## _cr03208 ## Source details **Canonical URL:** [_cr03208](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2003/_cr03208.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2003/_cr03208.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2003/_cr03208.pdf.json) --- ### Public sector debt and debt management - Major findings: - Public sector net debt: £303 billion nominal; 30 percent of GDP as of February 2002. - Public sector net debt (end-February/ end-March series, £ billions): 1997 £348.5; 1998 £352.9; 1999 £348.6; 2000 £340.1; 2001 £305.9; 2002 £303.2. - Public sector net debt as percent of GDP: 1997 44.0 percent; 1998 41.9 percent; 1999 39.7 percent; 2000 36.4 percent; 2001 31.2 percent; 2002 29.9 percent. - Consolidated gross debt (nominal, £ billions): 1997 £393.4; 1998 £394.3; 1999 £392.5; 2000 £387.3; 2001 £375.0; 2002 £369.9. - Consolidated gross debt as percent of GDP: 1997 49.7 percent; 1998 46.8 percent; 1999 44.7 percent; 2000 41.4 percent; 2001 38.3 percent; 2002 36.5 percent. - Public sector liquid assets (less): 1997 £44.9; 1998 £41.4; 1999 £43.9; 2000 £47.2; 2001 £69.0; 2002 £66.8. - Debt management objective and strategy: - Objective (set in 1995): "To manage over the long-term the cost of meeting the Government’s financing needs, taking into account risk, whilst ensuring that debt management is consistent with the objectives of monetary policy." - Strategies: open, predictable issuance; benchmark conventional gilts; adjust maturity via issuance, switch auctions, conversion offers, buy-backs; develop liquid gilts market; offer cost-effective retail instruments. - Risk approach: manage expected debt service costs over the long-term and protect against wide range of shocks. - Fiscal rules: - Sustainable investment rule: aim to keep public sector net debt below 40 percent of GDP over the economic cycle. - Golden rule: over the economic cycle, government will borrow only to invest, not to fund current spending. ### Central government debt composition and gilt market structure - End-February 2002 sterling gross debt components (£ billions and percentages): - British Government Gilt Stocks total 269.7 (72.5 percent): Conventional 198.8 (53.4 percent); Index-linked 70.9 (19.1 percent). - Sterling Treasury bills 7.9 (2.1 percent). - National Savings & Investment 62.5 (16.8 percent). - Certificates of tax deposits 0.5 (0.1 percent). - Other sterling debt 27.9 (7.5 percent). - Central government sterling gross debt 368.4 (99.0 percent). - Foreign currency gross debt total 3.6 (1.0 percent); Total central government gross debt 372.0 (100.0 percent). - Distribution of gilt holdings (December 2001, market values, £ billions and percentages): - Insurance companies and pension funds 183.7 (62.7 percent). - Nonresidents 53.4 (18.2 percent). - Households 18.8 (6.4 percent). - Public sector (net of central government holdings) 4.4 (1.3 percent). - Total 292.9 (100.0 percent). - Market statistics and composition (amounts outstanding, £ billions, end of period): - Gilts: 1990 125; 1995 233; 1998 301; 1999 294; 2000 294; 2001 275. - Interest rate swaps (single currency, notional principal outstanding): 1992 167; 1995 541; 1998 1,979; 1999 2,194; 2000 2,651; 2001 3,456. - Total market (selected years): 1990 1,021; 1995 1,935; 1998 4,251; 1999 5,111; 2000 5,478; 2001 6,149. - Gilt issuance and market effects: - Gross issuance peak: £55 billion in financial year 1993–94; trough: £8 billion in 1998–99. - Average duration of gilt stock: 7.5 years (end-March 2002). - Index-linked and Treasury bills constitute almost a quarter of marketable debt portfolio. ### Debt management transparency, DMO institutional arrangements, and operations - Debt Management Office (DMO): - Executive agency of HM Treasury since April 1998; took debt management from Bank of England then; full cash management responsibility assumed April 2000. - DMO employs approximately 80 people organized around ten business units. - Operational practices: - Annual published remits, pre-announced auction calendar, auction-based issuance, target issuance percentages across gilt classes in remit. - Auction formats: conventional gilts multiple price; index-linked uniform price; GEMMs non-competitive facilities: conventional 0.5 percent of amount; index-linked aggregate ceiling 10 percent. - Collateral policy: accepts gilts, Treasury bills, HM Treasury FX issues, selected €-denominated sovereign issues, selected highest-rated supranational debt and selected bank bills (broad outline; specifics not published). - Cash management buffers: - DMO targets a balance of £200 million at the Bank of England to cover rare unforecasted cash changes; Ways and Means advance normally stands at £13.4 billion. - Since transfer of cash management to DMO, the £200 million target covered all but two daily cash shortfalls; the two exceptions (in 2000–01) required modest (~£20 million) fluctuations in Ways and Means; both reversed the following business day. - Market conduct and interventions: - DMO prepared to serve as instrument of Treasury for transparent public intervention to support markets, separated from normal operations. - Identified transparency gaps and planned improvements: - Limited public information on considerations behind cost-risk trade-offs in annual remit. - Authorities plan to publish work on fiscal policy–debt portfolio linkages and to develop a comprehensive asset and liability risk monitor; preliminary version published in 2002-03 DRMR ahead of Whole of Government Accounts in 2005-06. ### Debt strategy risks and issuance preferences - Policy favors issuance across instruments with a preference for longer-term securities to minimize rollover risk and meet institutional demand. - Index-linked issuance: strong demand persists but expected cost advantage declined as nominal-real yield spread settled just above 2 ½ percent inflation target. - Foreign currency borrowing: not used to finance domestic borrowing in peacetime; swaps used to augment FX reserves—approximately £10 billion of such swaps outstanding at the end of March 2002. - CGNCR (Central Government Net Cash Requirement) forecasts (April 2002 PBR, £ billion): - 2001-02 projection: 6 - 2002-03: 14 - 2003-04: 18 - 2004-05: 16 - 2005-06: 21 - 2006-07: 24 ### Key policy recommendations (debt management) - Introduce indicators to articulate cost-risk trade-off underpinning remit decisions. - Automate bid-capture for gilt and Treasury bill auctions (telephone system to remain as fall-back); consult market before implementation. - Formalize the role of DMO Advisory Board and introduce selection criteria for membership if formalized. --- ### Gilt market microstructure, primary dealers (GEMMs), and IDBs - GEMM structure: - 16 firms recognized as GEMMs by DMO; 10 of 16 also recognized as Index-linked GEMMs. - Obligations include active participation in issuance, making two-way prices, providing market information to DMO. - 2002 quoting rules: firm two-way quotes to other GEMMs in a small set of benchmark gilts for at least 5 hours a day on IDB screens; ensure at least £28 million liquidity across yield curve available to any GEMM. - GEMM auction allocation limits: 25 percent (conventional) and 40 percent (index-linked) of amount on offer. - Inter-Dealer Brokers (IDBs): - Three IDBs operate in gilt market; their main purpose: enable GEMMs to unwind positions anonymously. - IDBs registered with LSE and endorsed by DMO; prohibited from proprietary positions and dissemination beyond GEMM community. - Expectation: number of IDBs likely to shrink as electronic dealing grows. - Electronic trading and automation: - Alternative electronic trading systems (BrokerTec, Euro MTS, TradeWeb) gaining popularity; DMO consulted and supported inter-GEMM electronic market in 2002. - DMO encouraged to automate auction bid-capture to reduce operational risk and improve processing times (current gilt auctions ~30 minutes; automated systems can reduce to ~15 minutes). --- ### Payment systems and systemic liquidity — NewCHAPS, CHAPS Sterling & Euro, and Bank of England operations ### NewCHAPS assessment and operational features - Overall assessment: - NewCHAPS observed applicable CPSS Core Principles and central bank Responsibilities after governance reforms; initial phase: fully observed seven Core Principles; two broadly observed; one not applicable. - System architecture and performance targets: - Availability target: 99.95 percent of the operating day (average over each month). - MoU transmission time target between Members: no longer than 60 seconds (30 seconds network processing and 30 seconds RTGS processor). - TARGET maximum total processing time: 30 minutes; optimal target less than one minute. - Throughput statistics (average daily; selected years): - NewCHAPS average daily volumes (000’s) and values (£ millions): - 1999 Sterling Vol 78.5 Val 177,396; Euro Vol 9.7 Val 85,367. - 2000 Sterling Vol 86.1 Val 195,023; Euro Vol 12.9 Val 99,277. - 2001 Sterling Vol 91.7 Val 202,857; Euro Vol 14.5 Val 118,368. - Average transaction values (£): - 2001 Sterling 2,211,854; Euro Domestic 4,628,028; Euro Cross-border 9,253,968. - CHAPS Sterling composition (CHAPS Traffic Survey 2001): - Financial transactions: 76 percent by value and 38 percent by volume. - Payment size distribution: 21 percent of payments below ₤1,000; 47 percent below ₤10,000. - Peak sterling values: 28/09/01 £318.95 billion; 29/06/01 £311.30 billion. - Concentration: - CHAPS Sterling: the 5 biggest banks account for over 80 percent of both value and volume; CHAPS euro/TARGET: top 5 account for just over 67 percent of volumes. - Contingency by-pass mode: - RTGS by-pass mode moves to end-of-day bilateral net settlement; identified financial exposure risks if used; CHAPS Board agreed procedures (to be implemented during 2003) to limit exposures in by-pass mode. ### Bank of England monetary operations and systemic liquidity findings - Bank implements monetary policy via lending at two-week repo rate; typical operational day comprises multiple rounds (4 rounds including late-round for settlement banks). - Liquidity supply and turnover (Table 5 figures in £ billions): - Average Liquidity Supplied by Bank of England: 1999–2000 1.2; 2001 2.5 (Standard deviation: (0.8)(1.0) (1.5)). - Average Daily Turnover in Gilt Repo: 23; 28; 28. - Collateral risk management: - Daily valuation and VAR-based margins applied; suggestion to consider minimum liquidity/credit rating thresholds for broadened collateral pool. - Supervisory observations and recommendations: - Consider reactivating longer-term operations to manage balance sheet composition. - Strengthen surveillance of bilateral unsecured exposures between banks; consider publishing highly aggregated exposure distributions to discipline credit lines. - Review SSLR and move to a new liquidity supervision approach recognizing behavioral maturity; FSA implementation expected in 2004–2005. ### Payment systems oversight and recommendations - Bank of England oversight: - Published "Oversight of Payment Systems" (November 2000); committed to annual reporting on oversight activities; June 2002 FSR began broader disclosure. - Recommendation: evolve oversight reporting into a regular annual account; consider statutory articulation of oversight responsibilities. - NewCHAPS governance reforms: - APACS/CHAPSCo governance clarified (effective September 8, 2002); CHAPSCo now explicitly responsible for its own governance; Company Call charge mechanisms and Bank RTGS fee objectives described. --- ### Financial sector supervision and regulatory architecture ### Financial Services Authority (FSA) — remit, governance, and transparency - FSMA established FSA as integrated regulator; four statutory objectives: maintain confidence; promote public understanding; protect consumers; reduce financial crime. - Structure and resources: - Budget circa £221.1 million (2002/2003); permanent staff ~2,200. - Board composition: Chairman, three executive directors, eleven non-executives (appointed by HM Treasury). - Regulatory approach: - Risk-based supervision with RTO (risks to objectives) framework and on-site/off-site mix; thematic reviews and skilled persons powers under FSMA Section 166. - Observed compliance with international standards: - Banking supervision: Overall the U.K. satisfies Basel Core Principles preconditions; many CPs assessed Compliant or Largely Compliant. - Securities regulation: All IOSCO Objectives and Principles observed; technical recommendations suggested (e.g., international enforcement cooperation, prospectus review risk-based approach, CIS delegate rules). - Insurance supervision: IAIS assessment found several CPs Observed or Broadly Observed; CP 13 (On-site Inspection) Materially Non-Observed at time of assessment; Tiner project implemented to strengthen on-site capacity and risk-based supervision. - Recommended supervisory improvements (selected): - Introduce periodic reporting on asset quality (CP 8). - Consider expanding supervisory staff for market risks testing (CP 12). - Develop new liquidity monitoring approach aligned with banks’ techniques (CP 13). - Automate supervisory validation of key returns and consider annual audit of key supervisory returns (CP 19). ### Banking supervision: key operational points - Threshold Conditions for authorization include Suitability and Adequate Resources; Minimum capital Euro 5 million equivalent; minimum capital ratio 8 percent; individual capital ratios typically higher per FSA determinations. - Liquidity supervision: - SSLR for major banks in place since 1996 but shortcomings identified; FSA and Bank of England moving toward new approaches with implementation expected 2004–2005. - Validation of supervisory returns: - FSA has powers under FSMA Sections 165/166 but no explicit requirement that key returns be audited annually—recommendation to require annual audit of key returns and extend listed-banks disclosure to non-listed banks. ### Insurance sector reforms and Tiner project - Insurance market significance: - Net premium income 2000: £174 billion; market is third largest globally. - Life insurers asset allocation at end-1999: Equities 467.3 (51.1%); Gilts 123.6 (13.5%); Total long-term assets 916.6 (£bill). - Tiner project objectives: - Strengthen prudential regime; increase on-site inspection; improve actuarial and reserving oversight; implement integrated prudential sourcebook; publish proposals on role of appointed actuary (CP167 consulted January 24, 2003). - Recommended insurance actions: - Make Financial Condition Report (FCR) mandatory and board-signed for high-impact firms. - Strengthen reinsurance oversight and develop thematic reviews of reinsurance operations. - Enhance supervisory capacity in reinsurance, actuarial modeling, and long-tail claims; establish Centre/Matrix of insurance specialists across FSA. ### Securities markets and IOSCO assessment highlights - FSA observed to implement IOSCO principles; technical suggestions include: - Reconsidering FSMA provision requiring consideration of U.K. interest when assisting foreign regulators. - Apply risk-based approach to prospectus review. - Consider continuous disclosure for CISs and enhanced rules for delegates/sub-delegates. - Collective Investment Schemes: - AUTs and ICVCs regulated; KFD (Key Features Document) required; suggestions to mandate affiliated-party transaction disclosure and improve delegate legal binding. --- ### Anti-Money Laundering / Countering Financing of Terrorism (AML/CFT) — comprehensive assessment and recommended actions ### Overall assessment summary - U.K. regime largely strong and comprehensive; PCA 2002 (Proceeds of Crime Act 2002) and Terrorism Act/ATCS 2001 strengthen framework. - FATF 40+8 assessment: U.K. compliant or largely compliant with most Recommendations; Special Recommendation VII (originator information on wire transfers) assessed NON-COMPLIANT pending legislative action and FATF Interpretative Note. - Key institutional elements: - NCIS (Economic Crime Unit) functions as FIU; planned enhancements under PCA 2002. - FSA: AML supervisor for prudentially regulated sectors (excluding general insurance); HMCE: supervisor for MSBs under 2001 Regulations. - Asset Recovery Agency (ARA) to commence operations on 24 February 2003. - Statistical and operational facts: - STRs (suspicious transaction reports): 31,251 filed in 2001 (including from 418 banks). - Confiscation receipts: 2000-01 £19,833,000 (noted figures in text). - Frozen assets under Taliban/Al-Qaeda/UN measures (2000-2001): £70 million. ### Key deficiencies and implementation gaps - Coverage gaps: - General insurance excluded from 1993 Regulations and thus from FSA AML supervision—identified as a significant gap. - Small, low-impact securities firms: FSA compliance checking limited; recommended randomized/systematic verification. - MSBs: HMCE supervisory regime recently introduced (2001 Regulations); self-financing fee proposed ₤100 per premises—effectiveness and resourcing to be reviewed. - Legal and operational improvements needed: - Make PCA 2002 provisions effective as soon as possible (STR filing to NCIS, account monitoring orders, broader confiscation, civil recovery and ARA). - Revise definition of ML under 1993 Regulations to include newer FT statutes (Terrorism Act, ATCS 2001) and remove obsolete cross-references. - Consider granting NCIS power to obtain supporting documents from reporting parties and authority to impose civil fines on non-FSA reporting parties for failure to report. - Consider admissibility of wiretap evidence in judicial proceedings with safeguards for national security and defendants’ rights. - Enhance mutual legal assistance/extradition framework—adopt legislation to streamline extradition procedures. - Require inclusion and retention of accurate originator information on funds transfers (SR VII), subject to FATF Interpretative Note; government consultative work underway. - Institutional and strategic recommendations: - Consider creation of a national law enforcement organization with combined criminal-investigation and foreign counter-intelligence remit (noted as a major structural proposal requiring broad review). - NCIS and partners should undertake vulnerability and trend analyses—focus on cash laundering channels—and develop a national strategy; ARA to host Centre of Excellence for training. - Intensify training for prosecutors and judges on ML and asset confiscation to ensure effective application of PCA 2002 mechanisms. - Ensure HMCE MSB supervisory fees and resource model are sufficient to permit adequate assurance visits and enforcement (review self-financing scheme). ### Specific operational recommendations (selected and preserved phrasing/numbers) - Make PCA 2002 provisions effective: Part 7 ML offenses intended effective date February 24, 2003; remaining provisions intended fully effective by May 24, 2003. - NCIS/statistics and timeliness: - NCIS analysis timeliness: concerns that NCIS can take up to three months to transmit review of STRs to agencies; recommendation to improve timeliness and targeted dissemination. - Wire transfers (SR VII): - Government consultative document proposes mandatory originator information (name, address and, where applicable, account information) on all transfers; FATF Interpretative Note pending—U.K. to legislate when Interpretative Note adopted. ### AML/CFT recommended legal/regulatory changes (condensed) - Ratify UN Convention Against Transnational Organized Crime (Palermo Convention) as soon as possible. - Revise 1993 Regulations and FSA Sourcebook to: - update ML definition; include FT predicate laws; specify minimum record-keeping content and retention (five years); require baseline originator information on transfers once FATF guidance clarified. - impose affirmative obligations to scrutinize complex/unusual transactions and transactions with higher-risk jurisdictions; require enhanced scrutiny for transfers lacking originator information. - require internal audit function in AML programs and that the “appropriate person” (MLRO) be at management level. - prohibit criminals from holding or controlling significant investments in financial institutions and MSBs; give HMCE explicit power to deny/cancel MSB registrations on integrity grounds. - provide civil administrative fines for breaches of AML-CFT procedural obligations (1993 Regulations currently criminal-only; MSB civil penalty maximum currently ₤5,000 for limited breaches). - Implement organizational and capacity measures: - Ensure ARA and NCIS are resourced and that training programs via the Centre of Excellence are rolled out to investigators, prosecutors and judges. - Systematically verify compliance among small securities firms and bring general insurance into AML/CFT supervisory scope. --- *Source: Office for National Statistics; prepared by the FSAP mission team; extracted from the provided content unit _cr03208.* ### 1. Public Sector Net Debt............................................................................................... ### _cr03208 - 1. Public Sector Net Debt............................................................................................... ### Major findings on public sector indebtedness and structure - Public sector net debt totaled £303 billion in nominal terms or 30 percent of GDP as of February 2002. - Public sector net debt figures by end-February/ end-March series: - Public sector net debt: 1997 £348.5; 1998 £352.9; 1999 £348.6; 2000 £340.1; 2001 £305.9; 2002 £303.2. - As a percent of GDP: 1997 44.0 percent; 1998 41.9 percent; 1999 39.7 percent; 2000 36.4 percent; 2001 31.2 percent; 2002 29.9 percent. - Public sector consolidated gross debt (nominal): 1997 £393.4; 1998 £394.3; 1999 £392.5; 2000 £387.3; 2001 £375.0; 2002 £369.9. - Public sector consolidated gross debt as a percent of GDP: 1997 49.7 percent; 1998 46.8 percent; 1999 44.7 percent; 2000 41.4 percent; 2001 38.3 percent; 2002 36.5 percent. - Public sector liquid assets (less): 1997 £44.9; 1998 £41.4; 1999 £43.9; 2000 £47.2; 2001 £69.0; 2002 £66.8. - Central government sterling gross debt components (End-February 2002, £ billions and percentages in italics): - British Government Gilt Stocks total 269.7 (72.5 percent); of which Conventional 198.8 (53.4 percent) and Index-linked 70.9 (19.1 percent). - Sterling Treasury bills 7.9 (2.1 percent). - National Savings & Investment 62.5 (16.8 percent). - Certificates of tax deposits 0.5 (0.1 percent). - Other sterling debt 27.9 (7.5 percent). - Central government sterling gross debt 368.4 (99.0 percent). - Central government foreign currency gross debt components: US$ debt 2.1 (0.6 percent); Euro Treasury notes 1.2 (0.3 percent); North American government war loans 0.2 (0.1 percent). - Central government foreign currency gross debt total 3.6 (1.0 percent). - Total central government gross debt 372.0 (100.0 percent). - Distribution of gilt holdings as of December 2001 (market values, £ billions and percentages): - Public sector (net of central government holdings) 4.4 (1.3 percent). - Banks and building societies 3.1 (1.0 percent). - Insurance companies and pension funds 183.7 (62.7 percent). - Other domestic financial institutions 29.6 (10.3 percent). - Households 18.8 (6.4 percent). - Nonresidents 53.4 (18.2 percent). - Total 292.9 (100.0 percent). ### Comparative position and policy rules - The U.K. had the lowest public sector net debt among G-7 countries as of the cited period. - Table: General Government Net Financial Liabilities for G-7 Countries (As a percent of GDP) — selected entries: - Canada: 1985 52.5; 1990 61.2; 1995 88.0; 2000 65.0; 2001 59.7; 2002 56.1; 2003 51.0. - France: 1985 10.6; 1990 16.1; 1995 35.9; 2000 42.2; 2001 42.2; 2002 42.6; 2003 42.2. - Germany: 1985 18.7; 1990 17.8; 1995 39.4; 2000 41.5; 2001 41.5; 2002 43.2; 2003 43.3. - Italy: 1985 79.6; 1990 83.7; 1995 108.7; 2000 98.7; 2001 95.5; 2002 93.0; 2003 89.8. - Japan: 1985 35.0; 1990 12.4; 1995 16.9; 2000 51.1; 2001 58.7; 2002 66.8; 2003 74.0. - United Kingdom: 1985 —; 1990 30.8; 1995 15.1; 2000 36.9; 2001 33.1; 2002 30.5; 2003 29.2; 2003 (alternate column) 28.5. - United States: 1985 41.9; 1990 49.9; 1995 59.2; 2000 43.4; 2001 41.1; 2002 41.4; 2003 40.0. - The U.K. government follows two fiscal rules: - Sustainable investment rule: public sector net debt as a proportion of GDP will be held at a stable and prudent level over the economic cycle; other things being equal, policy is for net debt to be maintained below 40 percent of GDP over the economic cycle. - Golden rule: over the economic cycle, the government will borrow only to invest, and not to fund current spending. ### Debt management objective, strategy, and operational practices - Current debt management objective (set in 1995): - "To manage over the long-term the cost of meeting the Government’s financing needs, taking into account risk, whilst ensuring that debt management is consistent with the objectives of monetary policy." - Strategies to achieve the objective: - Pursuing an issuance policy that is open, predictable, and transparent. - Issuing conventional gilts that achieve a benchmark premium. - Adjusting maturity and nature of the government debt portfolio via issuance, switch auctions, conversion offers, and buy-backs. - Developing a liquid and efficient gilts market. - Offering cost-effective retail savings instruments. - Risk approach: - Focus on managing expected debt service costs over the long-term and selecting a debt portfolio that protects against a wide range of shocks rather than attempting to time markets. - Operational changes since 1995: - Move away from highly discretionary policy toward open, predictable issuance with annual published remits, a pre-announced auction calendar, and auction-based issuance (replacing gilt sales by tap). ### Institutional arrangements and coordination with monetary and fiscal policy - Debt Management Office (DMO): - DMO became an executive agency of HM Treasury in April 1998 and took over debt management from the Bank of England as of that date. - Full responsibility for cash management was assumed by the DMO in April 2000. - Separation and coordination benefits: - Separation reduces perceptions of insider knowledge and potential conflicts of interest between debt management and monetary policy. - Bank of England’s Monetary Policy Committee (MPC) may raise issues via HM Treasury’s representative; the DMO does not contact the MPC about interest rate decisions or thinking. - Operational coordination measures: - DMO avoids holding tenders when the Bank is conducting money market operations and does not hold reverse repo tenders at the 14-day maturity range. - DMO does not conduct ad hoc tenders on MPC decision days. - DMO acts as a price-taker in market operations. - DMO may issue Treasury bills to assist the Bank of England at the Bank’s request (facility not used). - Cash management arrangements and buffers: - Arrangements for late changes to forecasts include use of the Bank of England’s 4:20 p.m. overnight repo facility for Exchequer cash surplus and bilateral borrowing from settlement banks for deficits. - DMO targets a balance of £200 million at the Bank of England to cover rare unforecasted cash changes. - Since transfer of cash management to the DMO, the £200 million target covered all but two daily cash shortfalls; the two exceptions occurred in the 2000–01 fiscal year and each required modest (~£20 million) fluctuations in the Ways and Means advance (which normally stands at £13.4 billion); both were reversed the following business day. - Fiscal coordination: - Annual borrowing program is set by HM Treasury based on budget fiscal plans and updated with the Pre-Budget Report cash forecast. ### Market conduct, collateral policy, and market support role - DMO conducts operations on a commercial basis and sets its own terms and conditions (e.g., eligible collateral). - Collateral accepted by DMO in market operations (broad outline; specific details not published): - All gilts, Treasury bills, and foreign currency issues of HM Treasury. - Selected European government €-denominated sovereign issues. - Selected highest-rated supranational £- and €-denominated debt. - Selected bank bills and other high quality short-term debt issued by supranationals and foreign governments. - Market role and interventions: - DMO promotes well-functioning markets, participates in market committees, works with market participants on innovations (e.g., electronic trading systems), and is prepared to serve as an instrument of the Treasury for public intervention to support markets, provided operations are transparent and clearly separated from normal DMO operations. *Source: Office for National Statistics; prepared by the FSAP mission team.* ### 19. Public debt management in the U.K. is conducted in an open and transparent ### _cr03208 - 19. Public debt management in the U.K. is conducted in an open and transparent ### Transparency and public reporting - Public debt management is conducted in accordance with the government’s Code for Fiscal Stability. - The DMO and HM Treasury maintain websites with comprehensive information and publications explaining: - objectives guiding debt and cash management activities; - the debt/cash management governance and institutional framework; - the government’s finances; and - debt/cash management operations. - Under statute, the government must publish details of its borrowing activities during the fiscal year and plans for the year ahead before the end of the fiscal year in the Debt and Reserves Management Report (DRMR). - The DRMR includes: - explanations of debt and foreign exchange reserves management operations of the fiscal year just ended and the coming fiscal year; - the financing requirement; - the forecast sales of gilts, their breakdown by maturity and instrument type; - the gilt auction calendar; and - planned short-term debt sales including Treasury bills. ### Auction process and market operations - An auction calendar is issued at the end of each quarter by the DMO confirming auction dates for the coming quarter and which gilts will be issued on which date. - Normally eight calendar days before an auction, the amount of stock to be auctioned is announced (and if it is a new stock, the coupon). At this point: - the stock is listed on the London Stock Exchange; and - ‘when-issued’ trading commences. - A quarterly auction calendar is also issued for Treasury bill tenders. - Gilts are issued by auction; the DMO retains the ability to: - buy-back or issue gilts in smaller quantities (by tap); - conduct special repos at short notice for market management reasons to address technical pricing distortions. - Operational transparency is enhanced through regular close consultation with market participants. ### Consultation, minutes, and market engagement - Market-makers and end-investor groups are consulted regularly through meetings with DMO staff during formulation of plans and quarterly before the DMO announces specific auction stocks. - Market participants are also consulted when authorities consider changes to debt management practices or market-enhancing initiatives. - Minutes of consultation meetings are published within a few hours of the meetings. ### Audit, reporting, and accountability - The National Audit Office (NAO) annually audits: - the government’s Debt Management Account (DMA); - the National Loans Fund (NLF); and - the administrative (agency) accounts of the DMO. - Audit results are published each year. - The DMO’s annual report reports its performance in meeting objectives set in its business plan; the DMO’s annual report and annual business plan are published on the DMO’s website. - The DMO’s activities are regularly reviewed by the parent department, with results reported to Parliament. ### Identified opacity and planned improvements - There is limited public information on the considerations behind the cost-risk trade-offs implicit in the annual remit provided to the DMO. - Authorities expect to publish work examining linkages between fiscal policy and the debt portfolio, including development of a comprehensive asset and liability risk monitor to quantify central government balance sheet risks. - A preliminary version of the risk monitor was published in the 2002-03 DRMR as a precursor to publication of the Whole of Government Accounts in 2005-06. ### Institutional and legal framework - Debt management is principally handled by two executive agencies: - the Debt Management Office (DMO) manages domestic wholesale market borrowings and domestic cash balances; - National Savings and Investments (NS&I) oversees the government’s savings instrument program raising funds directly from U.K. households. - Foreign currency debt management and management of foreign currency reserves are conducted by the Bank of England as agent for HM Treasury under a formal remit; annual remits to the DMO and NS&I and the MOU between the Bank and HM Treasury are published in the DRMR. - Legal borrowing powers: - Treasury’s power to borrow for the National Loans Fund is conferred by section 12 of the National Loans Act 1968, allowing the Treasury to raise any money it considers expedient for promoting sound monetary conditions, within or outside the U.K., and in other currencies. - Treasury’s power to borrow for the Debt Management Account is conferred by paragraph 4 of Schedule 5A of the National Loans Act 1968, with similar wide discretion and no set limits on borrowing from outside the United Kingdom. - Short-term Treasury Bills (12 months maximum) are issued under the Treasury Bills Act 1877. ### DMO organizational structure and governance - The Chancellor of the Exchequer, advised by Treasury officials, determines policy and financial framework; the Chief Executive of the DMO is delegated operational decisions on debt and cash management. - The Chief Executive: - is appointed by HM Treasury; - reports to the Permanent Secretary (on expenditure), to Treasury Ministers (on policy), and to Parliament (formal accounts); - is responsible to Treasury Ministers for overall operation of the DMO and for delivering the remit in a way judged to involve the least long run cost to the Exchequer, subject to other policy considerations. - The DMO employs approximately 80 people organized around ten business units. - Corporate governance includes: - an informal high-level Advisory Board advising the Managing Committee (the senior