A deluge of new regulation and disruptive technology are presenting banks with a range of legal challenges. Marialuisa Taddia reports.
The banking industry has been hit by a raft of reforms, driven by the G20 global agenda following the 2008 financial crisis when thousands of banks worldwide were bailed out. Since the collapse of Lehman Brothers, capital requirements for the largest banks have increased substantially, with more than 80 pieces of legislation and rules passed, according to the British Banking Association.
AIFMD, MiFID and MiFIR, EMIR, CRD, and MAR are a few of the acronyms from the glut of EU directives and regulations introduced since the crisis, alongside the far-reaching Dodd-Frank Act in the US, the domestic Banking Reform Act, which ‘ringfences’ banks’ retail arms from their other operations, and the new Senior Managers Regime (SMR), which makes senior bankers more accountable. More regulation is on its way.
Many of the world’s largest banks have faced a series of regulatory investigations from multiple government agencies and watchdogs, including the UK’s Financial Conduct Authority, which came into being in 2013. Probes into the rigging of the foreign exchange and the London Inter-Bank Offered Rate (Libor) saw banks pay billions to settle claims.
In response to new rules and tighter controls over banks, the role of their legal advisers has changed.
As Herbert Smith Freehills partner Karen Anderson explains: ‘About a decade ago, many banks and investment firms delegated the task of keeping abreast of regulatory change to in-house regulatory or government affairs teams.’ But, she adds: ‘Largely as a result of the sheer volume, detail and complexity of all this new regulation – and it’s happening everywhere, not just in the EU or the UK – financial firms have been reaching out to legal advisers to help with their regulatory radars to identify challenges and impacts on particular business lines.’
Banks have not outsourced their legal advice – indeed, many in-house teams have got bigger. But there has been ‘much more partnering’ with external firms, Anderson explains: ‘[Banks] are increasingly relying on adviser firms because the landscape is just so huge. It is not just regulation. There are all sorts of changes that can come from laws and regulations that you might have not been watching out for.’ The Modern Slavery Act 2015 is one example, Anderson says.
Work has not just grown in volume, it has also changed in nature. External firms are increasingly part of a bank’s systems and controls for managing regulatory risk. ‘The work we are doing is increasingly multidisciplinary,’ Anderson says.
She has spent much of the past year helping banks implement the Markets in Financial Instruments Directive (which takes effect from January 2018), the Market Abuse Regulation (which became effective in July) and the Senior Managers and Certification Regime (which in March introduced new rules on individual accountability within the UK banking industry).
Anderson is part of HSF’s global financial services regulatory practice but recently worked with the firm’s employment and insurance teams to help a bank implement the SMR. This entailed: advising on compliance, regulatory, employment and insurance issues; on governance and strategy; designing policies; providing HR support; and bespoke training.
Guy Wilkes, Mayer Brown’s financial services regulatory and enforcement partner, has been equally busy. He says: ‘Financial crime, money laundering and terrorist financing in particular continue to be a priority area for regulators throughout the world. This is reflected in the resources that our clients continue to devote to this area and the mandates we receive to provide advice across our offices.’
Wilkes, a former head of department in the FCA’s enforcement and market oversight division, adds: ‘Regulators are increasingly taking action in respect of matters occurring across a number of jurisdictions, so our mandates frequently involve lawyers across a number of our offices.’ US and European authorities have fined seven banks more than £6.4bn for allegedly rigging foreign exchange markets between 2008 and 2013, including a £284.4m fine imposed on Barclays by the FCA, the biggest in UK history. The other major scandal to engulf some of the world’s biggest banks was Libor, with settlements of $9bn.
Simon Hart, a partner in RPC’s banking and financial markets litigation team in London, represents claimants such as fund management companies, pension funds and smaller financial institutions in disputes and litigation against banks. His team recently advised a financial institution in a ‘significant’ dispute with the administrators of Lehman Brothers, and an investment bank over the valuation and management of collateral in repurchase agreement transactions.
