Floating charges for building societies

From 26 March 2015, building societies will be able to create floating charges. What will these changes mean in practice?

Financial Services (Banking Reform) Act 2013 (Commencement (No 8) and Consequential Provisions) Order 2015: A provision in the Financial Services (Banking Reform) Act 2013 (FS(BR)A 2013) is commenced which allows UK building societies to create floating charges without a registration scheme and makes consequential provision in relation to this. It is coming into force on 26 March 2015.

What is changing?

The Financial Services (Banking Reform) Act 2013 (Commencement (No 8) and Consequential Provisions) Order 2015 brings into force FS(BR)A 2013, Sch 9, para 4 on 26 March 2015 and repeals the prohibition on building societies creating floating charges under Building Societies Act 1986, s 9B (BSA 1986). The effect of the changes is that building societies will be allowed to create floating charges and will not be obliged to register any such charge.

The Order also makes consequential amendments to the Building Societies (Financial Assistance) Order 2010,SI 2010/1188 and provides for the creation of floating charges by building societies in Scotland.

What is the background?

The government has recognised that the current prohibition on building societies creating floating charges (contained in BSA1986, s 9B) causes practical difficulties for building societies as floating charges are common place in the financial services industry and banks are not restricted in a similar manner. It is accepted that the original reason for introducing a ban on the creation of floating charges by building societies is no longer relevant given the changes in insolvency law in 2002. An interim measure, made under the Banking (Special Provisions) Act 2008 in response to the difficulties surrounding Northern Rock, enabled building societies to grant floating charges to the Bank of England or anyone acting on the bank’s behalf, in connection with the provision of financial assistance to them.

The impact assessment to this Order highlights the fact that the existing prohibition places building societies at a disadvantage as they are precluded from being offered 'delivery by value' transactions by banks. 'Delivery by value' transactions may be undertaken by building societies with market counterparties through the CREST system in order to turn Treasury bills or other financial assistance into cash. Under existing financial assistance programmes, such as the Special Liquidity Scheme (SLS), the Bank of England provides recipients with Treasury bills. Building societies can then enter into a repo in respect of these Treasury bills in order to generate funding. Repos of Treasury bills can be made directly with market counterparties, directly with the Bank of England under its weekly Open Market Operations, or through the 'delivery by value' mechanism through CREST. In a 'delivery by value' transaction, the counterparties agree the cash amount of the repo and the CREST system automatically allocates and delivers assets from the borrower’s account to cover the value of the deal (ie they are 'delivered by value') and marked to market based on the closing CREST market prices. 'Delivery by value' repos unwind automatically the following day reversing the cash and the security transfers within CREST.

In order to conduct the 'delivery by value' transaction, participants need to be able to create charges in favour of their settlement bank over their assets. Banks do not permit building societies to participate in 'delivery by value' transactions as there is a risk that the security granted would be void under existing legislation if re-characterised as a floating charge due to insufficient control being exercised (see Re Spectrum Plus Ltd; National Westminster Bank plc v Spectrum Plus Ltd and others [2005] UKHL 41, [2005] 4 All ER 209). Without access to 'delivery by value' transactions, building societies will miss out on yield as they are required to hold more cash in overnight deposit or reserve accounts with the Bank of England, instead of holding gilts (which typically have a higher yield of 0.2%).

What are the implications?

The removal of the prohibition means that a bank will likely offer building societies access to 'delivery by value' transactions, since there will no longer be a risk that the bank's security granted over the building society's account being void should it be re-characterised as a floating charge instead of a fixed charge(if insufficient control is exercised by the bank over these assets). Building societies can then hold gilts instead of having to hold this cash with the Bank of England and earn the missed yield of 0.2%, which would result in significant savings. The freedom to create floating charges will allow building societies to compete on a level playing field, as banks are already able to undertake this activity.

With the ability to create a floating charge, a building society can grant a charge over its non-fixed assets and it can continue to use and deal with such assets which are the subject of a floating charge. This includes its mortgage book assets. This right will be in addition to the current ability by building societies to create fixed charges.

Nick How, solicitor in the Lexis®PSL Banking & Finance team.

First published on LexisPSL Banking & Finance. Click here for a free trial.

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