Global Financial Market Watch : Global Financial Lawyer & Attorney : K&L Gates Law Firm : Government Enforcement, Investment Management

By: Ian Fraser, Philip J. Morgan, Victoria Green

The FSA has released Remuneration Policy Statement templates for firms in Proportionality Tiers 2, 3 and 4 of the Remuneration Code, as well as guidance that firms should complete these and have them available for inspection by the FSA from 1 September 2011. Our experience in drafting Remuneration Policy Statements in 2009 and 2010 suggests that firms will need to give significant thought to the disclosures required in these reports and should give themselves sufficient time for preparation, review and sign off in order to meet the 1 September 2011 deadline.

The FSA has also released draft guidance on retention periods, guaranteed variable remuneration and FAQs on the Code, guidance on varying a firm's Proportionality Tier, and a proposal to extend the deadline on implementing share-based awards for non-listed companies by up to one year.

To view the complete alert online, click here.
 

• Email This
• Print
• Comments
• Trackbacks

By: Anthony R.G. Nolan, Lawrence B. Patent, Lloyd H. Johnson

On April 12, 2011, the Office of the Comptroller of the Currency (the “OCC”), the Board of Governors of the Federal Reserve System (the “Fed”), the Federal Deposit Insurance Corporation (the “FDIC”), the Farm Credit Administration (the “FCA”) and the Federal Housing Finance Agency (the “FHFA,” and with the OCC, Fed, FDIC and FCA, collectively, the “Prudential Regulators”) and the Commodity Futures Trading Commission (the “CFTC”) issued proposed rules regarding margin requirements for non-cleared swaps (and, in the case of the Prudential Regulators, security-based swaps) pursuant to the Dodd-Frank Act.

Public comment on the Prudential Regulator Proposed Rules must be submitted on or before June 24, 2011. Public comment on the CFTC Proposed Rules must be submitted by June 27, 2011.

To view the complete alert online, click here.
 

• Email This
• Print
• Comments
• Trackbacks

By Ian Fraser, Victoria Green, Philip J. Morgan.

On 17 December, the UK's Financial Services Authority published the final text of its revised Code of Practice on remuneration. The Code will apply from 1 January 2011 onwards to all FSA-regulated banks, building societies and investment firms that fall within the scope of the EU's Markets in Financial Instruments Directive (MiFID).

The Code has the following main implications:

• The approximately 26 biggest banks, building societies and broker-dealers operating in the UK continue to be subject to the Code but have additional requirements for remuneration design and delivery and new reporting and public disclosure obligations;

• Another approximately 2,500 financial services firms, including investment advisers, fund managers and smaller banks and broker dealers, will now be subject to the Code. However, for most of these firms a "proportionality principle" should mean that some of the Code's provisions can be "neutralised" and that lower levels of reporting and public disclosure should apply.

To view the complete alert online, click here.

• Email This
• Print
• Comments
• Trackbacks

By Ian Fraser, Philip J. Morgan, Victoria Green

The UK FSA has released a consultation paper on reporting requirements under the FSA's Remuneration Code, which could be of relevance to US banks and investment firms operating through a UK subsidiary or branch.  While the full implications of the revised Remuneration Code for the 2,500 firms within its scope will remain uncertain until the final Code is published in mid-December, it is clear from the consultation paper that all in-scope firms will be expected to make public disclosures regarding their remuneration policies at least in respect of:

• corporate governance processes relating to remuneration policy;
• information on the link between pay and performance; and
• aggregate quantitative information on remuneration, broken down by (i) business area and (ii) senior management and members of staff whose actions have a material impact on the firm’s risk profile.

All firms within the scope of the Remuneration Code will need to determine the level of disclosure that applies to them and how disclosures should be presented to the public. Please contact any of the authors to discuss any aspect of the Remuneration Code.

To view the complete alert online, click here.

