UK Government's Banking Support Measures

Part I: UK Government's Package Of Financial Support For

The UK Banking Industry ("Bank Rescue Package")

With the credit crunch rapidly deteriorating into a full-scale

global financial crisis, the UK's HM Treasury ("HMT")

announced on 8th October 2008 a comprehensive package of measures

to help support the banking industry financially and to strengthen

depositor protection, with the aim of stabilising the UK financial

system.1

The initial package of measures were approved by the European

Commission on 13th October 2008 under the state aid rules under

Article 87 of the Treaty establishing the European Community

(commonly referred to as the "EC Treaty"), which HMT

immediately proceeded to implement.

On 19th January 2009, the UK Government ("Govt.")

announced a second rescue package for UK banks,2

extending some of the existing measures as well as introducing new

ones, following renewed turbulence in bank share prices. These

further measures are aimed at stimulating lending by banks to the

economy, which the initial £400 billion bail-out package in

October 2008 failed to induce.

As part of the same initiative, the Financial Services Authority

("FSA") on 19th January 2009 issued a

statement3 clarifying its regulatory approach to bank

capital requirements as set out in its previous statement dated

14th November 20084 in relation to the initial package

of bank recapitalisation and related support measures launched by

the Govt. on 8th October 2008. In order to counteract the

'procyclical' effects of Basel II capital framework, FSA

will allow banks to measure the credit risks on their loan

portfolios on a 'through the cycle' basis rather than a

'point in time' basis and to reduce their Tier 1 capital

and core Tier 1 capital during an economic downturn to 6-7% and 4%,

respectively, of their risk-adjusted assets.

We summarise below the various measures comprising the Bank

Rescue Package (as they are currently implemented or, subject to

European Union ("EU") approval, soon to be implemented),

as well as the pending Banking Bill which is designed to reform the

UK banking regulation by addressing the issues highlighted by the

ongoing crisis.

Government Recapitalisation Scheme

("GRS")5

The GRS was launched on 8th October 2008 and enables the Govt.

to make capital investments of up to an aggregate of £50

billion in "Eligible Institutions", in order to help

increase their Tier 1 capital and strengthen their finances. These

investments may take the form of preference shares (or permanent

interest bearing shares).

"Eligible Institutions" mean UK incorporated banks

(including UK subsidiaries of foreign banks) that have a

substantial business in the UK. The initial list of Eligible

Institutions published by HMT include HBOS, RBS, Lloyds TSB,

Barclays, Nationwide, Standard Chartered, Abbey National, and HSBC.

Other UK incorporated banks may also apply to be included in the

GRS.

In return for the investment, the Govt. will require a number of

commitments from the banks concerned:

to maintain competitively priced lending to homeowners and

small businesses at 2007 levels for the next 3 years;

to support the Govt. in connection with schemes to help

struggling mortgage borrowers stay in their homes and to support

the expansion of financial capability initiatives;

for 2008, not to pay any cash bonuses to board members and

going forward, to review executive remuneration policies to link

them to long-term value creation (taking account of risk) and

restricting the potential for "rewards for failure";

to give HMT the right to agree with the board of directors on

the appointment of new independent nonexecutive directors; and

to amend dividend policies.

Pursuant to the GRS, HMT initially made investments totalling

£37 billion in the preference shares of RBS (£20

billion, amounting to a 58% holding) and of the Lloyds Banking

Group (£17 billion, amounting to a 43.3% holding) formed by

the Govt.-sponsored merger of HBOS and Lloyds TSB completed on 16th

January 2009. The intention of these investments is for both banks

to raise their Tier 1 capital ratios above 9% (compared with the

minimum Basel II requirement of 8%). The terms of the preference

shares purchased by the Govt. require payment by both banks of a

fixed 12% p.a. dividend and an undertaking not to pay any dividend

on ordinary shares until those preference shares have been fully

repaid.

In addition, these banks have committed to maintain

competitively priced lending to homeowners and small businesses at

2007 levels, and the Govt. has established a Lending Panel

comprising lenders, consumers, trade bodies, regulators and the

Bank of England (the "BOE") in order to monitor lending

by banks taking advantage of the GRS. 6

On 19th January 2009 HMT announced that it has agreed to convert

£5 billion of its preference share investment in RBS into

ordinary shares in order to boost RBS's core Tier 1 capital and

to enable RBS to increase its lending to the real economy by

another £6 billion in the next 12 months (i.e., over and

above existing commitments).7 The conversion does not

involve any injection of new capital but will raise the Govt.'s

stake in RBS by a further 12% to about 70%. A similar offer has

been extended to the Lloyds Banking Group.