decision-making body); - a Credit and Risk Committee and strategy groups for Debt, Cash, and Investment; - two external non-Executive Directors on the Advisory Board (also on the Audit Committee) together with a member of HM Treasury. - The Advisory Board currently lacks formal standing in the governance framework; authorities may consider formalizing it and introducing selection criteria for membership. ### Financial controls, HR, and internal controls - The DMO is financed as part of HM Treasury and operates under arrangements controlling administrative expenses; subject to internal audit and external audit by the NAO. - The Chief Executive is the Accounting Officer for the office’s administrative accounts and the accounts of the DMA. - Human resource arrangements: - The Chief Executive sets personnel policies and manages staff; delegated authority exists for pay, pay bargaining, training, and terms and conditions within broader public sector and Civil Service Management Code constraints. - The DMO achieved Investors in People accreditation in June 2000. - DMO staff are bound by conflict-of-interest guidelines and the U.K. civil service code-of-conduct. - Internal controls and risk management: - The Statement of Internal Controls (SIC) in the DMO’s Annual Report & Accounts (ARA) 2000-2001 describes the DMO’s operational risk management approach. - The Audit Committee, chaired by an external non-executive director, regularly reviews risk management and internal controls. - A Business Continuity Plan exists, including the capability to conduct business at a Disaster Recovery Site; a notice would be posted on the web site if invoked. - A market-wide business continuity plan is being developed with key market participants under Bank of England stewardship. ### Operational risk and auction automation - Current auction bid submission is by telephone; DMO staff call bidders back to confirm details before processing. - Risks and comparisons: - Telephone bidding is resilient but can result in human errors and slower processing. - Other industrial countries have automated bid-capture using Bloomberg or customized systems, reducing auction processing times to 15 minutes, compared to 30 minutes for gilt auctions. - DMO intentions and considerations: - The DMO would like to automate the bid-capture process and expects to consult the market later this fiscal year. - Hurdles include handling bidding limits for dealers and end-investors; some countries have systems with such features. - Automation would transfer some operational risk to the market and may not be enthusiastically endorsed by counterparties. - The DMO is encouraged to follow through with automating bid-capture for gilt and Treasury bill auctions, although Treasury bill automation should wait until dematerialization of those instruments. - The telephone system could remain as a fall-back. ### Debt strategy, risks, and composition - HM Treasury, with input from the DMO, determines the desired structure of new issuance for the year ahead, taking into account financing requirements and costs and risks across instruments; the remit is published in the DRMR and expressed as percentage issuance across each class of gilt and overall financing to be raised through Treasury bills. - The DMO takes tactical decisions on features and timing of new issues after consulting HM Treasury and market participants; significant changes to projected borrowing may prompt remit revisions. The Chancellor’s Pre-Budget Report (typically published in October or November) provides an opportunity to revise the remit. - Risk management and issuance preferences: - Policy favors issuance across a variety of instruments with a preference for longer-term securities. - The average duration of the gilt stock was 7.5 years (at end-March 2002), longer than most OECD governments, reflecting a desire to minimize rollover risks and to meet institutional demand for long-maturity debt. - Longer-duration debt helps provide certainty to projections of future nominal debt servicing costs and limits effects of supply-side shocks. - Potential adjustments: - If yield curve distortions recede, authorities may consider shortening average duration to realize debt service cost savings at the expense of added portfolio risk. - The 2002–03 remit provides for a more balanced distribution of gilt sales across short, medium, and long tenors compared to 2001–02, which emphasized the long (15+ year) tenor. - Portfolio composition and hedging: - Almost a quarter of the government’s marketable debt portfolio consists of index-linked gilts and Treasury bills; NS&I debt is short-duration in nature. - In a demand shock, changes in debt servicing cost for these parts of the debt can mitigate effects on the fiscal balance. - Index-linked securities provide protection against a “nominal” shock. The expected cost advantages of issuing these securities have declined as the spread between nominal and real yields has settled just above the 2 ½ percent inflation target for monetary policy. - Authorities note continued strong demand for index-linked gilts with limited private-sector substitutes. - Foreign currency borrowing: - U.K. governments have not used foreign currency debt to finance domestic borrowing requirements in peacetime; recent issuance of foreign currency debt has been to augment foreign currency reserves. - Issuing liabilities in the currency of desired reserve holdings helps hedge foreign currency reserves against unexpected exchange rate fluctuations. *Source: _cr03208 - 19. Public debt management in the U.K. is conducted in an open and transparent* ### 40. The development of an active currency swap market has meant that the ### The development of an active currency swap market has meant that the ### Currency swap market and sterilized foreign reserve funding - Currency debt issued and the currency in which assets are held do not necessarily have to be the same. - Authorities have recently: - Issued additional amounts of domestic currency debt and swapped the proceeds into another currency to augment the government’s foreign currency reserves and maintain issuance volumes in the domestic market. - Primary decision criterion: - Value for money when deciding whether to fund foreign currency reserves from debt issued in sterling swapped into foreign currency, or from issuance of foreign currency denominated debt; comparisons are made on a swapped basis. - Risk controls: - Stringent controls limit basis risk and credit risk associated with these swap transactions. - Stock outstanding: - Approximately £10 billion of such swaps were outstanding at the end of March 2002. ### Cash management - DMO practices and instruments: - The DMO manages domestic cash balances primarily through Treasury bill tenders conducted on a competitive bidding basis and repo or reverse repo transactions. - Treasury bill tenders tend to be used to manage longer-term swings in cash flows within the fiscal year. - Repo operations with market participants are used to manage shorter-term swings of less than one month. - Market assessment: - The DMO’s management of the government’s cash balances is highly respected by the market; market participants praised its professionalism and especially its smooth investment of receipts from the third generation mobile phone license auction (3G) in fiscal year 2000–01. - Information and forecasting issues: - Forecast errors are much smaller than in past decades, but the quality of information from government departments on magnitude and timing of cash flows could be improved. - HM Treasury’s Exchequer Funds & Accounts team coordinates the cash forecasting process across departments and agencies. - A system of financial rewards and penalties has been established to encourage good forecasting behavior at the department/agency level. - Authorities may wish to consider larger rewards/penalties to motivate better performance, provide financial managers in departments/agencies with more information on timing and magnitude of aggregate government revenues and expenditures, and introduce rewards/penalties to encourage synchronization of expenditures with government cash receipts. ### Risk management framework (VI) - Ongoing work: - Managing risk in the debt portfolio by assessing resilience of cost and tax smoothing properties for different debt structures to a range of economic conditions and shocks. - HM Treasury and the DMO will consider “cost-at-risk” and robustness of different issuance strategies to different possible economic outcomes generated using Monte Carlo simulations within a reduced form macroeconomic model. - Results will be subjected to a range of stress tests to allow for particular shocks (for example supply shocks). - Purpose of analysis: - Quantify an optimal debt portfolio against which an issuance strategy and long-term performance could be assessed. - Facilitate identification of a counterfactual portfolio to inform the DMO’s annual financing remit and articulate government cost-risk preferences via simple indicators. - Help separate accountability for choice of optimal debt portfolio (policy decision) from accountability for realization of the remit (DMO’s tactical mandate). - Concerns about explicit performance benchmarks: - HM Treasury and the DMO have significant concerns if this approach led to an explicit performance benchmark for the DMO: - Risk of encouraging short-term opportunistic behavior by debt managers striving to meet the benchmark to the detriment of long-run cost minimization. - No expectation that the DMO can predict gilt yield curve movements more accurately than the market as a whole; a benchmark could create perceptions of privileged information or active interest-rate views. - Dominant issuer status makes it impossible to derive an objective benchmark not affected by the debt manager’s own actions. - A benchmark approach could curtail ability to pursue wider debt management objectives (e.g., maintain liquidity or build benchmarks at particular tenors). - Interest rate swaps would not resolve the conflict because swap counterparties would purchase gilts at the tenor the government was swapping out of, negating strategic issuance effects. - Indicators vs. benchmarks: - Introducing indicators articulating cost-risk preferences underpinning the remit would not necessarily induce opportunistic behavior if the DMO remains governed by the current remit’s strict guidelines on amount and tenor of new borrowings. - The risk of opportunistic behavior would arise if the DMO were given a more flexible remit allowing additional discretion to set issuance strategy or use derivatives to actively manage risk. - Several EMU countries have given public debt managers such discretion; the U.K. sees no need to change the DMO’s remit structure at this time. ### Scope for active management - Policy stance: - Since almost all government borrowing is conducted in domestic markets, U.K. authorities do not seek to actively manage the debt portfolio to profit from movements in interest rates and exchange rates. - Active profit-seeking management is viewed as risking financial loss, sending adverse signals to markets, conflicting with monetary and fiscal policies, and adding market uncertainty that could be passed on as higher borrowing costs. ### Contingent liabilities - Management: - Contingent liabilities are managed separately from the debt program. - Government generally tries to avoid taking on contingent liabilities; decisions on financing commitments through debt or guarantees are political after considering HM Treasury and DMO information on opportunity cost. - Publication and composition: - Details of contingent liabilities are published each year in the Supplementary Statements accompanying the Consolidated Fund and National Loan Fund accounts. - A list of contingent liabilities and their maximum potential loss is produced; they mainly consist of the cost of nuclear waste cleanup, export credits, and guarantees for construction of the Channel Tunnel. - Further work: - Additional work is planned to quantify and assess risks of these liabilities so estimated values can be calculated within a probabilistic framework. ### Developing and maintaining an efficient market for government securities (VII) - Gilt market overview: - The gilt market is the smallest segment of the sterling capital market, although the gilt repo market is becoming an increasingly important component of the sterling money market. - The relatively small size of the gilt market reflects the government’s modest borrowing requirements in recent years. - Gilts are actively traded in the secondary market, while other sterling-denominated bonds are not. - Gilt trading volumes have held fairly steady despite the shrinking size of the market in recent years. - Selected market size statistics (Amounts outstanding, £ billions, end of period): - Money market1/: 1990 183; 1995 195; 1998 434; 1999 475; 2000 504; 2001 541 - Gilts: 1990 125; 1995 233; 1998 301; 1999 294; 2000 294; 2001 275 - Non-gilt bonds: 1990 60; 1995 117; 1998 203; 1999 255; 2000 314; 2001 379 - UK equities2/: 1990 486; 1995 849; 1998 1,334; 1999 1,893; 2000 1,715; 2001 1,498 - Interest rate swaps3/: 1992 167; 1995 541; 1998 1,979; 1999 2,194; 2000 2,651; 2001 3,456 - Total: 1990 1,021; 1995 1,935; 1998 4,251; 1999 5,111; 2000 5,478; 2001 6,149 - Source: Bank of England. - Footnotes (preserved terminology): - 1/ Defined here as amounts outstanding in the interbank, certificate of deposit, gilt repo and stock lending, bill, and commercial paper market. - 2/ Measured as market capitalization of the FTSE All-Share index; 1990 data are estimated. - 3/ Single currency interest rate swaps, notional principal outstanding. 1990 data are not available so the table uses 1992 data; 2000 data are end-June. - Secondary market turnover (Average daily amount, £ billions): - Gilts Conventional: 1998 7.4; 1999 5.2; 2000 6.1; 2001 7.7 - Indexed-linked: 1998 0.3; 1999 0.2; 2000 0.3; 2001 0.3 - Gilt futures: 1998 4.9; 1999 3.3; 2000 2.1; 2001 2.6 - Non-gilt bonds: 1998 0.4; 1999 0.3; 2000 0.4; 2001 0.5 - UK equities: 1998 4.1; 1999 5.6; 2000 7.5; 2001 7.5 - International equities1/: 1998 8.7; 1999 9.6; 2000 14.0; 2001 14.5 - Source: London Stock Exchange and London International Futures and Options Exchange. - 1/ Foreign firms listed for trading on the London Stock Exchange. - Market structure and participants: - Most gilt trading is over-the-counter between market makers and customers. - The gilt interdealer market is perceived as less active than comparable markets in Europe and North America. - Institutional clients expect to transact £25 to £100 million with tight spreads, while trades of £5 million are more common in the interdealer market. - Market is dominated by about 25 insurance and pension fund clients that deal primarily through the five most active gilt-edged market makers (GEMMs). - GEMMs prefer to intermediate transactions through their client base rather than trade with each other to retain bid-offer spread; limited number of large investors helps limit search costs. - GEMMs have become more cautious since 1997 about quoting tight spreads for large orders as risk management tightened. - 1997 cross-country comparison highlights (selected figures preserved): - UK: Bid-offer Spreads 3-8; Annual Trading Volume US$ billions 3.222; Stock Turnover Ratio 7.0 - US: Bid-offer Spreads 1.6-3.1; Annual Trading Volume US$ billions 75.901; Stock Turnover Ratio 22.0 - France: Bid-offer Spreads 4-24; Annual Trading Volume US$ billions 18.634; Stock Turnover Ratio 33.8 - Canada: Bid-offer Spreads 2-10; Annual Trading Volume US$ billions 6.243; Stock Turnover Ratio 21.9 - Italy: Bid-offer Spreads 3-6; Annual Trading Volume US$ billions 8.419; Stock Turnover Ratio 7.7 - Japan: Bid-offer Spreads 5-16; Annual Trading Volume US$ billions 13.282; Stock Turnover Ratio 6.9 - Sweden: Bid-offer Spreads 4-27; Annual Trading Volume US$ billions 3.626; Stock Turnover Ratio 32.7 - Netherlands and Switzerland: Annual Trading Volume and Stock Turnover Ratio notes indicate some data may include repos or buy/sellbacks and certain entries marked “...”. - Source: Bank for International Settlements, Committee on the Global Financial System. 1999. “Market Liquidity: Research Findings and Selected Policy Implications” BIS-CGFS Study No. 11. May. - Footnotes (preserved terminology): - 1/ The range of interdealer bid-offer spreads for benchmark securities, expressed in 1/100 of a currency unit for the face value of 100 currency units. - 2/ Data may include trading other than outright transactions, such as repos or buy/sellbacks. - 3/ Annual trading volume divided by the stock of debt outstanding. ### Structure of the gilt market — Gilt-edged Market Makers (GEMMs) - Primary dealer system: - The U.K. Government bond market operates as a primary dealer system. - There are 16 firms recognized as primary dealers (GEMMs) by the DMO. - Each GEMM is authorized by the Financial Services Authority (FSA) and must be a member of the London Stock Exchange. - GEMM obligations: - Participate actively in the DMO’s gilt issuance program. - Make effective two-way prices on demand in almost all gilts (very small issues excluded). - Provide information to the DMO on market conditions. - 10 of the 16 recognized GEMMs are also recognized as Index-linked Gilt-edged Market Makers (IG GEMMs), with obligations extending to inflation-indexed gilts. - 2002 quoting rules: - Beginning in 2002, GEMMs are required to provide firm two-way quotes to other GEMMs in a small set of benchmark gilts. - Purpose: ensure minimum intra-GEMM liquidity for the benefit of the entire secondary market. - Requirements: quotes to be made for at least 5 hours during the eight hour London trading day on any of the three recognized interdealer broker (IDB) screens. - Ensure at least £28 million of liquidity is available across the yield curve to any GEMM needing to lay-off an undesired position. - Non-GEMM participants do not have access to these screens, but market transparency is aided by GEMM prices on wire services and DMO’s real-time indicative mid-prices for benchmark gilts. - Retail-level transparency: all trades of less than £50 thousand (par-value) are published in real time by the London Stock Exchange on its ticker tape. - Mandatory bid-offer spreads on inter-GEMM quotes: 3 basis points or less; two-way quotes expected to be good for dealing amounts up to £5 million for short and medium-term gilts, and £2 million for long-term gilts. - In severe market crises the DMO would consider relaxing the maximum spread obligation. - GEMM perspectives and benefits: - Some GEMMs regret mandatory quoting rules as they cause marginal distraction from servicing their client base; smaller GEMMs are the most active IDB market users. - Benefits received by GEMMs include: - Exclusive rights to competitive telephone bidding at gilt auctions and taps (for own account or on behalf of clients). - Exclusive access to a non-competitive bidding facility at outright auctions. - Exclusive facility to trade or switch stocks from the DMO’s dealing screens. - Exclusive facilities to strip and reconstitute gilts. - Invitation to a quarterly consultation meeting with the DMO to advise on stocks scheduled for auction and discuss market issues. - Exclusive access to gilt IDB screens. - Any transactions undertaken by the DMO for market management purposes are only carried out with or through the GEMMs. *Italic: Source: _cr03208 - 40. The development of an active currency swap market has meant that the* ### 56. There are three IDBs operating in the gilt market. Their main purpose is to ### _cr03208 - 56. There are three IDBs operating in the gilt market. Their main purpose is to ### Inter-Dealer Brokers (IDBs) and GEMM market structure - There are three IDBs operating in the gilt market. - Main purpose: support liquidity in the secondary markets by enabling the GEMMs to unwind on an anonymous basis any unwanted gilt positions acquired in the course of their market-making activities. - Almost all inter-GEMM trades are executed through an IDB. - Non index-linked GEMMs do not have access to index-linked screens. - IDBs are registered with the London Stock Exchange (LSE) and endorsed by the DMO. - The DMO monitors this segment of the market to ensure IDB services are available to all GEMMs on an equitable basis and that the market maker structure is effectively supported by the IDB arrangements. - IDBs are subject to specific conduct of business rules promulgated by the LSE, including prohibitions on: - taking proprietary positions; and - disseminating any market information beyond the GEMM community. - Although IDBs cannot take proprietary positions, they serve as the counterparty between the GEMMs involved in a transaction going through them to protect GEMM anonymity (counterparties see only the name of the IDB). - The London Stock Exchange’s default rules apply if an IDB fails to honor transactions: - Under Rule 15.18 a Stock Exchange official (default official) would determine payments due to or by the IDB on the transactions in default on the basis of the current market or “hammer” prices. - Under Rule 15.24 (b) the default official would put the counterparties to unsettled trades in direct contact with one another, and the counterparties is required to complete the trade at the price at which the original order was submitted. - In the second half of 2002, the London Clearing House introduced a central counterparty clearing service for cash and gilt repo transactions, currently restricted to conventional gilt transactions. - Most IDB transactions are executed through voice broking systems rather than electronic trading platforms, though electronic platform usage is growing rapidly, especially for straightforward transactions involving benchmark securities. - Expectation: number of IDBs likely to shrink as market preferences favor one or two electronic dealing systems. ### Auction formats and issuance mechanisms used by the DMO - The DMO uses market-based mechanisms to issue debt and manage the stock of debt outstanding in a transparent and predictable fashion. - Auctions are the exclusive means by which the DMO issues gilts as part of its scheduled funding operations. - Two auction formats: - conventional gilts: multiple price auction; - index-linked gilts: uniform price basis. - Rationale: - Conventional gilts: less primary issuance risk, existing similar gilts aid pricing, hedging via gilt futures possible, relatively liquid secondary market. Multiple price auction reduces government risk of implicit collusion by strategic bidding. - Index-linked gilts: harder to hedge, less liquid secondary market, increases Winner’s Curse risk for bidders; uniform price auctions reduce uncertainty and encourage participation; fewer index-linked bonds on issue makes pricing a new index-linked security harder. - GEMM non-competitive bidding facilities: - conventional gilt auction: non-competitive bid up to 0.5 percent of the amount of stock on offer per GEMM; - index-linked auction: proportion of stock available to each IG GEMM tied to their performance in the previous three auctions and an aggregate ceiling of 10 percent of the total amount of stock on offer. - DMO allotment discretion and limits: - DMO may not allot all securities in exceptional circumstances (e.g., auction covered at level unacceptably below prevailing market yield). - DMO may decline allotment if it would likely lead to market distortion. - Guideline allotment limits for successful bidders (GEMMs or end-investors): - should not expect to acquire at auction for their own account more than 25 percent of the amount on offer (net of GEMM’s own short position in the when-issued market or parent stock) for conventional gilts; - 40 percent for index-linked securities. - Purpose of limits: minimize undue influence on prices and promote diversified investor base. ### Tap issues, conversion offers, and switch auctions - Tap issues: - DMO uses taps of both conventional and index-linked gilts only for market management reasons, in conditions of temporary excess demand for a particular stock or sector. - Last tap issue was in August 1999. - Conversion offers: - Used to minimize debt stock fragmentation and promote a well-functioning secondary market. - Allow debt holders to convert or switch holdings of one gilt into another at a conversion rate related to market prices. - Main purposes: - build up size of new benchmark gilts more quickly than auctions alone (important during low issuance); - concentrate liquidity across the gilt yield curve by reducing small, high coupon gilts and converting into larger, current coupon gilts of broadly similar maturity. - Conversion candidate criteria: - normally around five years or more to maturity; - less than £5.5bn nominal outstanding; - conversion offers will not be made for a stock that is cheapest-to-deliver, or has reasonable likelihood of becoming cheapest-to-deliver, for any gilt futures contracts (with outstanding open interest). - Price terms decided by DMO using its own yield curve model as benchmark ratio; adjusted for observed cheap/dear characteristics of source and destination stocks. - Conversion offers open for three weeks from initial announcement to allow retail participation. - Accrued interest incorporated in dirty price ratio for forward settlement. - Conversion involves no exchange of cash flows. - Stocks chosen with similar durations to limit exposure to yield curve fluctuations during the three-week offer period. - Acceptance voluntary; holders may keep existing stock though liquidity may decline if most holders convert. - If amount outstanding becomes too small for a two-way market, DMO may bid a price of its choosing for the gilt and relax GEMM market-making obligations; DMO will announce “rump” status if used. - Switch auctions (introduced in 2000): - Objectives: - facilitate switching by index-tracking funds as a stock is about to fall out of a significant maturity bracket, contributing to market stability; - allow DMO to minimize rollover risk by smoothing maturing gilt redemption profile by offering switches out of large maturing issues into the current 5-year benchmark (or other short-term instruments). - Held only for a proportion of a larger stock too large for outright conversion offer; DMO ensures sufficient source stock remains for viable liquid market. - Conditions and limits: - will not hold switch auction for a conventional stock that would reduce amount in issue to below £4.5 billion (nominal); - only held where both respective stocks are within the same maturity bracket (short and ultra-short 0-7 years; medium 5-15 years; longs 14 years and over); - will not hold a switch auction out of a stock that is cheapest-to-deliver, or likely to become so, into any of the ‘active’ gilt futures contracts (may switch into such a stock). - Participation and pricing: - open to all holders of source stock (non-GEMMs must route bids through a GEMM); - competitive bid price basis; successful competitive bidders allotted at their bid prices; - no non-competitive facility and DMO does not set a minimum price. - Index-linked switch auctions exceptions: - only where both stocks have longer than 4½ years to maturity and source stock has not been auctioned in previous six months; - nominal size of any single switch auction limited to £250 million to £750 million of the source stock; - will not hold switch that would leave index-linked stock with resultant amount outstanding of less than £1.5 billion nominal; - auctions conducted on uniform bid price basis; all successful bidders receive stock at same price; allotments above striking price given in full, allotments at striking price may be scaled; - published results include common allotment price; pro rata rate at this price; real yield equivalent to that price (and inflation assumption used); and cover (ratio of bids received to amount on offer). - Only one index-linked switch auction has been held to date. ### Gilt repo facility and creation of stock - DMO can create and repo specific stocks to market-makers or other counterparties under a special repo facility if a particular stock is in exceptionally short supply and distorting orderly market functioning. - In June 2000 the DMO introduced a non-discretionary standing repo facility to manage actual or potential dislocations in the gilt market. - Any GEMM or other counterparty may request temporary creation of any non-rump stock for repo purposes. - DMO charges an overnight penal rate; returned stock is cancelled. - Facility is cash-neutral: operations involve creation of additional stock in exchange for general collateral securities. - Penal rate detail: - penal rate of interest is ten percent of the prevailing Bank of England two-week repo rate. - example given: if Bank of England’s two-week repo rate is 4 percent, institution borrowing stock from the DMO would receive an annualized rate-of-return of 0.40 percent on funds lodged with the DMO in exchange for the stock. ### Gilt strips market - Launch date: 8 December 1997. - Not all gilts are strippable. - Purposes for investors: - match cash flows of assets (strips) to liabilities (e.g., annuities); - enable different types of investment risk to be taken; - align U.K. product range with other large markets (United States, Japan, Germany, France). - Issuer perspective: strips market can slightly lower financing costs if market willing to pay a premium for strippable bonds. - As of March 28, 2002: - 13 strippable gilts in issue totaling £133.94 billion (nominal). - £1.4 billion of stock was held in stripped form. - All issues have aligned coupon payment dates (coupon fungibility), but coupon and principal strips paid on same day are not fungible to protect overall size and benchmark indices. - First series coupon dates: June 7/December 7; in 2001 two new conventional stocks issued with March 7/September 7 coupon dates; these became strippable in April 2002 to avoid concentration of cash flows. - Only GEMMs, the DMO, or the Bank of England can access CREST to strip or reconstitute a strippable gilt. - GEMMs obliged to make a market for strips; end-investors must deal through a GEMM. - Growth of strip market slow due to: - need for pension fund trustees to authorize managers to invest in strips; - inverted yield curve since inception making strips appear expensive relative to conventional gilts; - retail tax treatment: securities taxed each year on accrued capital gain or loss even though no income payment made. - Expectation: ability to hold strips within some tax-exempt savings products should reduce tax disincentives to personal investment in strips. ### Recent factors shaping the U.K. gilt market and declining government debt - Reforms since the 1995 debt management review refined and expanded debt instruments and produced structural changes to lower long-term public financing cost. - Recent influencing factors: budget surpluses, rapid rise of U.K. corporate bond sector, institutional changes (insurance companies and pension funds), technological and other market-structure advancements. - Declining levels of government debt: - Government’s percentage of overall outstanding sterling debt has been steadily declining. - Falling government funding requirements led gilts to acquire a scarcity premium, especially longer-dated bonds, resulting in reduced yields and an inverted yield curve pronounced in absolute terms and relative to other G-7 countries. - U.K. experienced low inflation/low interest environment, increasing investor appetite for credit risk. - Gross issuance of gilts declined from a peak of £55 billion in financial year 1993–94 to a trough of £8 billion in 1998–99. - Policy consideration: maintain minimum level of issuance to sustain market infrastructure and liquidity to absorb future larger gross issuance. - April 2002 PBR forecasts for the Central Government Net Cash Requirement (CGNCR) (£ billion): - 2001-02 projection: 6 - 2002-03: 14 - 2003-04: 18 - 2004-05: 16 - 2005-06: 21 - 2006-07: 24 ### Selected market-statistic highlights - GEMM auction allocation limits: 25 percent (conventional) and 40 percent (index-linked) of amount being auctioned. - GEMM non-competitive conventional bid limit: 0.5 percent of stock on offer. - Index-linked GEMM aggregate non-competitive ceiling: 10 percent of total stock on offer (with individual allocations tied to previous three-auction performance). - Strippable stock as of March 28, 2002: 13 gilts totaling £133.94 billion (nominal); £1.4 billion held stripped. - Penal repo rate: ten percent of prevailing Bank of England two-week repo rate (example: if two-week repo rate is 4 percent then annualized return = 0.40 percent). - Historical gilt gross issuance: £55 billion peak in 1993–94; £8 billion trough in 1998–99. - Table 8 (Yield Curve Slopes in G-7 Countries) — UK values shown in source: - 1996: +71 - 1997: -5 - 1998: -78 - 1999: -48 - 2000: -76 - 2001: +5 - 2002: +20 *Source: _cr03208 - 56. There are three IDBs operating in the gilt market. Their main purpose is to / extracted text.