• Email This
• Print
• Comments
• Trackbacks

By: Ian Fraser, Philip J. Morgan, Victoria Green

The FSA has published a consultation paper proposing significant changes to its Remuneration Code, including a major increase in scope from the approximately 27 largest banks, building societies and broker-dealers operating in the UK that are currently covered to over 2,500 FSA-authorised banks, building societies, asset managers, UCITS investment firms and some firms engaged in corporate finance, venture capital, the provision of financial advice and stockbrokers. The asset managers within the scope of the proposed rules are those to which the Markets in Financial Instruments Directive rules apply, other than so-called exempt CAD firms which do not exercise investment discretion.

To view the complete alert online, click here.
 

• Email This
• Print
• Comments
• Trackbacks

By: Philip J. Morgan and Neil Nick Robson

On 22 June 2010, the UK's new Chancellor of the Exchequer, George Osborne, delivered the new Government's “emergency” budget. Amongst a package of other measures, he announced a bank levy from 1 January 2011, and plans to carry out further work to tackle unacceptable bank bonuses, including a consideration of the costs and benefits of a “Financial Activities Tax” on bank profits and remuneration.

• Email This
• Print
• Comments
• Trackbacks

By: Philip J. Morgan and Nicholas Brown

UK Chancellor of the Exchequer George Osborne yesterday announced the scrapping of the Financial Services Authority as part of a major shake-up of the regulation of financial services in the UK.

The FSA will be replaced by three new entities:

• a prudential regulator, which will be a subsidiary of the Bank of England, and will be responsible for oversight of UK-based retail lenders, investment banks, building societies and insurers, and regulation of capital requirements of financial institutions;

• a Consumer Protection and Markets Authority, responsible for the protection of consumers and day-to-day policing of financial firms; and
   
• a financial crime agency, incorporating the current financial crime powers of the FSA, the Serious Fraud Office and the Office of Fair Trading.
   

• Email This
• Print
• Comments
• Trackbacks

By: Kay A. Gordon, Dr. Wilhelm Hartung, Cary J. Meer, Philip J. Morgan, Mark D. Perlow, Neil Nick Robson, Richard Guidice, Jr

Changes in the regulatory approach to the short selling of listed securities have recently been announced in both the United States (U.S.) and the European Union (EU). In the U.S., rule amendments were recently adopted by the Securities and Exchange Commission that generally restrict market participants' ability to sell short listed securities whose price has dropped by at least 10% in a single day. In the EU, a new regulatory proposal would (to the extent adopted by the EU member states) require private disclosure of net short positions above a 0.2% threshold to the applicable regulator, and public disclosure to the market of such positions above a 0.5% threshold. We summarize in this alert what these changes entail and what each will mean for market participants.

To view the complete alert online, click here.
 

• Email This
• Print
• Comments
• Trackbacks

Contacts: Diane E. Ambler, Michael J. Missal, Matt T. Morley, Mark D. Perlow

2009 brought a further transformation in the relationship between business and government. Regardless of political systems or philosophies, governments around the world became more dynamic and intrusive in response to the financial crisis.

This 2010 Annual Report, prepared by members of the K&L Gates Global Government Solutions initiative, contains concise articles that seek to forecast likely government actions and priorities regarding a broad spectrum of topics.

To view the report, click here.

• Email This
• Print
• Comments
• Trackbacks

By: Claudia Harrison, Katie Hillier

1. Introduction
 

Since the introduction of the stabilisation measures we reported in the previous edition of this newsletter, the global economic downturn has intensified, prompting the UK government to announce further efforts to combat financial instability and support economic recovery.  The new measures both extend and supplement the Special Liquidity Scheme, the Bank Recapitalisation Scheme and the Credit Guarantee Scheme described in the previous edition.  They do not have any immediate impact upon the draft legislation we reported previously.

2. Updates on Existing measures

2.1 Special Liquidity Scheme ("SLS") and Discount Window Facility
Upon the closure of the SLS at the end of this month, an alternative source of long-term liquidity will be provided under the discount window facility.  This is an existing facility provided by the Bank of England ("BoE") which ordinarily provides liquidity for periods not longer than 30 days and operates on similar principles to the SLS.  Under the new proposals, maturity periods of one year will be available with the aim of allowing banks to access longer-term liquidity support on demand.  The 30-day facility will continue to be available.