‘We have seen the tail end of the post-2008 litigation,’ Hart says, but there is unlikely to be a decline in litigation involving banks any time soon. ‘There has been a change in mindset. Funds or high-net-worth individuals are more willing to challenge their banks, be it in disputes or actual litigation, than perhaps they were before 2008.
‘There is more of an appetite for bringing a claim, or at least looking at claims. People see what the banks were accused of and think, “actually, I am not going to let it go”.’
The Libor scandal, which erupted in March 2012 when it emerged that regulators were investigating Bank of America Corp, Citigroup Inc and UBS AG over Libor rate manipulation, led to a significant increase in claims against banks in 2013 and 2014, according to Brick Court Chambers data. However, a review of decided cases over the previous 12 months showed that investor and mis-selling claims against banks were ‘overwhelmingly’ likely to fail, according to Mark Hapgood QC, speaking at an IBC conference on financial institutions litigation in October.
‘It is absolutely right that the law around some of these claims is difficult,’ Hart says. ‘Banks have been careful to fight and only take to public judgment those cases where they feel on strongest ground, because they don’t want to unravel the case law which is currently in their favour.’
But he notes that while not all claims against banks fall into the ‘mis-selling’ category, statistically most cases settle before they get to trial. ‘People are now more [inclined] to talk to lawyers when they have a problem and if they have a legal claim, in some shape or form, they are more willing to take it to the next stage,’ Hart concludes.
Increased regulation and vigilance on compliance has not just affected banks’ external legal advisers. Joanna Day, director of legal services at Santander, describes the regulatory pace of the past few years as ‘intense’.
‘Regulation is increasing and therefore that has an impact on our role,’ she says, emphasising that it is growing in complexity and extending its global reach. Day heads the legal side of Santander’s commercial and retail banking. Consumer protection legislation is heavily influenced by EU laws (for example, the Consumer Rights Act 2015 which implements the EU’s Consumer Rights Directive) and their interpretation by the Court of Justice of the EU. ‘The impact of European judgments on existing legal principles and provisions, are among the biggest challenges we face,’ she says.
But Day also highlights the ‘encroaching reach of other jurisdictions outside Europe’. Take the Dodd–Frank Wall Street Reform and Consumer Protection Act, which affects financial institutions and markets outside the US.
There has been a ‘twin peaks’ system since April 2013, with the responsibility of the former Financial Services Authority split between the Prudential Regulation Authority and the FCA, which has become ‘the overall super-regulator’.
‘More and more aspects of regulation are now being brought under the FCA,’ Day says. For instance, the responsibility for the regulation of consumer credit has moved from the Office of Fair Trading to the FCA. This change has kept Day and her team busy as they helped prepare Santander’s retail unit. ‘The OFT was never really regarded as a regulator with teeth,’ she says. ‘We are now moving to a more aggressive and prescriptive regime.’
As an in-house lawyer at one of the UK’s largest banks, how has her role changed? ‘We are focused on regulation but also the detail, eventualities and consequences for Santander and its customers. It is quite intense,’ she says, adding: ‘This is a move from the days of being able to take a commercial view [only].’ She points to the SMR, which strongly emphasises individual responsibility and accountability within banks. Day says there is ‘huge nervousness’ among in-house lawyers as to how the regulator would perceive their giving ‘a view or suggestion or saying to the business you may want to do something in a certain way’.
The FCA has published a discussion paper (comments can be submitted until 9 January) to clarify how and why the legal function (that is, head of legal and GCs) is currently captured under the new regime, and to consider whether it should continue to be part of it. Law Society chief executive Catherine Dixon said Chancery Lane ‘is clear that legal functions should not be included in the regime because it can create conflict and erode legal professional privilege’.
The rise of fintech
Incumbent banks are working with start-ups at the cutting edge of technology in an effort to reduce high cost-to-income ratios resulting from increased regulation, low interest rates and new distribution channels, among other pressures the sector has come under since the financial crisis. This is in turn generating additional work for law firms.
