General framework and conduct of business
What legislation governs authorization and regulation of
banking activities in your jurisdiction? What has been the most
significant regulatory issue in your jurisdiction?
Authorization of banks, investment banks and other financial
market participants is governed by the Financial Services and
Markets Act 2000 (FSMA). The FSMA, which was implemented in 2001,
provides for the establishment and operation of the Financial
Services Authority (FSA), the unitary regulator of banking,
securities, derivatives and insurance business in the UK. The FSA
has four regulatory objectives: maintaining market confidence,
promoting public awareness, securing the protection of consumers
and the reduction of financial crime.
Key regulatory issues for the FSA have included:
- restoring consumer confidence following reviews of the
mis-selling of pensions, mortgage endowments, shares in
investment trusts, and so-called precipice bonds;
- enhancing the financial regulation of insurance companies;
and
- addressing conflicts of interest in relation to the
production of research by analysts working within
multi-function firms and the provision of research and other
services in return for order flow (soft commission).
Preparing for implementation of directives flowing from the EU
Financial Services Action Plan has also been a major feature of
regulatory work, with directives on the distance marketing of
financial services and the regulation of financial conglomerates
about to be implemented. Consultation is also underway in relation
to the implementation of the Market Abuse and Prospectus Directives
and the Modernization of Accounts Directive for Lloyds' of
London.
What are the key activities for which authorization is
required in your jurisdiction?
Under the FSMA, the FSA took over responsibility for the
regulation of a number of activities from various self-regulatory
organizations. Its remit includes banking (deposit-taking), issuing
electronic money, insurance, designated investment business (which
includes dealing (as principal or agent), arranging deals in,
managing, custody of, and advice in relation to, securities and
derivatives), underwriting and membership at Lloyd's, and even the
sale of rights under funeral plan contracts. The FSA's scope is
shortly to be extended to cover regulation of residential mortgage
lending, long-term care insurance and insurance mediation
activities, and will be further extended to cover home reversion
plans as soon as parliamentary time allows.
What sanctions are available to the regulator in your
jurisdiction when taking action against regulated
bodies?
The FSA is granted wide-ranging disciplinary powers under the
FSMA against authorized companies and their employees, together
with a detailed disciplinary process under the auspices of the
Financial Services and Markets Tribunal. These range from informal
statements of concern and private warnings (used for minor matters
without the formal commencement of the FSA's disciplinary process),
to statements of public censure and financial penalties. There is
no limit on the amount of the financial penalty which FSA can levy
on a firm for a breach of its rules. In addition, where the FSA has
very serious concerns about a firm or the way in which its business
is or has been operated it can seek to cancel a firm's permission
and effectively revoke its authorization to carry on regulated
activities.
The FSA also has a similar range of enforcement tools for
disciplining of staff of authorized firms who are approved persons.
Approved persons for these purposes include the chief executive,
other directors, finance officer, compliance officer and
individuals engaged in significant management functions and
employees who deal with or for, or advise, customers.
The profile of the FSA's enforcement actions has risen in the
past year as the amount of its penalties has increased
substantially with fines of £1.25 million ($2.2 million) imposed in
relation to money laundering control failings (August 2003 and
January 2004) and £2.3 million for serious compliance failings
(December 2003).
Another key area is the market abuse regime, which grants the
FSA considerable power to levy fines on any person (whether
authorized by and subject to the FSA's oversight or not) who has
committed market abuse. For these purposes, market abuse is
behaviour which occurs in relation to investments traded on a UK
recognized investment exchange and is of one or more of the
following three types, and which is likely to be regarded by a
regular user of the market as a failure on the part of the person
concerned to observe the standards reasonably expected of such a
person in their position in relation to the market. The three types
of abusive behaviour are:
- misuse of information;
- dissemination of information which is false or misleading;
and
- distorting the market.
Any action for market abuse is a civil action and the burden of
proof is lower than that required to obtain a criminal conviction.
In one recent action, the FSA imposed a fine of £17 million for
market abuse and breach of the Listing Rules.
Does the regulatory regime for banking business in your
jurisdiction include regulatory conduct of business rules governing
the obligations of a bank to its customers?
