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Between a rock and a hard place
What are the likely repercussions if the
government is found to be breaching European law as far as the
nationalisation of Northern Rock is concerned? Business Money talks
to Nigel Frudd, head of financial services division, Rosenblatt
Solicitors
March 2008
Robert
Lefroy: You believe that the nationalisation of Northern Rock
contravenes European law?
Nigel Frudd: The nationalisation of
Northern Rock does not of itself contravene European law and of
course we must assume that the government has taken some of the best
legal and technical advice so that it does not contravene Article
87. Nevertheless, I think the deposit guarantee is open to challenge
in the long run as it is a state benefit not available to other
banks and can distort competition if consumers decide to make a
flight to Northern Rock, unless the government feels that it can
offer the same type of protection to all those who have deposits in
banks. My concern is a practical one of actually monitoring what
happens. Northern Rock is being privatised primarily, we are told,
so that it can be packaged for sale to the private sector at the
best price for the tax payer. This means that it must trade in the
ordinary course and it certainly is not clear to me how the
government propose to deal with a flood of deposits into Northern
Rock. Clearly this would bolster the cash position of Northern Rock,
help its capital adequacy and enable it to do business in the
mortgage market, which is all good for the tax payer. However, if
there is a flood, it will obviously distort competition and bring
the government into contravention of Article 87. As we are in a
volatile market and investors are looking for safe havens, my
concern is that the government has underestimated the consumer
appetite for placing deposits in Northern Rock. Of course, if the
flight to Northern Rock is material, it may have to close to new
business in order to prevent breach of Article 87, but that in
itself is not the most straightforward thing to do and would have
knock-on effects in terms of an entity regulated by the Financial
Services Authority treating its customers fairly, let alone the
impact on jobs.
RL: In which area do you consider the
law has been broken?
NF: I do not think the law has been
broken yet. However the initial six month period for rescue aid runs
out on 17 March and the rules for restructuring thereafter are more
demanding.
The danger is that Northern Rock will, backed by the government,
prove to have an unfair competitive advantage.
The Banking (Special Provisions) Act 2008 is now law and this
enables the government to nationalise any deposit taker where the
Treasury considers that there will be a serious threat to the
stability of the UK financial system if nationalisation was not
effected. Also, the Treasury can nationalise any deposit taker where
financial assistance has been provided by the treasury to the
deposit taker again for the purposes of maintaining the stability of
the UK financial system.
The actual transfer of Northern Rock was pursuant to the Northern
Rock plc Transfer Order 2008 and this is the order that legally
transfers Northern Rock plc to the state.
RL: What action will Europe take?
NF: Europe has a process of
investigation and will review the position after 17 March. In
reality, Europe will be looking closely at what is happening in the
market and listening to other deposit takers and any complaints they
may have. If the government is found to be in breach of Article 87,
the guarantee given to Northern Rock plc would cease as will any
other elements of government support found to be in breach of the
rules.
RL: Could this close down Northern
Rock?
NF: Breach of Article 87 would not
close down Northern Rock but its effect could be to initiate a
flight of capital out of Northern Rock into other deposit takers
which would then damage the prospects of returning Northern Rock to
the private sector.
RL: How
long would the process take if it had to?
NF: It is likely that an investigation
would take a number of months before any action be taken.
RL: What would then happen to its
customers?
NF: The customers would still be
customers of Northern Rock, but without the guarantee.
RL: Does this bill give the government
authority to nationalise other banks if necessary?
NF: The Banking (Special Provisions)
Act 2008 undoubtedly enables the government to nationalise any
deposit taker in order to maintain the stability of the UK financial
system (Section 2(1), (2)).
RL: What are your thoughts on the
government trying to waive the Freedom of Information Act in its
nationalisation bill?
NF: This is actually covered in the
Northern Rock plc Transfer Order 2008 and is specific to Northern
Rock only. Frankly, if the aim is to return Northern Rock to the
private sector, then I cannot see why Northern Rock should be in a
different position to banks in the private sector as to their future
strategy and confidential information. On balance I think the
government’s approach is correct.
RL: The government has paid out large
professional fees before proceeding. Was the advice it received
wrong?
NF: I think we have to assume with the
calibre of the professional firms involved, that the government has
been well advised at a technical level and that their advice is
correct. My question is whether this actually deals with the
practical consumer behaviour and indeed the practicalities of
dealing with a nervous investor public in times of volatile markets,
where daily we hear about a flight to cash for reasons of investment
risk. If the advice it has received is wrong, then of course the
government is open to sue the advisors concerned but I would assume
that they are all bomb proof.
RL: Is there a way the government can
get around the difficulties you have highlighted?
NF: Whilst Northern Rock is in its
ownership, it has to monitor the situation carefully to ensure there
is no breach of section 87. Clearly, the best way to mitigate the
government’s difficulties is for Northern Rock to be parcelled up
and sold on to the private sector as soon as possible.
Nigel Frudd,
partner, head of financial services division,
Rosenblatt Solicitors,
tel: +44 (0) 20 7955 1438,
e-mail: nigelf@rosenblatt-law.co.uk