* ### 82. In view of the limited amount of gilt issuance in recent years, the DMO adopted ### _cr03208 - 82. In view of the limited amount of gilt issuance in recent years, the DMO adopted ### DMO strategies to sustain gilt-market liquidity - Adopted strategies to concentrate debt issuance into larger benchmark issues at three maturity points, with a 5-, 10-, and long terms to maturity. - Objective: capture a liquidity premium across the yield curve by issuing larger benchmark issues. - Initiatives used to support issuance and reduce fragmentation: - running down the stock of NS&I securities; - postponing the ramping up of the Treasury bill program; - introducing buyback swaps and secondary market purchases of existing stock; - increased holdings of financial assets (such as running larger cash balances). - Conversion and switch auctions used to build benchmark issues. ### Structured gilt buy-back and reverse-auction operations - Authorities launched a structured gilt buy-back program in FY2000–01 to add to gross issuance and help maintain market liquidity during strong demand periods. - Following market consultations, reverse auctions were reintroduced in FY2000–01. - DMO secondary market acquisitions included short-dated index-linked gilts and double-dated gilts. - DMO purchases near-maturity gilts (with less than six months residual maturity) as part of regular operations to smooth cash-flow effects of redemptions. - Market outcomes: - more than 90 percent take-up of conversion offers, apart from the one in November 1998; - switch auctions covered with a comfortable margin; three longer-dated switches secured very attractive forward-dated funding rates; - repurchases in reverse auctions occurred at yields considered “cheap” relative to the DMO’s fitted yield curve. ### Effects of pension fund and accounting rule changes on gilt pricing - Key rule changes affecting pricing: - Minimum Funding Requirement (MFR) introduced in 1997 (part of the 1995 Pensions Act), applied to defined benefit occupational pension schemes; MFR discount rate based on prevailing market yield on a basket of gilts with a maturity of 15 years. - Financial Reporting Standard 17 (FRS 17) requires defined benefit pension assets measured at fair value; liabilities discounted using the prevailing yield on AA-rated corporate bonds with a similar tenor; net surplus/deficit recorded in balance sheet; other surpluses/deficits recognized in STRGL; transition period prior to full adoption for accounting periods ending on or after June 22, 2003. - Observed market effects and dynamics: - Concerns that MFR induced pension funds to hold more gilts as a hedge against short-term fluctuations in the MFR discount rate, contributing to relatively price-insensitive demand and, together with declining net gilt issuance, possibly contributing to inversion of the gilt yield curve. - Chancellor announced intention to repeal MFR in the March 2001 Budget; application of the MFR test was relaxed in February 2002. - Institutional investors began shifting demand from gilts to non-gilt bonds in anticipation of MFR demise; gilt yield curve significantly disinverted. - Uncertainty remains over new European Community pension rules that could require continuous full funding and potentially increase demand for fixed-income securities. - FRS 17 and an aging population are prompting pension funds to shift investments from equities to bonds as liabilities shorten in duration. - Empirical portfolio shifts: - Non-gilt holdings as a proportion of insurance companies’ and pension funds’ asset portfolios doubled since 1997 to 16 percent of total assets; - Equity holdings declined by more than 6 percentage points to 61 percent. - Accounting Standards Board delayed full implementation of FRS 17 in mid-2002 to align with IAS and EU directives. - Explanations for continued long-term gilt holdings despite yield-curve inversion: - Corporate and nonresident sterling issuance has grown and at times outstripped U.K. government borrowing; European Investment Bank has been a larger sterling borrower than the DMO at times. - U.K. corporate long-term borrowing is very price sensitive—enter market typically when long-term gilt yields are less than 5½ percent. - Foreign borrowers’ entry to sterling market sensitive to currency swap rates and transaction costs/counterparty risk. - U.K. insurance companies and pension funds historically limited appetite for non-gilt debt: - difficulty implementing long-term exchange-rate hedges due to lack of long-tenor foreign exchange swap market (three years appears to be the longest tenor available) whereas desired tenors exceed 15 years; - trustee rules and governance clauses limited portfolio manager discretion; - trustees described as unsophisticated and conservative, reluctant to obtain expertise for complex strategies; - strong late-1990s equity market reduced incentives to shift strategies because marginal gains would accrue to plan sponsors rather than beneficiaries. - Recent years: weakness in equity markets has prompted some insurers and pension funds to hire staff experienced in corporate debt investing. - Assessment: - Distortions from MFR and FRS 17 are beginning to fade as market participants adapt and other issuers enter the sterling bond market. - Lesson: policymakers must be vigilant to unintended financial-market consequences of rules in other domains, especially in markets dominated by a narrow investor group. ### Emergence and implications of alternative trading systems - Alternative fixed-income electronic trading systems gaining popularity; GEMMs supported platforms including BrokerTec, Euro MTS, TradeWeb, BondClick (now part of EuroMTS and BondVision). - DMO consultations in 2000–2001 led to introduction in 2002 of an inter-GEMMs electronic market with mandatory quote obligations in the more liquid gilts. - Rationale and expected benefits: - Model similar to mandatory liquidity provision in most European government bond markets. - Central committed market should benefit entire market, ensuring GEMMs access to minimum depth of liquidity and efficient prices, supporting wider market-making activities. - Aims to keep entry barriers for prospective GEMMs at acceptable levels and maintain competition in market-making. - Implementation decisions: - Supply of trading systems delegated to elected GEMM representatives and a DMO representative. - Group concluded each GEMM should supply prices to any recognized IDB to preserve competition and avoid fragmentation while giving all GEMMs equal access to recognized IDBs. - Retail and platform developments: - Three GEMMs servicing retail clients launched BondScape, a multiple dealer-to-client electronic trading service for sterling-denominated fixed income products, providing basic bond analytics and firm prices in small sizes to retail brokers and direct individual clients. - Electronic auctions: - Electronic primary auctions could reduce operational risk and speed processing and broaden direct auction access, but settlement safeguards needed to protect government against settlement risk. - Uncertainty whether major investors would participate directly—some prefer when-issued trading; index-trackers may wait to trade post-auction to align with gilt-index calculation prices. ### Overall assessment and policy recommendations - Summary assessment: - Public debt management not a source of vulnerability given low government indebtedness and conservative risk management. - U.K. practices consistent with IMF/World Bank Guidelines for Public Debt Management. - Commended for smooth transfer of cash management responsibilities from Bank of England to the DMO in 2000 and for many innovative initiatives to minimize debt-stock fragmentation and maintain issuance volumes amid modest borrowing requirements. - Suggested minor technical innovations for consideration: - (i) introduce some indicators to explicitly articulate the government’s preferred cost-risk tradeoff to increase public understanding of debt management remit decisions and reinforce separation between policy strategy and DMO tactical mandate; - (ii) automate the bid-capture process used in debt auctions to reduce operational risk and improve auction-processing times; - (iii) formalize the role of the advisory board in the DMO’s governance framework and introduce some selection criteria for members if the body is expected to become a permanent fixture in the DMO. - Conclusion on market distortions and intervention: - Distortions from accounting and pension rule changes are gradually resolving through market adaptation and entry by other borrowers. - No apparent need for additional public intervention beyond DMO measures to maintain gilt issuance volumes and minimize debt-stock fragmentation. - New mandatory quotation rules in the interdealer gilt market have prompted GEMM concern that quoting obligations may distract from customer-serving activities; however, rules should make interdealer market more accessible and are judged appropriate at this stage. - Maximum bid-offer spreads, though wider than typical market spreads, serve as a useful backstop; future growth best supported by participant-driven competition to set spreads. *Source: Technical Note: Systemic Liquidity Arrangements in the United Kingdom, May 2003 (excerpts)._ ### 4. Turnover of Sterling Money Market.................................................................................... ### 4. Turnover of Sterling Money Market ### Introduction - Good systemic liquidity management practices and well functioning money and foreign exchange markets are essential preconditions for ensuring that funds are allocated efficiently in the economy and to underpin London’s role as an international financial center. - The Bank of England’s monetary operating procedures were reviewed from the perspective of systemic liquidity management, as were the functioning of the sterling money and foreign exchange markets. The review was based on information provided by the U.K. authorities, as well as discussions with a broad range of financial market participants. - Particular attention was paid to: - the Bank’s ability to forecast the daily shortage in the sterling money market; - the frequency and tenor of its daily monetary operations; and - ways in which it manages the risks associated with the collateral received in its repo operations. ### Key findings on systemic liquidity and market functioning - The Bank’s operating procedures are fundamentally sound and have benefited significantly from recent reforms. - Liquidity forecasting: - The uncertainty inherent in projecting the demand for bank notes results in some residual uncertainty in the process used to forecast the daily shortage. However, the liquidity forecasting process works well. - Over time, the Bank may wish to consider streamlining the number of daily operations if the daily liquidity forecasting process can be improved. - Collateral risk management: - Methods used to manage market risks of collateral received in monetary operations are appropriate. - Credit and liquidity risk of collateral is not an issue for securities issued by the Bank of England or the U.K. government. - Given the substantial widening of eligible collateral in recent years, prudent risk management would suggest introducing controls for other securities accepted as collateral, for example: - adopting minimum liquidity or credit rating thresholds; or - limits on the amount of securities of a single issuer that can be pledged by a counterparty. - Term operations and balance sheet composition: - The Bank may wish to consider reactivating longer-term operations used during the millennium date change period to manage the composition of its balance sheet and the growth in the stock of refinancing, which has been slowly rising since April 2000. - No change is recommended to the two-week tenor for the policy interest rate. ### Market distribution of liquidity and resilience - The money market distributes liquidity supplied by the Bank effectively: - Demand for precautionary balances at the Bank of England has been only £50 million compared to the £28 billion traded each day in the sterling interbank and gilt repo markets. - Market structure and risks: - The money and foreign exchange markets are very liquid, although the increasing ‘lumpiness’ of order flows could make it difficult for traders to manage positions in stressful situations. - Because the sterling money market mainly consists of unsecured obligations issued by banks, available data suggest that if one of the largest banks failed to honor its obligations, some banks (notably small and medium-sized banks) might experience financial difficulties. - Authorities were encouraged to: - strengthen surveillance of bilateral unsecured exposures between banks to better assess the distribution of systemic risk; and - consider publishing results in a highly aggregated form for banks to take into account when deciding how much unsecured credit to extend to one another. - Authorities may wish to champion measures that encourage netting and more trading on a secured basis, possibly using euro-denominated securities as collateral. ### Supervision of bank liquidity - The Sterling Stock Liquidity Ratio: - Used to supervise liquidity of major U.K.-owned banks, but appears to have come to the end of its useful life. - Shortcomings identified: - does not fully take into account maturity distribution (contractual, behavioral, and stressed) of banks’ sterling assets and liabilities; - allows banks to count (to a limited extent) CDs issued by other banks as an offset against maturing wholesale liabilities, which does not encourage greater use of unsecured instruments; and - does not take into account significant foreign currency-denominated assets and liabilities. - The FSA is reviewing its approach to supervision of liquidity; the new approach will involve both quantitative and qualitative assessment against a common framework, including liquidity data on a consolidated basis where appropriate and taking into account maturity distribution in contractual, behavioral, and stressed contexts. ### Monetary operating procedures (mechanics and timing) - Policy implementation: - The Bank implements monetary policy by lending to counterparties in the sterling money market at rates anchored by the official two-week repo rate chosen by the MPC. - The Bank holds on its balance sheet assets acquired from counterparties in its money market operations, mostly repos involving U.K. government bonds (gilts) and euro-denominated European government securities as collateral. - The ‘stock of refinancing’ turns over regularly and is the main factor creating the demand for base money (the ‘shortage’) in the market each day. - Counterparties and instruments: - In open market operations the Bank deals with a small group of counterparties (banks, securities dealers, and building societies); in recent years there have been around 15-20 counterparties. - Funds are supplied primarily in the form of repo; counterparties sell assets to the Bank with an agreement to repurchase them in about two weeks time. - The Bank also buys outright treasury bills and other eligible bills with remaining maturities of about two weeks or less. - Daily timetable and facilities: - At 9:45 a.m., the Bank announces the estimated size of that day’s shortage and the main factors behind it. - On non-MPC meeting days, the first round of operations is held at 9:45 a.m. (12:15 p.m. on MPC meeting days). Results from each operation are announced about 10 minutes later. - Liquidity forecast updated at 2:30 p.m., and a second round of operations is conducted. - If the remaining shortage is not entirely relieved at 2:30 p.m., the Bank holds a round of overnight repo operations at 3:30 p.m. at a rate of one percent above the Bank’s repo rate. - If the system is still short at 4:20 p.m., the Bank deals directly via a late-repo facility with the settlement banks; the rate on the 4:20 p.m. facility is one percent above the Bank’s repo rate. - Settlement banks’ accounts at the Bank need to be in credit at the end of the day. - Overnight deposit facility (introduced June 2001): - Collateralized overnight deposit facility (overnight reverse repo) supplements daily open market operations to moderate the extent to which overnight interest rates trade below the Bank’s two-week repo rate and to enhance intermediation when market mechanisms are impaired. - The new deposit facility is available to counterparties at 3:30 p.m.; if deposits are made at 3:30, the Bank adds the funds deposited to the amount of liquidity supplied to settlement banks at 4:20 p.m. - The interest rate the Bank pays on overnight deposits has been set at one percent below the Bank’s two-week repo rate. - The Bank already had an overnight repo lending facility limiting overnight rates trading above its official repo rate. - Corridor and market discipline: - Bank officials noted that the width of the corridor for the overnight rate (200 basis points) represents a trade-off between limiting excessive volatility in the overnight rate and encouraging private sector participants to test their names by trading with each other before accessing central bank facilities. - The corridor allows for credit tiering; widening spreads can signal potential financial distress. - Intraday credit and penalties: - There are no statutory reserve requirements in the United Kingdom. - Settlement banks can obtain intraday credit from the Bank on a collateralized basis in both sterling and euro to facilitate CHAPS systems; no interest is charged but it must be repaid before the payment system closes for the day. - To ensure intraday liquidity does not spill into overnight liquidity, the Bank applies early cut-offs for customer and interbank CHAPS payments and applies penal rates for any overnight repo required to prevent a bank from going into overdraft. - The penalty charged by the Bank for provision of such a repo depends on circumstances but is usually a minimum of 300 basis points above the Bank’s repo rate. ### Recent reforms to operations (Box 1 — summary) - 1997 reform: - Shift from discounting bills of exchange to repurchase agreements collateralized by gilts and broadening the range of counterparties. - Resulted in more collateral in the system (gilt repo offered more than £100 billion versus the £10-15 billion expected from bills) and more efficient liquidity management. - 1999 reform: - Further expansion in the range of collateral accepted ahead of the millennium date change by accepting debt issued by EEA governments accessible through European central banks. - Expanded potential collateral pool from about £350 billion to about £2 trillion—well in excess of the current stock of refinancing associated with the Bank’s operations (typically about £15-20 billion). - Ready access to a very large collateral pool enables the Bank to manage spikes in demand for liquidity on intra-day or longer bases; demands on this collateral pool could emerge in other jurisdictions that accept the same collateral, especially when markets are under stress in more than one jurisdiction. _This summary is based solely on content from the provided source._ ### 12. The Bank auctions three- and six-month euro-denominated bills each month, ### The Bank auctions three- and six-month euro-denominated bills each month, and also auctions three-year euro-denominated notes in order to obtain the euro liquidity it needs to support the functioning of the TARGET payment system for banks located in the United Kingdom. ### Euro liquidity operations and limits - The Bank auctions three- and six-month euro-denominated bills each month. - The Bank also auctions three-year euro-denominated notes to obtain euro liquidity to support TARGET operations for U.K.-located banks. - Arrangements with the European Central Bank for intraday liquidity incorporate a €3 billion limit on the total amount of intraday liquidity that can be provided to the U.K. market by the Bank of England. - There is a €1 billion limit to any one participant for intraday liquidity provided by the Bank of England. - Excess funds are held in the Bank of England’s own foreign exchange reserves. ### Foreign exchange intervention practice - The Bank has not conducted any foreign exchange market intervention for monetary policy purposes since the introduction of the current monetary framework in 1997. - The Government determines the exchange rate regime for the U.K., but: - The Bank may hold its own separate pool of foreign exchange reserves which it can use at its discretion to intervene in support of its monetary objectives. - The Bank is required to execute foreign exchange market intervention as the government’s agent for non-monetary policy purposes (for example, coordinated G-7 intervention), using the government’s foreign exchange reserves. - Such government-agent interventions are automatically sterilized. - When sterling money market shortages have been large, the Bank has occasionally used foreign exchange swaps to supply liquidity to the sterling money market. ### Key issues — ability to forecast the daily shortage - Transfer of Exchequer cash management from the Bank to the DMO in April 2000 modestly improved the Bank’s ability to forecast shortages. - Two principal factors now influencing the money market’s need for financing from the Bank: changes in the note issue and the maturity of the existing stock of refinancing operations. - The liquidity forecasting process functions well; mean absolute forecasting errors have fallen sharply since April 2000. - Improvement in the standard deviation of forecast errors is less pronounced at the 2:30 and 4:20 rounds, and unclear at the 9:45 round. - Standard deviations of the errors were less than 10 percent of the average daily shortages in 2001. - Residual uncertainty remains in forecast items, particularly the note issue; this should decline with the restructuring of the bank note operation. - Further improvements to shortage forecasting could enable less frequent Bank operations in the sterling money market. ### Daily shortage forecast errors (Table 1 summary) - Errors are defined as projections minus actual shortage. - Source: Bank of England. - Reported numerical entries (as presented in the source): - 1999: 14551312249472 (Mean of Absolute Daily Errors and/or Standard Deviation entries as shown) - 2000 (Jan. - Mar.): 181502323710953 - 2000 (Apr. - Dec.): 8938171307838 - 2001: 813313 2166749 - Note: Table presents columns for 9.45am, 2.30pm, and 4.20pm forecast rounds for mean absolute errors and standard deviations; exact numeric layout preserved above as in source. ### Frequency and tenor of the Bank’s monetary operations - Notable operational features: - Number of operations conducted each day: four (if one includes the late-day round for settlement banks). - Policy rate defined with reference to a two-week tenor. - Questions considered: - Could the Bank operate less frequently each day? - Would it be more appropriate to set the target policy rate with reference to an overnight rate? - Points in favor of multiple daily rounds: - Multiple rounds facilitate relationship-building with market participants and provide starting points for discussions and market intelligence. - Multiple rounds help markets manage uncertainty in the forecasted shortage, which tends to decline as the day progresses. - Counterpoints and potential future changes: - Some market participants attribute willingness to speak with the Bank to the quality of discussions and respect for the Bank, not necessarily the operations. - As forecasting improves, the Bank may consider fewer daily rounds (e.g., aiming for two rounds in the long run) to reduce its market presence and potentially impose added market discipline. - Rationale for two-week tenor: - Easier to influence one-month interest rates, which are thought important for transmission to longer tenors. - One-month tenor may be impractical because rates at that tenor become sensitive to non-monetary factors. - Two-week tenor has been long-practiced and is a market-comfortable convention. - Balance-sheet management advantage: two-week tenor reduces the need to roll over all operations daily relative to overnight tenor. - The Bank could conduct longer-term operations at prevailing market rates or reactivate longer-term repo facilities as needed. - The stock of refinancing rose from £14 billion in April 2000 to £18 billion in January 2002. - A two-week tenor is consistent with the European Central Bank’s signaling tenor and is appropriate given U.K.–Europe linkages. ### Managing risks associated with collateral underpinning monetary operations - Collateral valuation and margining: - All securities held as collateral are valued daily in sterling at the close of business. - Aggregate exposure to each open market operation counterparty is calculated daily. - Any counterparty whose margin-adjusted value of collateral is more than £1 million lower than the amount (including interest) owed to the Bank is required to post additional collateral (variation margin) the next day. - Margin methodology: - Margins are set using a value-at-risk (VAR) approach, reviewed annually to ensure assumptions remain appropriate. - Requirements protect the value of collateral against interest rate risk and, where appropriate, exchange rate risk. - Front and back office maintain close contact; persistent or unusual variation margin calls are monitored and investigated. - Credit and liquidity risk controls: - Given the high quality of underlying collateral, the Bank has not introduced formal credit or liquidity risk controls but monitors quality and liquidity and is willing to introduce formal measures if required. - The Bank sets limits on the amount of acceptances that eligible financial institutions can issue; accepting limits are based on capital and scale of sterling business, indirectly capping exposure to any one accepting institution. - Recommendations / prudent practice noted in the source: - The Bank may wish to consider introducing minimum liquidity or credit rating thresholds or limits on the amount of securities of a single issuer that can be posted by a counterparty to achieve broader collateral diversification. - Application of in-house good risk management practices can set an example for market participants and demonstrate commitment to financial system resilience. ### Sterling money market structure and developments - Market composition as of end-2001: - Interbank deposits and certificates of deposit (CDs) accounted for 58 percent of sterling money market instruments outstanding. - Most interbank deposits and CDs issued by the nine major U.K. banks; some European banks are also large issuers. - Trends and shifts: - Stock of interbank deposits and CDs grew by about 4 percent annually since 1990. - Their share declined from around 80 percent prior to introduction of gilt repos in mid-1990s to about 58 percent by end-2001. - Gilt repos grew rapidly since 1997 to about a 24 percent share of the money market. - Treasury bills and commercial paper represent less than 5 percent of sterling money market instruments outstanding. - Drivers of repo market growth: - More stringent capital adequacy regulations lowered the cost of repo financing relative to unsecured financing. - Contraction in unsecured credit lines in the interbank market, partly due to bank mergers, led institutions to prefer repo. - CD issuance grew in the latter half of the 1990s as banks repo’ed gilts in exchange for CDs. - Introduction of the stock sterling liquidity regime (SSLR) in 1996 allowed limited recognition of other banks’ CDs as liquidity, supporting willingness to hold CDs. - Cross-country contrasts: - The prominence of interbank and CD markets in the U.K. contrasts with U.S. and Canada, where government and corporate securities dominate money markets. - Similarity to euro area, where unsecured bank claims are also the largest segment. - Structural reasons: - U.K. government debt is less than 30 percent of GDP and skewed toward long-term bonds; historically a preference to limit Treasury bills issuance to avoid conflicts with monetary policy and to minimize market and rollover risks. - U.K. corporations rely more on bank loans than commercial paper for short-term credit. - Plans to dematerialize T-bills and other money market instruments expected to promote future market growth. ### Prudential supervision of commercial bank liquidity management (SSLR summary) - SSLR introduced in 1996 to ensure major U.K. banks hold sufficient liquidity against potential loss of short-term sterling wholesale funding. - Two SSLR requirements: - Sterling stock liquidity ratio of at least 100 percent at all times; ratio = stock of eligible liquid assets divided by a measure of outflows (contracted wholesale sterling net outflows over next 5 business days minus sterling CDs held up to 50 percent of the wholesale sterling net outflow, plus 5 percent of maturing retail deposits). CDs subject to a 15 percent discount. - A sterling stock ‘floor’ of liquid assets at all times, agreed with the FSA, usually set at 50 percent of the bank’s internal limit for maximum net outflow over five working days. CDs not included in the permanent ‘floor’ requirement. - SSLR does not cover foreign currency activity. - CDs are treated as ‘second tier’ liquidity; not accepted in Bank of England’s open market operations. - Since 1999, a revised maturity mismatch approach applies to banks not subject to SSLR; these banks are generally smaller and may rely on committed funding lines from larger banks. - Banks must report cash flows out to six months; mismatch guidelines for cumulative periods up to eight days and up to one month typically set at zero and minus 5 percent respectively. *Source: IMF staff summary of the Bank of England materials contained in the provided chapter.* ### 25. Secondary market trading in the money market is dominated by trading in short ### _cr03208 - 25. Secondary market trading in the money market is dominated by trading in short ### Secondary market structure and instruments - Secondary market trading is dominated by trading in short sterling futures contracts and options on these futures contracts, both traded on the London International Financial Futures Exchange (LIFFE). - Futures and options markets are accessible to a wide range of participants, subject to margin requirements, and trading now takes place electronically via the exchange’s computer system. - Major banks in London actively transact to hedge exposures to short-term interest rate movements and to arbitrage pricing discrepancies between futures and underlying interbank markets. - The London Clearing House (LCH) interposes itself as counterparty to all trades executed on the exchange, providing security that facilitates leveraged speculative positions during heightened uncertainty. ### Cash markets, OTC derivatives, and electronic trading platforms - Transactions in cash markets and non-exchange-traded derivatives markets (e.g., the SONIA swap market) are conducted on an over-the-counter (OTC) basis, typically via screen-based interdealer brokers or directly by telephone. - Screen-based inter-dealer brokers reduce search costs and preserve trader anonymity until completion. - Electronic proprietary trading systems (example cited: BrokerTec) are growing in popularity in some segments (notably gilt repo), aiding price discovery with fewer transactions and greater execution efficiency. ### Trading volumes, transaction sizes, and bid-offer spreads - Trading volumes have been fairly stable in recent years in both the gilt repo and unsecured segments. - Market participants report increasing lumpiness in interbank trading flow as the number of active participants dwindles and average transaction sizes increase to a range between £100 and £500 million for interbank deposits and CDs. - In gilt repo, many counterparties regularly trade in lots of £100 million in the broker market rather than the £25 million minimum transaction size. - Indicative bid-offer spreads have been fairly stable, widening by only a few basis points in periods of heightened uncertainty (examples: the millennium date change and post-September 11). ### Turnover of Sterling Money Market (Average Daily Amounts, £ billion) — Table 4 - Short Sterling Futures: 1997: 40; 1998: 67; 1999: 54; 2000: 45; 2001: 67 - Short Sterling Options: 1997: 6; 1998: 15; 1999: 13; 2000: 8; 2001: 15 - Interbank (overnight) (a): 1997: 6; 1998: 7.5; 1999: 8; 2000: 10; 2001: 10 - Gilt Repo: 1997: 15; 1998: 15; 1999: 14; 2000: 18; 2001: 18 - CDs, bank bills and treasury bills: 2001: 12 - Source note: (a) Figures based on unsecured cash transactions brokered in London as reported to the WMBA. ### Interest rates, credit lines, and market access - Interest rates paid by banks in interbank deposit and CD markets do not vary much with bank credit rating; allocation is governed by the size of informal, normally stable bilateral credit lines. - Unsecured market access is generally limited to banks perceived to have a credit rating equivalent to single-A or better; weaker institutions typically raise funds on a secured basis. - Credit lines are generally reviewed regularly (quarterly appears to be the norm) with ad-hoc reviews after shocks (example: large foreign exchange trading losses at Allied Irish Bank). - Credit lines are adjusted in response to shifts in trading activity between counterparties even without changes in credit assessments, indicating credit line determination is influenced by potential profits from trading relationships. - Perception exists that credit lines to the most active sterling interbank participants—the major U.K. clearing banks—may be somewhat larger than their credit standing suggests due to a latent belief in a Bank of England backstop; this is seen as less important post-Barings (1995). - Sterling CDs of the largest U.K. banks are thought to pay a few basis points less than similarly-rated institutions, mainly attributed to a liquidity premium effect. ### Bank of England and FSA engagement; committees and market development - The Bank of England and the FSA actively work with market participants to develop the sterling money market. - Key committees: Foreign Exchange Joint Standing Committee; Sterling Money Markets Liaison Group (MMLG); Stock Lending and Repo Committee (SLRC). All three are chaired by senior Bank officials, include a broad range of private and public sector participants, and minutes are posted on the Bank’s internet web site. - Committee work examples: preparations for the millennium date change; guidance on good trading practices in wholesale financial markets; review of money market instruments and plans for dematerialization for CREST settlement; reviews of main legal agreements used in various markets. ### Efficiency of sterling money market in distributing monetary liquidity - The Bank of England normally aims to supply the market’s net liquidity requirement each day plus a small margin to address precautionary balances, encouraging inter-dealer clearing of long and short positions. - Data indicate the market effectively distributes Bank-supplied liquidity (Table 5): - Average amount of liquidity provided by the Bank each day in 2001: about £2.5 billion (standard deviation: £1.5 billion). - Average daily volumes transacted in interbank and repo markets: £28 billion. - Demand for precautionary balances at the Bank of England in 2001: around £50 million (standard deviation: 70 million); not sensitive to market uncertainty (balances did not rise following September 11). - To avoid undue concentration of Bank liquidity among a few counterparties, in December 2001 the Bank notified counterparties that it may individually scale counterparties’ bids in open market operations (a provision in the Operational Notice). ### Daily liquidity supplied by Bank of England — Table 5 (figures in £ billions) - 1999–2000 | 2001 - Average Liquidity Supplied by Bank of England: 1.2 2.5 - (Standard deviation): (0.8)(1.0) (1.5) - of which: - Overnight: 0.2 0.3 0.6 - Two-week: 1.0 1.7 1.9 - Average End-of-Day Balances at Bank of England: 0.1 0.1 0.05 - (Standard deviation): (0.1)(0.07) (0.07) - Average Daily Turnover in Gilt Repo: 23 28 28 - Sources: Bank of England and Fund staff calculations. ### Bank actions, market response, and monitoring risks - Market participants reported that Bank action alleviated technical distortions; short-term rates aligned more with the Bank’s two-week policy rate after the change. - The Bank must remain vigilant against potential collusion to hoard liquidity; it monitors correlations in trading behavior of major participants. - Uncertainty around bid scaling (no fixed ratio or formula; Bank may inform counterparties if bids risk being scaled back) can act as a tactical deterrent to gaming. ### Resiliency of the unsecured sterling interbank market in periods of stress - Interbank market allocates credit via quantity credit rationing through credit lines; deficiency in pricing for counterparty risk can increase dependence on central banks during crises. - Failures to honor unsecured interbank deposit and CD obligations have been rare and mainly limited to smaller institutions. - Market performed well across events such as LTCM, the millennium date change, and post-September 11. - Recent official emergency liquidity support to U.K. banks occurred in the early 1990s to prevent wider loss of confidence; 25 banks failed or closed during that period. - The Bank did not intervene to prevent Barings’ collapse in 1995; that event did not threaten the system. - Authorities state emergency assistance decisions are driven by systemic importance rather than institution size. ### Potential for contagion and dependency on major banks - The interbank market could act as a contagion channel if a major U.K. clearing bank were unable to honor unsecured obligations because banks hold significant portions of sterling liquid assets as claims issued by other banks. - Assessing dependence on the financial condition of individual participants and adequacy of supervisory liquidity oversight is important. ### U.K. banks’ sterling liquid assets as of December 2001 — Table 6 (in percent of Total Sterling Liquid Assets) - Major Banks | Other Large U.K. Banks | Small U.K. Banks | Foreign Banks - Bank Obligations: 53 79 82 53 - U.K. Government Gilts and Treasury Bills 1/: -21 ... 