In light of the economic turmoil and loss of consumer confidence which has blighted the UK and international financial system over the past two years, the Tripartite Authorities have sought to reform the UK banking industry by strengthening the financial system’s stability and resilience. The Tripartite Authorities have also been working alongside their European and international counterparts to create a more stable and transparent system.
This update sets out those key UK, European and international reforms, and proposals for reform. This update sets out the position as at late July but this is an ever changing regulatory environment. Care should be taken when using the update as it will become out of date relatively quickly. We intend to provide a further update in October.
The Walker review on corporate governance, published on 16 July, has set out 39 recommendations which are intended to improve the governance of UK banks and other financial institutions.
The review has called for “an environment in which effective challenge of the executive is expected and achieved in the boardroom before decisions are taken on major risk and strategic issues” and has earmarked non-executive directors (“NEDs”) to play a more significant role in risk management.
Among its recommendations to increase the effectiveness of NEDs, the review has proposed providing NEDs with a personalised approach to induction, training and development, and has stated that NEDs should be expected to commit themselves for a minimum of 30 to 36 days in a major bank board. Chairmen should be expected to commit not less than two-thirds of their time to the business of the entity. The Financial Services Authority’s (“FSA”) interview process for NEDs should involve questioning and assessment by one or more senior advisers with relevant industry experience.
The role of institutional shareholders will be enhanced through encouraging adherence to principles of best practice and by giving weight to these ‘Principles of Stewardship’ through their ratification by the Financial Reporting Council. Authorised institutional investors should describe their policies on engagement and how they seek to discharge their responsibilities that commitment to the Principles entails on their websites. The boards of banks and other financial institutions should establish a board risk committee, served by an independent Chief Risk Officer, with responsibility for oversight and advice to the board on the current risk exposures of the entity and future risk strategy. A board risk report should be included as a separate report within the annual report and accounts.
The review also stresses the need for substantial enhancement in board level oversight in remuneration policies. One of the most notable recommendations is that at least one-half of variable remuneration is offered in the form of a long-term incentive scheme in which half of the award vests after not less than three years and the remainder after five years. Short-term bonus awards should be paid over a three year period with not more than one-third in the first year.
The consultation period will run until 1 October, with conclusions in November 2009.
On 27 July 2009 the FSA published a policy statement (PS09/14) setting out changes to the approved persons regime following its consultation in December 2008.
The FSA wishes to ensure that those individuals who are likely to exert a significant influence over a regulated firm fall within the scope of the approved persons regime.
The changes have extended the scope and application of the director function (CF1) and non-executive director function (CF2) to include those persons employed by an unregulated parent undertaking or holding company, whose decisions or actions are regularly taken into account by the governing body of a regulated firm. The definition of the significant management controlled function (CF29) has also been extended to include all proprietary traders who are not senior managers but who are likely to exert significant influence on a firm.
The application of the approved persons regime has been extended to UK branches of overseas firms based outside the EEA and the rule requiring firms to provide references for applicants of the customer function (CF30) has been extended so that it applies to all controlled functions.
These changes will come into effect on 6 August 2009 with a transitional period of 6 months. Firms should now begin to assess which individuals require approval and submit timely applications to comply with the end of the transitional period.
RETAIL BANKING REGULATORY REFORM
During 2008 the FSA began a review of the Banking Code and the Business Banking Code (the “Codes”) to ascertain whether the existing arrangements were the right model for the future. Following its review of the Codes the FSA proposed a new framework to regulate the way banks and building societies treat their retail customers in its consultation paper CP08/19.
The review confirmed that the Codes’ scope is broadly correct and that the Banking Code Standards Board (“BCSB”) enforces them effectively. However, the FSA proposed that it would be more effective to move away from the voluntary regulation of deposit-taking activities and to extend its regulation across all aspects of the relationships between banks, building societies and their retail customers, excluding credit regulated by the OFT such as unsecured loans and credit cards.
Key reasons for this proposed move included the Codes’ lack of a standard equivalent to the FSA’s overarching fairness objective in FSA Principle 6 on treating customers fairly, and weaknesses in the BCSB’s disciplinary powers and regulatory approach.
Responses to CP08/19 were largely supportive of the FSA’s proposals and, in PS09/6, the FSA confirmed that it intends to implement the new framework as proposed and take over all retail banking conduct of business regulation from 1 November 2009.