2.2 Credit Guarantee Scheme ("CGS")
The deadline for issuing debt to be guaranteed by this scheme is extended from 9 April 2009 to 31 December 2009.  All other aspects of the scheme will remain the same.

2.3 Bank Recapitalisation Scheme
Under this scheme, the UK government invested approximately £20bn in the Royal Bank of Scotland plc ("RBS").  The government is converting the £5bn of this stake that are held in preference shares into ordinary shares, thereby increasing its common holdings from 58% to nearly 70%.  This conversion will reduce by approximately £6bn the amount of preference dividends that RBS is required to pay each year to the UK government.  In return, RBS has committed to maintaining lending to large corporations, small businesses and homeowners at 2007 levels and to increase its lending activities by £6bn over the next year.  These commitments reflect the government's concern to protect the wider economy from the underlying lack of credit in the financial sector.

2.4 Financial Services Authority ("FSA") on Capital Ratios
The FSA has given additional guidance on its expectations regarding capital ratios for banks.  No new requirements are currently being proposed, as the FSA considers that the recent recapitalisation exercise undertaken by certain banks has created a sufficient capital buffer to withstand losses and facilitate new lending.  The guidance introduces the concept of counter-cyclical measures so that during good years banks build a capital 'buffer' on which they can draw in harder times.  The Basel Committee is now working to develop this principle and it is possible that the regulatory framework may be adapted in the longer term.

2.5 Northern Rock
There has been concern that the timetable set by the government for Northern Rock to repay its loans was requiring it to reduce its mortgage lending too quickly.  This reduction was working against the government's desire to expand mortgage lending, and so the deadlines for repayment by Northern Rock have been extended.

3. New Measures

3.1 Additional credit guarantee scheme
As well as extending the deadline of the CGS, the government has proposed a new guarantee scheme, commencing in April 2009, for certain triple-A rated asset-backed securities.  Eligible securities may be backed by mortgages and corporate/consumer debt and must have transparent structures.  Eligibility for institutions will be by the same criteria as the CGS.  Further details on this proposal are expected in the next few months.

The rationale for this scheme is, in part, the need to maintain banks' mortgage lending capacity.  Typically, mortgage-backed securities have supported a third of mortgage lending in the UK, and the government hopes that a guarantee scheme which supports the market in these securities will help to maintain banks' capacity for such lending activity. 

3.2 Asset Purchase Facility
The UK government is allocating a fund of £50bn to be used by the BoE to purchase certain high-quality private sector assets, including corporate bonds, syndicated loans and asset-backed securities.  The programme will come into effect from 2 February 2009, and purchases will be funded by the issue of Treasury bills.  The BoE will be authorised to use this facility for monetary policy purposes such as meeting the inflation target.  Further details of how this facility will operate are expected before the end of January.

3.3 Asset Protection Scheme ("APS")
The UK government, for a fee, will provide banks with insurance against future credit losses on their riskiest assets.  The government will assess the likely performance of assets under consideration in order to set the level of probable loss and the fee to be charged.  The APS will then cover a substantial part of any loss sustained over and above this probable loss, i.e., the exceptional loss.  In addition, in order to incentivise participating institutions to minimise their losses, the institution will also have to bear a proportion (for example, 10%) of the exceptional loss.  The scheme is available to UK-incorporated authorised deposit takers with more than £25bn of eligible assets.  It intends to target the assets most affected by current economic conditions with a view to reducing uncertainty about the value of such assets.  In order to support wider economic recovery, participants will have to provide a commitment to the government to maintain lending to creditworthy borrowers in a commercial manner.  Further details of the scheme are expected to be issued by the end of February.

4. Conclusion
The theme running through this latest package of measures is an effort to limit the effect of the financial crisis on the wider economy.  In the aftermath of the collapse of a number of high street retailers, and as monthly unemployment increases reach levels last seen in 1991, this objective is understandable.  However, it remains to be seen whether on the high street are already beyond the reach of such protection.