15 -105 - Other U.K. Debt Securities: 19 21 2 32 - Gilt Repo: 39 ... ... 101 - Other Repo: 3 ... ... 17 - Bank notes and Bank of England Deposits: 7 ... 1 2 - Total: 100 100 100 100 - Source: Bank of England - Note: 1/ Negative numbers reflect the repo-ing of gilts in exchange for cash. ### Bilateral interbank market exposures and surveillance recommendations - Examining bilateral unsecured interbank claims can help assess vulnerability to failures of individual participants by revealing the distribution tails of exposures that could generate chain reactions. - FSAP team suggested using these data to prepare frequency distributions of exposures to assess vulnerability; authorities were encouraged to step up surveillance of bilateral unsecured exposures (sterling and foreign currency-denominated interbank deposits and CDs, foreign exchange, and payment system exposures). - Authorities accepted this point and have stepped up surveillance; full assessment may require collaboration with authorities in other jurisdictions because many exposures involve foreign institutions and offshore activities of foreign banking groups. *Source: IMF staff report text as provided.* ### 39. The authorities may also wish to consider publishing the results obtained, albeit ### _cr03208 - 39. The authorities may also wish to consider publishing the results obtained, albeit ### Publication of aggregated supervisory results - Recommendation: - Publish results in a highly aggregated form to protect confidentiality of individual banks. - Rationale and expected benefits: - Individual market participants cannot obtain raw data because they are considered highly confidential by individual institutions. - Publishing highly-aggregated frequency distributions would enable market participants to gain an appreciation over time of the vulnerability of the market as a whole to the failure of an institution(s) without impairing the confidentiality of individual banks. - Such publication could inject market discipline and help bank credit departments set credit lines on a more informed basis. ### Systemic interbank exposures and contagion risk - Key findings: - If a bank failed, other banks might also be threatened. - Many banks hold a large share of their sterling liquidity in the form of claims issued by other banks. - More than half of sterling and foreign currency interbank claims are held by less than ten institutions. - IMF staff estimates: - These claims represent about 4 percent of total assets for the largest U.K.-owned banks. - These claims represent more than 12 percent for other U.K.-owned banks. - These claims represent about 35 percept of Tier 1 capital for both groups. - Caveats noted: - Estimates do not account for potential chain-reactions feeding back onto the largest banks if one bank’s failure undermined others. - Estimates do not include interbank exposures denominated in foreign currencies, or those arising through foreign exchange trading or payment system activities. ### Supervision of bank liquidity management practices - Context: - Box 2 (referenced) summarizes the FSA’s approach to regulating commercial bank liquidity management practices. - Several features of the sterling stock liquidity ratio (SSLR) appear to be adversely affecting market functioning. - Some smaller banks supervised under the SSLR may focus too much on meeting the supervisory requirement rather than using more sophisticated liquidity management practices. - Identified deficiencies and implications: - SSLR and maturity mismatch: - SSLR does not fully take into account the maturity distribution of assets and liabilities for the largest U.K.-owned banks. - Maturity mismatch data are collected for other banks operating in the U.K., but the SSLR uses a five business-day horizon that could miss significant mismatches outside that horizon. - Recommendation: collect maturity mismatch data using a common reporting system applicable to all banks to monitor systemic liquidity risks and prepare for chain-reactions. - Potential benefit: collecting these data from major U.K.-owned banks might encourage attention to mismatch positions rather than just meeting the SSLR margin. - Treatment of owned sterling CDs in SSLR: - The SSLR allows major U.K.-owned banks to net holdings of sterling CDs issued by other banks against their own maturing deposits to a certain extent. - Concern: sterling CDs issued by other U.K. banks may not be readily available when one bank’s failure threatens system stability. - Observation: this provision has contributed to the growth of CDs, an outcome incompatible with encouraging secured transactions and reducing systemic risks given large unsecured exposures in the sterling money market. - Recommendation: authorities were encouraged to reconsider the treatment of owned CDs in SSLR calculation. - Foreign currency liquid assets and liabilities: - SSLR gives no consideration to major U.K.-owned banks’ significant holdings of foreign currency liquid assets (except euro-denominated securities accepted by the Bank as collateral) and their foreign currency liabilities. - Risk: these liabilities could run-off fairly quickly if a bank experienced difficulties; investor behavior is similar regardless of location or currency denomination. - Note: foreign currency liquid assets held in deep and liquid markets (euro area, United States) could be used in a liquidity crisis if readily liquidated and converted into sterling. - Recommendation: supervise liquidity of banks on a global basis (as done for some foreign-owned banks), while possibly giving some preference to holding liquidity in sterling assets due to the authorities’ greater control over sterling liquidity. - FSA actions and timeline: - FSA recognizes deficiencies and plans to revise its supervisory approach. - March 2002: FSA issued a consultation paper to begin dialogue with stakeholders on regulating and supervising bank liquidity management practices. - Implementation of the FSA’s proposals is expected to take place in 2004 and 2005. ### Measures to encourage secured interbank trading - Observations: - An active unsecured segment can encourage banks to test their names and impose market discipline, but the unsecured segment constitutes more than half of the sterling money market. - Market behavior suggests some banks set credit limits assuming a non-zero probability that the Bank of England will not allow a major U.K. clearing bank to fail. - Recommended steps to encourage secured trading: - Remove preferential treatment given to CDs in the SSLR to avoid unintentionally encouraging unsecured trading. - Supervise liquidity positions on a global basis to remove impediments to efficient global liquidity management by major U.K.-owned banks. - Champion measures to facilitate netting arrangements and other risk mitigation techniques, such as trading sterling liquidity using other sterling securities and euro-denominated instruments as collateral (using foreign exchange swaps to minimize exchange rate risk). - Continue improvements to payment and securities settlement procedures and systems to make secured trading more attractive over time. - Caution: - Ensure risk-mitigation steps do not unduly undermine positions of a bank’s unsecured creditors. ### Pound sterling foreign exchange market: structure and resiliency - Market role and size: - The pound was the fourth most actively-traded currency in the world, accounting for 13 percent of global market turnover (triennial survey April 2001). - Most transactions are conducted against the U.S. dollar; pound-euro transactions are not insignificant. - In terms of transaction-type, most are foreign exchange swaps for tenors ranging up to 12 months. - Function of foreign exchange swaps: - Used to transfer liquidity between domestic money markets on a fully-hedged basis and to smooth pricing discrepancies due to local liquidity imbalances. - Important for ensuring covered interest parity between countries. - Trends and market structure observations (1998–2001): - Reported trading volumes for the pound declined in absolute terms between 1998 and 2001, but the pound’s share of global foreign exchange market activity rose from 11 to 13 percent. - Decline in trading volumes may reflect consolidation in the banking industry and increased use of electronic broking. - Electronic broking: - Market estimates suggest over two-thirds of U.K. inter-dealer spot activity is now conducted using electronic brokers, such as EBS and Reuters, compared to 30 percent in 1998. - Electronic trading increases price transparency, reduces need for phone-based price discovery, leads to a more efficient market, fewer arbitrage opportunities, and overall decline in turnover. - Note in source: "An increasing amount of trading is being conducted over the internet, but the extent of this is reportedly small in both percentage and volume terms." - Market depth and transaction costs: - Transaction costs are low; bid-offer spreads in the interdealer market for the pound are less than 5 basis points for spot and short-term swap transactions. - Traders can reportedly execute transactions of several hundred million pounds without triggering significant exchange-rate moves if orders are worked patiently. - Settlement and operational risk mitigation: - Standard confirmation and messaging systems (e.g., SWIFT) are used. - Herstatt Risk exists due to time-zone differences causing non-simultaneous settlement of trade legs. - Continuous-Linked Settlement Bank (CLS) introduced in September 2002 (initially covering trades between CLS members in the seven largest currencies, including the pound) should help reduce Herstatt Risk by settling both legs simultaneously. - For foreign exchange swaps, unsecured credit risk can arise during the tenor if a counterparty fails at maturity; banks manage this with counterparty swap limits. - Market resiliency in stress episodes: - Depth and breadth have allowed the market to function normally in times of volatility; prices may move sharply but liquidity and price-making continued. - Bank of England has not had to intervene in the foreign exchange market to promote orderly trading conditions since the adoption of the current monetary framework in 1997. - After September 11, market continued to operate efficiently in much reduced volumes as dealers focused on positions and settlement. - Some U.K. banks expressed dissatisfaction with the time it took the Bank of England to announce availability of the emergency swap facility with the Federal Reserve; previously-negotiated swap facility had lapsed and required renegotiation and redocumentation. - Steps taken by the Bank and the Federal Reserve to ensure quicker initiation of the facility with minimal new paperwork in future. - Sponsors of electronic broking systems have taken steps to improve resiliency after operational difficulties (e.g., EBS); major dealers ensured direct dealing could resume if necessary. - Specific numeric and dated items from the text: - "more than half of sterling and foreign currency interbank claims are held by less than ten institutions." - IMF staff estimates: "about 4 percent of total assets" (largest U.K.-owned banks); "more than 12 percent" (other U.K.-owned banks); "about 35 percept of Tier 1 capital for both groups." - SSLR horizon: "five business-day". - FSA consultation: "March 2002". - FSA implementation expected: "2004 and 2005". - Unsecured segment share: "more than half of the sterling money market." - Pound share of global turnover: "13 percent" (April 2001 triennial survey). - Foreign exchange swaps tenor: "up to 12 months". - Electronic broking share estimates: "over two-thirds" of U.K. inter-dealer spot activity; "30 percent in 1998". - Bid-offer spreads: "less than 5 basis points" for spot and short-term swap transactions. - Bank of England non-intervention since: "1997". - CLS introduction: "September 2002". *Italicized source attribution line.* ### 2. Over the past decade, the London interbank market has become increasingly ### Over the past decade, the London interbank market has become increasingly ### Overview and market composition - Over the past decade, the London interbank market has become increasingly dominated by U.K.-owned and other European banking groups, reflecting, to a large extent, the withdrawal of Japanese banks when their credit ratings slipped. - Table summary (December 2001; percent of total global cross-border claims): - U.S. Dollar: 17 - Euro: 22 - Japanese Yen: 18 - U.K. Pound: 49 - Other: 8 - Total U.K. Share: 18 - Table summary (U.K. cross-border interbank claims by bank nationality; totals in billions of U.S. dollars and percentages in italics): - Total: 1990 — 425 100; 1995 — 437 100; 2000 — 513 100; 2001 — 518 100 - U.K.-Headquartered Banks: 1990 — 72 16; 1995 — 81 17; 2000 — 168 33; 2001 — 179 35 - Foreign Banks (aggregate): 1990 — 354 83; 1995 — 356 83; 2000 — 345 67; 2001 — 339 65 - Selected foreign nationals (2001 figures where shown): French Banks — 32 6; German Banks — 100 19; Japanese Banks — 38 7; Dutch Banks — 15 3; Swiss Banks — 44 9; U.S. Banks — 28 5; Other — 82 16 - Note: Claims on related institutions accounted for more than 60 percent of cross-border interbank transactions involving U.K.-domiciled banks in 2001. ### Foreign exchange market activity - London is the most active trading center in foreign exchange, with daily trading volumes in excess of $500 billion in 2001 (31 percent of daily global foreign exchange turnover), even though transactions involving pound sterling accounted for 13 percent of global market turnover. - Transaction-type composition (consistent with international practice): - Foreign exchange swaps: 60 percent - Spot: 30 percent - Outright forwards: 10 percent - U.K. foreign exchange market share (in percent of global trading activity): - U.K. market total: 1992 — 27; 1995 — 30; 1998 — 33; 2001 — 31 - By currency (2001): U.S. dollar 31; Euro currencies 35; Pound sterling 61; Japanese yen 24; Swiss franc 29; Other 20 - Pound sterling (global total): 1992 — 14; 1995 — 9; 1998 — 11; 2001 — 13 - Foreign exchange turnover by transaction type (net average daily turnover in notional amounts, $ billions; selected 2001 figures preserved exactly): - Spot total: 151 - Of which (percent): U.S. dollar 84; Euro currencies 48; Pound sterling 18; Japanese yen 24; Swiss franc 6; Other 18 - Outright forward total: 53 - Of which (percent): U.S. dollar 86; Euro currencies 44; Pound sterling 26; Japanese yen 15; Swiss franc 5; Other 23 - Foreign exchange swaps total: 300 - Of which (percent): U.S. dollar 96; Euro currencies 37; Pound sterling 27; Japanese yen 14; Swiss franc 6; Other 20 - Total (all transaction types): 504 - Of which (percent): U.S. dollar 92; Euro currencies 41; Pound sterling 24; Japanese yen 17; Swiss franc 6; Other 20 - Domestic vs cross-border (percent of turnover): Domestic 33; Cross-border 67 - Note: Since two currencies are involved in each transaction, the sum of percentage shares of individual currencies totals 200 percent instead of 100 percent. ### Fixed-income and equity markets - Fixed-income: - Bond trading in London is estimated to account for 70 percent of the global market for eurobonds (International Financial Services, London estimate). - Largest borrowers in the 12 months ending April 30, 2001 were mainly U.S. entities, notably Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. - Equity: - Market capitalization of foreign companies traded on the London Stock Exchange at end-December 2001: £2.6 trillion. - Market capitalization of domestic (U.K.) companies at end-December 2001: £1.5 trillion. - More foreign companies are listed on the London Stock Exchange than on any other exchange. - Daily trading volumes for international equities in London are almost double those for domestic companies. - London Stock Exchange selected figures (preserved exactly where given): - U.K. Equities — Market Capitalization (1990–2001): 1990 — 450; 1995 — 900; 1997 — 1,251; 1998 — 1,422; 1999 — 1,820; 2000 — 1,797; 2001 — 1,524 - U.K. Equities — Average Daily Trading Volume (1990–2001): 1990 — 1.25; 1995 — 2.56; 1997 — 4.02; 1998 — 4.12; 1999 — 5.60; 2000 — 7.52; 2001 — 7.53 - International Equities — Market Capitalization (selected years): 1997 — 1,124; 1998 — 2,357; 1999 — 2,429; 2000 — 2,805; 2001 — 3,577; 2001 (alternate row) — 3,525; 2001 (final) — 2,580 (as presented in table) - International Equities — Average Daily Trading Volume (1990–2001): 1990 — 1.16; 1995 — 3.14; 1997 — 5.70; 1998 — 8.66; 1999 — 9.60; 2000 — 13.97; 2001 — 14.53 ### Derivatives markets - London is the most active trading center for over-the-counter (OTC) derivatives, with a BIS survey reporting a market share of 36 percent in 2001 (sterling-denominated transactions accounted for only eight percent globally). - U.K. OTC derivatives turnover (daily averages of notional amounts, billions of U.S. dollars; 2001): - United Kingdom: 275 36 - Total global turnover (2001): 764 - U.K. OTC derivatives transactions by instrument in 2001 (daily averages of notional amounts, $ billions): - Interest rate instruments: - FRAs: 83 - Swaps: 142 - Options: 13 - Foreign exchange instruments: - Currency swaps: 4 - Options: 33 - Exchange-traded derivatives: - Euronext LIFFE: seventh most active derivatives exchange in the world. - London Metal Exchange: 16th. - London-based International Petroleum Exchange: 25th. - Overall: London is the fifth largest center for exchange-traded derivatives contracts with a 7 percent share of global trading activity. ### Market participants and operational features - Principal market participants in London wholesale markets are mainly branches or subsidiaries of foreign financial institutions; several large U.K.-owned institutions (e.g., Barclays and HSBC) are also important players. - Foreign commercial banks prefer branches over locally-incorporated subsidiaries to economize on the use of capital. - Major British banking groups’ share of selected global OTC markets in 2001 (In percent): - Foreign Exchange — London Market: Sterling 26 1/; Other Currencies 20 1/; Global Market 7 2/ - OTC Derivatives — London Market: Sterling 45 1/; Other Currencies 31 1/ - Global Debt Markets: 8 3/ - (Footnotes indicate survey/measurement caveats and data sources.) ### Recent structural trends and implications for resiliency - Increasing reliance on electronic trading in wholesale markets, including some OTC markets, is changing microstructure: - Electronic systems increase accessibility, transparency, and lower transaction costs. - Small to medium-sized transactions increasingly use electronic platforms; larger trades are often bilateral with large market-makers (LCFIs). - Financial consolidation and market integration are producing lumpier order flows as the number of market players declines and trade sizes increase: - This makes it more challenging for market makers to manage order flow and to lay off positions, potentially affecting their ability to supply liquidity during London trading hours in periods of heightened uncertainty. - Growing use of benchmarking and advanced risk management systems is contributing to herding behavior: - Short-term benchmarks encourage more passive, benchmark-tracking investment. - Real-time risk management signals can lead senior management to rein in traders simultaneously, increasing the propensity for synchronized position reductions in market stress. - Overall assessment: - While global markets are deep and liquid in normal circumstances, these trends suggest they might become less resilient in periods of heightened uncertainty. - Market participants and authorities agreed there is no evidence that these effects are any more significant in London than in other trading centers, nor more visible in sterling markets than in other currencies. ### Perceived systemic risk and policy stance - Consensus among market participants and officials: global financial market activity in London does not appear to pose significant risks to the stability of U.K. financial markets or to the domestic financial system more generally. - It is noted that, at the margin, London-based global market activity may contribute to more efficient markets for sterling-denominated claims. *Prepared by the FSAP mission team as background work for the U.K. FSAP; primary contributor Mark Zelmer, IMF’s Monetary and Financial Systems Department.* ### 16. Channels of transmission for financial stresses and strains between the global ### _cr03208 - 16. Channels of transmission for financial stresses and strains between the global ### Macro linkages: transmission and resilience - No evidence that, because of London’s role as an international financial center, the U.K. financial system has been disproportionally adversely affected by the large number of financial shocks in recent years. - Examples of global shocks absorbed during the 1990s without major disruption to the U.K. financial system: the September 11 terrorist attack; the millennium date change; the introduction of the euro; the collapse of Long Term Capital Management (LTCM); a number of emerging market country debt crises; episodes of major bond and major currency market turbulence. - U.K.-origin financial problems cited as home-grown: the failure of Barings in 1995; the small bank crises in the early 1990s; the collapse of a number of small U.K. financial institutions in the 1970s. These tended to affect sterling markets but did not materially affect the global financial system or London’s role as a trading center. - Reasons for relative insulation: - Links between foreign financial institutions operating in London and their U.K. domestic counterparts are mainly in wholesale market activities; many large global and regional institutions generally are not actively involved in providing retail financial services in the United Kingdom. - U.K. financial institutions obtain most profits from domestic retail operations; activities in London wholesale markets do not have an important bearing on the domestic flow of funds. - Significant counterparty relationships with foreign institutions and overseas activities exist, but such exposures are normal in international markets and not evidently unique to London’s location. - Cross-border portfolio positions: - U.K. holdings of foreign securities and nonresidents’ portfolio claims against U.K. residents both exceed 90 percent of GDP in the U.K., compared to less than 60 percent for other G-7 countries. - Caution: U.K. statistics include a large number of foreign financial institutions that book global market transactions in the U.K. ### Macro linkage: contribution of global trading to the U.K. real economy - The global trading activities in London significantly contribute to U.K. economic activity: - Financial sector accounts for about 5 percent of GDP (reaches 8 percent if a broader definition including professional and support services related to the sector is used). - Employed more than one million people in March 2002. - Financial sector net overseas earnings rose from less than £10 billion in the early 1990s to over £30 billion in the past three years. - Risk channel: weaker business conditions in global trading activities based in London could reduce employment and weaken local economic conditions, posing increased risks to U.K. financial institutions’ domestic lending activities. ### Micro linkages: infrastructure, payments, and settlement - General assessment: London’s international trading role does not appear to place significant additional demands on U.K. payment and securities settlement systems according to market participants and U.K. officials. - Currency transaction settlement mechanics: - Foreign currency payments associated with London trading ultimately reach final settlement through the payment systems of the currency involved, not through U.K. payment systems, unless sterling is one leg of the transaction. - Example: the U.S. dollar leg of a currency trade that takes place in London settles through CHIPS in the United States. - Exception: the euro leg of transactions initially passes through CHAPS-Euro and TARGET in the U.K. on their way to the euro area; these systems are considered capable of handling flows associated with London transactions. - Securities settlement: - Transfer of non-U.K. securities ultimately takes place through securities settlement systems located outside the United Kingdom, such as Euroclear. - Trades initiated in London generally have final settlement elsewhere, aside from some trade processing work carried out in U.K. offices of counterparties. ### The London Clearing House (LCH): central counterparty considerations - Role and coverage: - LCH is the major central counterparty clearer in the U.K., acting as counterparty to trades on derivative exchanges, the LSE’s electronic trading system (SETS), and OTC (swaps and repos). - LCH is increasingly serving as central counterparty for OTC markets, including OTC interest rate swaps denominated in sterling and other currencies. - Risk management practices: - LCH applies a conservative view in setting margin requirements. - Monitoring of clearing members is well developed, including daily stress testing of members’ positions. - Identified weaknesses and remediation efforts: - At time of assessment, LCH settled cash payments across accounts at various commercial banks rather than in a default-risk free settlement asset, creating material intraday risk exposures. - LCH is considering reducing exposure by replacing current payment arrangements with settlement across the books of the Bank of England for sterling and euro settlements. - LCH traditionally invested cash resources in the unsecured deposit market, exposing it to credit risk; an active programme is underway to transfer placements from an unsecured basis to a collateralized basis. - Legal protections: LCH has had special protection under English law since 1989, extended to cover OTC business and designation under the EU’s Settlement Finality Directive; small remaining legal uncertainties are being addressed. ### Risk transfer markets in the U.K. (Box 1): structure, size, and monitoring needs - Market characteristics: - Risk transfer is an OTC market comprising transactions to transfer credit or insurance risk (e.g., credit default swaps, asset-backed securities, catastrophe bonds). - Size and growth: - At the end of 2000 the global market size was estimated at around $893 billion and expected to be around $1,500 billion by end-2002 (a 9-fold increase in the 5-year period 1997 to 2002). - Still small compared with an aggregate stock of outstanding contracts in the Global OTC markets of around $100 trillion. - Market participants and market share: - Banks are the main credit protection buyers: 63 percent of the market. - Main protection sellers: banks 47 percent, insurance companies 23 percent, securities houses 16 percent. - Around 50 percent of the global OTC credit derivatives markets trade in London. - U.K. insurer involvement: - FSA survey indicates limited involvement to date by U.K. insurers in selling credit risk protection; foreign insurers have greater appetite. - Current reporting systems limit the ability to assess the degree of involvement with full certainty. - Given stresses in the insurance industry, some U.K. insurers could have incentives for more active involvement in these markets in the future. - Regulatory and monitoring implications: - U.K. banks involved in these markets are subject to requirements based on an interpretation of the Basel Capital Accord; the proposed new Capital Accord will deal more explicitly with risk transfer transactions when implemented. - Recommendation: careful ongoing monitoring of risk transfer markets and U.K. institutions’ involvement, particularly insurers. - Need for improved reporting system for risk transfers due to transaction heterogeneity and lack of standardization. - Suggested reporting enhancements: beyond simple statistics (notional amounts, type and number of transactions), institutions reporting expected and unexpected losses in their portfolios of risk transfers, potentially based on internal models. ### Operational resilience and contingency planning - Post-September 11 considerations: - Market consensus that rerouting global market trading from London to another center in the event of operational difficulties could be accomplished if necessary without seriously disrupting the global or U.K. financial systems, though not easily. - Market participants have implemented backup facilities and contingency plans to shift trading to other cities in Europe if necessary. - Historical precedent: global wholesale market community cooperated to shift trading temporarily from New York to London after September 11 and ensured settlement of trades despite disruptions. - Caveat: whether similar cooperation can be relied upon again is an open question; the small number of LCFIs can facilitate consensus in dire circumstances. ### Potential marginal benefits to sterling markets from London’s international role - Liquidity: - Presence of many foreign institutions in London can be a marginal source of liquidity in sterling markets via global trading operations exploiting arbitrage opportunities. - Such opportunities could be pursued from offshore; physical presence may offer marginal benefits. - Diffusion of techniques and instruments: - Sophisticated foreign trading operations in London can disseminate new trading techniques and financial instruments to sterling markets (example: smoother introduction of repo contracts to sterling in 1996 due to foreign institutions’ prior experience). *Source: _cr03208 - 16. Channels of transmission for financial stresses and strains between the global* ### 30. In contrast to the exchange-traded markets and sterling markets where U.K. ### _cr03208 - 30. In contrast to the exchange-traded markets and sterling markets where U.K. ### Supervisory roles for global trading in London - U.K. authorities have well-defined roles for supervising exchanges and domestic financial institutions, but roles are "somewhat less clear-cut" for global financial trading by foreign financial institutions during London trading hours. - Significant reliance on cross-border supervisory cooperation is "important and necessary" because foreign financial institutions operating in London are "predominantly chartered and supervised elsewhere." - The FSA will only grant foreign banks branching licenses to non-EU banks when: - the banks "originate from jurisdictions in which the U.K. authorities are satisfied with the level of home-country supervision," and - there is "a good working relationship with the supervisor in question." - If U.K. authorities are not content with home-country supervision for a third-country institution, the institution is "only allowed to operate in the U.K. as a locally-incorporated subsidiary" so that U.K. activities come under formal FSA supervision. ### Oversight and informal supervision of global OTC derivatives markets - U.K. authorities play an informal role in supervising trading practices in global OTC derivatives markets (e.g., interest-rate and foreign-exchange swaps markets). - Markets are largely: - interbank, led by the LCFIs, which "generally serve as market-makers," - mostly self-regulated, with major market-makers subject to banking or securities regulations and supervision in their home jurisdictions. - The Bank of England and the FSA: - "work closely with market participants through various market committees to promote improvements to trading conventions and appropriate trade documentation," - are "in regular contact with market participants to keep abreast of market developments" to spot emerging issues (prudential standing, unusual trading practices). - Example: the Bank "worked very closely with market participants to introduce the necessary changes to the financial market infrastructure in London to handle the introduction of the euro," despite the U.K. not adopting the euro. ### Institutional responsibilities, surveillance, and international role - The U.K. authorities view the presence of global markets in London as imposing "extra responsibilities" and feel a "special obligation, together with the U.S. authorities, for safeguarding the stability of global financial markets." - The Bank of England and the FSA: - devote additional resources to encourage other national authorities and market participants to improve global market functioning, - conduct "high quality surveillance of conjunctural developments and structural changes" in the global financial system to influence market practices and international policy responses, - participate in "the evolving informal surveillance of global financial markets." - The London trading window provides U.K. authorities with information on global market functioning "useful in the surveillance of the major U.K. financial institutions and the potential international threats to U.K. financial stability." ### Macro-level implications for the U.K. economy - A "very large share" of financial market trading in London represents trades between foreign financial institutions denominated in currencies other than the British pound. - This trading activity is largely insulated from the U.K. domestic financial system because it "primarily involves wholesale market transactions between foreign institutions" with little connection to the U.K. domestic financial system, though several large U.K.