Between the revolving door of penury-claiming
banks and the head spinning sums being allocated, seemingly weekly, to
leading U.K. financial players, one could be forgiven the sense of
vertigo. Now in its third round of Royal Bank of Scotland (RBS) rescue,
Her Majesty's (HM) Treasury and the Financial Services Authority (FSA)
are hopeful that this “third time is the charm.” Of course,
in this the U.K. is not alone. A regulatory and financial football
match is underway with equally generous healers of the U.S. government
and their latest ward, Citigroup. Playing from the same regulatory
playbooks, albeit in a different order, the two governments have set
themselves up to be both significant regulators and overwhelming
owners. The impact, thus far, has been to dilute shareholders, protect
creditors and salvage the financial system. What remains to be seen is
whether this suffices.
With global banks teetering from dizzying change, governments continue
to intervene with balms and salves. Their playbooks consist of a
similar set of structures, including different ways of contending with
toxic assets: backstopping/insurance, toxic asset sales, and good
bank/bad bank structures, among others. In the U.K. in particular,
with an initial focus on the case of RBS, the key legal mechanisms
include:
- Backstopping/insurance, initial "core" amounts are ring-fenced with the potential losses covered by the government;
- Remuneration/executive compensation restrictions utilize both
prospective restrictions and retroactive clawbacks and are intended to remedy
risk-promoting behaviors;
- Equity stakes, intended to compensate taxpayers for the immense risks they are assuming;
- Seniority-promoting
shareholder repayment restrictions (including dividends and share
buybacks) and other share-related rights; and
- Extensive new regulations released on the fly (which is always dangerous as these may result in unintended consequences).
Backstopping
in the U.K. has been introduced through the Asset Protection Scheme (APS),
announced on January 19 as part of the U.K. government's "comprehensive
measures" to address the continuing economic crisis and first detailed
by HM Treasury on February 26. This scheme is structured to separate
the riskier assets of a participating bank under a "ring fence" from
the healthier assets. This move is intended to avoid the need for
additional capital to offset losses as the values of the riskier assets
are written down. At the same time the government will provide
protection on up to 90% of the losses to these ring fenced assets with
the participating bank responsible for the first 10%.
Participants are required to pay a fee, which may be funded through a
share issuance, as well as enter into agreements with the government
requiring increased lending activity. RBS is the first
participant in the scheme and will have £325 billion in assets
protected for a fee of £6.5 billion paid through the issuance of
ordinary B shares to HM Treasury. RBS will be responsible for up to
£19.5 billion of losses incurred after January 1, 2009 on the
protected assets. The bank also agreed to increase lending by £25
billion for 2009 and 2010. Other banks may follow.
Remuneration controls are an important component of government financing in the U.K.
(and the U.S.). The Asset Protection Scheme plan
also addressed cooperative efforts between HM Treasury and the FSA to increase transparency and provide
guidance on remuneration. A joint consultation document on disclosure
standards will be issued by HM Treasury and the FSA in the future and
the FSA issued a draft code of practice on remuneration policies aimed
at limiting risk-taking by executives based on the structure of their
compensation. This policy is similar to the steps taken by the U.S.
government to limit executive compensation for recipients of government
assistance under the Troubled Asset Relief Program (TARP).
Equity investment is the third leg of the U.K. government’s
recent moves, executed outside of the Asset Protection Scheme. An
announcement issued by RBS on February 26 spells out the details of
a £13 billion contribution towards its Tier 1 capital. This
contribution was made by HM Treasury, in exchange for ordinary B
shares, the same type as those used to pay for the participation fee in
the APS. These B shares come with strings attached: they are
convertible into ordinary shares; restrict RBS from repurchasing its
ordinary shares while the B shares are outstanding; and give HM
Treasury demand rights for RBS to list the B shares. If converted, the
government could end up holding 95% of the bank on an economic
basis, though its voting rights would be capped at 75% under the
terms of the B shares. At the same time RBS released an agreement
with the U.K. government, as a majority shareholder, over executive pay
and rewards, both clawing back past rewards and severely capping those
going forward.
If all of this sounds familiar to those with an eye to the
U.S., it should. Many of the same moves were adopted in the U.S.
rescues (yes, plural) of Citigroup, though in a slightly different
order. In the latest scrum, Citigroup hit up the U.S. government
for a third time through the potential exchange of up to $25 billion in
preferred stock the U.S. Treasury was issued through the Capital
Purchase Program into common stock. The agreement is contingent
on Citigroup also converting approximately $27.5 billion of preferred
securities held by other investors. If all of the eligible preferred
securities are converted the U.S. government would end up with
approximately 36% of the outstanding common stock and existing
shareholders with approximately 26%.
On all sides, the
participants hope that the “third time is a charm”. Both
RBS and Citi are on their third round of government assistance and both
leave their governments with the dual roles of regulator and
significant shareholder. Of note: while RBS is the first British
bank to participate, it may not be the last. News stories are already
circulating around Lloyds and expensive payments to parting HBOS
employees. HSBC, another London-based global bank, has for now decided
on a rights issue worth up to £12.5 billion as a means of
increasing capital, in place of government funding. Its success
remains to be seen.
More explicit global alignment may soon result. Meetings
between U.K. Prime Minister Brown and U.S. President Obama will
undoubtedly seek to further cooperative actions to address the economic
crisis. Look for possibly coordinated actions with additional
participants of the G-20 as the global scale of the crisis plays out.
Published: March 3, 2009
