Separating retail and investment banking: the impact on outsourcing arrangements
At the time of writing, George Osborne has announced – in brief – plans that will force banks to separate their retail banking operations from their investment banking operations, so that, in the event of another financial crisis, the retail element can be saved whilst the investment banking arm is left to fail.
There are various issues this announcement throws up; this article looks at the practical impacts on sourcing arrangements that would need to be addressed. As the Chancellor’s proposals become clearer and the Independent Commission on Banking’s final report is released in September, we will take a further look at the impact on sourcing arrangements.
The impact will likely arise not just because of the requirement to ring-fence the investment banking arm, but because any failure in the service delivery to that investment banking arm will affect the other ‘good’ parts of the bank that should be being protected. So, we anticipate that the sourcing arrangements will need to look at how to maintain the continuity of service to the ‘good’ bank in the event of a failure affecting the investment banking arm.
The identity of the client contracting entity
This should be a relatively straight-forward issue, but making sure the contract is entered into by the company that is going to be ‘safe’ from the failure of another part of the business will avoid any potential issues regarding supplier termination (see below), and allow for the continued provision to that entity / division.
The end of the shared services model?
The shared services model is predicated on using resources and services that are not dedicated to any one business unit. Depending on the extent of any required ring-fencing (that is whether it relates just to the financial treatment of the revenue and risks, or whether it goes further so as to require, effectively, separately operated companies), it may no longer be permissible to allow operating divisions or companies to ‘share’ the receipt of services, or may require the contract to allow for the separation of service provision to a number of group companies to be separated from one another if required.
Where services are provided for the benefit of a group of companies, or across a series of business units, (and assuming either of these are permissible under the proposed ring-fencing options) it will be important to maintain service delivery where one of the companies or business units has been spun out of the main bank.
Many outsourcing agreements contain provisions that require the service provider to perform services to a divested affiliate for a period of time, and the same type of provisions are likely to be relevant in the case of a requirement to spin out the investment banking arm. There is likely (as we saw with the demise of Lehman Brothers) to be an attempt to sell parts of the ‘failing’ division, and they will be more attractive to sell and better placed to receive value in administration or insolvency if there is some continued provision of services to them so as to enable them to unwind in an orderly fashion.
Catering for change in a long-term contract is already a pre-requisite; if there becomes a need for the service to adjust to increases or decreases in scope or use of the services, then having a clear and predictable mechanism for doing this set out in the contract will make the continuing day-to-day management of the agreement much easier, and more cost-effective. Similarly, effective mandatory change and emergency change procedures will be key.
Supplier termination rights?
Already, supplier termination rights are often limited to material non-payment of fees, certain insolvency events and, potentially, certain material breaches that might not be capable of being compensated in damages.
The insolvency rights tend to link to the entire client organisation, and so might not be triggered in the case of a future failure of part of the client. Accordingly, suppliers might start to look at more pre-emptive rights of termination should this situation occur.
From a customer perspective, the trigger points, the extent and timing of any termination, and the impact on the provision of exit assistance will need to be carefully considered to understand whether it would be acceptable (or whether, perhaps, it would be better rejected on the basis that the ‘good’ part of the business underwrote the fees payable in respect of services provided to that ‘bad’ part).
Where we are today
At the moment, we do not have sufficient clarity of the intended scope of any ‘ring-fencing’. As mentioned at the beginning of this article, we can anticipate that the impact of the ring-fencing will be designed not so much to let the investment banking arm fail, but to protect and secure the continuity of the non-investment banking elements of a bank, and so from a sourcing perspective, will concentrate on making sure the ‘good’ customer is not affected by the investment bank’s failure. We will continue to keep a watch on these impacts as the proposals become clearer.
About the Author
Duncan Pithouse is a partner at DLA Piper. He specialises in non-contentious technology and sourcing matters, and focuses on complex international outsourcing contracts. He has extensive experience in this field and has advised on a wide range of outsourcing transactions relating to business functions and activities such as IT infrastructure, application design, build and support, finance and accounting, HR, procurement, pension administration and actuarial services.