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Britain's ring-fence a new hurdle for bank directors

[LONDON] Britain's major lenders may find it hard to hire dozens of directors that are required as part of a radical reshape of the industry aimed at protecting it from future investment bank crashes.

Britain wants banks such as HSBC, Barclays and the UK arm of Spain's Santander to ring fence their retail units from their wholesale operations, including creating a separate board for their retail divisions that would be independent of the parent group.

But the banks may struggle to fill these boards because the directors will be more exposed if things go wrong, particularly under new rules which will make it easier for the regulator to hold senior bankers to account for misconduct, including the threat of jail for reckless decisions that cause a bank to fail.

"I think it may be hard to find directors for these ring fenced banks," said Simon Gleeson, a partner at UK law firm Clifford Chance. "You're practically volunteering for the role of scapegoat." "It almost feels as if the ring fenced bank is going to operate on a kind of strict liability level because having been set up to be failsafe, if it does fail, regulators, politicians and others will be very, very incensed."

Investment banks are viewed as riskier because they make bets on markets but retail banks are also sources of instability. Many of the banks that got into trouble during the global financial crisis were retail banks that provided loans to finance home purchases such as Britain's HBOS, which was taken over by Lloyds.

Britain wants to make directors more accountable and responsible for their actions, aiming to prevent a repeat of the 2007-09 financial crisis when taxpayers spent tens of billions of pounds bailing out major banks whose directors walked away with their pensions intact.

The threat of prison will be remote and tougher rules are necessary, bankers and headhunters admit, but it will add another reason to avoid bank boards, already shunned by some qualified candidates because of the increased workload and complexity of being a financial services sector director following the crash.

"We should be under no illusions: finding enough people with the appropriate experience, who are not tainted by the financial crisis, and who are willing to take on the extra responsibility and culpability placed on them by the senior manager regime will be challenging," said Omar Ali, head of UK banking and capital markets for consultancy EY.

This week two board members of HSBC's UK unit were preparing to quit, partly because of concern about regulation, a person familiar with the matter said.

Any bank with 25 billion pounds (S$51 billion) of UK deposits will need to set up a ring-fenced unit by 2019 and will have to submit preliminary plans to the Bank of England by January 6 of next year.

At present, six firms would need to do so: HSBC, Lloyds Banking Group, Barclays, Royal Bank of Scotland, Santander UK and the Co-operative Bank.

Another batch of lenders have deposits of almost 25 billion pounds and could be above that level by 2019, including TSB , Virgin Money, National Australia Bank's UK operations, and Williams & Glyn, a business being spun out from RBS.

Some, like TSB, may be pure retail banks so will not have to set up a separate ring-fenced structure.

That could leave seven or eight ring-fenced banks, each with a board of 8-12 people, industry sources said, meaning that more than 60 people could be needed to fill the positions, including 40 non-executives.

The expected surge in demand for directors comes at a time when there has already been increased calls for directors with financial experience as several new banks have set up in Britain and international banks have been trying to improve the quality of their UK boards.

The breadth and depth of the financial crisis mean there is a limited number of experienced people, untainted by the misdeeds of the past, who banks can call upon. "They need to find more people to do this at a time when some people think the risk/reward has tilted against non-execs, so you may find a situation where supply has gone down at a time that demand has gone up," said Clifford Smout, Deloitte's co-head for regulatory strategy in Europe.

Widening the pool to people outside of financial services can also be problematic. Non-executive directors of banks typically have to devote one day a week to the role compared to an average of around 25 days a year before the crisis and that's assuming they are willing to enter an industry which in Europe is still a lightning rod for public criticism. "Any executive I sit down with who is shifting into non-executive roles will typically open the conversation by saying, 'I will join the board of any industry unless it's tobacco, defense or financial services'," said one London-based headhunter.

Bank non-executives could be paid more, or have contracts specifying their responsibilities and with indemnities to cover problems in areas outside their reach, headhunters said.

Sitting on the board of a ring-fenced retail bank will also open the director to conflicts of interest between their obligations to the ring-fenced bank and the wider group.

The idea of shielding the retail bank from the rest of the group is to ensure that it is not treated like the company piggy bank, its deposits plundered to support risky market bets.

But a situation could arise where it makes sense for the good of the overall business if funds or funding or capital is transferred from the ring-fenced bank to another ailing part of the group.

The directors are then faced with a conflict between their obligations to the regulator under the ring-fencing rules and their obligations to shareholders under English corporate law. "You have got a set of rules coming in which can never satisfactorily resolve that conflict of interest," said Bob Penn, a partner at Allen & Overy, a London law firm. "This will embed a very conservative, possibly overly cautious approach on the part of management dealing with the wider world because they have to look over their shoulders on every decision." So far, the Bank of England appears to be leaving it to the banks to solve any conflicts, noting in its consultation paper this week that the ring-fenced banks must set out, "arrangements to identify and manage" any such potential friction.

But it remains to be seen how constrictive the Bank of England's rules will be. Many issues still need to be clarified, including how much capital the ring-fenced bank needs to hold and how far it can share technology and other assets with the rest of the group. Reuters