-banking groups are important players. - U.K. financial institutions "typically obtain most of their profits from the provision of financial services to the U.K. domestic economy." - The principal channel between global financial markets operating in London and the U.K. domestic financial system is "an indirect one and an economic one": - "The health of London’s financial services industry plays an important role in determining the health of the U.K. economy in the London area," which can affect loan-portfolio quality for U.K. financial institutions lending in that area. ### Micro-level implications: settlement, payment systems, and infrastructure - Trading location in London is "to an important extent divorced from the settlement of transactions." - While significant trade processing occurs in the U.K., global market trading in London does not place much additional demand on U.K. payment and securities settlement systems with two major exceptions: - the London Clearing House, which "is playing a growing role in serving as the central counterparty to global OTC market transactions," - the RTGS payment system for the euro, which "has an important node in London." - It is critical that these parts of the U.K. payment and settlement systems "maintain their efficiency and risk containment systems" to handle demands from global financial market activity. ### Box 3 — U.K. authorities’ role in supervising global OTC markets (key points) - OTC markets are subject to "significantly less supervision than the domestic exchange-traded markets" because they are professional wholesale markets among sophisticated institutions and do not operate on organized exchanges. - OTC markets consist of a network of institutions negotiating "customized large-value transactions" via telephones and electronic systems. - Confidence in counterparties' prudential standing is essential for OTC market functioning. - FSA: - is prudential regulator for entities it authorizes, including U.K.-incorporated subsidiaries of foreign institutions, - does not have prudential responsibility for U.K. branches of passporting EEA institutions (prudential responsibility lies with country of incorporation), though "the FSA may take responsibility for supervising branch liquidity." - Under the EC Banking Investment Services and Insurance Directives, U.K. authorities "rely on the prudential regulation of the home country" for EEA-incorporated banks and investment firms. - Even without centralized platforms, U.K. authorities "work with market participants and foreign regulators to ensure that these markets are deep and liquid" and able to function under a wide range of conditions. - The Bank of England and the FSA maintain continuous bilateral relationships with key market participants and liaise through local committees (e.g., Foreign Exchange Joint Standing Committee, Sterling Money Market Liaison Group, Stock Lending and Repo Committee); minutes are posted on the Bank’s website. - FSA Handbook material on Inter Professional Conduct: - prepared collaboratively with market participants, - aims to secure good market practice for bilateral OTC dealings, - contains rules on suitability and advice, communication of advice, agency/principal/arranger status, and inducements, - scope can be "quite limited" reflecting "the light touch of regulation" historically preferred by market participants, - includes extensive provisions to prevent improper use of markets (e.g., ensuring transactions "are not undertaken at prices other than market prices"). ### Overall assessment and concluding observations - Global financial market activity in London "does not pose undue risks for the U.K. domestic financial system" beyond normal cross-border activity risks of U.K. financial institutions. - Nonetheless, such global activity requires "some additional surveillance and informal supervisory responsibilities" for the Bank of England and the FSA. - Together with central banks and supervisors in other international financial centers, the U.K. authorities "play an especially important role in promoting and fostering the smooth functioning of global financial markets." - The London trading window provides U.K. authorities with "a valuable perspective on developments and trends in the global financial markets," aiding assessment of potential strains affecting the U.K. domestic financial system. *FINANCIAL SECTOR ASSESSMENT PROGRAM — UNITED KINGDOM — TECHNICAL NOTE: THE INSTITUTIONAL FRAMEWORK FOR U.K. FINANCIAL STABILITY POLICY — MAY 2003* ### 8. It is important to note that the MoU goes on to state clearly that the FSA and ### _cr03208 - 8. It is important to note that the MoU goes on to state clearly that the FSA and ### MoU, information sharing, and coordination - The MoU states that the FSA and BoE “will establish information sharing arrangements to ensure that all information which is or may be relevant to the discharge of their respective responsibilities will be shared fully and freely” (emphasis added). - Once information is identified by one party as relevant to its responsibilities, that information must be shared promptly (subject only to applicable confidentiality requirements as regards further release). - The FSAP mission emphasizes the importance of effective information exchange and coordination, and judges that the MoU framework in the United Kingdom provides strong incentives for timely sharing. - Any coordination or information sharing glitches are expected to be second-order administrative issues, fixable quickly by managers. ### FSMA, the FSA creation, and scope - The FSA is described as the first fully integrated regulator in a major economy, formed by combining and regrouping up to 11 predecessor agencies. - The FSMA: - Represents a comprehensive update of U.K. financial supervision legislation. - Consolidates authority for financial supervision under the FSA and gives the FSA broad new statutory authority. - Displaces most self-regulatory arrangements that had been a traditional feature of U.K. financial markets. - Reorients the U.K. approach to financial regulation by making reducing financial crime and ensuring appropriate consumer protection explicit statutory objectives. - The FSMA generally provides a framework; the FSA is delegated powers to prepare more detailed rules and Rulebooks and has produced a handbook after lengthy consultation processes. ### Regulatory architecture: three levels - The new framework consists of three levels of regulations: - (i) Primary Legislation—i.e., the FSMA itself: contains the four objectives, seven principles of good regulation, the FSA powers and functions, applicable accountability mechanisms, etc.; - (ii) Secondary Legislation: around 90 pieces of such secondary legislation that regulate different aspects of FSMA more precisely; - (iii) the FSA Handbook: collects all the regulations issued by the FSA. ### FSMA’s statutory objectives (four) - The FSMA identifies four regulatory objectives for the FSA: - maintaining confidence in the financial system; - promoting public awareness and understanding of the financial system; - appropriately protecting consumers of financial services; and - the reduction of financial crime. ### Seven “principles of good regulation” - In pursuing the four objectives, the FSA must also take into account seven principles: - minimizing adverse effects of regulation on competition; - encouraging competition among firms regulated by FSA; - using its resources economically; - taking account of the responsibilities of those who manage the affairs of authorized persons; - following the principle that a burden or restriction imposed on a regulated firm should be proportionate to the benefits expected; - being attentive to facilitating innovation in connection with regulated activities; and - observing the international character of financial services and markets and the desirability of maintaining the competitive position of the U.K. - The distinction between objectives and principles establishes a clear sense of priority: the principles are to be taken into account (not directly pursued), guiding implementation and accountability. ### Governance, accountability, and transparency - The FSA is required to consult extensively and publicly on proposed rules and regulatory guidance. - Transparency practices are characterized as very strong; the FSA publishes a corporate plan, annual report, Progress Reports, and other publications. - Checks and balances in governance include: - Board composition: contains appointees from the financial services industry and others, with a majority of non-executive directors required; Board deliberations are tied to FSMA objectives and principles and U.K. corporate governance principles. - Government role in Board appointments and removals is constrained by FSMA and published procedures for public appointees. - Two advisory panels formalized by FSMA: a Practitioner Panel and a Consumer Panel, each able to feed views to the FSA Board through public reports. - Review mechanisms for FSA supervisory powers: independent Tribunal for case-related decisions; independent FSA Complaints Commissioner who can report publicly and recommend compensation; governmental competition agencies; and “value-for-money” audits or specific independent inquiries commissioned by government. ### Operational framework: “risks to our objectives” (RTO) - The FSA has elaborated an operational RTO framework for setting supervisory priorities and allocating supervisory resources. - Key features of RTO: - Serves as a corporate planning framework for supervisory strategies, work program guidance, resource allocation, regulation design, and evaluation of supervisory effectiveness. - Distinct from firm-level risk-based supervision: RTO links firm risk and environmental risk to risks to the FSA’s four statutory objectives. - The FSA identified seven high level risk groups linked to the objectives: financial failure, misconduct/mismanagement, consumer understanding, incidence of fraud or dishonesty, market quality, incidence of market abuse, and incidence of money laundering. - Firm-specific risk is divided into two broad categories: business risk and control risk, subdivided into some 40 risk elements. - Based on risk assessment, firms are categorized as High Impact, Medium High Impact, Medium Low Impact, or Low Impact; this categorization determines the nature and intensity of supervision. - Firm size is a central factor but not exclusive in determining impact categorization. - The RTO approach allows flexibility and judgment; the risk analysis and categorization are highly subjective and the framework does not prescribe exact supervision intensity metrics. - Supervisory strategies at the firm level are guided by conventional risk assessments as well as RTO factors. - The framework requires explicit cost-benefit analyses for material proposals and broad consultation, enhancing consistency, openness, and challengeability. ### Insurance supervision: reform and priorities - The U.K. authorities are strengthening insurance supervision and shifting FSA resources to insurance sector oversight. - Drivers include the importance of U.K. insurance companies and markets, the highly sophisticated nature of the U.K. market, significant current stress in the industry, and incentives for excessive risk taking. - Immediate supervisory responses have included increased monitoring of insurers’ financial modeling and modifications/temporary suspensions of the FSA’s “resilience tests” for insurers to avoid “fire-sale” problems from forced asset sales. - The FSA had begun developing a strengthened insurance supervision approach under the “Tiner project” at the time of the FSAP assessment; early implementation stages had proceeded further in the interim. - Main findings at the time of assessment included: - The FSA’s regulatory and prudential regime required an increased degree of hands-on prudential supervision and was not sufficiently proactive. - Absence of formal actuarial, general insurance, and reinsurance involvement in the risk review and assessment process could limit comprehensive review of firms’ risk management systems, asset allocation limits, and internal controls. - Desk-based analysis of statutory returns may not adequately capture the nature and scale of risks from underlying asset and reinsurance exposures. - Recommendations and developments: - Authorities were encouraged to strengthen insurance supervisory resources and processes within the FSA. - Improved transparency of early intervention actions, and stronger reporting, disclosure, and governance-related requirements for insurance companies were stressed. - The Tiner project reforms are expected to remedy most of the shortcomings noted against (an enhanced version of) the IAIS Insurance Core Principles. - The FSA has integrated into its supervision team the previous work of the Government Actuary’s Department (GAD). - A noted deficiency is the dearth of timely, public aggregate financial indicators for the U.K. insurance industry; stronger reporting and disclosure are priorities to improve availability of financial soundness indicators. *Source: IMF FSAP assessment excerpt (provided content).* ### 21. The MoU clearly recognizes that core central banking functions are as much a ### _cr03208 - 21. The MoU clearly recognizes that core central banking functions are as much a ### Core central banking functions and financial stability - The MoU recognizes that core central banking functions are as much a part of the overall financial stability regime as institution-specific supervision functions. - Monetary (price) stability is identified as a cornerstone of financial stability in its broader sense. - System-wide liquidity management arrangements serve dual purposes: - To ensure key financial markets continue to function effectively, even in time of stress. - To undertake effective and efficient monetary policy. - Systemic liquidity arrangements are discussed in detail in another FSAP Technical Note. ### Bank of England (BoE) roles beyond core functions - The MoU highlights the BoE’s central role in: - Advising on, overseeing and helping to implement appropriate changes in the payments system infrastructure. - Undertaking surveillance of the financial system as a whole, including significant international financial market surveillance given London’s role as a major international financial center. - In exceptional cases, undertaking last resort lending of one form or another. - Payments system responsibility arises from the BoE’s role as “bankers’ bank” and provider of the central settlement asset underpinning the infrastructure. - The BoE supplements institution-by-institution supervision with perspectives drawn from financial markets and payments systems, and from international and domestic analysis and forecasting needed for monetary policy formulation. - The BoE can facilitate corporate workouts under the “London Approach” and has done so in several past cases. ### Evolution and outputs: Financial Stability Review (FSR) - The BoE’s six-monthly Financial Stability Review (FSR) has evolved: - Progressed from an early ad hoc collection of articles (first published in Autumn 1996) to a comprehensive compendium of conjunctural and structural/institutional trends and issues. - Reflects considerable efforts in international market surveillance and linkages to the U.K. financial system. - The FSAP mission judged U.K. financial sector surveillance to be “at the forefront internationally,” as demonstrated inter alia in the FSR. ### Key remaining tasks and recommended priorities - Extend and deepen knowledge of inter-institutional exposures, especially regarding unsecured interbank funding: - Exposures include explicit interbank market exposures and less explicit intraday exposures between indirect clearing banks and their direct clearing sponsor banks. - Transactions not covered by RTGS risk reduction/transparency arrangements affect only clearing banks. - The June 2002 FSR included a major first step in analysis of such exposures; BoE is encouraged to continue prioritizing improved monitoring and analysis. - Monitor potential interinstitutional exposures in derivatives markets, including risk transfer markets: - These require close monitoring in both institution-/market-specific supervision and broader system-wide surveillance contexts. - Relevant FSR articles cited include: David Rule in December 2001 FSR and June 2001 FSR on credit derivatives and risk transfer. - Improve the quality and timeliness of aggregate financial soundness indicators (FSIs) for the United Kingdom: - Challenges arise from varied historical data sources with different objectives and institutional coverage. - Recent FSR work (including June 2002 articles by Andrew Gracie and Andrew Logan; and by Glen Hoggarth and Darren Pain) are important steps forward. - FSAP encouraged continued work and stressed the desirability of producing timely official FSI data for the insurance sector. - Significant proposed changes to insurance supervision (the “Tiner Report” project) should facilitate improved insurance-sector FSI data. - Strengthen quantitative analysis of aggregate financial sector indicators and link them into the BoE’s macroeconomic model: - BoE work contributed to design and calibration of stress testing scenarios used by banks in the U.K. FSAP exercise and to authorities’ own “top-down” stress analysis (related work depicted in the June 2002 FSR). - The FSAP team encouraged further work so system-wide stress testing analysis could become a standard part of financial sector surveillance in the United Kingdom. ### Illustrative timeline and references cited in text - Institutional reforms referenced: 1997-98. - FSR first published: Autumn 1996. - Specific FSR publications and articles cited: - June 2002 FSR: analysis of interbank exposures; articles by Andrew Gracie and Andrew Logan; Glen Hoggarth and Darren Pain. - December 2001 FSR: David Rule, “Risk Transfer Between Banks, Insurance Companies and Capital Markets: an Overview.” - June 2001 FSR: David Rule, “The Credit Derivatives Market: Its Development and Possible Implications for Financial Stability.” - June 2002 FSR: BoE’s related work on stress testing referenced (see article by Hoggarth and Pain). *Source: Excerpt from _cr03208 (FSAP Detailed Assessments), pages 13–15.* ### 27. Recommended Actions to Improve Observance of CPSS/IOSCO ### 27. Recommended Actions to Improve Observance of CPSS/IOSCO ### Assessment scope and methodology - Assessment conducted as part of the Financial Sector Assessment Program (FSAP) at the request of the U.K. authorities over the period February–July 2002. - Assessment team: John Abbott (IMF-MAE), Laurie Edlund (Office of the Comptroller of the Currency), and Jan Rein Pruntel (Netherlands Bank). - Methodology: Core Principles Methodology published by the Basel Committee On Banking Supervision in October 1999. - In view of the highly developed nature of the U.K. banking sector, the assessment takes into account both the essential and the additional criteria set out in the Core Principles Methodology. - Major documentary sources: comprehensive self-assessment submitted by the U.K. authorities prior to the May mission; numerous publications from the FSA website; the Financial Services and Markets Act 2000 (FSMA); a CD-ROM provided by the FSA containing its Handbook of rules and guidance; presentation material and internal documents provided by FSA officers; background material from various industry sources. - Major interlocutors: FSA officers; representatives of major U.K. incorporated banks and U.K. branches of overseas banks; senior representatives of the British Bankers Association; the Foreign Bankers and Securities Association; the Practitioners Panel on transparency established under the FSMA; the Institute of Chartered Accountants in England and Wales. ### Institutional and macroprudential setting — key facts and findings - Creation and legal framework of the FSA: - The FSA was established by the U.K. Government in May 1997, and commenced operation in an interim or transitional way in June 1998. - The FSMA was passed in 2000 and took full legal effect on December 1, 2001, a date usually referred to in this context as N2. - The FSA initially absorbed activities of nine previous regulators or government departments and in bank supervision specifically absorbed the previous supervisory function of the Bank of England. - Macroeconomic environment: - The U.K. banking industry has benefited from a remarkably stable macroeconomic environment and sustained growth over nearly a decade. - Recent imbalances have emerged, particularly in the expansion of credit to consumers and businesses and burgeoning house prices. - Although these imbalances are, on the whole, not large and likely to be resolved gradually, they pose risks to the financial system that require monitoring and management. ### Preconditions for effective banking supervision — legal, professional, and market infrastructure - Legal and judicial framework: - The United Kingdom has a well developed judicial system with a reputation for probity and professionalism. - Civil commercial matters are normally heard in one of the divisions of the High Court, with appeal processes available through the Court of Appeal and, if accepted, the House of Lords. - EU law overrides domestic law under the Treaty of Rome; EU directives must be converted into national law by member states. - From a regulatory point of view the legal and judicial precondition to effective banking supervision are very well satisfied. - Accounting and auditing professions: - Chartered accountants are expected to continuously maintain minimum levels of professional training; the U.K. professions are described as world class with strong qualification and accreditation requirements. - A new system of non-statutory independent regulation of the accountancy profession’s audit activities has recently been established under the auspices of the Accountancy Federation, intended to raise standards for oversight of the accountancy profession. - Convergence toward fair value accounting (IAS 39) will introduce new issues for both firms and regulators; the U.K. profession is beginning to address these issues. - External auditors need to be members of recognized supervisory organizations and to remain eligible under those organizations’ rules (leading to a practicing certificate); the main coordinating body for the six U.K. accounting bodies is the Consultative Committee of Accounting Bodies, a recognized supervisory body. - The assessment team was not able to determine the level of performance of the internal audit function within the banking sector, but there appear to be varying degrees of competence and awareness of the risk based approach. - Corporate governance and market discipline: - The United Kingdom is among the leading countries in setting standards for corporate governance, including public disclosure practices. - Market discipline in the regulated financial sector is reinforced by U.K. authorities’ publicly stated view that it is neither possible nor desirable to remove all risk of financial failure. ### Insolvency, resolution powers, and depositor treatment - Insolvency framework: - The United Kingdom has no special statutory insolvency procedures for banks; banks and other FSA-supervised financial institutions are generally subject to the same insolvency laws and procedures as non-regulated companies. - FSMA gives the FSA a limited role in statutory insolvency procedures for financial institutions, including the power to petition for an institution to be placed in administration or winding-up proceedings. - Under the current system, bank depositors are treated like other creditors at the beginning of administration proceedings and delays in repayment of deposits can span several weeks. - Pre-statutory resolution and financial stability: - FSMA provides the FSA with a broad range of powers to resolve problems in banks, ranging from public censure to withdrawal of authorization. - The financial stability Memorandum of Understanding (between HMT, the FSA and the Bank) provides a broad framework within which official intervention of various sorts could be contemplated in more systemically important cases. *Source: _cr03208 - 27. Recommended Actions to Improve Observance of CPSS/IOSCO* ### 13. Overall the U.K. satisfies the Basel Core Principles preconditions for effective ### Overall the U.K. satisfies the Basel Core Principles preconditions for effective banking supervision ### Principle 1 — Objectives, Autonomy, Powers, and Resources: overview - The FSMA defines the FSA’s responsibilities and objectives; general functions are in FSMA Section 2 (4). - Four regulatory objectives (FSMA Section 2 (6)): market confidence, public awareness, protection of consumers, and reduction of financial crime. - Seven principles of good regulation (FSMA Section 2 (3)) guide the FSA, including proportionality, competition, efficient use of resources, facilitating innovation, and observing the international character of financial services. - The FSA has rulemaking powers under the FSMA; Rules and Guidance are set out in the FSA Handbook and primarily cover prudential matters. - Banks must meet “threshold conditions” (FSMA Schedule 6) and comply with FSA rules; branches of EEA banks are supervised by home supervisors. - Assessment: Compliant. - Comment: FSMA clearly defines the FSA’s role; transparency measures exist (annual reporting to Treasury, annual public meeting, non-executive committee review). Industry-level financial information is published by the Bank of England and the British Bankers Association. The FSA has projects exploring additional industry information provision. ### Principle 1(2) — Operational independence and adequate resources - The FSA is an independent non-governmental body, established as a company limited by guarantee; governed by a Board appointed by HM Treasury (Executive Chairman, three Managing Directors, eleven non-executive members, one ex officio). - Funding is provided by industry via annual fees; FSMA (Schedule 1, paragraph 17) authorizes the FSA to require payment of fees and mandates consultation on proposed fees (e.g., CP111 addresses the post-N2 fee assessment process). - The FSA has four resource strategies: People, Space, Cash and Information; a monthly Resources Report tracks progress (including staff turnover). - Training and staffing metrics: the FSA spent approximately £2.8million on training in 2001/2, with an average of 6.2 days per person on formal training activities in the same period. - Use of secondments: inward secondments from industry and professional firms; outward secondments via a Graduate Development Program. - Governance/appointment issues: HM Treasury appoints and may remove Board members; FSMA does not set a term for the chairman or require public reasons for removal. - Assessment: Compliant. - Comments: - Industry concern that consumer-focused objectives may push the FSA toward being more prescriptive or consumerist, potentially creating tension with a risk-based approach. - The FSA pursues proportionality in supervisory costs (including use of “skilled persons” reviews paid by firms). - Staff credibility and experience are high; turnover and depth of specialist staff have been issues. Turnover figures for banking supervision divisions ranged from 3.5 percent to 9.7 percent in the twelve months to June 2002. - The adequacy of specialist staffing (small cross-sector teams) and the roll-out of the new risk assessment process should be closely monitored. ### Principle 1(3) — Legal framework for authorization and ongoing supervision - The FSMA provides the legal framework for authorization, ongoing supervision, and enforcement, supplemented by secondary legislation and FSA rules made under section 138 of FSMA. - The FSA Handbook contains manuals on Authorization, Supervision, and Enforcement; FSA produces rules and guidance, mainly covering prudential matters. - Assessment: Compliant. - Comment: FSMA clearly identifies the FSA as responsible for authorization and supervision; FSA has broad powers to require information. Rules and guidance are prepared in consultation with industry. ### Principle 1(4) — Powers to address compliance and safety/soundness - FSMA (Schedule 1 paragraph 6) requires the FSA to maintain a process to determine compliance with FSMA and FSA rules. - Information and investigatory powers: FSMA Section 165 (require information/documents), Section 166 (obtain information through authorized person), Sections 167–176 (appoint investigators); processes articulated in the Enforcement manual (ENF). - Remedial and enforcement powers: withdraw authorization, limit deposit-taking, require cessation of activities; prompt remedial action via supervisory notice under FSMA Section 45 (subject to referral to an independent FSM Tribunal; Tribunal procedures in Part IX of FSMA). - Penalties: FSMA Part XIV permits fines or public censure via decision notices; appeals typically within 28 days. - Assessment: Compliant. - Comment: FSA has a range of supervisory and enforcement options including prompt remedial action and authorization revocation where necessary. ### Principle 1(5) — Legal protection for supervisors - FSMA Schedule 1 paragraph 19 provides that the FSA and its members, officers, and staff are not liable in damages for acts or omissions in the discharge (or purported discharge) of functions, except for acts in bad faith. - FSMA protection does not prevent awards under Section 6(1) of the Human Rights Act 1998. - Complaints scheme (FSMA Schedule 1 paragraphs 7 and 8) allows an appointed investigator to recommend compensatory payments or remedies. - The FSA may require payment of fees to cover costs of defending actions and covers legal costs of defending staff in relation to their work. - Assessment: Compliant. - Comment: Protection is provided for good faith acts, but compensation may be payable under the FSMA-mandated compensation scheme or Human Rights Act awards. ### Principle 1(6) — Information sharing and confidentiality safeguards - The FSA has a published MOU with the Bank of England and HM Treasury covering information exchange. - FSMA Part XXIII restricts disclosure of information but includes exceptions allowing disclosure to other regulators (subject to EU directives). FSMA Section 354 requires cooperation with similar-function entities and cooperation related to prevention/detection of financial crime. - The FSA has formal information exchange arrangements with domestic, EEA, and overseas supervisors; confidential information disclosed remains subject to FSMA restrictions and must be subject to equivalent restrictions by overseas recipients (Banking Consolidation Directive standard). - The FSA may refuse confidential information requests except for limited cases (court orders in criminal cases, Parliamentary inquiries, and some personal data under data protection legislation). - Assessment: Compliant. - Comment: FSMA provides a suitable framework for information sharing and safeguards confidentiality, with limited exceptions to refusal. ### Principle 2 — Permissible Activities - The FSMA does not expressly define “bank” but Schedule 2 identifies deposit taking as a regulated activity; the Regulated Activities Order includes accepting deposits. - For applying parts of the FSA Handbook, the FSA defines a bank as: a. A firm with Part IV permission which includes accepting deposits, and (i) which is a credit institution; or (ii) whose Part IV permission includes the requirement that it complies with IPRU (Bank); But which is not a building society, a friendly society, or a credit union. b. An EEA bank. - FSMA Section 19: no person may carry on a regulated activity unless authorized or exempt. FSMA Section 24: offense for an unauthorized person to describe themselves as an authorized person or hold themselves out as such. - Assessment: Compliant. - Comment: Although “bank” is not expressly defined, regulated activities (including deposit taking) are defined; use of the term “bank” would be presumed to indicate regulated activity and require authorization. ### Principle 3 — Licensing criteria (beginning) - When granting or varying Part IV permissions, FSMA section 41(2) requires the FSA to be satisfied that the applicant satisfies and will continue to satisfy the threshold conditions in FSMA (Schedule 6) for all regulated activities for which permission is sought. - There are five threshold conditions (listed in FSMA Schedule 6). *Source: _cr03208 - 