• Email This
• Print
• Comments
• Trackbacks

By: Robert V. Hadley,  Matt T. Morley

On 5 January 2009 the FSA imposed a penalty of £5.25 million on the insurance brokerage firm Aon Limited because the firm lacked adequate systems and controls to address the risk that third parties would make corrupt payments to assist Aon in winning business in overseas jurisdictions.  See http://www.fsa.gov.uk/pubs/final/aon.pdf.  The FSA’s Final Notice alleged that due to these failures, the firm had made sixty-six "suspicious payments" totalling more than US$5 million.  The Final Notice, which Aon consented to, states that the firm’s procedures failed to require adequate training of relevant personnel as to bribery and corruption risks, adequate due diligence prior to the retention of third party representatives, and appropriate monitoring of those relationships going forward.  In addition, Aon’s supervisory committees were not provided with adequate information or otherwise did not assess whether the firm’s corruption risks were being effectively managed.

The FSA’s action is particularly notable for several reasons.

• While the FSA is not directly empowered with jurisdiction over domestic or foreign corruption offenses, which are ordinarily the responsibility of the police or the Serious Fraud Office ("SFO"), the FSA has a specific statutory objective to prevent financial crime.  The Final Notice makes clear that Aon was fined for breaches of FSA Principle 3 ("A firm must take reasonable care to control its affairs responsibly, with adequate risk management systems").  Conceivably, the FSA could also act in such cases under Principle 1 ("a firm must conduct its business with integrity").  Of course, a firm is likely to more readily agree to a public statement of a systems and controls failure than to acting without integrity, but, for the FSA, the level of fine, the publicity, and the resulting deterrent value of the FSA action remains the same.
  
   
• Aon already had in place a policy that prohibited corrupt payments such as the ones that came to light.  Yet, as US law enforcement authorities have so often emphasized with regard to the US Foreign Corrupt Practices Act, a “paper program” is not enough, and firms must also take additional steps, such as training, due diligence, monitoring and auditing, in a meaningful effort to assure compliance.
  
   
• Aon promptly self-reported to the Serious and Organised Crime Agency ("SOCA") and the FSA its discovery of the questionable payments.  The firm went on to conduct its own internal review of its anti-bribery systems and controls, and all payments to third party representatives for the previous six years.  Aon implemented all recommendations resulting from this review, and took disciplinary action against personnel found to have been involved.  Aon co-operated fully with the FSA's investigation.  While these steps, and the cost involved, were taken into account by the FSA when assessing/agreeing the financial penalty imposed, the firm did not avoid sanctions.

Margaret Cole, the FSA's Director of Enforcement, said that the fine "sends a clear message to the UK financial services industry that it is completely unacceptable for firms to conduct business overseas without having in place acceptable anti-bribery and corruption systems and controls".  Ms. Cole added that the FSA "has an important role to play" in UK steps against overseas corruption.

There are at least two important messages being sent by the FSA by its action against Aon.  First and most clearly, the case makes clear that the FSA expects regulated firms to have effective anti-corruption compliance measures in place – not simply a policy prohibiting corrupt payments, but coordinated efforts to require training of relevant personnel; due diligence on agents and other intermediaries acting on the firm’s behalf; monitoring and auditing compliance with the policy; and disciplinary action where violations of the policy occur.  Firms that fail to take these steps face potential sanctions under Principle 3.

Beyond this, the Aon case sets the precedent that in the eyes of the FSA regulated firms are required to self-report potential overseas corruption violations to the FSA.   FSA Principle 11 provides that "a firm must deal with its regulators in an open and cooperative way and must disclose to the FSA appropriately anything relating to the firm of which the FSA would expect notice."  We know the FSA's position from the Aon case, notwithstanding the FSA’s lack of criminal jurisdiction over such conduct, and that such matters are discloseable under Principle 11 also follows from the fact that firms are authorised by the FSA and individuals are approved by the FSA on the basis of their being "fit and proper." 