The new retail banking conduct of business regime will apply to banks, building societies and credit unions, and will involve the application of the FSA’s Principles for Businesses and a new “Banking Conduct of Business sourcebook” (“BCOBS”).
The FSA has indicated that BCOBS and the Payment Services Regulations 2009, which implement the Payment Services Directive (this aims to harmonise services across the EU that allow consumers and businesses access to payment systems), will together form the Banking and Payment Services conduct regime (“BPS”).
The new framework for the regulation of retail banking will involve the full application of the FSA’s Principles for Businesses to the regulated activities of accepting deposits and issuing electronic money to the extent compatible with European law. There will also be a “short” BCOBS applying to “retail banking services” which will contain new high-level outcome-focused rules primarily relating to information to be provided to banking customers, as well as the existing Conduct of Business sourcebook rules and guidance that apply to deposit-taking activities.
The FSA is currently consulting on its proposed amendments to BCOBS in Chapter 6 of CP09/20. The proposals include adding guidance to BCOBS on the advance notification to a banking customer of material changes to interest rates and of bonus or introductory rates coming to an end, as well as adding provisions on liability for losses in respect of unauthorised transactions on accounts outside the scope of the Payment Services Regulations.
These and the other proposed changes will take effect on 1 November 2009. The final text of the new Handbook rules and guidance for the BPS is set out in Appendix 1 to PS09/6, and the proposed changes to that text can be found in Appendix 6 to CP09/20. Responses on the amendments to BCOBS are required by 17 August.
Enhancing the international framework
The Basel Committee on Banking Supervision (“BCBS”) has recently published three papers in regard to enhancing the existing bank capital framework: Enhancements to the Basel II framework, Revisions to the Basel II market risk framework, and Guidelines for computing capital for incremental risk to the trading book.
Under the BCBS’s proposals for enhancing Pillar 1 (minimum capital requirements) of the existing Basel II framework, banks will be required to revise their standardised risk weights and increase their risk weights to re-securitisation exposures. Banks will no longer be permitted to assign risk weights to asset-backed commercial paper based on guarantees provided by the same entity and, should banks wish to use the Basel II risk weights, they will be required to perform their own due diligence rather than simply relying on external credit rating agencies. The credit conversion factor for all eligible liquid facilities will be raised from 20% to 50%, regardless of the maturity of the liquid facility. Banks are expected to comply with the revised requirements by 31 December 2010.
The Committee has issued supplemental guidance under Pillar 2 (the supervisory review process) with respect to banks’ firm-wide risk management and capital planning processes. The guidance states that a sound risk management system should have active board and senior management oversight, appropriate policies, procedures and limits and comprehensive internal controls. Risks should be identified, measured, mitigated, controlled, monitored and reported in a comprehensive and timely fashion whilst appropriate management information systems should be implemented at the business and firm-wide level.
The guidance raises the standard for capturing the risk of off-balance sheet exposures and securitisation activities, managing risk concentrations, and providing incentives for banks to better manage risk and returns over the long term. The supplemental guidance also incorporates the Financial Stability Board’s (“FSB”) Principles for Sound Compensation Practices (see below for more information). Banks and supervisors are expected to begin implementing the Pillar 2 guidance immediately.
The third pillar (market discipline) enhancements are designed to strengthen disclosure requirements for securitisations, off-balance sheet exposures and trading activities. These additional disclosure requirements will help reduce market uncertainties about the strength of banks’ balance sheets related to capital market activities.
New trading book rules take effect at the end of 2010 and introduce higher capital requirements to capture the credit risk of complex trading activities. They also include a stressed value at risk requirement which the BCBS believes will help dampen the cyclicality of the minimum regulatory capital framework.
The European Commission (“EC”) has published a series of proposals over the past year on amending the Capital Requirements Directive (“CRD”), which applies to banks, building societies and certain types of investment firm, with the aim of maximising the effectiveness of the capital rules in ensuring continuing financial stability, maintaining confidence in financial institutions and protecting consumers.
On 27 July 2009, the Council of the European Union announced the adoption of a Directive updating capital requirements.
The Directive seeks to strengthen the supervision of cross-border banking groups by requiring close coordination between the supervisor of the member state where the parent undertaking is located and the supervisors of its subsidiaries with regard to decisions relating to risk assessment and additional capital requirements. Reporting requirements will be fully harmonised at European level by 2012 and colleges of supervisors, chaired by the supervisor of the parent undertaking, will be established for all cross-border groups. The role of the Committee of European Banking Supervisors (“CEBS”) has been strengthened and the mandates of national supervisory authorities are given a European dimension.
