Law to require investment banks to prepare for failure

UK investment banks may have to plan for their own failure to prevent a repeat of the chaos after Lehman Brothers went bust last year.

By Philip Aldrick
Telegraph, 11 May 2009

The Treasury has begun consultation into the insolvency regime for investment banks to plug one of the holes in Britain's regulatory regime. "The failure of Lehman highlighted two areas of difficulty: first, around trading, clearing and settlement; and second, around the return of client assets," the consultation document says. "Each needs to be addressed to maintain financial stability and protect the reputation of London as a world-class venue for investment banking."

When the US authorities last September put Lehman into administration, it left counterparties and clients in the UK with no idea how to settle their positions or recover their assets. While the US Chapter 11 regime allowed time for the bank to settle its US positions, the UK rules caused havoc by spreading panic among counterparties, which spooked the whole financial system.

According to administrator PricewaterhouseCoopers, which says the bank's administration may be the most costly and complex in history, 1.5m positions remained open in the UK.

"The ability of market participants to achieve clarity into their open positions and hedge their exposures, is critical to a well-ordered and effective financial system," the Treasury says.

On client money, it adds: "Prior to the failure of Lehman, the impact of insolvency proceedings in respect of a major investment bank had not been factored into market expectations." A new regime must resolve such issues "promptly" and with greater "transparency".

Ash Saluja, of City law firm CMS Cameron McKenna, said: "This is another example of firms being required to plan for their own demise – investment banks may have to draw up contingency plans which administrators and regulators would use if the bank ever hit the rocks."

The paper also proposes "a special insolvency procedure for investment banks". The Treasury hopes to publish draft regulations by the end of the year.