Disclosure of such matters may also be driven by the obligation of persons in the regulated sector (very broadly the financial services industry) to inform the SOCA where there is a suspicion of money laundering under the Proceeds of Crime Act 2002.   UK prosecutors regard any revenue from a contract obtained through a corrupt payment or offer of payment as the proceeds of crime, so that possession or any dealing with such funds is potentially a money laundering offence. Accordingly, the risk of a failure to disclose an offence or the need to set up a defence of SOCA's consent by disclosure to SOCA arises in almost every case where there is a suspicion of corruption. Once the need or obligation to make a report to SOCA is triggered, a regulated firm would be taking a serious risk by not also disclosing to the FSA under Principle 11. 

Overseas corruption is a hot topic in England and Wales, and the SFO has also taken recent steps to increase enforcement activity, increasing its manpower dedicated to looking at these matters by over 50% in 2008.  Last year saw the first UK convictions for overseas corruption, with the conviction of the head of the British company CBRN in connection with security services contracts in Uganda (see: http://www.guardian.co.uk/uk/2008/sep/23/ukcrime.law).  The SFO also reached a settlement with the construction company Balfour Beatty, in which that company admitted to historic accounting irregularities in some of its African operations.  Balfour Beatty paid a civil fine of £2.5million and was not subjected to criminal prosecution.  This case can be seen as a model for the SFO’s efforts to create a culture of self-reporting and to increase deterrence in the overseas corruption field.  In this way, the SFO can be seen to be taking enforcement steps without running the risk of a failed prosecution.

Both the SFO’s settlement with Balfour Beatty and the FSA's approach to Aon bear a strong resemblance to efforts by the US Securities and Exchange Commission and the US Department of Justice to pursue violations of their anticorruption statute, the US Foreign Corrupt Practices Act.  The great majority of such cases are resolved by violators consenting to the entry of court orders finding legal violations and imposing significant financial penalties as well as disgorgement of profits, as in the recent case involving Siemens AG and the imposition of more than $1 billion in fines.  As in the Siemens case, a further condition of these kinds of settlements is the creation of remedial programmes and the installment of external monitors, at the company’s considerable expense, empowered to review the firm's anti-corruption programmes for several years and report back to law enforcement authorities.  Self-reporting of potential violations is also encouraged by US authorities, who state that the consequences of violations will be less severe for those who come forward voluntarily. 

It remains to be seen whether the SFO’s resolution of the Balfour Beatty case will provide a model for future cases, but in the financial services arena, the die seems to have been cast by the Aon case by the rather straightforward application of the FSA’s Principles to require regulated firms to implement anti-corruption compliance programs.

• Email This
• Print
• Comments
• Trackbacks

By: Claudia Harrison, Katie Hillier

1. Introduction

At the start of 2008, few people predicted the dramatic financial events of the past year.  Governments have rallied to stabilise financial systems which have been severely shaken and remain wary of further possible aftershocks.  This article considers the stabilisation measures already implemented by the British government and the draft legislation for a permanent statutory regime to deal with failing banks.

2. Measures already implemented

2.1 Special Liquidity Scheme ("SLS")
The Bank of England (the "BoE") summarises the SLS as a scheme enabling banks "to swap temporarily assets that are currently illiquid in exchange for UK treasury bills".   In fact, the BoE lends treasury bills in return for security over 'swapped' assets.  It is limited by eligibility restrictions for both institutions (only those eligible to subscribe to BoE standing facilities) and assets (only those backed by residential mortgages or credit card debt).  Despite these limitations, it has proved so popular that both its availability period and its value have been extended. 

A key feature of the SLS is that the risk associated with the 'swapped' assets remains with participants.   The public sector would only be exposed if a bank failed to return its treasury bills at maturity and the value of the assets it had pledged as security fell short of the value of the bills borrowed.  The use of a margin or 'haircut', intended to ensure that the value of security assets is always greater than the value of the bills, reduces this risk. 

