in that for litigants, because you will get a care and attention which exceeds even that that you already get in the Commercial Court and the Chancery, because everyone is determined that this should work well.’
Concerns raised over the court so far include confusion over which cases are considered appropriate, as the Financial List claims definition has been described as too broad. Essex Court Chambers heavyweight silk Joe Smouha QC pointed out that where a case could relate to loans, project finance, banking transactions, derivatives and complex financial products, this ranges across a significant amount of litigation heard in the Commercial Court and the Chancery Division and may not necessarily be appropriate for the Financial List.
Though in early stages, the Financial List is predicted to see considerable uptake by litigants, particularly in light of an increasingly resource-strapped judiciary tackling issues of low morale on the bench.
There is no escaping the uncertainty Brexit has already caused financial institutions. The most pressing concern is the threat Brexit poses to London, which a significant number of non-EU financial institutions use as a gateway to access clients and markets across the region.
Clifford Chance (CC) finance partner Kevin Ingram says there are two sides to the story: ‘The first is Dirty Brexit, a very hard end where we are not part of the Single Market, we have no passports in financial services and no customs union or bilateral trade agreements. In this territory there will be huge upheaval because every piece of legislation that comes through Europe will have to be looked at. The second option is a Soft Brexit, where we’ll be afforded EEA membership with access to the Single Market. Dirty or not, there will be business no longer carried out in London.’
PwC chief risk officer and general counsel, Margaret Cole, a veteran in the financial services industry and a former enforcer of the Financial Services Authority, says: ‘Losing the international passport system would be catastrophic. There are others that think it won’t be a problem at all because there is an equivalent system… almost more worrying is this next period where people try to figure out what’s going to happen, whether that means rebalancing their business or not.’
For banks and other financial institutions requiring the European passport, inevitably losing such a right will see operations moved out of the City. It is already assumed that, among others, the European Banking Authority will leave its base at Canary Wharf.
Ingram adds: ‘You’ll see a shrinking in the size of banks rather than total removal. It may not be Lloyds [Banking Group] or RBS, but it will be significant enough – those US or European banks with London offices. The more the UK moves away from the Single Market and the adoption of European laws and regulation, the more extreme conversations become.’
David Bickerton, managing partner for London and the Middle East at CC, observes that the current political uncertainty is forcing clients to dedicate time and energy to needlessly planning for ‘in the event of’ scenarios.
Referencing the current predicament surrounding the triggering of Article 50, he says: ‘The danger is people start doing contingency planning before they know what the contingency is. It effectively requires them to prepare for the worst where it may not be necessary.’
Meanwhile, Baker & McKenzie’s head of securitisation, Jonathan Walsh, is ‘hopeful that common sense will take precedence’ and the UK will adopt rules equivalent to EU regulation. ‘There is a natural tendency to move towards recognising equivalence. The EU recognises American and Japanese banks and they’re not part of the EU, so there’s obviously a way that this can be tackled. Not a huge amount of thinking has gone into that. And we don’t know the politics, whether passporting and equivalence goes hand-in-hand with free movement of people. That’s very difficult to predict.’
Beware the watchdog
Brexit aside, a major issue ranking high on the agenda of financial institutions is the unprecedented levels of regulation hitting the sector. In particular, the rules surrounding capital adequacy requirements, the most recent version named Basel III, are designed to reduce the risk of a run on the banks and have subsequently created a heavy workload for industry players. In recent years, banks have raised billions in capital and invested heavily in hiring regulatory expertise. But this has also meant divesting riskier business assets and products to achieve compliance.
Although the rules won’t take effect until 2019, preparing for change has proved to be a bone of contention within the industry. Walsh says: ‘Securitisation has been very affected by the whole debate. It’s a testament to the resilience of the market that we’ve continued to get deals done. The process is far from over. Even before it’s inked in, already further developments are being mooted. It’s too complicated. Securitisation should be encouraged and there are those that should get beneficial capital treatment. Even though the rules are being adhered to, it has still caused headaches for people.’
The industry tends to attract clever people who want to try and do things in different ways. I can’t imagine that changing.
Margaret Cole, PwC
Speculation is now mounting around Basel IV, the name bankers are giving to proposed rules that could increase the capital requirements imposed on the world’s 100 largest banks by up to €350bn, although some regulators deny that it even exists.
Ingram says too much rule-making can come at the expense of innovation: ‘The sector has always been able to adjust to the new framework or landscape but people are not prepared to jump out and do things that involve significant cost and effort where the outcome is uncertain. If things become clearer, people will find ways of being innovative in a way that gets them ahead of others.’
Also gaining much attention is the Financial Conduct Authority’s Senior Managers Regime, which requires firms to map out the roles of their senior managers and allocate responsibilities to them in order to make them individually accountable. There is a current consultation on whether general counsel, given their quick ascension up the corporate hierarchy in recent years, should be classed as senior managers under the regime too.
Macfarlanes’ financial services head David Berman, who in September resigned for Quinn Emanuel Urquhart & Sullivan, says: ‘You can see that if GCs are brought under the regime they will face something of a predicament. They’ll have regard to doing their job as a lawyer and at the same time, have regard to their regulatory responsibilities. It’s certainly not inconceivable that those two responsibilities will be aligned with one another.’
Despite the increasingly onerous regulations imposed on banks since the credit crisis, lenders are – for the right assets – more than willing to provide funding, giving their lawyers a more diverse range of sophisticated deals to grapple with.