The Directive also seeks to improve the framework for securitisation practices by obliging originators to retain 5% of the risks transferred into investors on their balance sheets. The classification of banks’ “tier 1” capital funds and hybrid instruments has been harmonised, with a central role given to CEBS in ensuring greater uniformity of supervisors’ practices. New rules on liquidity risk management have been introduced, in particular with regard to the setting up of liquid asset reserves, conducting liquidity stress tests and establishing contingency plans. The supervision of exposures to single counterparties, whatever their nature, have been tightened (in all cases, the limit is 25% of banks’ own funds).
These adopted amendments are further supplemented by amendments proposed in the latest EC consultation, published on 24 July 2009. The proposed amendments relate to through-the-cycle expected loss provisioning, specific incremental capital requirements for residential mortgages denominated in a foreign currency, and the removal of national options and discretions. In addition, the changes are meant to simplify the Bank Branch Accounts Directive (this regards obligations relating to the publication of annual accounting documents of bank branches in Member States where their head office is in another Member State). Responses are requested by 4 September 2009.
The revised CRD is unlikely to be in force until late 2011.
The FSA is currently considering the UK and international approaches to capital policies as part of the Turner Review. The FSA is assessing issues such as the level of capital credit institutions are expected to hold and the quality of capital. The FSA interim regime recommending 4% core tier 1 capital is already in place although international agreement on a long-term regime is required.
The FSA published its views on the definition of capital in its July 2008 feedback paper (FS08/5). Among the key points of the feedback statement was the acceptance of the proposal to categorise capital according to its purpose (i.e., going and gone concern capital) and to retain the current characteristics of hybrid instruments.
The FSA set out its proposals for “a far-reaching overhaul” of the liquidity requirements for banks, building societies and investment firms in its December 2008 consultation paper (CP08/22). The amended rules are designed to enhance firms’ liquidity risk management practices and to improve the FSA’s ability to monitor and supervise firms’ liquidity risk exposures. The five key aspects of the FSA’s proposed new liquidity policy are: that all FSA-regulated firms have adequate liquidity and are self-sufficient; a proposed new systems and controls framework; new individual liquidity adequacy standards; a new group-wide and cross-border liquidity management framework; and a new reporting framework for liquidity.
The FSA expects that many institutions will need to significantly reshape their business model as a result of the proposals. The draft Prudential Sourcebook for Banks, Building Societies, and Investment Firms (Liquidity) Instrument 2009, containing the proposed amendments to the FSA’s Handbook, is set out in Appendix 1 to CP08/22.
The FSA’s consultation paper (CP09/13) on liquidity reporting, on consequential amendments to the FSA Handbook and on transitional arrangements, was published on 15 April 2009. The FSA plans to monitor liquidity not just at an individual firm level, but also at market-wide and sectoral-levels. The FSA plans to achieve this by collecting quantitative liquidity information that is “granular, frequent, standardised, and based on firms’ contractual commitments and exposures.” The FSA will use this information to conduct internal stress testing, “what if?” analyses and peer comparisons.
Although respondents were broadly supportive of the FSA’s proposals in the pre-consultation, the FSA has made a number of significant changes to its original proposals in CP08/22 in light of the comments received, which should “make the overall approach less onerous”. The changes include: allowing certain firms to opt for a simplified regime that involves reporting less frequently and with extended submission deadlines; clarifying how the proposals on cross-border and intra-group management of liquidity will affect regulatory reporting; revising submission deadlines, including weekly and crisis-time submission deadlines for daily reporting, to make them more manageable; and reassessing the implementation timetable for the quantitative reporting requirements.
Whilst the FSA recognises the new requirements will be costly for firms to implement it believes the information it plans to request would usually be required by most firms for internal liquidity risk management. The FSA’s draft instrument outlining the proposed changes to the Handbook, including chapter 16 of the Supervision manual (“SUP”) is set out in Annex 1 to CP09/22. The deadline for submitting responses has closed.
On 5 June 2009, the FSA published a consultation paper (CP09/14) setting out proposed transitional provisions that are designed to give firms time to prepare to implement the new liquidity regime. The proposed, phased implementation plan covers elements such as systems and controls requirements, new quantitative and reporting requirements and proposed self-sufficiency requirements.
