U.K. Outlines Insolvency Overhaul After Lehman

The U.K. Treasury will call for faster payments to creditors and greater clarity on trades in the event an investment bank collapses, an effort to overhaul insolvency law after the demise of Lehman Brothers Holdings Inc.

Investors will have more protection and information to determine the legal position of outstanding trades once liquidators have been called in. The proposals to reshape insolvency rules were published in London today, forming the basis for a formal consultation later this summer.

"The reforms considered in this report demonstrate the government’s commitment both to financial stability, and to the future of London as a global investment banking hub," Treasury minister Paul Myners said in a statement today.

The U.K. has already overhauled bank rescue rules and is seeking to restructure financial supervision after the global credit crunch forced the government to nationalize Northern Rock Plc and take control of Royal Bank of Scotland Group Plc and Lloyds Banking Group Plc.

The government wants insolvency laws to have special provisions for investment banks after the collapse of Lehman revealed the rules aren’t "well adapted" to that scenario. It will shun adoption of U.S.-style Chapter 11 protection from creditors because it isn’t suited to English law.

Lehman filed the biggest bankruptcy in history in September, roiling financial markets and sparking lawsuits by former clients whose assets were frozen in insolvency proceedings around the world. Estimates show the bankruptcy cost creditors as much as $75 billion.

Early Access

The U.K. overhaul would allow creditors early access to some unsecured assets instead of having to wait until the whole liquidation process is complete. Such a shift is designed to strengthen financial stability, the person said.

A second pillar of the reform would seek to force investment banks to make more use of clearing houses for trades. It would also require greater legal clarity on trades so that counterparties understand their position in case of administration.

About 1.5 million over-the-counter cash equity trades, exchange-traded derivatives and other derivative contracts were open in the U.K. when Lehman’s European unit ceased trading in September.

The Treasury also wants more preemptive steps in case of a bank’s collapse, forcing them to explain to investors in sales prospectuses how they will proceed in case of insolvency.

It wants the Financial Services Authority to review contingency plans, appointing special insolvency agents and forcing banks to continue trading while insolvency proceedings take place.

The proposals put forward today follow talks between investment banks, lawyers, insolvency experts, the FSA, the Bank of England and the Treasury.

The markets regulator in April already put financial companies on notice about the need to research and "ring- fence" client assets in the wake of Lehman’s failure.

(Published by Bloomberg - May 11, 2009)