13. Overall the U.K. satisfies the Basel Core Principles preconditions for effective* ### 1. Legal status. Deposit-takers must be bodies corporate or partnerships. ### 1. Legal status. Deposit-takers must be bodies corporate or partnerships. ### Legal status and location - Deposit-takers must be bodies corporate or partnerships. - If the bank is a body corporate constituted under the laws of any part of the U.K., then it must have its head office and, if it has one, its registered office in the U.K. - A body incorporated in one part of the U.K. may have its head office in any other part. - If the bank has its head office in the U.K. but is not a body corporate, it must carry on business in the U.K. ### Close links (threshold condition) - The threshold condition on “close links” applies when an applicant has close links with another person that could prevent the FSA from effectively supervising the applicant. - FSMA Schedule 6 paragraph 3 provides a definition of close links. - Two tests if close links exist: - The links must not be likely to prevent effective supervision of the applicant by the FSA. - If the linked person is situated outside the EEA, the laws, regulations, and administrative provisions that apply must not prevent effective supervision of the applicant by the FSA. ### Adequate resources (threshold condition) - Adequacy of resources considers both financial and non-financial resources and means of managing resources. - Resources may include: capital, provisioning, availability of liquid assets, human resources, and risk management systems. - FSA assesses readiness, willingness, and organization to comply with the high level systems and controls requirements in the SYSC chapter of the FSA Handbook. ### Suitability (fit and proper) - The applicant bears the burden of satisfying the fit and proper test. - FSMA section 59 permits the FSA to specify “controlled functions” that must be performed by individuals assessed as fit and proper. - FSMA sections 60 and 61 allow the FSA to establish application procedures and factors to be determined; the FSA may issue statements of principles and a code of practice applicable to individuals performing functions under section 59. - The FSA’s approach is set out in the FIT chapter of the FSA Handbook. - When evaluating proposed directors and senior management, the FSA uses FIT criteria including: - honesty, integrity and reputation (FIT 2.1); - competence and capability (FIT 2.2); - financial soundness of a person (FIT 2.3). ### Threshold Conditions application and enforcement - Additional assessment criteria are set out in the Conditions (COND) chapter of the FSA Handbook. - The Threshold Conditions are used to assess license applications and are considered in ongoing supervision. - The FSA may reject an application if the applicant fails to satisfy one or more threshold conditions, or provides inadequate information. - Under FSMA sections 42 and 43 the FSA may impose limitations or requirements on a bank’s permission or grant permission to a narrower range of activities. - FSMA section 45 permits the FSA to vary or cancel a permission if the authorized person is failing, or is likely to fail, to satisfy the threshold conditions. - Knowingly or recklessly providing false or misleading information to the FSA is an offense under FSMA section 398. - FSMA section 354 requires the FSA to cooperate in sharing information with other U.K. and overseas authorities with similar functions; the FSA seeks home country supervisors’ views for overseas banks wishing to establish a branch or subsidiary. ### Application requirements and governance assessment - Applicants must submit: a strategic and operating plan, a business plan, details of management and organizational structure, operating procedures, systems and controls, and any outsourcing arrangements. - Assessments focus on: - Whether corporate governance is proportionate to the bank’s business; - Whether the bank will be managed in a competent and prudent manner; - Whether appropriate systems and controls are in place. - Approval for individuals includes assessing knowledge required for the bank’s intended financial activities; cumulatively senior management should have experience and skills to cover all proposed activities. - Business plan should set out regulated and unregulated activities, related risks, a financial budget and projections demonstrating ability to comply with financial resource requirements. - Shareholder status and ability to support the business are considered; letters of comfort from major shareholders may be obtained in some cases. ### Principle 4 — Ownership (control) - FSMA Part XII addresses control over authorized persons. - FSMA section 178 requires prior notification to the FSA by any person proposing to take control (or increase control) of an authorized person; general threshold for control is 10 percent. - Voting power or holdings of controller’s associates (as defined in FSMA section 422) are considered. - FSA may require additional information under FSMA section 182 and may object to a proposal unless satisfied that the acquirer is fit and proper and consumer interests are not threatened. - FSA powers under FSMA: - unconditional approval (section 184), - approval subject to conditions (section 185), - restrict shares acquired in contravention of objection (section 189), - apply to court to order sale of shares acquired contrary to FSA objection or condition. - SUP Chapter 11 contains rules and guidance on controllers and close links; section 11.4.10 requires banks to take reasonable steps to keep informed of the identity of controllers. - Banks must notify the FSA of controllers and close links annually (SUP sections 16.4 and 16.5). ### Principle 5 — Investment criteria and large exposures - SUP Chapter 15 requires notice to the FSA of proposed restructuring, reorganization, or business expansion with significant impact on risk profile or resources. - SUP Chapter 11 addresses notification and approval for close links and changes of control. - Principle 11 of the Principles for Businesses requires firms to disclose to the FSA matters the FSA could reasonably expect to be notified. - IPRU (Bank) section LE addresses large exposures and investments: - Banks must notify the FSA of any investment exceeding 10 percent of capital. - Banks must pre-notify the FSA of any investment exceeding 25 percent of capital. - Large exposure rules do not apply to U.K. branches of overseas banks; U.K. branches incorporated outside the EEA have large exposure reporting requirements. - The FSA assesses acquisitions/investments for continued satisfaction of Threshold Conditions and consumer interest protection; it may prohibit major acquisitions or investments that would cause non-compliance. - Notifications may be required prior to acquisition/investment; prior notification thresholds are defined relative to the bank’s capital. ### Principle 6 — Capital adequacy - FSMA 2000 and FSA regulations require both an absolute minimum amount of capital and an adequate level of capital. - Threshold Condition 4 requires all banks to maintain adequate resources, financial and non-financial. - Minimum capital amount is Euro 5 million (or sterling equivalent). - On an on-going basis a minimum capital ratio of 8 percent has to be maintained. - Components of regulatory capital and methodology for calculating the capital ratio are detailed in IPRU Banks. - U.K. capital requirements are based on relevant EU directives, fully in line with the Basel Capital Accord; all U.K. incorporated banks are required to maintain Basel standards. - General rule: maintain capital commensurate with nature and scale of business and inherent risks (IPRU Ch. GN 3.3.13R); group members’ activities impacting the bank must be considered. - Individual required capital ratios are set for each U.K. incorporated bank and are in almost all cases higher (and never lower) than the Basel minimum of 8 percent; individual ratios are determined by each institution’s overall risk profile and applied on a solo and consolidated basis. - Banks report solo capital ratio quarterly and consolidated ratio semi-annually; components of capital and risk-weighted assets must be reported. - Capital requirements must be met continuously; breaches of individual required capital ratios must be immediately notified to the FSA, leading to a plan and timetable to achieve compliance via capital injection or balance sheet restructuring. - FSA enforcement powers include variation or cancellation of permitted activities and withdrawal of license. ### Principle 7 — Credit policies and internal controls - Threshold Condition on Suitability expects regulated firms to identify and consider risks and install appropriate control systems. - IPRU Banks Chapter AR requires adequate accounting and other records and adequate systems of control appropriate to the nature, scale and complexity of the business. - Directors and management are responsible for establishing and maintaining systems and controls and for determining required management information and recipients (IPRU Banks Chapter AR Section 3.2.3). - Banks are expected to have management information accurately covering risk exposures (IPRU Banks Chapter AR Section 3.3.5). - No prescriptive FSA rules for loan and investment policies; these are management responsibilities, but the FSA expects: - prudent credit granting and investment criteria, policies and procedures reflecting asset types, - board approval and periodic review of such policies, - adequate staff training on internal control policies and procedures, - appropriate credit assessment procedures to identify, measure, monitor and control credit risk, - internal records reflecting analysis undertaken and counterparty exposure limits approved by management, with ability to measure actual exposures against limits (IPRU Banks Chapter AR). *Source: _cr03208 - 1. Legal status. Deposit-takers must be bodies corporate or partnerships.* ### Section 3.2.2). Also, each bank is required to have a policy on large exposures (see Principle 9). ### Section 3.2.2). Also, each bank is required to have a policy on large exposures (see Principle 9). ### Credit granting, supervision, and large exposures policy - The policy should outline the approval process for major credits, the circumstances in which limits may be exceeded and who is authorized to approve such excesses (e.g., a bank’s board or credit committee). - The FSA will verify whether a bank has followed prudent credit granting criteria, policies and procedures through desk-based analysis of prudential returns. - Peer group review is used, particularly for the purpose of assessing the adequacy of management information systems. - If desk-based analysis indicates a need for further scrutiny, supervisory tools may be applied in an escalating fashion: - visits by the supervisory team to the bank, - specialist credit evaluation visits, - skilled persons (i.e., outside auditors) investigations. - Ad hoc meetings with senior management may be held to assess their understanding and implementation of the criteria, policies and procedures. - The supervisory team will consider: - size, maturity, currency, marketability and sources of repayment, - geographic dispersion of assets, - whether credit decisions have been taken on an arm’s-length basis, - whether adequate checks are made of the total indebtedness of the entities to which the bank extends credit. - No routine reviews of credit files are conducted. - The FSA expects a bank to give the supervisory team full access to all information relevant to the credit and investment portfolios; if voluntary access is not forthcoming, the FSA will use its statutory powers. - The FSA frequently requests receipt of banks’ own management information to help it verify adherence to the credit policies set. Assessment - Compliant Comments - Although no specific rules have been set, the FSA requires a bank to have credit-granting procedures that identify, monitor and control credit risk. - The bank’s policies should reflect the range and type of its assets. - Periodic evaluation of a bank’s credit-granting criteria is undertaken by means of a mix of desk-based analysis, on-site visits, ad hoc meetings with management and skilled persons reports. ### Principle 8. Loan Evaluation and Loan-Loss Provisioning — Description and requirements - Banks are required to maintain such systems and controls as are appropriate to their business (SYSC 3.1.1R). - These should include monitoring asset quality and the adequacy and value of collateral on a net realizable basis (SYSC 3.2.11 and IPRU Chapter PN). - Banks must maintain adequate provisions for any depreciation in the value of their assets (IPRU Chapter GN 3.3.17R). - Banks are required to set out their policy on making provisions in a written statement, which should include details of their loan classification arrangement and should be reviewed annually (IPRU Banks Chapters GN 3.4.5R and PN 3). - The FSA does not prescribe a particular format for the policy statement; the FSA expects the provisioning policy statement to cover: - who is responsible for drawing up and monitoring the policy, - what areas of the bank’s business are covered, - what types of management information is generated, - how implementation of the policy is checked, - how non-performing exposures are identified, etcetera. - A copy of the provisioning policy statement has to be supplied to the FSA. - Provisioning policies should cover both on and off balance sheet positions. ### Provisioning practice, classification, and oversight - Provisioning and loan classification policies are not rule or formula based but must be appropriate to the bank’s business. - Provisioning decisions are taken by management or the board based on a true and fair view of the quality of the assets. - Banks normally follow the accounting guidelines issued by the British Bankers Association; any deviations have to be explained. - These guidelines require the making of provisions once assets are identified as impaired. - Loans are impaired when there is reason to believe that not all amounts (both principal and interest) will be collected in accordance with the contractual terms of the loan. - The external auditor has to approve the provisioning decisions made by management in the context of his review of the financial statements. - Banks’ provisioning policy statements should include criteria for loans to be classified as non-performing; this would normally be when payments were a minimum number of days in arrears (usually 90 days), but a bank could make specific provisions earlier if this is considered appropriate. - Provisioning decisions with regard to individual assets have to be based on an impairment that has actually been identified; no general provisions are to be included. ### FSA assessment and supervisory action on provisioning - In assessing the adequacy of a bank’s provisions, the FSA looks at its provisioning policies, and the methods and systems for calculating provisions in accordance with those policies. - The FSA seeks to ensure through risk mitigation programs and other work that procedures and resources for monitoring and dealing with problem loans are adequate. - The FSA does not as a standard practice require periodic reporting of classified and non-performing loans. - Where the FSA has concerns over a bank’s asset quality, it can seek regular reports on watch list loans. - The level of provisioning is normally reported either on a quarterly or a semi-annual basis, but the frequency can be increased, and the required contents of reports expanded, if necessary. - When there are doubts about a bank’s credit controls or the adequacy of provisions, the FSA will have these assessed by its own credit specialists or by an external skilled person. - A plan of action would be tailored to the outcome of such reviews. - If the FSA continued to have doubts on a bank’s provisioning practices, it may use its enforcement powers. Assessment - Compliant Comments - Banks are required to supply the FSA with policy statements outlining their approach to asset classification and provisioning arrangements. - External auditors routinely review the adequacy of banks’ provisions as part of the audit process. - The FSA does not have a formal requirement that loans be classified when payments are contractually a minimum number of days in arrears (as called for in Additional Criteria 1, of the Core Principles Methodology) as the classification and provisioning system is not rule but principle-based. - In practice, loans tend to be classified after 90 days of arrears. - This system works well and actual provisioning levels in U.K. banks appear to be adequate. - The FSA should consider introducing a requirement for periodic reporting on credit quality based on each bank’s own asset classification policy and internal credit ratings. This would strengthen off-site monitoring by allowing early identification of asset quality trends. ### Principle 9. Large Exposure Limits — Description (fragment) - Each bank must set out its policy on large exposures in a written statement (IPRU Chapter GN *Source: IMF staff extract from _cr03208 - Section 3.2.2). Also, each bank is required to have a policy on large exposures (see Principle 9).* ### Section 3.4.1R). The policy should outline the circumstances in which limits (e.g., types of ### _cr03208 - Section 3.4.1R). The policy should outline the circumstances in which limits (e.g., types of ### Large exposures: policy, systems, and supervision - A bank must have a written large exposures policy statement that: - Outlines circumstances in which limits (e.g., types of counterparty, individual counterparties and connected exposures) may be exceeded and who is authorized to approve such excesses (e.g., a bank’s board or credit committee). - Is approved by the bank’s board and agreed with and copied to the FSA. - Is reviewed and, if necessary, updated at least once a year. - Requires prior discussion with the FSA before incorporating significant departures from the stated policy (e.g., new types of lending or breaches of existing limits). - Banks must have adequate systems and controls to monitor and control large exposures and to calculate large exposures accurately and promptly (IPRU Chapter GN Section 3.3.19R). - Supervisor verification methods: - Periodic supervisory visits. - Ad hoc meetings with senior management and the board. - Skilled person reports. - Thematic work by the FSA. ### Regulatory limits, definitions, and notification - Maximum limits for exposures to individual and group borrowers are set by the EU Large Exposures Directive (now included in the Consolidated Banking Directive) and implemented in FSA guidance. - The IPRU chapter on large exposures: - Provides a comprehensive definition of "exposures", including on and off balance sheet items. - Provides guidance covering the 10 percent and 25 percent limits and the calculation of a bank’s large exposure capital base. - Requires limits, notification, and reporting to be met on both a solo and consolidated basis, as appropriate. - Definition of "closely related group": - Exists where two or more individual counterparties constitute a single risk because one directly or indirectly controls the other(s), or where counterparties are connected such that the financial soundness of any may affect the others or the same factors may affect them all. - Where doubt exists banks should discuss circumstances with the FSA to determine reporting (IPRU Chapter LE Section 5). - Notification and treatment of 25 percent exposures: - A U.K. bank must notify the FSA if a proposed transaction would result in an exposure exceeding 25 percent of its capital (IPRU Chapter GN Section 3.3.21R). - Excesses of the 25 percent limit may be allowed in certain limited cases (mostly trading book positions) with possible incremental capital requirements. - The FSA may allow a solo-level breach if the consolidated limit is met. - All breaches of large exposure limits must be notified to the FSA immediately (IPRU Chapter LE Section 3). ### Reporting requirements and supervisory use of data - Reporting to the FSA: - The FSA receives details of the twenty largest bank and non-bank exposures and any exposures of 10 percent or more of a bank’s regulatory capital base via a large exposures report submitted quarterly by U.K.-incorporated banks (SUP 16.7.8R). - Branches of non-EEA incorporated banks submit half-yearly reports of their twenty largest bank and non-bank exposures (SUP 16.7.12R). - Reports should be completed on an unconsolidated or solo-consolidated basis and on a consolidated basis. - The FSA considers concentrations of risk (sectoral and geographic) in large exposure policy statements and during regular risk assessments. - The FSA frequently requests banks’ own management information to help verify adherence to policy statements. ### Assessment and supervisory comment on large exposures - Assessment: Compliant - Comments: - Clear and precise regulations reflect the relevant EU Directive. - The FSA’s requirement for a written policy statement is appropriate to stimulate prudent behavior regarding risk concentrations. - Large exposure policies are monitored and enforced by the FSA using normal supervisory tools. ### Connected lending: policy, limits, and controls - Inclusion in policy: - Banks’ policies on connected lending should be included in their large exposures policy statements (IPRU Banks Chapter LE Section 8.1). - Definition of connected exposures: - Includes intra-group lending, lending to directors, senior managers, controllers (i.e., major shareholders) and their associates (including close family members), and lending to non-group companies with which the bank’s directors or controllers are associated (IPRU Chapter LE Section 5.3). - The FSA retains discretion to determine connectedness where doubt exists. - Standards and safeguards: - Connected exposures should remain an insignificant proportion of a bank’s assets. - Clear and objective credit assessment processes required; lending to connected parties only for the clear commercial advantage of the bank and on an arm’s-length basis. - Factors to assess arm’s-length basis include shareholder influence, management roles, and whether usual monitoring and recovery procedures would apply (IPRU Chapter LE Section 5.3.7). - Limits and concessions: - Aggregated connected lending should be a maximum of 25 percent of a bank’s capital base. - The FSA may consider requests for higher limits in very limited circumstances (example given: group treasury function allowing higher limit for exposures under one year maturity). - Requirements for concessions set out in IPRU Banks (Chapter LE 9.2.2-9.2.5). - FSA may deduct exposures to connected companies/persons from capital if they are capital investments or made on concessionary terms (IPRU Chapter LE 5.3). - Reporting and verification: - Aggregated connected lending reported quarterly via large exposures report. - FSA requires systems to identify all connected exposures and detailed breakdowns of exposures to connected counterparties. - Compliance verification via supervisory or specialist credit visits or skilled persons reports. ### Assessment and supervisory comment on connected lending - Assessment: Compliant - Comments: - The FSA’s supervisory approach offers sufficient safeguards for arm’s-length connected lending. - Requirements for board approval and procedures to prevent beneficiaries participating in assessment are covered by general objective credit assessment requirements and FSA Handbook guidance. - The FSA requires an independent risk management function so parties benefiting should not be part of the risk assessment process. ### Country risk: policies, provisioning, and supervisory information - Policy expectations: - A bank’s approach to sovereign lending and country exposure limits should be included in its large exposure policy statement (IPRU Banks Chapter LE Section 8.1). - The FSA expects policy statements to include limits on a country-by-country basis, though no specific requirement prescribes it. - Notification and supervisory action: - Exposures to overseas countries exceeding 25 percent of capital are not covered by pre-notification requirements for large exposures. - Significant departures from a bank’s large exposure policy statement should be notified in advance and discussed with the FSA. - If dissatisfied with a bank’s country risk policy, the FSA may instruct reductions in exposures or require increased capital. - Provisioning: - FSA guidance for provisioning policy statements does not specifically reference provisioning for country exposures. - Provisioning for country risks is covered by the general requirement to maintain adequate provisions. - The FSA does not set specific provisioning requirements but expects appropriate provisions after discussions with external auditors; it would hold discussions if provisions appear inadequate. - Supervisory monitoring and data sources: - Adherence to country risk and provisioning policies checked via desk-based reviews, on-site inspections, or skilled persons reports. - The FSA obtains country, sectoral, and regional exposure information from banks’ internal monitoring systems and discusses with management (IPRU Banks Chapter LE Section 9.2.7.21). - The FSA has access to country exposure statistical data collected from banks by the Bank of England, including individual banks’ returns identifying cross border claims by country and sector. - Bank of England data are collected quarterly and must be submitted to the Bank of England within two months of the reporting date. ### Assessment and supervisory comment on country risk - Assessment: Compliant - Comments: - Although the FSA does not provide specific guidance on country risk exposures and provisioning, it requires and verifies adequate attention to these issues. - The FSA abandoned setting individual country risk exposure limits as not generically definable and instead focuses on control risks, aligning with international risk management practices. ### Market risks: measurement, controls, capital, and model recognition - Policy and expectations: - Banks are required (IPRU Chapter GN rule 3.4.7) to have a written Trading book policy statement covering identification, valuation, and measurement of market risks in the trading book, including interest rate risk. - Banks must identify, measure, monitor and control exposures to foreign exchange and other market risks across all products (IPRU Banks Chapter AR Section 3.2). - Banks should collect information to measure actual exposures against management-authorized exposure limits, including trading positions (intra-day and overnight) in securities, foreign exchange, futures, options, forward rate agreements and swaps. - Capital charges and data requirements: - The FSA has imposed specific capital charges for market risks (IPRU Chapter CO Section 3) in accordance with the 1996 amendment to the Basel Capital Accord and the EU Capital Adequacy Directive. - Capital charges set for foreign exchange and commodities position risk in the banking and trading books combined. - Separate capital requirements set for equity and interest rate position risk, and for counterparty, underwriting and settlement risk in the trading book. - Firms need good management systems to collate accurate data for valid capital calculations. - Supervisory verification and on-site review: - Compliance determined through desk-based analysis of returns, on-site visits, and ongoing discussions with senior management. - FSA often requests ad hoc management information (analyses) for greater insight. - On-site visits assess senior management’s understanding and involve front office, financial control, risk management, operations, systems development, IT and audit as applicable. - Traded Risk Review Team and model recognition: - FSA has a Traded Risk Review Team in the Risk Review Department focusing on trading and markets activities and their management. - Team has specialists to undertake on-site reviews of treasury systems and controls; on-site visits typically last between one and three days. - Purposes include evaluating whether internal market risk measurement and pricing models can be recognized for calculating market risk capital requirements. - Once recognized, quarterly update visits assess control environment, model outcomes, backtesting and related data; provision of this data is shortly to be automated. - Stress testing: - Banks using internal models for supervisory capital calculation must have a rigorous and comprehensive stress testing program (IPRU Chapter TV Section 9). - FSA examines stress testing programs as part of model recognition; it will not normally prescribe scenarios but may do so in particular market circumstances. ### Assessment and supervisory comment on market risks - Assessment: Compliant - Comments: - The FSA uses specific capital requirements for separate categories of market risks and verifies compliance via desk-based analysis and on-site visits. - Adequacy of controls surrounding market operations is tested by periodic reviews by FSA specialists or skilled persons. - The Traded Risk Review Team appears thinly staffed relative to the number of banks; only about 10 to 12 banks engage in trading highly complex financial products, and a similar number are allowed to use value-at-risk models for supervisory capital calculations. ### Other risks: comprehensive risk management and governance - High-level expectations: - Banks required to maintain systems and controls appropriate to their business (IPRU SYSC 3.1.1R). - Under the Threshold Condition on Suitability, regulated firms must identify and consider the various risks in conducting business and install appropriate control systems. - Directors and management responsible for establishing and maintaining systems and controls appropriate to the nature, scale and complexity of the business. - Internal controls and management information: - FSA guidance on adequate controls and records (IPRU Banks Chapter AR Section 3) includes: - Systems to assure revenues accrue to the bank, expenditures are authorized, assets are safeguarded, liabilities recorded, and statutory/supervisory requirements met. - Management information showing the bank’s state of affairs and exposure to each risk compared to relevant management limits. - High level controls to include strategy and plans, organizational structure and delegation systems (including segregation of duties), approval of risk policies by management, review of high level MI, and monitoring implementation of review action points. - Internal control systems should provide reasonable assurance that management can monitor adequacy of capital, liquidity, profitability, and asset quality, and make appropriate provisions for bad and doubtful debts. - The FSA expects banks to have an internal audit function (allowing outsourcing in some cases) and an audit committee. - Liquidity policy: - Banks are required to provide the FSA with a statement of liquidity policy (IPRU Chapter LM). - Assessment: (assessment text continues in source beyond provided extract) *Source: IMF staff extract from _cr03208 - Section 3.4.1R). The policy should outline the circumstances in which limits (excerpt).