Out-Law / Your Daily Need-To-Know

Third party contracts and bank ring-fencing

Out-Law Guide | 18 Dec 2013 | 4:14 pm | 2 min. read

This is one of a  series of guides  on issues connected to ring-fencing and banking reform faced by banks. Other guides cover issues such as tax, real estate, employment, pensions, litigation and competition considerations.

This guide was updated on December 2013

The treatment of commercial contracts is an important element of the transition to the new ringfencing regime. The idea behind the ring fence is that the different areas of the bank need to be able to operate independently, with the acid test being whether they could function independently if forced to operate as completely separate entities.

Banks will be keen to avoid a period of contractual chaos which could affect the bottom line and disrupt the customer experience. Aside from the obvious issues related to customer contracts and the necessary novation of large numbers of retail loan and mortgage agreements, issues with third-party suppliers should not be underestimated.

Rigorous due diligence will be key to ascertaining whether it is possible for existing contracts to be used across different parts of the bank, and whether they are capable of separation. Most banks are including divestment and third party beneficiary provisions in new sourcing arrangements, but these provisions may not appear in historic contracts.

Banks have a myriad of contracts governing their businesses, including supplier and services contracts, software licences, maintenance contracts and so forth. Each of those will bring its own challenges.

It is likely that new contractual arrangements for ring fenced banks will be put in place over time, with a transitional services arrangement (TSA) covering the interim period. One challenge with TSAs is that they require that the bank document in a contract the services which are likely to have been provided on an in-house and relatively informal basis. This involves management time in relation to drafting service descriptions and arriving at acceptable service levels and liability provisions.

It is also likely that there will be some 'in flight' projects which the bank will need to manage. The cost of and output from these in-flight projects will need to be allocated to the correct parts of the ring fenced areas of the bank.

Having conducted diligence and ascertained that contracts should be 'owned' by different parts of the bank on either side of the ring-fence, it may be necessary to novate or assign the contracts to achieve this. Anyone who has ever been involved in such novations or assignments knows that they can be time-consuming, and there is a risk that suppliers will try to hold you to ransom by demanding money in return for consent to a novation or assignment. The likely bargaining power of the bank will help to mitigate against this risk, but some large suppliers may still feel that they are in the driving seat and in a position to make demands.

Having completed the ring fence transaction, there will be ongoing issues to consider. For example, reporting and management information obligations in the contract will need to be managed to ensure that the different parts of the bank on either side of the ring-fence receive the right information.

 

Information Technology: The Eye of the Storm

After a period of high-profile IT failures resulting in customer 'outages', IT contracts in particular will likely require special attention.

Software licences in particular may need careful review - the number of end users may have to increase as a result of the ring-fence arrangements, which could have pricing implications. In addition, the scope of the relevant licence will need to be reviewed, to ensure that all parts of the ring fenced bank are entitled to use the software.

The customer impact

Customers will of course expect any internal reorganisation of their bank to be seamless. This applies both to novation of their own agreements with the bank, and also those of any third parties contracting with the bank – such as IT providers – where any disruption to service could impact their experience. However, banks will also need to be sensitive to public relations considerations around customers and suppliers not being 'kept in the dark' over change.