2.2  Bank Recapitalisation Fund ("BRF")
The government has made available up to £50bn for equity share capital investments in certain UK banks.   The overriding objective of the BRF is to ensure that banks maintain capital positions which support market confidence in them.  The foundations of such confidence include banks having sufficient capital to absorb losses and to continue normal commercial lending.  So far, Lloyds TSB, Halifax Bank of Scotland and Royal Bank of Scotland are participating in the BRF.  Others intend to increase capital through normal commercial measures.  Naturally, banks wish to minimise any government shareholding to ensure independence and avoid the stigma of public ownership.  However, if the poor uptake of RBS's recent share placing is any indication, the amount needed from the government may be higher than anticipated.  Predictions suggest that the banking system may need capital investment of at least £100bn before confidence in it recovers. 

2.3 Credit Guarantee Scheme
This scheme aims to encourage wholesale lending by issuing government guarantees in respect of certain debt instruments issued by eligible institutions.   In theory, if a bank is backed by a government guarantee, other banks will be less reluctant to lend to it.  Wholesale funds will start to move more readily and LIBOR will fall as confidence between banks is restored.  However, the scheme's eligibility conditions, both for participants and instruments, limit its scope so that it may only boost confidence in institutions least in need of such support. 

3.  Permanent Statutory Regime

3.1 Banking Bill 2008 (the "Bill")
The Bill, published in October, is the government's proposal introducing for the first time a permanent statutory regime for dealing with troubled banks.  This replaces emergency legislation passed earlier this year, which expires in February 2009.  It proposes a 'Special Resolution Regime', conferring various powers upon the tripartite authorities - the UK government, Financial Services Authority (the "FSA") and BoE.  These powers include three 'stabilisation options' (to be used to rescue a failing bank), a bank insolvency procedure ("BIP") and a bank administration procedure ("BAP").

(a)  Stabilisation options
These options restate and reinforce the authorities' powers under the emergency  legislation.  They are triggered if a bank fails to meet the conditions of its FSA authorisation (normally because of a failure to maintain adequate resources to conduct its business, in the FSA's opinion).  The options are to transfer all or part of the shares or business of a failing bank to either (i) a private sector purchaser, (ii) a 'bridge bank' (a BoE subsidiary), or (iii) temporary public ownership.

(b) BIP and BAP
The FSA already has statutory authority to apply for an administration order or petition for the winding up of a bank. The Bill extends this power so that, where certain conditions are met, any of the authorities can apply for a failing bank to be placed in BIP and the BoE can apply for a failing bank to be placed in BAP. These procedures follow the same structure as existing insolvency and administration regimes, with different 'officeholders' objectives. Ordinarily, a liquidator's objective is to realise an insolvent company's assets for distribution to creditors. A bank liquidator's primary objective is to ensure that eligible depositors receive compensation speedily or have accounts transferred to an alternative institution. Similarly, an administrator has three objectives, in order of priority: first to rescue the company as a going concern, secondly to achieve a better result for the company's creditors as a whole than would be likely if the company were wound up, or, if neither of the first two are possible, to realise assets to make distributions to secured creditors. In contrast, BAP will be used to oversee the operation of the 'residue' of any bank, following a partial property transfer under the stabilisation options referred to above. Consequently, a bank administrator's primary objective is to facilitate such transfer to the bridge bank or private purchaser.

3.2 Comment

In general the Bill has been welcomed, but there is widespread concern about certain of its provisions.  This has led to calls for more consultation time to ensure that haste does not lead to measures which, instead of improving stability in financial markets, actually undermine it further.

• The Bill is primarily designed to limit the instability caused by failing banks by establishing an orderly regime for dealing with them.  However, some consider that instability is an inevitable consequence of the failure of large financial institutions, and that stability will only be protected by tighter regulation which reduces the inherent risk of such failure.  A consultation document on regulation regarding liquidity risk management and supervision is expected from the FSA in 2009.  Critics suggest that the FSA's measures and the Bill should be developed concurrently.
  