High-profile deals included Anheuser-Busch InBev’s takeover of SABMiller for which it obtained $75bn of finance, constituting the biggest corporate loan on record. The joint bookrunners and global co-ordinators were Bank of America Merrill Lynch, Barclays and Deutsche Bank in addition to a syndicate of 21 underwriting banks on the offering of notes for AB InBev issued by its subsidiary.
Before the Brexit referendum Europe’s debt markets were showing similar activity levels to the boom years before the financial crisis, bolstered by a shift towards the US-style deals favoured by alternative lenders.
Amol Prabhu, head of EMEA emerging markets banking legal at Barclays, says from a transactional perspective, investment banks are looking at products that are not capital intensive. ‘You need to be a professional at structuring a deal, executing and distributing it, but you needn’t provide a huge loan in order to get that business. It is very difficult, particularly for international banks that are global and highly regulated to just write big cheques like they historically would have done. In a very cost constrained environment, banks are looking at the bottom line, they don’t look at how much turnover you have but how much profit there is in those deals.’
With banks hunting for yield and increasing support this year from the collateralised loan obligation market, it remains a very sponsor-friendly environment for deal finance, with borrowers able to tap a widening range of funding options and debt providers.
Current investor appetite means the most attractive terms can be selected from both markets and across product lines, with the result being that European-based loan arrangers, investors and advisers are seeing more US market-derived provisions than ever before.
European lenders have in response been much more inclined to provide terms to sponsors that more closely resemble covenant-lite loans that are common in US credit markets. For large-scale deals, key financing products current in vogue include high-yield bonds, Term Loan B, Yankee loans and hybrid European leveraged loans with New York-style covenant packages.
Pinsent Masons finance partner Tony Anderson says: ‘On financial products it depends how the banks want to tag themselves. They are looking for ways to make money due to this low-interest environment and looking at ways of generating profit and cutting costs – we’re also seeing a lot of them partnering with fintech companies to produce results.’
Fight club: key finance disputes to watch
A glance at high-profile financial services cases heard in London courts over the last year include the long-running £4bn shareholder group action against the Royal Bank of Scotland over its rights issue in 2008. Notably defendant adviser Herbert Smith Freehills has racked up sizeable legal fees, estimated over the summer to exceed £90m this year.
The Libyan Investment Authority continues its $2.1bn claim for rescission of a series of trades purportedly entered into with members of the Société Générale Group, on top of a separate $1bn claim against Goldman Sachs over nine large financial derivative transactions that lost over 90% of their value.
In late 2015 the Serious Fraud Office issued the first criminal proceedings against ten former employees of Deutsche Bank and Barclays accused of manipulating the Euro Interbank Offered Rate (Euribor). A cohort of French, German, British and Danish bankers are set to face a jury trial in September 2017. However, the UK watchdog this year suffered a high-profile defeat after six City brokers who were alleged to have helped manipulate the London interbank offered rate (Libor) were acquitted by a jury, just months after securing the conviction of former banker Tom Hayes. In a warning to junior bankers, however, it did score a major win after three former Barclays traders were found guilty by a jury of conspiring to fraudulently manipulate global benchmark interest rates in July.
Private individuals involved in high-profile financial disputes in London’s courts currently include Georgian billionaire and former prime minister Bidzina Ivanishvili, who launched a dispute against Credit Suisse for losses over mismanagement of his portfolio in Switzerland. Elsewhere, MasterCard became the first victim of new UK laws allowing US-style class actions for competition-related damages claims, where a group comprising British debit and credit card users hit with ‘illegal charges’ brought a £19bn claim against the financial services giant.
The new order
In a quarterly inflation report given in early August by the Bank of England, governor Mark Carney said the decision to leave the European Union marked a regime change from which some adjustments to a ‘new reality’ may prove difficult.
However, he added that the UK economy can endure such a period of heightened uncertainty, and measures to withstand the turbulence include a new programme of private sector asset purchases with up to £10bn of UK corporate bonds as well as a £60bn expansion of gilt purchases – bonds that are issued by the British government, and generally considered low-risk investments.
Confidence levels nevertheless remain precarious. In Strasbourg, Jean-Claude Juncker, president of the European Commission, is calling for a quick exit and staunchly argues that Britain should not retain its full EU market access if it blocks free movement from the EU. Meanwhile, executives from leading financial services providers, including HSBC, Allianz and Bank of America Merrill Lynch, insist the banks need more than two years to adapt if the market is to avoid disruption.
For in-house lawyers, managing the logistics of structural change will also remain high on the agenda, as ring-fencing reforms prove an ongoing challenge. So far, banks including Barclays, RBS and Lloyds have paid out substantial legal fees to ensure compliance rules are met. Lloyds is said to have a particularly eye-watering legal budget, ranging between £70m to £100m over three years, with Linklaters serving as the primary external adviser to the in-house function.
Anderson concludes: ‘There is dedicated resource to this area – it is a major transformational project for each bank. A project of that magnitude impacts all teams across the bank. It involves a lot of time and cost.’
But with huge resources available internally and externally, it is expected that legal teams in the financial services industry will show the stamina to ride out the uncertainty. As Cole concludes: ‘The industry tends to attract clever and thoughtful people who want to try and do things in different ways. I can’t imagine that changing. People are thirsting for certainty. I have no doubt the financial services industry will find an innovative way to move forward in all this.’