Payment and other technologies such as P2P lending, robo-advice and blockchain offer opportunities for banks to generate new business, transform operating models and reduce costs. But they also bring challenges, Joerg Ruetschi, principal at PwC, told the IBC conference. He said that new players were emerging and ‘disrupting the traditional banking model’, as they vied for control of the ‘digital banking platform’, the interface between banks and customers.
In the context of free banking, and customers struggling to see the benefits of switching from one provider to another, HSBC’s Simon Burden said that ease of use of banking apps was increasingly becoming the ‘parameter’ upon which banks compete with each other, each trying to be the interface of choice for customers.
Banks are responding by investing in or partnering with the new technology providers. For example, BBVA has bought digital-only banks Atom and Simple, and Clydesdale and Yorkshire Bank’s app-based bank B.
‘It would be misleading to describe the growth in FinTech simply in terms of the threat to banks,’ says Mayer Brown’s Guy Wilkes. ‘FinTech also provides huge opportunities for established players. We are increasingly seeing deals being driven by technology, with significant interest in partnerships, joint ventures and mergers to deliver efficiencies, new products and improved customer experience.’
FinTech is one of the fastest growing areas of practice in the New York office of Latham & Watkins, the world’s biggest firm by revenue. ‘That is really an expanding industry and as a result it is an expanding area of legal services,’ managing partner Michele Penzer says.
Latham recently advised a consortium of banks comprising Goldman Sachs, JPMorgan Chase and Morgan Stanley on the formation of a company, in partnership with technology provider SmartStream, that will supply reference data on financial instruments.
Day says Santander like others is ‘looking to engage with the Law Society’ on this issue: ‘How do you advise your senior managers who are subject to the regime? It could impact on the independence and objectivity that lawyers can bring to an issue. It might mean, therefore, that you’d have more need to have external advice rather than internal advice.’
Since April last year, the FCA has had ‘concurrent’ competition powers with the Competition and Markets Authority (CMA) to enforce EU and UK competition law in the provision of financial services. FCA director of enforcement and market oversight Mark Steward told the IBC conference that one investigation into anti-competitive practices is already afoot. Fines can reach up to 10% of financial firms’ annual turnover.
It is not a surprise then that banks are beefing up their in-house competition law expertise. For example, HSBC hired its first competition lawyer in 2012 and now has six. ‘We just about manage, the six of us,’ says senior competition adviser Simon Burden.
Incumbent banks were waking up to the ‘competitive threat’ of game-changing technology and groundbreaking new regulation such as the Second Payment Services Directive (PSD2), Burden argues.
PSD2, which must be implemented in national law by 13 January, will require banks to open up access to account data and payment infrastructure to third parties, including retailers and financial technology groups.
In parallel, the CMA wants to exploit ‘big technology changes’ in banking to increase competition in personal current accounts and in banking services for small and medium-sized enterprises. It has proposed that banks ‘swiftly introduce an Open API [application programming interface] banking standard’, which means sharing customer data with other banks and third parties.
It will enable bank customers, for instance, to click on an app that will direct them to the bank account which offers them the best deal.
Scott McInnes, a partner in the Brussels office of Bird & Bird, and formerly senior regulatory counsel at MasterCard, has been helping clients, including banks and card schemes, comply with the PSD2, the Interchange Fee Regulation (IFR) and the European Banking Authority (EBA) guidelines on the security of internet payments. ‘Each of those regulatory requirements raises a lot of legal issues of interpretation,’ McInnes says.
Rapidly evolving technology is also introducing many legal issues. ‘Handset manufacturers are now part of the payments value-chain,’ McInnes says. He cites Apple Pay, which allows consumers to tap their iPhone on a contactless terminal to make a card payment. Apple Pay currently charges banks and credit card issuers a fee for transactions paid using the mobile payment.