The FSA's Conduct of Business Sourcebook provides for conduct of
business obligations on banks and other regulated entities. These
include requirements as to marketing (financial promotions), which
apply to all activities including deposit-taking. The FSA also
expects compliance with the Code of Conduct for the advertising of
Interest Bearing Accounts issued by the British Bankers'
Association and the Building Societies Association. This code
recommends certain calculations for the quotation of various types
of rates of interest.
In addition, the sourcebook contains a substantial amount of
provisions relating to designated investment business but not to
deposit-taking (other than where the deposit is a cash ISA),
including requirements to classify and have written terms of
business with customers, and various obligations in respect of
disclosures to, advising and selling to, dealing and managing for,
and reporting to customers, and the holding of client assets.
Supervisory requirements
Does the regulatory regime for banking business in your
jurisdiction include regulatory capital requirements? If so, are
these based on the Basel Accord and are there significant
variations from the core Basel recommendations?
The regulatory capital regime for UK banks is set out in the
Interim Prudential Sourcebook for Banks, which is a part of the FSA
Handbook. The sourcebook implements the European Banking
Consolidation Directive (2001/34/EC), which in turn implements the
Basel Accord, as amended. It should be noted that the scope of the
sourcebook is of wider application than the Accord, as it applies
to all UK banks (as opposed to the Accord, which applies only to
internationally active banks). The sourcebook is also
superequivalent in a number of respects to the Directive.
What effect will Basel II have on banking transactions in
your jurisdiction? Are financial institutions already taking
account of its future effect?
The text of the revised Basel Capital Accord, known as Basel II,
was published at the end of June 2004. It is intended that Basel II
be implemented with effect from December 31 2006 but that the most
advanced approaches to assessing regulatory capital will not be
available until the end of 2007. Implementation in the UK will be
via EU capital directives. In July the European Commission
published a proposal for the recasting of the Capital Adequacy and
Banking Consolidation Directives.
The two most significant changes are the introduction of an
operational risk charge and the differentiation of capital
requirements by reference to the sophistication of the internal
systems of banks (reflected in the more favourable reduced capital
requirements associated with the internal ratings-based approach to
credit risk, and with the advanced measurement approach to the
calculation of operational risk). These favour the larger and
better resourced banks which can attain the high standards required
to achieve the more favourable requirements.
Basel II provides for significant amendments to the calculation
of credit risk on exposures to counterparties. The capital charge
associated with any particular transaction is a considerable part
of the cost of funds to the bank in lending to most counterparties.
In terms of current practice, banks can seek to take account of the
changes by backing off the risk of increased costs associated with
the implementation of the new regime on borrowers. Banks are also
beginning to devote considerable resources to putting in place the
necessary systems and controls to obtain more favourable treatment
under the new regime.
Does the regime in your jurisdiction include rules and
operational and organizational requirements relating to internal
controls and operational risk?
Around the time of the implementation of the FSMA, the FSA
placed a great deal of emphasis on the importance of the
maintenance of internal systems and controls. This is reflected in
Principles for Businesses 3, which requires that authorized firms
"take reasonable care to organize and control [their] affairs
responsibly, with adequate risk management systems".
There are detailed rules elaborating on this Principle in FSA's
Senior Management Arrangements, Systems and Controls
Sourcebook (SYSC). The core rules of SYSC are that every
authorized firm must take reasonable care to maintain a clear and
appropriate apportionment of significant responsibilities among its
directors and senior managers in such a way that it is clear who
has those responsibilities, and its business and affairs can be
adequately monitored and controlled by the directors, relevant
senior managers and governing body of the firm. A firm must also
take reasonable care to establish and maintain such systems and
controls as are appropriate to its business.
The forthcoming integrated Prudential Sourcebook, which will
reflect Basel II and related EU legislation, will include a chapter
on operational risk that will apply to banks and other higher risk
firms.
Do you believe that Sarbanes-Oxley will have a material
impact in your jurisdiction?
The Sarbanes-Oxley Act covers a range of issues associated with
listed companies whose shares are publicly traded, independence of
auditors, corporate governance and conflicts of interest in
investment research. Particular areas that are attracting attention
in the UK are investment research and conflicts of interest with
the introduction of a requirement for firms to publish a conflicts
management policy addressing matters such as:
- dissociating analysts' remuneration from investment banking
transactions;
- not using an investment analyst in a marketing
capacity;
- imposition of systems to withstand pressure from subject
companies; and
- greater disclosure by firms as to their interest(s) in
subject companies.