The FSA intends to publish a policy statement that sets out the finalised liquidity regime and reporting rules, as well as the transitional arrangements, in the third quarter of 2009. The FSA aims to have new liquidity rules and guidance taking effect from the fourth quarter of 2009. The consultation period closed on 31 July 2009.
The FSA has set out proposed changes to the rules and guidance on stress and scenario testing in SYSC, GENPRU, BIPRU and INSPRU in a consultation paper published on 9 November 2008 (CP08/24). In the consultation paper, the FSA encourages firms to review their existing stress and scenario testing arrangements and to start to identify where improvements can be made now, ahead of the finalised rule changes being made. The FSA also indicates that it expects to increase its supervisory focus in this area, and intends to establish an industry forum to facilitate the development of good practice on stress and scenario testing arrangements. Specific policy proposals include introducing a ‘reverse-stress test’ requirement in which firms consider the scenarios most likely to cause their current business model to become unviable.
The consultation period for the proposals has already closed. The FSA plans to publish its policy statement, together with final FSA Handbook text, on its new stress and scenario testing requirements in the third quarter of 2009.
The FSB’s Principles for Sound Compensation Practices require compensation practices in the financial industry to align employees’ incentives with the long-term profitability of the firm. The Principles call for effective governance of compensation, and for compensation to be adjusted for all types of risk, to be symmetric with risk outcomes, and to be sensitive to the time horizon of risks. Their implementation by firms will be reinforced through supervisory examinations at the national level.
The FSB’s Principles were endorsed at the G20 summit on 2 April 2009 in London and Heads of State and Finance Ministers agreed to implement them. They also agreed that national supervisors should ensure “significant progress” in implementing the Principles in 2009, and that the BCBS should implement the Principles into its risk management guidance by autumn 2009.
CEBS published its finalised, high-level principles for remuneration policies on 20 April 2009. The principles cover an institution’s remuneration policy at all levels of the organisation and relating to all categories of employees. Banking institutions falling within CEBS’ remit are expected to implement the principles before the third quarter of 2009, so that supervisors can make an initial assessment of progress in their implementation. CEBS has indicated that firms may allow for a transitional period following implementation, which may be used for renegotiating existing contracts. CEBS intends to integrate the principles into its Guidelines on the Application of the Supervisory Review Process under Pillar 2 of Basel II.
The EC’s Recommendation on remuneration policies in the financial services sector states that remuneration policy should be consistent with and promote sound and effective risk management and should not induce excessive risk taking. In particular, Member States are invited to adopt measures based on principles in the following areas: structure of pay, governance, disclosure and supervision.
The Recommendation believes that remuneration policy should be in line with business strategy, objectives, values and long-term interests, and be consistent with principles relating to the protection of clients and investors in the course of the services provided. Where remuneration includes a variable component or a bonus, it should be structured so that the fixed component represents a sufficiently high proportion of the total remuneration, and where a significant bonus is awarded, the major part of the bonus should be deferred with a minimum deferment period.
The EC has also published a Recommendation on the remuneration of directors of listed companies. The Recommendation believes that a listed company’s directors’ remuneration policy should base pay on performance and encourage directors to act according to a company’s medium and long term interests.
The Commission invited Member States to inform it by 31 December 2009 of what they are doing to promote the application of the Recommendations.
On 26 February 2009 the FSA published a draft code of practice on remuneration policies that was meant to apply to all FSA-authorised firms. However, the code has since been published in a revised form in the FSA’s consultation paper (CP09/10) which also sets out the FSA’s proposals on implementing the code and its scope. The FSA has stated it now feels the code should only apply to certain large banks, building societies and broker dealers.
In its consultation paper the FSA explains that it is incorporating the code into its Handbook to enable it to enforce it directly. It is also proposing that the general requirement in the code that “a firm must establish, implement, and maintain remuneration policies, procedures and practices that are consistent with and promote effective risk management” becomes a Handbook rule. The remaining principles will become evidential provisions or guidance to guide firms on the evidence the FSA would be focusing on in assessing compliance with the new rule. The consultation period has already ended. The FSA wants to bring the code into effect by November 2009.
On 1 July 2009 the British Banker’s Association (“BBA”) published its response to CP09/10. Although the BBA generally supports the FSA’s proposals to align remuneration policy with risk management, and to link remuneration practice to capital planning, it raised a number of concerns about the code. The BBA expressed concerns that the proposals go further, and are more prescriptive, than the FSB’s compensation principles and the European Commission’s Recommendation on remuneration. The BBA believes that remuneration requirements should allow firms to decide on the most appropriate form of remuneration, provided it supports risk management.