   
• The Bill's stabilising effect is limited because it does not apply to foreign or investment banks, two categories with a significant impact on market conditions.
  
   
• In the context of a partial property transfer, the transferee may be able to 'cherry pick' the highest quality assets, disproportionately reducing assets available for residual creditors and undermining rights of set-off against other transactions with the same counterparty.  Any such interference in creditors' rights or the ability to override contractual provisions could seriously damage confidence in UK financial markets and in particular London's competitiveness as an international financial centre.  The government is consulting on secondary legislation to address this issue.
  
   
• There could be problems regarding transparency in how the authorities' powers are used.   For example, it is proposed that the BoE should no longer have to disclose details of its emergency lending operations.  The aim is to prevent the media-fuelled panic which occurs when news of a bank's financial difficulties breaks.  However, it could lead to a more general sense of uncertainty as opposed to instability concentrated around the institutions which are the source of it. 

• Email This
• Print
• Comments
• Trackbacks

By Robert V. Hadley and Philip J. Morgan

Last week, two leading UK newspapers reported interviews with the new Chairman of the FSA, Lord Adair Turner, in which he is said to have warned that the days of “soft-touch regulation” are over. He also spoke of the FSA’s plans to pump more resources, and to recruit high quality people from the private sector at considerable expense, into the regulation of systemically important institutions.

Earlier last week FSA Chief Executive Hector Sants struck a slightly different tone when he noted that the concept of “heightened supervision” - jargon for an FSA enhanced regulatory regime for banks where failure appears possible - was a last resort. He also said that the term “heightened supervision” was a colloquialism that reflects the fact that the FSA adopts a risk-based approach. Certain risks now being clear it is appropriate, and consistent with the FSA’s stated and historic approach, and nothing new, for supervision in relation to such risks to be “heightened.”

The new Chairman is plainly looking to stamp his authority in a very public way. Interviews with national newspapers are not a common occurrence for leaders at the FSA. And “light-touch regulation” has long been a mantra of FSA leaders, Mr Sants included. But does Lord Turner's intervention last week signal a real change of direction for the FSA?

Risk-based regulation, which continues to be at the heart of the FSA’s approach, and light-touch regulation run hand in hand - a business that presents a limited risk to the FSA’s statutory objectives can be regulated in a less hands-on fashion than higher risk businesses the failure of which may have systemic consequences. We suspect therefore that many people regulated by the FSA will notice little difference with the tougher stance signalled by Lord Turner.

On the other hand, it is clear that the FSA is currently far more focused, as a matter of necessity, on issues that can have consequences for the stability of the financial system as a whole. Lord Turner mentioned in particular FSA work in three areas:

(i) the capital adequacy regime for banks - in relation to which he noted that the current regime seems to encourage the banks to lend too much in the boom times and too little when times get tough;

(ii) liquidity - where the focus would be on whether the business model of financial institutions was solid enough in bad times as well as good; and

(iii) pay - although Lord Turner was clear that this area plays second fiddle to capital adequacy and liquidity

Also, it would appear that under Lord Turner's watch the FSA will be taking a renewed close look at the risks posed by hedge funds. For example, it was reported that he thinks that hedge funds, up to now beneficiaries of “light-touch regulation” in the UK, could evolve to pose a systemic risk, much as the Wall Street banks did during the past few decades.

The truth, it seems to us, is that whilst the FSA is set to get tougher with high-impact, systemically important firms, notably significant banks and insurance companies, much of the rest of the FSA’s work will probably carry on as before, at least for a while. Lord Turner himself summed up the balancing act as follows:

“There is no doubt the touch will be heavier… We have to make sure that it is intelligent and focussed on where the risks really are.”

It does remain interesting, though, that the new Chairman, unlike the last, does not seem minded to defend the concept of “light-touch regulation,” even choosing to refer to it by the more pejorative “soft-touch regulation.” It remains to be seen whether Mr. Sants will adjust his tone to be more in keeping with his new boss’s tough talking.