HMT has repeatedly stated its intention to dispose of all its

investments under the GRS in due course. To this end the Govt. has

set up an independent holding company named "UK Financial

Investments Limited" ("UKFI") to manage its

shareholdings in RBS and Lloyds Banking Group (and any other

Eligible Institutions) on a commercial basis, in order to maximise

value for UK taxpayers.8 The Govt. also intends that

UKFI will in due course manage its investments in Northern Rock plc

and Bradford & Bingley plc, both of which banks are wholly

owned by the Govt.9

HMT has stated that "transparent arrangements" will be

implemented to ensure that its role in the investment decisions is

clearly defined.10

Credit Guarantee Scheme ("CGS")

The CGS was initially launched by HMT on 13th October 2008 as

part of the initial package of Govt. measures to support UK banks

in the face of the global banking crisis.11 Under the

CGS, HMT will guarantee, in return for a fee and subject to certain

conditions, new issuances of short-term or medium-term debt

securities by Eligible Institutions, in order to help refinance

their funding obligations. The initial uptake of this scheme by

eligible banks has been estimated to amount to £250

billion.

The CGS was amended on 15th December 2008 in light of further

market developments and the measures being implemented by other EU

member states. In particular, the amendments reduced the fee

payable by the bank to the Govt. for the use of the CGS, extended

the maximum term of guarantee to 5 years (by way of a roll-over of

the instruments) and widened the range of eligible

currencies.12

On 19th January 2009 HMT proposed to extend the drawdown window

of the CGS (during which period Eligible Institutions may issue new

guaranteed debt) from 9th April 2009 to 31st December 2009.

Thereafter, participating institutions may keep rolling over up to

100% of their guaranteed debt until 13th April 2012 and thereafter

up to one-third of such debt until 9th April 2014.13 The

final maturity date of 9th April 2014 and all other features of the

CGS will remain unchanged.

HMT's Rules of the 2008 Credit Guarantee Scheme effective

13th October 2008,14 as subsequently amended, impose the

following conditions for participation in the CGS:

Issuance Period

The CGS covers new issuances by "Eligible

Institutions," prior to 31st December 2009 ("Issuance

Period"), of short to medium term Eligible Scheme Liabilities

(as defined below).

Eligible Institutions

As under the GRS, "Eligible Institutions" are

defined as UK incorporated banks (including UK subsidiaries of

foreign banks) which have a substantial business in the UK, but

these institutions must further maintain a level of Tier 1 capital

in amount and form deemed appropriate by the Govt. (whether by

Govt. subscription or private investors) to qualify for the CGS.

Only one entity within a single banking group will be allowed to

participate in the CGS.

Eligible Scheme Liability

To qualify as an "Eligible Scheme Liability," the

debt instruments must, among other things,

be senior unsecured debt instruments with standard market terms

(whether stand-alone or off programmes), excluding any

complex instruments, which fall within one of the following

categories: (i) certificates of deposit, (ii) commercial paper and

(iii) bonds or notes;

be denominated in one of Sterling, Euro, US dollars, Yen,

Australian dollars, Canadian dollars or Swiss francs; and

have a maturity date no later than 13th April 2012, subject to

a possible roll-over of part of the guaranteed debt up to the CGS

end date of 9th April 2014 with Govt. consent.

Furthermore, the terms and conditions of the instruments should not

contain any cross-default or cross-acceleration provisions, nor any

call option for the issuer. Once approval is granted under the CGS

and the Eligibility Certificate is issued, the instruments must be

issued within 30 days and the proceeds of the issue must be applied

to refinance the institution's wholesale funding obligations as

they mature.

Payment of fees

A fee will be charged for participation in the CGS, of 50

basis points plus 100% of the bank's median 5-year Credit

Default Swap ("CDS") spread during July 2007 –

July 2008 as determined by HMT,15 payable to HMT. There

may also be an incremental fee payable for non-Sterling

issues.

If the application is approved, HMT will issue an

"Eligibility Certificate" to the applicant bank under the

CGS, which will signify that the specified instruments are

unconditionally and irrevocably guaranteed by HMT to ensure their

timely payment.16

Issuers are obliged to notify HMT of the guaranteed liabilities

which they issue under the CGS, and HMT maintains a list of such

liabilities.1...

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