UNAUTHORISED BANK CHARGES
The OFT and several major banks1 have taken a test case to the High Court in order to establish legal certainty on the lawfulness and fairness of charges levied by current account providers for unauthorised overdrafts.
In April 2008, the High Court held that the unfairness rules of the Unfair Terms in Consumer Contract Regulations 1999 can be applied to assess the fairness of unauthorised overdraft charges in personal current accounts. The High Court’s finding was upheld by the Court of Appeal in February 2009. It concluded that these terms and charges are not part of the ‘core’ or essential bargain between a consumer and its bank, and so can be assessed for fairness. The banks have appealed this decision to the House of Lords and a decision is expected by the end of 2009.
Whilst the test case is ongoing, the FSA has granted firms a waiver to enable them to leave the resolution of complaints about overdraft charges until the test case has been decided. The FSA granted a new waiver, for up to six months, on 22 July 2009.
SPECIAL RESOLUTION REGIME
Part 1 of the Banking Act 2009, which came into force on 21 February 2009, creates a special resolution regime (“SRR”) for dealing with UK banks that get into financial difficulty. The SRR consists of three stabilisation options, a bank insolvency procedure and a bank administration procedure.
The three stabilisation (pre-insolvency) options are the ability to transfer part or all of a failing bank or building society to a private sector purchaser, a publicly controlled bridge bank (a company wholly owned and controlled by the Bank of England), and to temporary public ownership (to a nominee of the Treasury).
There has been concern that the ability to transfer part of a failing bank would lead to legal uncertainty and a reduction in confidence of counterparties in doing business with such firms, especially for those counterparties entering into close-out netting arrangements.
The Banking Act 2009 (Restriction of Partial Property Transfers) Order 2009 (more commonly known as the Safeguards Order) protects transactions commonly found in set-off, netting and collateral arrangements from being partially transferred to another entity. The protection extends to swaps, options, futures contracts, contracts for difference and other types of derivative contract. Despite this protection, the general lack of clarity surrounding the partial transfer of rights may make potential counterparties more hesitant in dealing with UK banking entities.
Although the Tripartite Authorities have acknowledged that such powers may remove or adversely affect property, employment and other rights, they believe it justified in relation to the European Convention on Human Rights on “strong public interest grounds.”
The Treasury will be advised on the impact of the special resolution regime on financial markets by the Banking Liaison Panel, consisting of representatives of the Treasury, FSA, the Bank of England, the Financial Services Compensation Scheme and the banking sector, together with financial law and insolvency experts. The Panel will have ongoing responsibilities to keep the powers and regulations of the regime under review.
FINANCIAL SERVICES COMPENSATION SCHEME
In light of the events at Northern Rock, the Tripartite Authorities are concerned that the arrangements for depositor protection under the FSCS are inadequate in protecting customers and supporting market confidence.
As a result, in October 2008 the FSA amended the rules in its compensation sourcebook (“COMP”) by increasing the limit for depositors to £50,000 per institution. COMP was further amended in November 2008 to allow a building society that merges with another and continues to operate under its former name post-merger, to keep its separate £50,000 deposit protection limit.
New FSCS Policy
In order to minimise hardship to depositors, PS09/11 (published on 24 July 2009) sets out the FSA’s final policy and rules on speeding up the payment of compensation by the FSCS to depositors in the event a deposit-taking firm fails, and of the FSCS generally.
The new payout rules will mean many individuals and small businesses will receive compensation within seven days and all payments within 20 days as required under the Deposit Guarantees Schemes Directive. The fast payout rules will come into force on 31 December 2010.
Future payouts will be made on a ‘gross’ basis, which will effectively ring fence the deposits if a depositor has savings and loans with the same firm. Consumer awareness of the FSCS will also be boosted by a new rule, which comes into force from 1 January 2010, requiring firms to provide information on the existence of the FSCS and level of protection it offers to depositors, as well as proactively informing customers of any additional trading names under which the firm operates.
Further changes announced include ensuring that firms keep up-to-date information on customers to allow quick processing of claims by the FSCS if needed. This so-called ‘single customer view’ information enables deposit takers to provide an aggregate balance held by each depositor to ensure faster payout of compensation in the event of a default of a deposit taker. The FSA has also introduced changes to the calculation of payment of compensation on term accounts, which will mean that compensation is calculated as at the date of default (as opposed to the date when the contract ends).