* ### Section 3) that should set out their approach to liquidity management, including a description of ### _cr03208 - Section 3) that should set out their approach to liquidity management, including a description of ### Liquidity management policy requirements - Banks should set out their approach to liquidity management, including: - arrangements for management on a day-to-day basis; - an explanation of how much liquidity risk will be assumed. - Liquidity standards must be appropriate to the nature and scale of the bank’s business. - Banks must have systems enabling frequent and timely monitoring of their liquidity profile. - Banks with significant currency business should include policy for monitoring and controlling liquidity positions in individual currencies. - The policy statement should consider management of liquidity in both normal and abnormal circumstances. ### FSA monitoring approaches - The FSA monitors banks’ liquidity using either: - a mismatch approach, or - a stock approach. - Mismatch guidelines consider: volatility, diversity and source of deposits; deposit concentrations; degree of reliance on marketable assets and diversification; availability and reliability of undrawn standby lines; impact of off balance sheet obligations (IPRU Chapter LM Section 8.1). - For the minority of banks with a large retail deposit base in current accounts, a sterling stock liquidity regime requires holding a stock of liquid sterling assets that can easily be sold to replace funding withdrawn. - The stock approach treats a more limited range of assets as liquid than the mismatch approach, to reflect that significant sales by a large bank might unsettle the market. - For U.K. branches of foreign banks, the mismatch approach is normally applied, with the additional requirement that available liquidity actually has to be present in the U.K. - If the FSA is satisfied a branch is fully integrated with its head office for liquidity management and can rely on the home country supervisory regime, it may permit global liquidity management by the head office. ### Reporting frequency and supervisory techniques - Banks on the stock liquidity regime must report their liquidity position to the FSA on a monthly basis. - Banks on the mismatch regime must report on a quarterly basis. - If a bank is experiencing liquidity problems, the FSA may require more frequent reporting, if necessary on a daily basis. - The stock liquidity report must be prepared on a consolidated basis. - The FSA does not normally collect liquidity data in individual currencies but may require reporting in individual currencies if a bank has significant operations in illiquid currency markets. - Supplementary monitoring includes on-site visits and discussions with a bank’s ALM committee to assess management’s ability on issues such as multiple currency liquidity management. ### Interest rate risk in the banking book - No specific FSA guidance is given with respect to banks’ interest rate risk outside the trading book. - The FSA does not see a need for such guidance because many banks have a large proportion of floating rate assets in their banking book, reducing potential interest rate risk. - The FSA will use the Basel Committee’s Principles for the Management of Interest Rate Risk to assess adequacy of a bank’s interest rate risk management. - The FSA conducts stress tests on interest rate positions in the banking book, particularly for the larger banks. - Interest rate risk in the banking book is explicitly considered by the FSA when setting a bank’s individual capital ratio requirement (as are operational risks). - In practice, supervisors’ analysis of interest rate risk in the banking book rarely results in a material increase in a bank’s individual capital ratio. ### Operational risk and business continuity - Each bank is expected to have a control environment that: - minimizes loss from fraud; - safeguards assets; - controls liabilities; - provides reasonable reassurance that business is conducted in adherence to established policies (IPRU Chapter AR Section 3.3). - Specific guidance is given on controls in an IT environment (ibid. Section 3.3.6). - Relatively detailed guidance is given on outsourcing (IPRU Chapter OS). - Each bank is expected to have appropriate arrangements to ensure business continuity in the event of an unforeseen interruption (SYSC 3.2.19). - Through on-site visits, the FSA may check allocated responsibilities, lines of reporting, delegation of authority and other operational risk controls. - Operational risk is among the factors considered by the FSA when setting banks’ individual capital ratio requirements. - The FSA does not currently require a specific operational risk policy statement (in contrast to large exposures, liquidity, provisioning and, where applicable, the trading book). ### Corporate governance and internal control (Principle 14) - Principle 14: Banking supervisors must determine that banks have internal controls adequate for the nature and scale of their business, including: - clear arrangements for delegating authority and responsibility; - separation of functions that commit the bank, pay away funds, and account for assets and liabilities; - reconciliation of these processes; - safeguarding assets; - appropriate independent internal or external audit and compliance functions to test adherence to controls, laws and regulations. - Companies Act 1985 prescribes duties of directors; applies to all companies, including banks. - Banks listed on the London Stock Exchange are subject to a Listing Rule and Combined Code reflecting the Hampel Committee recommendations; requirement to produce a statement of directors’ responsibilities. - The Combined Code (provision D.2.1) states directors should, at least annually, conduct a review of the effectiveness of the group’s system of internal control and report that they have done so; review should cover financial, operational and compliance controls and risk management. - Specific internal control requirements and record keeping are outlined in SYSC and IPRU Banks (Chapter AR). - SYSC requires allocation to one or more individuals of functions dealing with apportionment of significant responsibilities and overseeing establishment and maintenance of systems and controls. - Banks must take reasonable care to establish and maintain systems of controls appropriate to the nature and scale of their business (SYSC, 3.1.1R). - Banks are required to have documented high level controls defining management responsibilities, identifying lines of reporting, and outlining implementation of requirements with respect to segregation of duties, accounting records and measures to safeguard assets (SYSC 3.2 and IPRU Chapter AR). ### Assessment and supervisory commentary - Assessment: Compliant - Comments: - Each bank is required to maintain systems and controls appropriate to the risks of its business. - The FSA has issued guidance on liquidity risk, interest rate risk and key aspects of operational risk, and applies specific capital requirements to foreign exchange risk. - The FSA verifies the extent to which a bank’s risk management system addresses key banking risks during on-site visits. - The FSA’s mismatch or stock liquidity regimes appear somewhat dated and not aligned with more sophisticated banks’ approaches to measuring and managing liquidity. - The FSA has begun considering development of a new approach giving banks a choice between a standardized measurement technique and the use of liquidity modeling techniques for liabilities with a behavioral maturity and contingent claims. - The new approach aims to create incentives for banks to develop their own liquidity measuring and management techniques. - Actual implementation of the new approach still appears to be some years off, but the mission believes it could constitute a significant step forward. *Source: IMF staff report content provided in the PDF chapter excerpt.* ### Section 3.3.5). The FSA also requires that banks have procedures to ensure that personnel have ### _cr03208 - Section 3.3.5). The FSA also requires that banks have procedures to ensure that personnel have ### Internal controls, segregation of duties and internal audit - FSA requirement: personnel must have "capabilities commensurate with their responsibilities" and implement effective segregation of duties (IPRU Chapter AR Section 3.3.5). - Internal audit required by IPRU (Chapter AR Sections 3.3.9 and 3.3.10); primary responsibility for preventing internal fraud lies with senior management. - Internal audit function expectations: - Clear responsibilities, objectivity and independence supported by appropriate reporting lines (typically dual reporting from head of internal audit to the chief executive officer and access to the audit committee) (IPRU Chapter AR Sections 3.3.9 and SYSC 3.2.16G). - Unrestricted access to all activities, records, property and personnel. - Outsourcing allowed but normally not to external auditors or skilled persons unless conditions safeguard independence; outsourcing proposals should be notified to the FSA (IPRU Chapter OS Section 4.7). - External auditors: - Test accounting procedures in financial statement audits and report significant deficiencies in a management letter. - May notify the FSA of information relevant to supervisory objectives (FSMA section 342). - Expectation that management forwards material management letters to the FSA; failure to do so may be reported as lack of integrity. - Assessment: Compliant. - Comments: FSA requires reasonable controls appropriate to nature and scale of business, including high level management controls and an appropriately resourced internal audit reporting to an audit committee chaired by an independent director. ### Fitness, approvals, and board composition - Directors and senior management must be vetted and approved by the FSA as fit and proper (FSMA Schedule 6, paragraph 5): honesty, competence, and financial soundness. - Applicant carries burden of satisfying the FSA; FSA considers board expertise distribution when assessing individuals. - Approved individuals must maintain fitness and propriety; FSA can initiate removal proceedings if no longer fit and proper. - FSA follows Cadbury and Hampel guidance on Audit Committees and non-executive directors (IPRU Chapter AR Section 3.3.10). - FSA expects an appropriate proportion of non-executive directors to executive board members (Guidance for firm specific risk assessment and risk mitigation, Appendix 3, Corporate Governance, version 5, November 2001). - FSA checks non-executive directors via on-site visits and documentation review that they: (a) have necessary skills/background, (b) participate fully in committee meetings, and (c) exercise independent judgment; non-executive directors must be vetted and approved by the FSA. ### Powers to require information and supervisory access - FSA powers: - Require banks to provide information (FSMA Section 165). - Require a report on the firm by a skilled person (FSMA Section 166). - Request copies of internal audit reports and minutes of audit committee meetings where necessary. - FSA assesses internal audit quality during on-site visits and meets at least annually with the chairman of a bank's audit committee. - Front/middle/back office effectiveness reviewed via regular on-site visits, specialist visits, or skilled persons. - Assessment status in section: Compliant (for governance and audit aspects noted above). ### Principle 15 — Money Laundering: statutory framework and FSA rules - Statutory objective: FSMA requires the FSA to reduce potential for regulated businesses to be used in connection with financial crime (money laundering, fraud or dishonesty, criminal market misconduct). - Money Laundering rules and Handbook references: - Money Laundering Sourcebook: ML 7.2 (systems and controls), ML 3 (customer identification), ML 4 (suspicious transaction reporting), ML 7.3 (record keeping requirements and period), ML 6 (awareness and training), ML 7 (appointment of MLRO and MLRO approval requirement). - Customer identification: banks must verify identity "as soon as is reasonably practicable" after first contact; obligation extends to business undertaken on behalf of another person. - JMLSG Guidance Notes: - Industry guidance (advisory) on how and when to identify customers; FSA takes them into account when evaluating customer identification procedures. - Guidance Notes cover tests for suspicion (e.g., size consistency with normal activity) and wire transfer issues (Guidance Notes 5.62-5.64). - Recognition and reporting of suspicious transactions: - No explicit FSA/Regulations requirement for formal procedures to recognize suspicious transactions, but JMLSG practices and Handbook obligations effectively require structured procedures. - All bank staff required to report suspicions to the MLRO; firms must take reasonable steps to ensure staff handling relevant transactions report promptly. - MLRO (an Approved Person) responsibilities include receiving internal reports, reporting to NCIS, ensuring awareness/training, monitoring day-to-day compliance, and preparing an annual report to management. - Annual MLRO report used to highlight compliance problems; FSA supervisors may request a copy. - Reporting obligations: - Banks must report suspicions to NCIS; no specific duty to report suspicions to the FSA, but regulatory obligation exists to notify the FSA of significant incidences of fraud. In assessing significance firms consider: (i) size of loss relative to bank or customers; (ii) risk of reputational loss; (iii) whether incident reflects internal control weaknesses. ### FSA supervisory approach to anti-money laundering - Risk-based approach: FSA identifies key risk criteria from money laundering typologies, scores criteria against bank business profiles, evaluates extent and probability of money laundering risk and potential impact to FSA objectives (size is a major scaling factor). - Outcomes of risk analysis determine supervisory tools, resources, intensity and focus. - July 2001 report "The Money Laundering Theme" identified six "clusters" vulnerable to money laundering; two clusters concerned banks. - Thematic supervision: - Horizontal review across banks, including on-site testing of AML procedures; theme reviews are targeted based on risk assessments. - FSA specialist resources and tools to assess AML compliance: - a Money Laundering Review Team; - power to appoint "skilled persons"; - an Intelligence and Records Department (liaises with law enforcement); - the Financial Crime Policy Unit (provides guidance). - FSA enforcement and information sharing: - Tools to compel compliance: financial penalties, public censure, vary/cancel permissions; FSA is a criminal prosecuting authority under the Regulations. - Confidentiality constraints apply; FSA may disclose information to equivalent international bodies under appropriate safeguards and to other regulators under cooperation agreements consistent with EU single market directives. ### Additional AML criteria and supervisory findings - U.K. laws/regulations largely compliant with FATF recommendations. - FSA Rules require relevant staff training at least every 24 months. - FSA Regulations require an FSA supervisor to report knowledge or suspicion of money laundering as bank staff would. - Criminal law gateways permit information sharing for criminal investigations or proceedings. - Assessment: Largely compliant. - Comments and gaps: - Essential Criterion 3 ("banks have formal procedures to recognize potentially suspicious transactions"): FSA does not mandate formal procedures, but supervisory regime and JMLSG Guidance effectively achieve the substance; FSAP team recommends a formal policy would strengthen internal governance. - Essential Criterion 11 (policy statement on ethics/professional behavior communicated to all staff): FSA does not explicitly require such a written policy, but Principles for Business and Statements of Principle for Approved Persons achieve the substance. - FSA supervision has intensified since FSMA; further reinforcement expected with Proceeds of Crime Act anticipated in 2002. - Concern considered about selectivity of risk-based supervision for smaller, low impact firms — FSAP team found targeted thematic visits mitigate this risk. ### Principle 16 — On-site and off-site supervision: model and practices - FSA combines on-site examinations and desk-based analysis; supported by risk review teams with specialized expertise (corporate governance, risk management, internal audit, IT, AML controls, quantitative modeling). - Power to appoint skilled persons (section 166 FSMA); skilled persons often auditors from big five; number of such reports reduced. - Sector-wide statistical analysis performed on prudential returns, financial statements, share prices, credit ratings and other quantitative information. - Risk-focused assessment model: - Identifies key risks to FSA statutory objectives; rates banks as high impact, medium high impact, medium low impact, or low impact. - Firm-specific model breaks down business and control risks; up to about 35 different business lines for a large bank. - Inputs include on-site work, management interviews, prudential returns, firms’ annual AML report, external auditors’ management letters, special information requests, and public information. - Findings from internal auditors considered if audit work is independent and competent. - Firm-specific assessment cycle: process will take three to six months; for large banks carried out on a one and a half to two year cycle. - Outcome: risk mitigation program detailing supervisory work until next cycle and actions for the institution. - On-site supervision intensity: - High impact firms: regular visits by dedicated supervisory teams, focused expert reviews, frequent management contact. - Low impact banks: largely off-site baseline monitoring, on-site visits at least once every three years (but more often in practice), no dedicated relationship manager under the new regime. - As of June 2002: 44 banks graded low impact (excluding 7 EEA branches and 9 banks part of a wider group); of the 44, 16 were branches of overseas banks and 28 included small retail banks and some wholesale specialists. - Six low impact banks were subject to intensive supervision because risks had crystallized. - Total deposit liabilities of the low impact banks amounted to 0.03 percent of total deposit liabilities of all U.K. banks. - On-site visit scope and duration: typically around three days, extending up to one week in some cases. - Thematic regulation development and Risk Management Units: - Themes covered include credit risk, systems and controls, AML measures. - Thematic outcomes may include rule changes, guidance letters, seminars, speeches, or enforcement action; themes may expand beyond initial samples if significant issues uncovered. - Quality assurance and confidentiality: - On-site and off-site effectiveness reviewed by a panel of senior and independent supervisors; supplemented by an internal Quality Assurance Department in the Chairman’s Office. - FSMA (Part XXIII) restricts disclosure of confidential supervisory information; FSA may provide confidential information to other regulators on condition of equivalent confidentiality protections. - Assessment: Largely compliant. - Comments: Risk-based approach concentrates supervisory resources on larger institutions; FSAP noted potential limitations for achieving in-depth understanding of smaller banks under off-site reliance and recommends consideration of more frequent audited returns and regular disclosures to strengthen off-site monitoring. Noted data points: - firm-specific risk assessment: three to six months; - large banks: one and a half to two year cycle; - up to about 35 different business lines for large banks; - on-site visits: typically three days up to one week; - as of June 2002: 44 low impact banks; total deposits 0.03 percent of all U.K. bank deposits. ### Principle 17 — Bank management contact and information flows - Intensity of contact linked to bank risk assessment and FSA judgment on bank risk management sophistication. - High-impact banks: frequent contacts with directors and senior management, bank-specific on-site visits, thematic visits involving middle management and other employees. - Low-impact banks: occasional thematic visits and less frequent meetings with directors/senior management; FSA asserts it has a good understanding of smaller banks due to their relative simplicity. - FSA supervisory tools for understanding operations: meetings, on-site visits, desk reviews, liaison with other regulators, analysis of periodic returns and notifications, access to internal audit reports and external auditors’ management letters, and commissioning of skilled persons. - Principle 11 of FSA’s Principles for Business: firms must deal with the regulator in an open and cooperative way and disclose anything the FSA could reasonably expect to receive notice of (including significant systems/control failures, capital adequacy changes, and proposed operational changes affecting risk profile). *Source: _cr03208 - Section 3.3.5). The FSA also requires that banks have procedures to ensure that personnel have (IMF content unit).* ### Section 15.3 requires specifically that the FSA must be notified immediately if a firm becomes ### _cr03208 - Section 15.3 requires specifically that the FSA must be notified immediately if a firm becomes ### Notification requirements (Section 15.3) - Section 15.3 requires specifically that the FSA must be notified immediately if a firm becomes aware that any of the following has occurred or may occur in the foreseeable future: - The firm’s failing to satisfy one or more of the threshold conditions - Any matter which could have a significant adverse impact on the firm’s reputation - Any matter in respect of the firm that could result in serious financial consequences to the financial system or to other firms - Any offences and breaches of the FSMA or rules established under the FSMA. - Assessment: Compliant ### Management fitness, approval, and supervisory contact - Banks must meet the threshold conditions for authorization on an on-going basis and key individuals within the bank have to be vetted and approved to carry out their particular functions. - An individual that does not meet the FSA’s fit and proper standards can be disapproved for carrying out particular functions or banned from employment in the regulated financial sector altogether. - Comments: - The FSA has frequent contacts, both through face-to-face meetings and other means, with various levels of management at the larger banks. - Meetings with managers of small banks appear to be rare, reflecting the FSA’s risk based approach which allocates scarce supervisory resources primarily to larger banks. - For low impact banks, the FSA relies mostly on desk based review of prudential returns, written material such as external auditors’ management letters and other quantitative and qualitative material, except for occasional visits in thematic reviews. - Management contact with low impact banks takes place once every three years at a minimum but in practice usually more often, especially after risks have crystallized. - The FSA expects to be notified if a low impact bank were to experience safety or soundness problems or to enter risky new business. - The mission welcomes the FSA’s intention to establish clearer guidelines for offsite monitoring triggers that would prompt it to initiate contact with low impact firms; such triggers would also be useful for medium-low impact firms and, in general, for all firms. ### Off-Site Supervision (Principle 18) — reporting framework and practices - Principle: Banking supervisors must have a means of collecting, reviewing, and analyzing prudential reports and statistical returns from banks on a solo and consolidated basis. - Description and reporting requirements: - Requirements for banks to report regularly to FSA are laid out in Chapter 16 of the Supervision (SUP) chapter of the Handbook. - Under Principle 11 banks are required to deal with their regulators in an open and cooperative way, and to tell the FSA appropriately anything of which the FSA would reasonably expect notice. - The required compliance reports include: - an annual report on controllers (SUP 16.4.) - an annual close links report (SUP 16.5) - an annual report listing all overseas regulators for each legal entity of a firm’s group - an annual organogram showing the authorized entities in the firm’s group (SUP 16.6.5) - SUP 16.7.7 identifies eleven separate reports that banks are required to submit with varying frequency over the course of the year. - Standardized forms address capital adequacy, large exposures and liquidity. - Specific returns and frequencies: - The standardized BSD3 Capital Adequacy Return filed semi-annually provides detailed information on both a solo and consolidated basis for on-balance sheet and off-balance sheet assets and liabilities, divided between the banking book and the traded book, profits and losses, counterparty exposure on derivative contracts, repos and similar transactions, large exposures, provisions against bad and doubtful debts and investments, deposit sources and market risk in the trading book. - IPRU (Chapter CS) sets out the basis on which consolidation will be required and the consolidation techniques that are to be applied for U.K. incorporated banks and banking groups with U.K. non-bank parents only. - For banks subject to the liquidity mismatch requirements, quarterly reporting is required using Form LR. - For firms subject to the stock liquidity regime, monthly reports are required, using Form SL R1. - The Liquidity Management (LM) chapter of the Handbook provides detailed guidance on the information to be provided in the liquidity reports. - U.K. banking groups are required to report quarterly on large exposures, on both a solo and a consolidated basis, using Form LE 2. - U.K. branches of non-EEA banks are required to report on profits, large exposures, balance sheet, off-balance sheet items, and bad and doubtful debt provisions using the half-yearly Form B7. They are also required to provide liquidity information quarterly, using Form LR. - Valuation (VA) chapter of the Handbook spells out FSA policies regarding valuation of assets and liabilities in considerable detail. - Enforcement and statutory powers: - Knowingly or recklessly giving information which is false or misleading in a material particular may be a criminal offence under sections 398 and 400 of FSMA. - The handbook (SUP 15.6.1R and SUP 15.6.3R) requires an authorized person to take reasonable steps to ensure the accuracy and completeness of returns and to notify FSA immediately if material or inaccurate information has been provided. - Failure to do so may result in fines or other disciplinary sanctions (ENF 13.5). - FSMA (Section 165) gives the FSA statutory powers to require the provision of information. - Assessment: Largely compliant - Comments and identified gap: - FSA has a well structured system of prudential reporting requirements for banking groups covering financial and compliance information; standardized reports are required on capital adequacy, large exposures and liquidity, on both a solo and a consolidated basis where appropriate. - Essential Criteria 4 of Principle 18 requires: “Inclusion of data on loan classification and provisioning is also required.” - FSA does not routinely collect standardized data on classified or non-performing loans. As a matter of policy, FSA has not established regulatory loan classification or loan delinquency systems, preferring to emphasize that proper loan classification and asset valuation are responsibilities of bank management based on the circumstances of the individual institutions. - The FSAP team believes the absence of reporting on classified loans and non-performing loans handicaps the ability of FSA to verify the credit risk environment of banks, particularly on an offsite basis. - Peer group analysis would be strengthened if standardized information were available on classified and non-performing assets. - Forthcoming adoption of Basel II and IAS 39 will require changes in firm practices with respect to provisioning and loan classification; IAS 39 will require a more rigorous approach to recognition of impaired assets and loan loss provisioning and Basel II will emphasize more rigorous internal loan classification systems. ### Validation of Supervisory Information (Principle 19) - Principle: Banking supervisors must have a means of independent validation of supervisory information either through on-site examinations or use of external auditors. - Legal authority and practices: - Section 165 of the FSMA gives the FSA the authority to obtain information from banks, including access to a bank’s directors, senior management, and key personnel. - The FSA uses on-site visits to most banks as part of its formal risk assessment process; however, a small number of small banks considered to be “low impact” do not receive a formal risk assessment and are reviewed primarily using desktop baseline monitoring, with on-site visits being event driven. - Risk assessment visits for the high, medium-high, and medium-low impact banks take the form of on-site high-level reviews by the supervisory team. Results are used to develop a risk mitigation program (RMP) which establishes supervisory objectives and identifies areas for further on-site review. - On-site reviews may be conducted by frontline supervision, by the FSA’s internal risk review teams, or by engaging skilled persons, e.g., external auditors, to validate supervisory information provided by banks. - Role of auditors: - The FSA Handbook (SUP 3) provides rules and guidance on the role auditors play in the FSA’s monitoring of a bank’s compliance with its rules and standards, addressing auditors’ qualifications, independence, reporting, and the duty to notify the FSA of any significant matters raised by the auditor. - The FSA rules place the duty on the bank to ensure the auditor is qualified and independent; however they prohibit a bank from appointing an auditor the FSA has disqualified. - The FSA rules establish specific areas to be covered in the auditor’s report, and require a copy of all reports be provided to the FSA. - SUP 3.8.2R requires the auditor to co-operate with the FSA. - While SUP 3 does not provide for FSA’s monitoring of the quality of the auditor’s work, provisions in SUP 5 relating to skilled persons reports provide for monitoring of work related to skilled persons reports. - The FSA meets periodically with the bank's external auditors, on a bilateral basis. External auditors have a statutory duty to inform the FSA of any concerns arising during the course of their work. *Source: _cr03208 - Section 15.3 requires specifically that the FSA must be notified immediately if a firm becomes* ### Section 166 of the FSMA gives the FSA the authority to require the bank to obtain a skilled persons ### Section 166 of the FSMA gives the FSA the authority to require the bank to obtain a skilled persons report ### Skilled persons reports: legal basis, process, and practice - Section 166(4) of the FSMA requires that the skilled person must be nominated or approved by the FSA, and that the skilled person must appear to the FSA to have the skills necessary to make a report on the matter concerned. - Additional rules and guidance relating to the use of skilled persons is found in the FSA Handbook (SUP 5). - The large international accountancy firms produce the vast majority of skilled persons reports. - The FSA will direct the scope of the review using a commissioning letter; the nature of work to be completed may be discussed by the FSA in advance. - SUP 3 reporting and notification rules also apply to skilled person’s reports. - The FSA may hold bilateral meetings with individual partners within these firms to provide feedback from supervisory teams on scope and quality; trilateral meetings are held to discuss findings of skilled person’s reports. - SUP 5 formal process elements: - Preliminary discussions about scope. - Engagement/scoping letter to the skilled person. - Definition of objectives to be accomplished by the review. - Section 166 exams may be required to cover internal control systems used to generate consolidated accounts. - In practice, large international firms perform the majority of external audits and skilled persons reports. ### Supervisory returns: review, validation, and limitations - Supervisory returns are reviewed by supervisors for consistency and plausibility. - Timeframes for supervisory returns review: - An initial check is required within 2 days of receipt. - A more detailed check is required to be completed within ten days of receipt. - Review procedures include trend analysis, plausibility checks, comparisons with previous returns, and checks against audited accounts for capital adequacy and large exposures capital base; supplemented by peer group analysis. - Validation checks completed by one supervisor must be checked and signed off by another supervisor. - Follow-up with the bank reconciles outlier data and inconsistencies. - Banks are subject to fines for late returns. - The FSA does not require auditors to examine certain key supervisory returns, such as capital adequacy, at least annually; FSA examiners do not routinely validate returns to bank records. - FSA powers to ensure validity of supervisory returns: - Authority under S165 of FSMA to request additional information from the bank at any time. - Authority under S166 to require skilled persons report to verify the accuracy of information provided. - Ability to request supplementary information from the bank’s auditors under SUP 3.8.2R (Auditor’s duty to cooperate with FSA). - The FSA can independently validate supervisory returns through: - Supervisory visits (used to review the bank’s process for completing reports; do not include validating key returns). - Risk Review Division visits. - Skilled person’s reports. - Use of internal risk review or skilled persons reports depends on issues raised during supervisory visits, firm impact rating, and resource availability. - FSA has identified validation of supervisory returns as a topic for theme supervision over the next year. ### Use of resources, frequency estimates, and constraints - Resource constraints and costs limit use of skilled persons reports and on-site risk review visits to validate supervisory information. - The FSAP team was told that, partly because of their expense, FSA has discontinued the routine use of skilled persons reports to validate regulatory returns; they may be used on an exceptional basis. - Going forward, skilled persons reports will focus on: - Situations where remedial work is needed quickly. - Situations where the FSA does not have the resources and/or expertise to conduct the review internally. - Estimated ordering of skilled persons reports: - The Major Financial Groups Division (MFGD) estimated that 70-120 skilled persons reports would be ordered per year across the 52 largest bank, securities and insurance groups firms supervised by the division. - The Deposit Takers Division (DTD) estimated that they would order about 15-20 skilled persons reports, across about 200 banks. - Internal risk review headcount and capacity: - Internal risk review has an approved head count of 46 (including administrative support) to support work across all of FSA. - MFGD supervisors indicated risk review currently is unable to fill all requests for their services; requests are prioritized and some reviews may be negotiated or deferred. ### Assessment, gaps, and recommendations on supervisory returns validation - Assessment: Largely Compliant - Comments: - The FSA has the means to independently validate supervisory information through supervisory visits, risk review division visits, or commissioning skilled person’s reports. - However, costs and resource constraints limit the use made of skilled persons reports or on-site risk review visits to validate supervisory information. - Essential Criteria 5 context: - Essential criteria 5 provides that the supervisor should require that certain key supervisory returns, such as capital adequacy, be examined at least annually by the auditors and a report submitted to the supervisor. - The FSA has no explicit requirement that supervisory returns be validated in the manner called for by criteria 5, although elements are met through the requirement for an annual audit of statutory accounts and FSA’s ability to consult with and request information from auditors. - Recommendation: - Because the FSA relies on supervisory returns as a key part of its risk based approach to supervision and particularly for its baseline-monitoring program, it is very important that the FSA be able to place reliance on the accuracy of that information. - The FSAP team recommends that FSA should consider going beyond the literal requirements of Essential Criteria 5 and consider requiring all banking groups to provide annual audits of key supervisory returns. - It would be useful if validation of supervision were made a regular topic for theme supervision. - It would be desirable for all U.K. banks to be required to publish audited financial reports on an annual basis, coupled with a continuous disclosure requirement — currently