The FLS allows banks and building societies to borrow from the BoE for an extended period, at a price below current market rates. The aim is to make lending to UK households and private non-financial companies both “cheaper and more easily available”. As at 30 November 2012, 35 financial institutions have signed up to the FLS including major banking groups such as Barclays, Lloyds and RBS. It is expected that the National Loan Guarantee Scheme (NLGS), an earlier scheme designed to deliver credit easing to the economy, will be gradually superseded by the FLS.
How does the FLS operate?
During the ‘drawdown period’ – a period of eighteen months from 1 August 2012 to 31 January 2014 – participating banks and building societies will be able to borrow UK Treasury Bills from the BoE for a period of up to four years for a fee. Participating banks and building societies will be limited to one FLS transaction on each business day. As security against the borrowing of UK Treasury Bills, participating banks and building societies provide collateral to the BoE – in the form of business or mortgage loans and other assets. The beneficial interest in the collateral is either assigned to the BoE or held on trust by the participating bank or building society. A fixed charge on the collateral is allowed only if the other two options are unavailable. When the loans from the BoE mature, the collateral is returned.
The BoE reserves the right to reject any assets for any reason at any time when determining the eligibility of the collateral. The BoE has published a high-level collateral eligibility criteria for its operations (which is accessible online), which set a baseline for the quality of collateral accepted. If any of the loans posted as collateral – whether funded by the FLS or otherwise – are not repaid, then the associated losses will be borne by the participating bank or building society. Participating banks and building societies will use the UK Treasury Bills accessed under the FLS to borrow funds in the wholesale market.
How much can participating banks and building societies borrow?
The more a participating bank or building society lends, the more it can borrow from the BoE. Each participating bank or building society is able to borrow an amount up to 5% of its existing loans to the UK non-financial sector as at the end of June 2012, plus any expansion of its lending from that date to the end of 2013 pound-for-pound. For example, a bank with a lending of £100bn in June 2012, which lent a further £7bn by the end of 2013, would be eligible to borrow a total of £12bn under the FLS (an initial £5bn (5% of £100bn) plus a further £7bn additional lending as a result of a pound-for-pound expansion of its lending). The BoE will publish data on the usage of the FLS along with lending data from the participating banks and building societies on a quarterly basis.
What is the cost of participating in the FLS?
A participating bank or building society pays an FLS fee for the amount borrowed depending on how much it lends. The fee is based on the quantity of loans made by the participating bank or building society during the ‘drawdown period’. This does not include securities, commercial paper or bills and acceptances. If a bank’s or building society’s net lending increases, the funding fee will be 0.25% per year on the amount borrowed. If it declines, the FLS fee will increase linearly, adding 0.25% for each 1% fall in lending (up to a maximum of 1.5%). There is also a fee on early termination.
The cost of funding for a participating bank and building society is, therefore, the FLS fee plus the cost of borrowing using the UK Treasury Bills accessed under the FLS.
What are the requirements for participation in the FLS?
To be eligible to apply for the FLS, banks and building societies must first be signed up to the BoE’s Discount Window Facility (DWF), a bi-lateral facility which allows eligible institutions to borrow money from the BoE usually on a short-term basis, to meet temporary shortages of liquidity. This is part of its Sterling Monetary Framework (SMF). Institutions which are already participants in the SMF, but have not yet signed up for the DWF, will need to make a separate application to the DWF first.
Once this has been received, banks and building societies will be required to sign a Scheme Letter, which must be signed by an authorised signatory and be accompanied by authorised signatory evidence in a form acceptable to the BoE. UK branches of banks incorporated overseas will be asked to provide a Legal Capacity Opinion (or Legal Capacity and Country Opinion).
Applying to the FLS involves the following documentation:
- the Terms and Conditions;
- the Operating Procedures;
- Market Notices;
- the Scheme letter;
- a Guarantee (if required);
- legal opinion(s);
- the Authorised Signatory Evidence Form (the person duly authorised to sign documentation on behalf of the participant); and
- details of standard settlement instructions (SSIs).
In addition to the absence of any events of default, eligibility and continued access to the FLS will be dependent upon the participating banks and building societies and other relevant members of its group (its FLS Group) acting, in the opinion of the BoE, in good faith and in a manner consistent with the objectives of the FLS.
When is the deadline for applying?
For 18 months following the official opening of the FLS on 1 August 2012, banks and building societies can apply to borrow from the BoE.
What impact will the FLS have on additional lending?
The FLS is designed to incentivise banks and building societies to lend more to UK households and non-financial companies and to reduce their lending costs. The BoE does not prescribe the terms and conditions of additional loans that must be made by a participating bank or building society, nor does it require a participating bank or building society to pass on the lower funding costs to UK households and non-financial companies. However, some of the participating banks and building societies have begun selling loans at reduced interest rates as part of the FLS.
How can CMS Cameron McKenna LLP help?
CMS Cameron McKenna LLP has a leading banking sector practice. We can assist banks and building societies wishing to utilise the FLS including:
- advising on the documentation required during the application and operational process (e.g. Scheme Letter, FLS Transaction Request etc);
- advising on the collateral requirements and fees;
- carrying out legal audits of mortgage collateral, as required by the BoE;
- ensuring general compliance with the FLS; and
- advising on new financial products that may be developed by banks and building societies as a result of the FLS.