‘The card issuer is sharing its (now regulated) “interchange fee” revenue with Apple, with no possibility for the card issuer to pass on that fee to the iPhone user,’ McInnes says. In a number of countries, including Australia, Apple Pay is already subject to competition law challenges from local banks over this and other issues such as access to its near field communication technology, which enables tap-and-go payments, he notes.
‘Competition law is being relied upon by new entrants to force banks to open up the infrastructure ahead of the PSD2 implementation,’ McInnes observes, highlighting the cases of Sofort in Germany and Trustly in Norway. ‘In addition, new entrants are lobbying their MEPs to influence the work that the EBA is currently doing in terms of defining how banks should be granting access to third-party players in the future.’
It is a similar story on the other side of the fence. Kristaps Sikora is senior regulatory counsel at MasterCard, part of a team responsible for issues relating to the implementation of EU payments legislation and competition law compliance across Europe. Sikora highlights the IFR, which caps interchange fees for card transactions and separates MasterCard’s scheme and processing activities, among other key provisions, and PSD2, as the most significant recent regulatory developments.
‘The IFR has had a profound impact on how MasterCard does business in the EU,’ Sikora says. ‘The wording of some of [its] provisions is rather vague and open to diverging interpretations.’ PSD2 is likely to have ‘a less direct impact on MasterCard than IFR’, Sikora observes, ‘establishing a landscape that would allow new payment service providers to compete against the traditional banks, which are our customers’.
June’s EU referendum vote has added to the regulatory burden. As one law firm partner puts it: ‘We had enough regulatory uncertainty without Brexit.’
Financial institutions’ risk approach to the referendum’s fallout has been ‘to hope for the best and plan for the worst’, ICBC Standard Bank’s head of regulatory change Michael Plumbridge told the IBC conference.
One central issue for City-based banks is to continue to ‘passport’ their services across the single market after the UK leaves the EU. A recent report by thinktank Open Europe found that the financial services passport was important to business in the banking sector (where around a fifth of the sector’s annual revenue is estimated to be tied to the passport), but less so in other financial services industries such as asset management and insurance.
Anderson, who has been advising banking clients on the implications of Brexit, says: ‘Banks are trying to work out what they have to do to ensure they don’t get caught by any gap.’ For instance, they are assessing what services, if any, they could continue to passport into the EU if Article 50 were triggered by 31 March 2017 without any agreement on transitional arrangements at the end of the negotiating period.
The magnitude of the implications of leaving the EU are such that legal advisers need to work very closely with colleagues from other departments. ‘Brexit shouldn’t be regarded as just a legal issue, it applies across the whole industry. Organisations such as Santander will have cross-functional working groups,’ Day says. On the passporting regime, she observes: ‘We would expect there to be an ongoing dialogue with the regulator as the negotiations proceed, so it is very early days.’
As Lord Justice Potter observed in Shamil Bank of Bahrain v Beximco Pharmaceuticals Ltd: ‘English law is a law commonly adopted internationally as the governing law for banking and commercial contracts.’ And it has long been a popular choice of law governing the standard documentation for derivatives transactions (ISDA Master Agreement).
The EU system of recognition and enforcement of judgments in civil and commercial matters ensures that judgments obtained in one member state can be recognised and enforced in any other EU country. But a ‘critical’ issue is whether or not member states’ courts would continue to respect English jurisdiction clauses and enforce English judgments post-Brexit, according to Ashurst Spain partner Manuel López. International investors and funders are now questioning whether English law remains a good choice, especially for long-term banking contracts such as loans.
The mutual enforcement of judgments is one area that potentially affects litigators, says Hart, but he adds: ‘The reality is that German parties with judgments want to enforce those in England just as much as English litigating parties want to enforce their judgments in Europe, so I suspect there is no great advantage to either side in not having some transitional, or an ultimate, arrangement which reflects the current situation. I think it will be sorted out pretty easily and fairly swiftly in due course.’