In its review of the Listing Rules, the FSA rejected a mandatory
requirement for issuers to accept codes of conduct but expressed
the view that the Financial Reporting Council should consider in
any future development of the Combined Code whether issuers should
be required to publish and maintain a code of conduct as a matter
of good corporate governance.
A consultation document seeking views on various aspects of the
governance of mutual life offices has recently been launched. It
also explores some wider issues, arising from Lord Penrose's report
on Equitable Life, relating to the role of non-executive directors
in complex businesses.
Does the regime in your jurisdiction include a
requirement for controllers and major shareholders of regulated
banking institutions to be approved by the supervisory
authorities?
The FSMA introduced a statutory regime for the approval of
controllers and major shareholders of authorized firms, including
banks. This implements the relevant provisions in the Banking
Consolidation and Investment Services Directives. Part XII of the
FSMA broadly requires a person proposing to acquire control (or to
increase control between certain thresholds) of a company
authorized by FSA to obtain FSA's approval before doing so. A
direct or indirect shareholding in excess of 10% or a right to
exercise significant influence over the management of the
authorized company or its parent will constitute
control.
Failure to obtain such approval before taking control is a
criminal offence. The FSA must consider whether the proposed
controller is a fit and proper person to have control of an
authorized company. FSA has up to three months to consider whether
to approve the change in control.
The FSA may serve a warning notice and then a notice of
objection unless it is satisfied that the person concerned is a fit
and proper person and that the interests of consumers would not be
threatened by the acquirer's control.
If, in breach of the provisions of the FSMA (which carry
criminal sanctions), a person becomes a controller in contravention
of a notice of objection FSA can serve a restriction notice and can
apply to the court for the sale of the shares.
Investor protection
Have there been any recent significant changes to
insolvency legislation in your jurisdiction, or are any such
changes proposed? Have they made/will they make the regime more or
less borrower friendly?
The Enterprise Act 2002 received Royal Assent on November 7
2002, and the provisions of Part 10 (Insolvency) make significant
changes to the law of corporate insolvency and the insolvency of
individuals.
The provisions dealing with corporate insolvency and Section 251
(abolition of Crown preference) came into force on September 15
2003; the remaining provisions came into force on April 1 2004.
The aim of the corporate insolvency reforms in the Act is to
promote the rescue of a company as a going concern, and to this end
administration replaces administrative receivership as the primary
means of enforcing full fixed and floating security. There is a new
out-of-court route into administration available to both the
company and a secured creditor with a full security package. The
secured creditor has first choice as to who is appointed. Unless an
exception applies, a lender with security is no longer able to
appoint an administrative receiver and is not able to prevent the
appointment of an administrator. The purpose for which an
administrator can be appointed has changed to give priority to the
rescue of the company, with the enforcement of security being
subordinated to this.
The main change for a secured creditor is likely to be one of
control. A secured creditor is only entitled to vote on the
administrator's proposals as to how the purpose of the
administration will be achieved, to the extent that there is a
shortfall in the value of the secured assets. However, the
administrator's proposals may not include any action that affects
the right of a secured creditor to enforce without that secured
creditor's consent. In practice this may mean that the
administrator will need the consent of secured lenders before
putting his proposal to the unsecured creditors. Once appointed,
the administrator's duty will be to all creditors. A
ring-fencing mechanism has been introduced whereby a certain
percentage of all floating charge realizations is made available to
the unsecured creditors, although the administrator may not have to
make a distribution from these funds if the costs of doing so
outweigh the benefits. Overall, the changes improve the position of
unsecured creditors with regard to secured creditors.
The changes in relation to the bankruptcy of individuals are
intended to encourage enterprise by reducing the stigma of failure
in honest cases while providing for robust and effective remedies
against the small minority who act recklessly or dishonestly. An
automatic discharge of the bankrupt takes place, in most cases,
after a maximum of 12 months, and the restrictions that were
previously automatically imposed on undischarged bankrupts (for
example disqualification from holding certain offices) are reduced.
However, a new court-based regime involving bankruptcy restriction
orders is introduced for bankrupts whose conduct before or during
bankruptcy the court has found to be culpable, or who fail to
cooperate with the Official Receiver or bankruptcy trustee. These
restrictions will run for a minimum period of two years and a
maximum of 15 years. In contrast to the corporate insolvency
reforms, the purpose of the changes relating to individuals is to
make the system more debtor friendly to encourage continued
entrepreneurship among those who have previously tried and failed
in business without dishonesty.
