Most lawyers in Europe advising investment funds and managers will have encountered an overwhelming uncertainty regarding “what happens next?” on September 15th 2008, when Lehman Brother’s UK prime brokerage business went into administration. While at the time there were some temporary measures to deal with the resolution of deposit taking banks (subsequently replaced by the Banking Act 2009), the position of investment banks had been overlooked.

At an early stage during the course of the administration it became clear that the existing insolvency regime in the UK was not suited to the particular issues of investment bank insolvency. The return of client assets (i.e. securities and other property held by Lehman, but owned by its clients) proved particularly problematic. At an initial stage, it was an open question whether it was even the administrator’s job to deal with client assets. Also, when the administrators applied to court to sanction their proposal to impose a bar date on claims by clients for their assets, the courts were clear that there was no legal basis for imposing such a scheme.

The situation has changed significantly with the recent introduction of the Investment Bank Special Administration Regulations 2011 (the “Regulations”). The Regulations have been made under the Banking Act 2009 and they build upon and adapt the bank insolvency and bank administration regimes applicable to UK Banks. The Regulations also apply to investment firms that are not banks that hold client assets (this would cover most of the UK operations of the major US prime brokers).

In terms of client assets held by an investment bank in administration, there are three key features of the Regulations to be noted.

  • First – the return of client assets is recognised as an objective of the administration.
  • Second – the administrator is given powers to process the return to clients of their assets. In particular, there is an ability to set and impose a bar date by which time clients will have to make a claim for the return of their assets.
  • Third – the Regulations provide clarity regarding the consequences of a shortfall in client assets.

Interesting questions arise at a European level in relation to the resolution of failed prime brokers. A firm that is passporting from another member state of the European Union will not come within the definition of an investment bank. The resolution of such firms and the return of their client’s assets will be subject to the laws of their home member state. Up until now the resolution of banks or investment banks has not been the subject of any European legislation. However, the EU Commission has recently issued a working document (PDF) regarding a possible EU framework for bank recovery and resolution. A significant omission from the document has been the failure to make any proposals concerning the return of client assets. It will be surprising if the issue does not arise during the legislative process, and even more surprising if the particular issues involved in the failure of a investment bank are not addressed.