United Kingdom: Credit Guarantee Scheme

Faced with the potential collapse of the financial system following the rescue of HBOS and Bradford & Bingley, the British government announced a package of measures on October 8, 2008, intended to “to ensure the stability of the financial system and to protect ordinary savers, depositors, businesses and borrowers” (HM Treasury 2008a). In addition to the Credit Guarantee Scheme (the Guarantee Scheme), this package included the £50 billion Bank Recapitalisation Fund (pursuant to which the government could inject capital into eligible institutions in return for equity) and an expansion of the existing Special Liquidity Scheme (pursuant to which banks could exchange high-quality mortgage-backed and other securities for HM Treasury bills for up to three years) to £200 billion, up from the £50 billion initially projected. The Bank of England declared debt guaranteed pursuant to the Guarantee Scheme eligible for all of the Bank’s extended collateral operations including the Special Liquidity Scheme.

This authority allowed for the establishment of the Guarantee Scheme without the need for additional legislation.

UK authorities notified the European Commission of the October 8 package of measures on October 11, 2008, and received approval on October 13, 2008, under a new accelerated procedure for emergency rescue measures. The European Commission found the measures to be “compatible with EU State aid rules, because they were an appropriate means to remedy a serious disturbance in the UK economy” under Article 87(3)(b)of the European Commission Treaty (EC 2008a). UK authorities subsequently notified the European Commission of modifications to the Guarantee Scheme (including an expansion of eligible currencies, a change to the formula for calculating fees, and an extension of the rollover window) on December 18, 2008, and received approval on December 23, 2008.

The British government established the size of the Guarantee Scheme at £250 billion, reflecting HM Treasury’s estimate of the amount of debt likely to be issued pursuant to the program. This total was subject to subsequent adjustment; because actual issuance proved to be far less than the £250 billion projection, no adjustment in total size was ever made.

When the British government introduced the Guarantee Scheme as part of the October 8, 2008, package of stabilization measures, it made eight institutions, consisting of the major UK banks and the largest building societies,^FSee footnote 1. automatically eligible for participation “in recognition of their commitment to strengthen their aggregate capital position” by a collective £25 billion in Tier 1 capital pursuant to the Bank Recapitalisation Fund that was also part of the package. This commitment occurred following “discussions convened by HM Treasury.” Other UK deposit takers (including UK-incorporated subsidiaries of foreign institutions) and building societies could apply to be eligible, with eligibility contingent on a determination by HM Treasury that the applicant possessed sufficient Tier 1 capital. Applicants would also be evaluated on their roles in the UK banking system and overall economy.

These instruments could take the form of a certificate of deposit, commercial paper, a bond, or a note. No cross-default or cross-acceleration provisions could be included.

The government does not appear to have established minimum maturity requirements for eligible debt.

This initial list of eligible currencies was ultimately expanded as part of the December 2008 modifications to include Australian dollars, Canadian dollars, Swiss Francs, and Japanese yen, with the objective of “further extending the investor base in UK banks and building societies” (HM Treasury 2008b).

Program documents did not provide a specific rationale for using this measure to determine individual participation caps.

HM Treasury charged a fee (payable in the currency in which the guarantee was denominated) equal to a per annum rate of 50 bps plus 100% of the median five-year CDS spread during the 12 months ended July 1, 2008, of the debt-issuing institution or any affiliate designated by HM Treasury. This fee could be increased in HM Treasury’s discretion to reflect any added cost associated with guaranteeing debt issued in currencies other than sterling.

This approach to determining fees based on institution-specific risk as measured through five-year CDS spreads was consistent with the fee framework subsequently set forth by the European Central Bank in its “Recommendations on Government Guarantees on Bank Debt” of October 20, 2008.  UK authorities initially chose the 12-month period ended October 7, 2008 as the CDS reference period for the fee calculation, but in December 2008 they shifted to the July 1, 2008 end date based on a desire to lower fees to be more consistent with other countries’ guarantee programs.  This revised reference period had retroactive effect.  

When introduced, the Guarantee Scheme contained a provision prohibiting eligible debt from including any right of prepayment by the issuer. On June 8, 2011, UK authorities amended the Guarantee Scheme to include a Buyback Facility pursuant to which issuers could repurchase and cancel guaranteed debt. Such repurchases would relieve the issuer of the obligation to pay any future guarantee fees on the cancelled debt, in exchange for which the issuer would pay a break fee equal to 15% of the total future guarantee fees avoided.

Institutions participating in the Guarantee Scheme initially had to limit their growth “to the higher of the average historical growth of the balance sheets in the UK banking sector during the period 1987–2007, or the annual rate of growth of UK nominal GDP in the preceding year.”  In December 2008, UK authorities eliminated this condition for institutions deemed “fundamentally sound.”

Participants also had to refrain from “explicitly promoting [themselves] on the basis of the state guarantee” (European Commission 2008b). These restrictions were consistent with European Commission guidelines subsequently released in October 2008 on potential safeguards “to minimize…distortions and the potential abuse of the preferential situations of beneficiaries brought about by a State guarantee” and “to avoid moral hazard” (European Commission 2008c).  

A set of additional conditions including compensation restrictions, lending commitments, and support for mortgage assistance programs imposed on participants in the Bank Recapitalisation Fund did not generally apply to the Guarantee Scheme but could be imposed on a case-by-case basis, particularly for institutions that made heavy use of it (European Commission 2008b).

In connection with the prolongation of the Guarantee Scheme in April 2009, UK authorities added a requirement that large banks (defined as having more than £25 billion in sterling eligible liabilities) issuing guaranteed debt after April 9, 2009 commit to a negotiated level of lending to the real economy.

UK authorities intended this requirement to help ensure that only those institutions that would be viable absent crisis conditions could access the Guarantee Scheme.

According to UK authorities, lingering uncertainty about the credit risk of individual financial institutions continued to hinder interbank lending markets as the Guarantee Scheme approached its originally scheduled issuance deadline.  This required that the Guarantee Scheme be prolonged.

Following the expiration of the issuance window, all guaranteed debt issued pursuant to an Eligibility Certificate could be rolled over until April 13, 2012. After that date, up to £83 billion (one-third the £250 billion program size) in guaranteed debt could be rolled over until April 9, 2014. The purpose of these rollover provisions was “to enable participating institutions to manage better the transition from guaranteed to wholly unsupported funding” (House of Commons 2008).