The FSA has also extended, until 30 December 2010, its interim rules which allow separate compensation cover for customers with deposits in two merging building societies. The same extension has been made for customers of a building society which merges with a subsidiary of another mutual society, and for customers whose deposits are transferred from a failed firm to another deposit taker where they already have an account.
Temporary high deposit balances
CP09/11 outlines proposals that the FSCS should provide extra protection for depositors holding temporary high deposit balances at a single deposit-taking institution in the event of failure of a deposit taker. The FSA is proposing a maximum protection limit of £500,000, for up to six months, for claims in relation to temporary high balances arising in connection with the sale of a main residence, pension lump sums, inheritance, divorce settlements, redundancy payments and proceeds of pure protection contracts.
The amended Deposit Guarantee Schemes Directive (“DGSD”) provides that a common protection limit of €500,000 will come into force across the EU in December 2010, unless the European Commission concludes that this limit increase is not needed, and the European Parliament and the Council of the European Union agree. The FSA has explained that if this common fixed limit is adopted, it will not be able to introduce higher protection for temporary high balances, unless the EU agrees that an exemption should be made.
The consultation paper also sets out the changes required to implement the Directive. Most of these changes came into force on 30 June 2009 and include a €50,000 minimum limit of protection for deposits and a new time limit of 20 working days to pay claims for deposit compensation (though this comes into force on 31 December 2010).
The FSA has stated it believes it best to wait until it is clear what any amendments to the DGSD might say before it takes a decision about making new rules, and has published details of the responses it received in relation to temporary high deposit balances in PS09/11.
In April 2009 the FSA announced its decision (see PS09/7) to proceed with proposals to change the FSCS compensation limits for insurance, investment and home finance business in the event a firm fails. The compensation limit for the provision and mediation of investments and for the mediation of house purchase finance will be £50,000, all claims for non-compulsory insurance (general and life insurance) will be paid at 90% of the claim, with no upper limit, and claims for the mediation of non-compulsory non-investment insurance (general insurance and pure protection contracts) will be paid at 90% of the claim, with no upper limit. These changes will come into effect on 1 January 2010. Claims relating to compulsory insurance will remain at 100% protection with no upper limit.
The Banking Act 2009
Part 4 of the Banking Act 2009 gives the Treasury the power to make certain changes to the FSCS, including introducing ‘pre-funding’ of the FSCS by allowing the FSCS to impose levies to build up contingency funds in advance of possible defaults by firms. The FSA is also given the power to make rules relating to contingency funds provided such rules are not inconsistent with the Treasury’s regulations.
The Treasury is given the power to require the FSCS to contribute to the costs of applying the special resolution regime to banks and building societies facing financial difficulties, and to allow the FSCS to invest levies collected to build up contingency funds in the National Loans Fund. The Act also allows the Treasury to make loans to the FSCS from the National Loans Fund. The Treasury is given these powers to help ensure that, in the future, the FSCS is able to deal with claims that are significantly greater than those envisaged when the scheme was originally set up.
SRR Costs Regulations
On 29 March 2009 the SRR Costs Regulations were made to enable HM Treasury to require the FSCS to make payments in connection with the exercise of SRR powers by the Bank of England in relation to the Dunfermline Building Society. The Treasury has since published a consultation paper seeking views on whether to amend the SRR Costs Regulations.
The views sought include those on costs to which the FSCS can be required to contribute, additional information needed to enable the nature, scale and scope of the costs to be understood, and whether the effects of making payments to meet SRR costs should be specified more precisely.
Levy for 2008/9 bank failures
On 29 July 2009, the FSCS announced that it will issue a levy of £406 million on deposit-taking firms for the initial interest charges, and related management expenses in respect of the HM Treasury’s loans it used to fund its compensation payments following the banking failures 2008/9. The FSCS and FSA will be writing to the deposit-taking sector about the costs and are sending invoices to individual firms.
INTER-BANK PAYMENT SYSTEMS
Inter-bank payment systems refer to arrangements designed to facilitate or control the transfer of money between financial institutions, such as systems for electronic payments between banks and building societies. Part 5 of the Banking Act 2009 gives the Treasury the power to make a recognition order in respect of an inter-bank payment system where it is satisfied that any deficiencies in the design of such system, or any disruption of its operation, would be likely to threaten the stability of, or confidence in, the UK financial system, or have serious consequences for business or other interests throughout the UK. The Bank of England is given an oversight role over a recognised inter-bank system, it may publish principles which system operators must comply with and require such operators to establish rules for the operation of their systems.