Regulations have been made to implement in the UK the Directive
on the reorganization and winding up of credit institutions
(2001/24/EC). These provide for the exercise of EEA liquidators of
their function in the UK and make changes to UK insolvency law in
relation to notifications of various matters. The Regulations also
make provision for application to credit institutions whose head
office is outside the UK and the EEA.
Does your jurisdiction operate a deposit protection or
guarantee scheme protecting retail depositors from loss in the
event of insolvency of an authorized bank?
Part XV of the FSMA is concerned with the Financial Services
Compensation Scheme. The Scheme provides for a body corporate,
Financial Services Compensation Scheme Ltd, and a scheme manager to
administer the Scheme and protects certain deposits and other
investments made with UK authorized persons and UK offices of
non-EEA authorized institutions against the insolvency of such
institutions.
All institutions are liable to make contributions to the Scheme.
There are two types of levy, the management expenses levy and the
compensation costs levy. The management expenses levy includes:
base costs (the amount required for the running of the Scheme);
specific costs (required for the running of the Scheme in a
particular year); and establishment costs (costs imposed for the
first three years of the Scheme and applied to the expenses of
setting up the Scheme). Base Costs and establishment costs are
payable by all participating firms. Specific costs are payable
depending on the contribution group to which a defaulting firm
belongs and contribution groups are dependent on the range of
permissions that a firm has. Each contribution group has a separate
tariff, which varies from year to year. The management expenses
levy is part of the regulatory costs that are payable to FSA from
year to year. The compensation costs levy is also payable by every
firm, depending on its contribution group, as are the costs
incurred in paying compensation.
The Scheme is available for eligible claimants, who are
primarily consumers and some small businesses. The maximum level of
protection for deposits is set at £31,700. The UK scheme now
applies to deposits not only in sterling but also in euro for UK
institutions with offices in the EEA. A UK institution can apply
for offices in other EEA states to be covered by the local deposit
protection schemes in those states instead of the UK scheme if the
local scheme offers greater protection, and similarly, an EEA
institution can apply for its UK offices to be covered by the UK
scheme instead of the home scheme of the EEA state where the
institution is established if the UK scheme offers greater
protection. A non-EEA institution can apply for its UK offices to
be covered by its home state scheme, instead of the UK scheme, if
the home state scheme offers the same level of protection to UK
depositors.
In recent years there have been relatively few bank failures
leading to calls on the predecessor to the present scheme, the
Deposit Protection Scheme.
Does your jurisdiction have an ombudsman scheme,
arbitration scheme or similar scheme for the resolution of disputes
between a bank and its retail customers other than through formal
legal proceedings?
Part XVI of the FSMA provides for the establishment of an
ombudsman entitled the Financial Ombudsman Service Limited. This is
a company limited by guarantee with statutory powers to administer
an ombudsman scheme, which is funded by a combination of a general
levy on firms subject to the compulsory jurisdiction of the
ombudsman, and case fees charged to individual firms who are the
subject of a complaint. The rules governing the ombudsman are set
out by FSA in the Dispute Resolution: Complaints Sourcebook.
The scope of the ombudsman scheme and jurisdiction of the ombudsman
covers activities with most retail banking customers (broadly
individuals and businesses, charities, and trusts with a net worth
under £1 million).
Complaints that are not satisfactorily resolved within eight
weeks of the customer's complaint are handled via an adjudicator,
whose role is to manage the complaint and who may institute
conciliation to settle the complaint or investigate it.
Determinations of the ombudsman are binding on authorized firms
(although not on complainants).
Author
biography
Bob Penn
Allen & Overy
Bob Penn is a senior associate in Allen & Overy LLP's
Regulatory Funds and Financial Markets Group, and is also a member
of the firm's Investment Structures Group. Bob advises on a range
of financial services regulatory matters, including capital
adequacy, custody, asset management (including funds), brokerage,
and the regulation of market infrastructure providers, including
exchanges, alternative trading systems, and clearing and settlement
systems.
Allen & Overy LLP
One New Change
London
EC4M 9QQ
United Kingdom
Tel: +44 20 7330 3000
Fax: +44 20 7330 9999
www.allenovery.com