• Email This
• Print
• Comments
• Trackbacks

By: Philip J. Morgan, Robert V. Hadley

A hallmark of enforcement by the U.K. Financial Services Authority (the “FSA”) in 2008 has been the effort to establish that abusive behavior is likely to trigger severe personal consequences - so-called “credible deterrence.”  The FSA is now spreading the message that it is “getting tough” and intends to increase its focus on deterrence through enforcement action.

The FSA has been saying for some time that it intends to boost credible deterrence and engage senior management in particular in relation to its strategic priorities of combating market abuse and insider dealing by three strategies: higher financial penalties; greater focus on enforcement actions against individuals rather than or as well as firms; and the prosecution of criminal cases.  Yet many have wondered when the rhetoric would be matched by action.  In all of 2007 the FSA imposed just one fine for abuse-related activity.  By the start of 2008 the FSA had brought one successful criminal prosecution since its establishment under the current regulatory regime on 1 December 2001.  It had prosecuted nobody for the criminal offence of insider dealing.

Now, things appear to be starting to change. The FSA has said that in order to achieve its aim of credible deterrence it must prosecute “a steady stream” of criminal cases.  Thus, in January of this year the FSA launched its first criminal prosecution for insider dealing against two individuals, one of whom was an in-house counsel.  In July it commenced two more prosecutions, one against a former Cazenove partner. There are said to be several others in the pipeline.

Also, on July 29, 2008, an extensive dawn raid operation was mounted on various addresses by the FSA under search warrants.  Eight individuals were arrested. The FSA said that this was in connection with “a major ongoing investigation into insider dealing rings.” The FSA does not comment on ongoing investigations, but this was a further clear demonstration of intent.

Individuals, and especially senior management and others in the regulated sector, can be in no doubt that there is at least some risk of criminal prosecution for insider dealing and other market manipulation offences. The risk is not merely of financial penalty imposed on their firm, or even on them personally.  Certainly no one can any longer say that the FSA has never prosecuted anyone for such activities.  The FSA’s aim is that any person with access to inside information or other opportunity to abuse the market should believe that these criminal cases are the first of its “steady stream,” and to think clearly that that is not where they wish to swim.

The FSA also will point to other recent actions as evidence of its new, more aggressive posture toward enforcement.

In the past two months, the FSA fined Credit Suisse £5.6 million for the mismarking of certain positions resulting in an overstatement in published accounts corrected some eight days later, and fined a GE Money mortgage brokerage operation £1.1 million for defective systems and controls leading to its not accounting correctly for customer funds, so that, for example, mortgages were overpaid on redemption and clients’ money was not applied to their mortgage accounts promptly or accurately (both fines imposed after the FSA acknowledged the full cooperation of the firms and after applying the 30 percent reduction for settling at an early stage of the enforcement process).  These cases are examples of the higher financial penalties that the FSA intends to seek.

The FSA fined Land of Leather Limited in May in relation to inadequate systems and controls to prevent the sale of Payment Protection Insurance which was unsuitable for customers’ needs, but will stress that it also fined the company’s Chief Executive £14,000 (after a 30 percent early settlement reduction) in respect of the same matter. This shows the FSA’s willingness to pursue senior management on the basis of senior management’s responsibility for a firm’s regulatory compliance.

Similarly the FSA extracted an undertaking from Mr. Steven Harrison, an investment manager at a hedge fund, effectively that he stay out of the financial services industry for 12 months (in addition to a financial penalty of £52,500 - after the 30 percent early settlement reduction).  The allegation was market abuse in the sense of instructing colleagues to purchase certain bonds while in possession of inside information.  The final notice acknowledges that Mr. Harrison’s conduct was not deliberate in the sense that he did not consider at the time that he had inside information, but the FSA’s position was that he should have recognized that fact.  The FSA thus intends to promote deterrence not only by fining individuals, but also by affecting their continued ability to earn their livelihood in the financial services sector.

• Email This
• Print
• Comments
• Trackbacks