CODE OF TAX CONDUCT
HM Revenue and Customs (“HMRC”) is to ask banks operating in the UK to sign up to a voluntary code of tax conduct, the first draft of which has been published for consultation on 29 June 2009.
Banks signing up to the voluntary code will be required to reject transactions that result in tax avoidance and judge what tax avoidance is not by the letter of the law but by its spirit, or the intention of Parliament. Although signing up to the code will be voluntary, failure to sign will be taken into account by HMRC in assessing the bank’s risk status and is likely to result in greater scrutiny. There is no sanction for non-compliance following signature though pressure will be put on the board to comply, and reports might be made to professional bodies when appropriate.
The consultation paper also raises the possibility that other deterrent measures, such as requiring a statement in the accounts that the code has been complied with, or an audit of compliance, might be imposed in the future.
Other proposals include requiring signatory banks to have a tax governance regime signed off at a senior level and for banks to work co-operatively with HMRC at identifying and reporting issues. Perhaps of most concern to banks is the section on tax planning which will raise issues on how banks conduct their business and maintain their position against competitors.
The FSA will be considering whether individuals employed by banks that have not yet signed up to the code will still be considered ‘fit and proper’ under FSA rules. As reported by the Guardian in an article on 23 July 2009, Hector Sants, the FSA Chief Executive, indicated that the issue was likely to be included in an FSA consultation paper to be published in the autumn of 2009. Lord Turner, the FSA Chairman, added that this area was “very complicated” and that the FSA is “not a tax enforcement agency.”
UK REGULATORY REFORM PROPOSALS
The uncertainty to much of the proposed changes in UK financial services regulation has been recently reinforced by opposing policies published in Treasury and Conservative party white papers.
HM Treasury proposals
The UK Government published its proposals on reforming the financial markets on 8 July. The Government stands by the tripartite framework it implemented and will seek to strengthen it further.
The Banking Act 2009 requires the Bank of England to develop a strategy for financial stability through its Financial Stability Committee, a sub-committee of the Bank’s Court of Directors which was established on 1 June. The Bank will work with the FSA which has also been provided with a statutory footing to maintain financial stability.
The Government believes it is more effective to manage systematically significant firms through stronger market discipline, better regulation, managing failure effectively and through better market infrastructure than by imposing formal limits on activities through legislation. Such ‘high impact’ firms will be required to hold capital and maintain liquidity that reflects the impact their failure would have on the system.
The white paper outlines plans to raise consumer financial capability by services funded by financial services firms. The services will introduce personal finance programmes in schools and give adults access to generic financial advice.
The FSA will shortly be consulting on a proposal to require firms to publish their own complaints data. The Government is also inviting views on proposed legislation to introduce a form of collective action which consumers can use to enforce their rights to redress.
Conservative party white paper
The Conservative party white paper, published on 20 July 2009, outlines the changes that will be implemented in financial services regulation should the party form the next UK government. Conservative party policy can be immediately distinguished from the Treasury’s proposals by its stance that the tripartite system has failed and that the current system requires fundamental change.
The Conservatives will create a stronger Bank of England which will be responsible for macro-prudential regulation and have the authority and powers necessary to ensure financial stability. The Bank of England will also take on the FSA’s role for the micro-prudential regulation of all banks, building societies and other significant institutions, including insurance companies, and will gain market experience through requiring regulated firms to participate in a secondment programme.
Banks that undertake large-scale proprietary trading whilst also taking capital deposits will have higher capital requirements. Capital requirements will also be used to crack down on bonus structures considered risky. A ‘backstop’ liquidity ratio will be introduced to limit how much banks can lend for a given amount of capital.
The Conservatives will appoint a senior Treasury minister to engage the government in the European legislative process and defend national interests. The party will fight against any new attempt to create an executive pan-European supervisor.
The FSA will be abolished and replaced by a new Consumer Protection Agency which will act as a consumer champion. The regulation of consumer credit will be transferred from the OFT to the CPA.
Among the most notable elements of the white paper, and much like the Treasury’s proposals, is the confirmation that a Glass-Steagall type separation of banking activities is not desirable and that there is no intention of limiting the size of UK banks. The additional risk implied by an institution’s size will be managed by capital and liquidity requirements.