these requirements apply only to listed companies. ### Consolidated supervision (Principle 20): scope and approach - Consolidated supervision is an essential element of banking supervision to supervise the banking group on a consolidated basis. - The FSA approach to consolidated supervision is set out in IPRU (CS Chapter) implementing the EU Banking Consolidation Directive and the EU Post-BCCI Directive. - Consolidation policy addresses three main concerns: - Losses in another group entity that could lead to financial pressure on the bank because of financial or reputational linkages. - Capital that is subject to double-gearing or leveraging (solo assessment may over-estimate available capital). - Business booked in an unauthorized group entity to avoid regulatory requirements. - FSA views consolidated supervision as complementing individual firm requirements rather than substituting for them. - FSA is required to undertake supervision on a consolidated basis by EU legislation, in particular the Banking Consolidation Directive. - Consolidated supervision framework consists of: - A qualitative assessment of the group as a whole (significant business units, business, controls, organization, management). - A quantitative, consolidated assessment establishing prudential requirements (capital adequacy, large exposures). - Scope and controls: - The scope includes all parents and subsidiaries of the bank, any of their parents or subsidiaries; any undertaking in which those parents or subsidiaries or the bank have a participation. - The FSA may require inclusion of an undertaking not formally in the group if omission would be misleading. - CS 3.1.3 requires the bank have adequate controls to produce any data required to supervise on a consolidated basis. - CS 3.3.19 requires adequate controls to identify and monitor large exposures. - Consolidated returns required twice annually; large exposures must be reported quarterly. - CS 3.3.7 requires a detailed organization chart and identification of subsidiaries supervised by others. - Offshore, cross-border, and coordination arrangements: - Consolidation usually applies to financial subsidiaries; insurance and insurance broking are not normally consolidated (CS 4.3). - For activities in the U.K., coordination among functional regulators of a group takes place within FSA. - Arrangements exist with home and host supervisors overseas for exchange of information on financial condition and risk management. - Where FSA is unable to satisfy itself that an overseas parent is subject to adequate home country consolidated supervision, FSA may require solo consolidation at the U.K. level. - Fit and proper tests may be applied to senior management of parent companies under the FSA’s authorized persons regime. - Offshore center exposures are included in quantitative consolidation and capital adequacy ratio and controls on large exposures; FSA may impose additional capital, deconsolidation, or restrict transactions with concern jurisdictions. - U.K. financial institutions must provide the FSA all information required for effective consolidated supervision wherever business is conducted. - FSA anti-money laundering policies expect overseas affiliates of U.K. banks to conform to the higher of U.K. or local standards; compliance is a duty of the bank’s MLRO, who must be authorized by FSA. - FSA places strong emphasis on quality of counterpart financial supervision in jurisdictions where business is conducted and on willingness of other supervisors to share information; FATF NCCT classifications and FSA experience are taken into account. - FSA has active involvement with numerous offshore centers, particularly U.K. overseas territories and dependencies, including regional participation and liaison with offshore supervisors. - Assessment: Compliant - Comments: - FSA has comprehensive arrangements to supervise U.K. banking groups on a consolidated basis, quantitatively and qualitatively, regardless of where business is carried out. - Capital requirements set procedures for consolidating group accounts to ensure U.K. banking activities are adequately capitalized on solo and consolidated bases. - Large exposure limits have clear policies enforced on solo and consolidated bases. - Management systems and controls are required to identify, measure, monitor and control risks from dealing with other parts of the group. - A variety of arrangements exist for coordinating and cooperating with other regulators at home and overseas. ### Accounting standards (Principle 21): records, audits, and auditor interaction - Principle 21 premise: Supervisors must be satisfied banks maintain adequate records drawn up in accordance with consistent accounting policies that enable a true and fair view of financial condition and profitability; banks must publish financial statements that fairly reflect condition on a regular basis. - Legal and regulatory requirements: - Threshold conditions require banks to have adequate resources, including high level systems and controls. - SYSC 3.1.1R and 3.2.20R require directors and management to ensure banks maintain adequate records (including accounting records) appropriate to scale, nature and complexity. - IPRU (Banks) Chapter AR provides guidance on adequate accounting records and internal control systems. - Banks must capture and record accurately and on a timely basis every transaction and commitment (IPRU Chapter AR 3.2.2). These provisions apply to all U.K. banks and branches of non-EEA banks. - For U.K. incorporated banks, further accounting record requirements are set out in the Companies Act 1985. - FSA has powers to enforce records requirements and may fine banks for late and inaccurate supervisory returns. - FSA authority under FSMA Section 166 can commission a skilled persons report to verify bank records in particular areas; internal risk review division may also be used. - Accounting principles and valuation: - Regulatory reporting forms are accompanied by detailed guidance notes including information on accounting treatment. - Banks are required to use generally accepted accounting principles when valuing assets. - FSA reports should be prepared using book value of assets and liabilities; banking and trading books should be valued on an accrual basis unless otherwise agreed in writing with FSA. - CAD banks should value trading books on a mark-to-market basis and banking books on an accrual basis. - IPRU (Banks), Chapter GN 3.3.17R requires U.K. banks and non-EEA overseas branches to maintain adequate provisions for depreciation or diminution in value of assets (including loan loss provisions), for liabilities which will or may fail to be met, and for losses which it may incur. - IPRU (Banks), Chapters VA and PN discuss valuation and provisioning policies. - Companies Act and auditing: - Companies Act 1985 requires U.K. banks to prepare accounts giving a true and fair view; accounts are subject to public filing and detailed provisions in Schedule 9. - General presumption that compliance with U.K. Financial Reporting Standards (FRS) and Statements of Standard Accounting Practice (SSAP) is necessary for a true and fair view. - Banks must state whether accounts prepared in accordance with these standards and disclose departures. - Banks are expected to comply with five industry-specific Statements of Recommended accounting Practice (SORP) and must state compliance or explain non-compliance. - All U.K.-incorporated banks must appoint an external auditor (SUP 3.3.2R); published accounts must bear an external auditor opinion on completeness and accuracy (SUP 16.7.8R). - Auditors must comply with Statements of Auditing Standards from the U.K. Auditing Practices Board; failure to comply with accounting standards would result in a qualified auditor opinion. - Auditors have a legal duty to report to the FSA breaches or possible breaches of laws or rules and other matters reasonably believed to be significant (FSMA Section 342 and SUP 3.8.10R). - Sections 342 and 343 of the FSMA provide protections for auditors reporting in good faith matters material to the FSA. - SUP 3.8 provides guidance regarding an auditor’s duty to report. - FSA authority and interaction with auditors: - FSMA gives the FSA authority to disqualify auditors if they have failed to comply with a duty imposed under FSMA; banks are prohibited from using disqualified auditors under SUP 3.4.5R. - If FSA has concerns about a bank’s external auditors’ abilities, it may request management to change the audit firm. - Under Section 166 of the FSMA, the FSA may appoint a skilled person to do onsite work on its behalf; the FSA determines that the skilled person has appropriate expertise. - SUP Chapter 3 governs FSA’s relationship with external auditors; SUP Chapter 5 addresses skilled persons reports. - Internal audit expectations: - The FSA does not have specific guidelines addressing scope and conduct of internal audits. - The FSA does look at the audit universe and may guide scope of internal audit when it meets supervisory needs. - The FSA would expect internal audit to have a risk based approach. *Source: IMF Financial Sector Assessment Program (FSAP) chapter text provided in the content unit.* ### Chapter 349 of the FSMA imposes confidentiality requirements on the FSA. Refer to CP 1(6) for ### _cr03208 - Chapter 349 of the FSMA imposes confidentiality requirements on the FSA. Refer to CP 1(6) for ### Confidentiality and public disclosure - Chapter 349 of the FSMA imposes confidentiality requirements on the FSA. - Refer to CP 1(6) for further details on confidentiality. - The FSA supports Basel and EU proposals to promote public disclosure by banks as a means of strengthening market discipline as a complement to other regulatory efforts. - Assessment: Compliant ### Principle 22. Remedial Measures — description and assessment - Requirement: Supervisors must have adequate supervisory measures to bring about timely corrective action when banks fail to meet prudential requirements, regulatory violations occur, or depositors are threatened; in extreme circumstances this should include ability to revoke or recommend revocation of a banking license. - FSA powers and measures: - FSMA Section 43: place requirements or restrictions in a bank's permission; require a bank to take or refrain from specified action. - FSMA Section 45: vary or cancel a bank’s permission. - FSMA Section 206: fines. - FSMA Section 205: public censure. - FSMA Section 53(3): may take Section 45 actions that have immediate effect if FSA reasonably determines immediate effect is necessary. - FSMA Section 380: injunctive relief available. - FSMA Section 382: restitution orders available. - FSMA Section 61: control over individuals performing “controlled functions” by requiring FSA approval. - SUP chapter of the FSA Handbook (Section 10, Approved Persons): list of controlled functions. - FSMA section 63: withdraw approval if person no longer fit and proper. - FSMA Section 66: action against an approved person for misconduct. - FSMA section 347: procedures regarding publication of information about a prohibited person when prohibition order is made. - Governance and appeals: - Regulatory Decisions Committee (RDC): committee of practitioners and public interest members appointed by the Board, independent of FSA executive staff; may take major regulatory decisions on behalf of, and is answerable to, the FSA Board. - FSM Tribunal: independent body to consider major regulatory decisions if referred by firm or individual. - Timeliness and procedures: - FSMA contains no express requirement that the FSA take action within any particular time frame, except for representations or referrals to the FSM Tribunal. - No formal guidance or voluntary commitment by the FSA to any timeframe; legal remedies include proceedings under general courts/Tribunal jurisdiction and Article 6 of the European Declaration of Human Rights (right to independent determination within a reasonable time frame). - Once formal supervisory or disciplinary action is initiated by service of a notice, a statutory time frame applies to completion of the process for making representations or referring to the Tribunal; no constraints on initiation of action. - FSMA Part XXVI requires compliance with formal written notice procedures when the FSA exercises formal disciplinary or supervisory powers. - Comments and assessment: - Assessment: Compliant - The FSMA provides the FSA with broad remedial and enforcement powers, including sanctions against individuals and firms. - Adequate protections (referral to the Tribunal) exist to guard against abusive enforcement or disciplinary actions. - The new enforcement powers under FSMA are very recent and have been used in a handful of actions to date; effectiveness of FSA’s use of powers is difficult to assess. ### Principle 23. Globally Consolidated Supervision — description and assessment - Requirement: Supervisors must practice global consolidated supervision over internationally active banking organizations covering foreign branches, joint ventures, and subsidiaries. - Legal/operational basis: - Authority for supervising overseas activities of U.K. incorporated banks provided in Threshold Condition 3: (Close Links), based on Paragraph 3, schedule 6 of FSMA; implements and expands EU Post BCCI Directive requirements. - FSA carries out global consolidated supervision for U.K.-based banking groups, including non-U.K. group companies. - Foreign branches of U.K. banks (not separate legal entities) are considered integral parts of the U.K. bank and supervised accordingly. - Quantitative consolidation (see Principle 18) applied to global undertakings of U.K.-based banking groups. - Supervisory approach: - Risk-based approach concentrates effort on significant business units identifiable geographically, legally or by business. - Supervisory effort directed at ensuring banks have information systems and controls adequate to manage risks in all business units, wherever located. - Heads of significant business units seen during risk assessment or in subsequent supervisory period. - Supervisors periodically visit major overseas operations; FSA conducts on-site examinations of overseas branches and subsidiaries, usually in conjunction with host country supervisor. - FSA imposes limitations on overseas activities where necessary to meet close links/supervisability requirements in Threshold Conditions. - FSA assesses extent of supervision undertaken by other supervisors and forms judgement on their compliance with the Basel Core Principles. - Assessment: Compliant ### Principle 24. Host Country Supervision — description and assessment - Requirement: Establish contact and information exchange with other supervisors, primarily host country authorities. - FSA arrangements: - Extensive network of formal and informal contacts with overseas banking supervisors for exchange of information; both multilateral and bilateral. - Active participation in supervisory groups: Basel committee, Banking Advisory Committee, Groupe de Contact. - Bilateral memoranda of understanding with numerous countries for information exchanges and on-site examinations of branches and subsidiaries of U.K. banks. - Active dialogue with supervisors in offshore centers, overseas territories and crown dependencies. - Information exchanges include written documentation for authorizations and oral sharing of supervisory judgements. - FSA regularly visits major overseas offices and frequently conducts joint examinations with host country supervisors. - Considerations and constraints: - Readiness of overseas supervisor to provide information is a factor in determining extent to which FSA can rely on their work. - Threshold Condition 3 (Close Links) would be breached if regulations of a non-EEA territory prevent FSA effective supervision of a bank or affiliate. - PRIN (Principle for Business) requires firms to deal with regulators openly and cooperatively and disclose to FSA anything it would reasonably expect notice of; enforced in Rule 2.1.1 in SUP. - COND 2.3.3G notes restrictions on information flow could stop a firm complying with SUP rules on information gathering and that branches are considered when assessing Threshold Condition 3. - Assessment: Compliant ### Principle 25. Supervision Over Foreign Banks’ Establishments — description and assessment - Requirement: Local operations of foreign banks must be conducted with the same high standards as domestic institutions; supervisors must have powers to share information needed by home country supervisors for consolidated supervision. - FSA treatment of foreign banks: - All banks (U.K. incorporated or branches of foreign banks) must satisfy and continue to satisfy Threshold Conditions in FSMA; Principles for Business apply to all banks. - Risk-based supervision does not differentiate between foreign and domestic banks; foreign banks subject to same risk assessment and mitigation as domestic banks. - Reporting requirements similar for all banks; differences in prudential returns for capital and large exposures apply mainly to branches of foreign banks (spelled out in SUP 16). - Prudential supervision of branches of EEA banks under EU passport: primarily responsibility of home country supervisor; prudential returns to FSA are limited. - For branches of non-EEA banks, FSA relies on home country supervisor for capital adequacy and large exposures; liquidity supervision of foreign branches addressed case-by-case, may defer to home country supervisor. - Before authorizing deposit-taking activities of a foreign branch of a non-EEA bank the FSA confirms bank is subject to consolidated supervision and home country supervisor approves proposal. (Similar procedures do not apply to EEA passport branches.) - Policy: If FSA cannot rely on home country supervisor on a continuing basis, branches of non-EEA banks should close or subsidiarise; policy enforced in individual cases. - For U.K. subsidiaries of overseas banks FSA seeks confirmation that home country supervisor practices effective consolidated supervision; if not satisfied, FSA will require corporate governance and risk management of the subsidiary be sufficiently robust to provide ring-fencing from the parent bank; policy enforced in individual cases. - FSMA permits FSA to share supervisory information with foreign supervisors subject to confidentiality safeguards; home country supervisors permitted to conduct on-site visits/examinations of U.K. branches and subsidiaries; FSA encourages this. - FSA informs home country supervisors of risk assessments and supervisory actions; urgent remedial actions promptly communicated. - FSA systematically informs itself of business strategies and risk/control regimes of parent banking groups through contacts with the group and home country supervisor information. - Assessment: Compliant ### Table 2. Summary Compliance of the Basel Core Principles (excerpt) - Core Principle: 1. Objectives, Autonomy, Powers, and Resources — C - 1.1 Objectives — C - 1.2 Independence — C - 1.3 Legal framework — C - 1.4 Enforcement powers — C - 1.5 Legal protection — C - 1.6 Information sharing — C - 2. Permissible Activities — C - 3. Licensing Criteria — C - 4. Ownership — C - 5. Investment Criteria — C - 6. Capital Adequacy — C - 7. Credit Policies — C - 8. Loan Evaluation and Loan-Loss Provisioning — C - 9. Large Exposure Limits — C - 10. Connected Lending — C - 11. Country Risk — C - 12. Market Risks — C - 13. Other Risks — C *Source: _cr03208 - Chapter 349 of the FSMA imposes confidentiality requirements on the FSA. Refer to CP 1(6) for* ### 14. Internal Control and Audit ### _cr03208 - 14. Internal Control and Audit ### Basel Core Principles: Assessment Summary and Recommended Action Plan - Assessment ratings included in the source: - C: Compliant. - LC: Largely compliant. - MNC: Materially non-compliant. - NC: Non-compliant. - NA: Not applicable. - Table 3 — Recommended Action Plan with Respect to the Basel Core Principles (selected items): - CP 8 Loan evaluation and provisioning - Introduce periodic reports on asset quality. - CP 12 Market risks - Consider expanding the supervisory staff responsible for testing banks’ market risks controls. - CP 13 Other risks - Develop a new approach to liquidity monitoring that will be more aligned to banks’ own techniques for liquidity management. - CP 15 Money laundering - FSA to monitor annually a sample of anti-money laundering reports from banks that have not been subject to on-site review. - CP 16 On-Site and Off-Site Supervision - See recommended actions under CPs 17, 18 and 19. - CP 17 Bank management contact - Identify criteria for banks to notify the FSA of emerging problems at an early stage. Establish off-site monitoring triggers for the FSA to contact banks with emerging problems. - CP 18 Off-site supervision - Introduce regular reporting requirement for data on classified and non-performing loans. - CP 19 Validation of supervisory information - Introduce a requirement for key supervisory returns to be examined at least annually by external auditors. Extend listed banks’ disclosure requirements to non-listed banks. ### Authorities’ Response to the FSAP Recommendations - General view: - U.K. authorities consider the FSAP assessment valuable and supportive of the U.K.’s very high degree of compliance with the Basel Core Principles. - They support the broad thrust of the findings and recommendations and intend to take forward existing strands of work. - They noted a small number of recommendations where they believe the current regime effectively fulfils the IMF’s requirements and some recommendations where further consideration of implementation costs versus benefits is required. - Specific comments by CP: - CP 8 - FSA operates a selective process to reporting asset quality: if concerns exist, the FSA may ask a bank to provide regular info on asset quality. - Approach being considered under the ongoing data needs project and in the same context as CP 18. - CP 12 - Authorities note finite supervisory resources and focus on institutions with the largest combination of impact and risk. - CP 13 - Authorities agree on usefulness of a new approach to liquidity monitoring; changes are in train. - Plans: consult on systems and controls requirements and introduce these in summer 2004. - Plan to consult on a framework of quantitative requirements for liquidity risk in summer 2003. - CP 15 - Authorities already monitor reports of Money Laundering Reporting Officers and undertook a specific study of reports from 75 banks. This program will continue. - CPs 16–19 (on/off-site supervision, management contact, validation of information) - In context of a risk-based approach, authorities consider some recommendations could be overly prescriptive and less relevant to low impact banks (which account for only 0.02 percent of deposit liabilities). - They consider current tools largely adequate; value of extra reports on asset quality may not outweigh cost. - They are reviewing data needs requirements and exploring ways of strengthening baseline monitoring, including data quality and timeliness of notifications. - For D firms (all low impact and low risk/medium low impact firms), authorities view new systems and processes as robust and appropriate given low RTO, and do not wish to overburden this sector. - CP 17 - Block one of the FSA handbook sets out senior management responsibilities and the Principles for Businesses; firms must disclose anything the FSA could reasonably expect to be notified of. - Authorities felt detailed criteria and triggers for firm notification could be counterproductive and might weaken senior management judgment. - CP 19 - FSA checks plausibility of comparisons and trend analysis on financial returns; supervisors can request further information or appoint a skilled person under S 166 of FSMA to verify accuracy. - Auditors have a statutory duty to report to the FSA. - CP 19 recommendation is being reviewed under the data needs project. ### IAIS Insurance Core Principles — Assessment Overview - Scope and methodology: - Assessment based on the Insurance Core Principles Methodology (ICP) of the IAIS dated October 2000, as modified by the joint IMF/World Bank assessment template. - Given the U.K.’s highly developed insurance market and international significance, assessment applied both essential and supplementary criteria and used override provisions to judge whether criteria are fulfilled in practice, not just in concept. - Assessors applied standards appropriate to a leading industrial country and judged the FSA as at the date of assessment when supervisory practices were still being developed and resourced. - Assessment team and contributors: - Conducted by Carl Hiralal and Rodney Lester; Frank Engels provided early commentary and participated in feedback sessions. - Major information sources included IMF questionnaire answers, a comprehensive self-assessment by the Insurance Firms Division, FSA website materials, FSA CD-ROM databases, presentation material from FSA officers, ABI and S&P Thesys statistics, and interviews with FSA, governmental/regulatory bodies, ABI, NAPF, Institute of Actuaries, chartered accountants, rating agencies, and industry senior management including Lloyds. ### Insurance Sector—Key Institutional and Market Facts - Market size and significance: - Net premium income in 2000: £174 billion or approximately 10 percent of the world market. - The U.K. is the third largest insurance market after the U.S. and Japan. - Lloyds and the London Market together account for 65 percent of approximately US$20 billion of annual global cross border general insurance premium flows (Source- Sigma No. 6, 2001). - Insurance penetration: 15.8 percent (premiums as a percentage of GDP). - Employment and economic contribution: - Industry employment: in excess of 220,000 people directly and another 115,000 indirectly, accounting for 1.5 percent of total U.K. employment. - Overseas earnings: in 2000 approaching £7 billion (£8.7 billion in 1999), major element being insurance ‘exports’. - Total FY 2000 financial assets of households and related non-profits: £3 trillion; more than 50 percent represented by insurance policyholder related liabilities. - Total investment assets under management at end-1999: slightly over £1 trillion. - Sector stress and market risk: - U.K. insurers affected by fall in stock prices and exceptionally low bond yields, long-term non-life claims, substantial losses related to September 11, and in some cases mounting liabilities from guaranteed annuities or defined-benefit schemes. - Insurers hold around a fifth of total U.K.-quoted equities and could resort to asset sales to safeguard profitability and regulatory capital. - Growing balance sheet concerns reflected in increased supervisory activity, including suspensions and modifications to the FSA’s resilience tests and enhanced monitoring of financial modeling of insurers. ### Insurance Sector Asset Allocation and Holdings (as presented) - Table 4. Gross Direct U.K. Sourced Premium Revenues (in £ billions) - Life – Ordinary: 1990 = 32.8; 2000 = 118.0 - Life - Industrial: 1990 = 1.4; 2000 = 0.7 - Non life: 1990 = 18.3; 2000 = 28.7 - Source: ABI. - Table 5. Insurance Sector Asset Allocation, end-1999 - Long Term (£bill) totals and percentages: - Cash 50.1 (5.5%) - Gilts 123.6 (13.5%) - Equities 467.3 (51.1%) - U.K. Corporate Securities 81.3 (8.9%) - Foreign Corporate Securities 21.8 (2.3%) - Foreign Gilts 9.3 (1.0%) - U.K. Loans 83.7 (9.1%) - Unit Trusts 28.5 (3.1%) - Other 51.0 (5.5%) - Total 916.6 (100%) - General (£bill) totals and percentages: - Cash 6.0 (6.6%) - Gilts 13.9 (15.4%) - Equities 18.8 (20.9%) - U.K. Corporate Securities 10.3 (11.4%) - Foreign Corporate Securities 14.0 (15.6%) - Foreign Gilts 1.4 (1.5%) - U.K. Loans 1.3 (1.4%) - Unit Trusts 22.9 (25.3%) - Other 1.7 (1.9%) - Total 90.3 (100%) - Source: ABI. - Note: ABI summary information oriented to turnover and assets; S&P Thesys cited as a source of financial analysis. Regulatory returns have been liability oriented; submission time recently tightened; option to file electronically; returns for individual companies publicly available from Companies House. - Table 6. Holdings of U.K. Securities 1998 (% of outstanding value) - Life Insurers - U.K. Gilts 43.0 - U.K. company shares 20.3 - Non Life Insurers - U.K. Gilts 5.5 - U.K. company shares 0.9 - Pension Funds - U.K. Gilts 30.6 - U.K. company shares 22.3 - Source: ONS. ### Preconditions for Effective Insurance Supervision - Legal and judicial framework: - Well developed judicial system; civil commercial matters heard in divisions of the High Court with appeals to Court of Appeal and House of Lords; EU law overrides domestic law under the Treaty of Rome where applicable. - U.K. case law significant to international insurance law; many insurance contracts worldwide remain subject to English law. - Professional resources: - In excess of 65,000 practicing chartered accountants in the U.K., many insurance specialists. - Approximately 3,000 actuaries active in the United Kingdom, expected to maintain minimum levels of continuing professional training. - Both professions regarded as having world class qualification and accreditation requirements and supporting effective supervision. *Source: IMF Financial Sector Assessment — chapter titled "14. Internal Control and Audit" (content unit _cr03208).* ### 26. One idiosyncratic feature of the U.K. environment is that there is no insurance ### _cr03208 - 26. One idiosyncratic feature of the U.K. environment is that there is no insurance ### Insurance accounting and reporting - There is no insurance accounting standard in the U.K.; instead there is a Statement of Reporting Principles (SORP). - SORP is largely worked out by the insurance sector on a modified regulatory reporting basis, but informed by general company reporting requirements, and with no objection from the Accounting Standards Board (ASB). - The ASB has the right to issue standards on its own authority, although under the guidance of the Financial Reporting Council. - The ASB has taken a limited interest in the financial sector allegedly because of the major scope for disagreement over reporting principles. - The imposition of IAS in the EU in 2005 is expected to "to a large extent supplant the ASB role" and enable the U.K. to enforce "an appropriate modern approach, which is still evolving." - The IASB is still engaged in resolving the contentious issue of the valuation of liabilities arising from insurance contracts. - Interim consequence: there is ongoing scope for there to be up to three different sets of accounts struck within the United Kingdom for a long-term insurer (regulatory, modified regulatory, and assessed value). ### Auditing, internal audit, and governance - The auditing profession is well established: external auditors must be members of recognized supervisory organizations and remain eligible under that organization’s rules (leading to a practicing certificate). - Recognized organizations must ensure their members are ‘fit and proper’ and that audit processes are carried out professionally and with integrity. - The role of the external auditor is increasingly prevention and detection focused; the FSA’s regulatory model seeks to build on this. - The CCAB is the main coordinating body for the six U.K. accounting bodies and is a recognized supervisory body. - The assessment team could not determine the level of performance of the internal audit function within the insurance sector; anecdotal evidence pointed to considerable variation in competence and awareness of the risk based approach. - A number of large insurers now employ distinct full time compliance teams with high level reporting lines. - Overriding governance roles are noted for directors and managers, supported by internal and external audit functions. ### FSA regulatory model and structural transition - The FSA model rejects the twin peaks model where market conduct and prudential supervision fall under different regulators/supervisors; many FSA officers have joint responsibility for financial strength and customer treatment issues. - This integrated role can place substantial demands on FSA supervisors if other parts of government make decisions affecting the trade off. - The regulatory environment is in rapid transition with the consolidation of at least nine former regulators into an independent FSA. - Prior to FSA formation the key formal insurance regulators were DTI and subsequently HMT, both advised by the Government Actuary’s Department (GAD). - These prior regulators were seen to have a light regulatory touch, with informal rules well understood by the market. - Rating agencies formed a third, market-based form of regulation in the general insurance segment, supplemented by the central role of the appointed actuary in the long term sector. ### Risk-based supervision and the Tiner project - U.K. authorities are strengthening insurance regulation along the lines of a risk-based approach to supervision. - The Tiner project was initiated to implement and advance a risk-based approach where regulatory attention focuses on firms and activities likely to pose the greatest risk to the achievement of the regulator’s statutory objectives. - Tiner project outcomes already reflected: - Inclusion of major life and non-life offices in the Major Financial Groups Division (MFGD) of the FSA, which conducts integrated regulation and supervision of the most important market participants. - Aims to improve prudential and conduct of business regimes for insurers, notably: - increased focus on firms’ strategies, quality of management and systems and controls; - an improved disclosure and financial reporting regime; - a more proactive prudential regime with less reliance on desk-based analysis of financial returns. ### Assessment findings and operational gaps - The U.K. easily satisfies the preconditions for a full assessment. - Key finding: FSA’s interim regime presently lacks a sufficient degree of experienced on site examination capacity. - Greater precision is desirable in defining what is required of management and boards, as many smaller institutions may not be familiar with modern risk management concepts. - Assessors agree FSA’s objective of placing more governance and internal control responsibilities on firms’ boards and management is highly desirable, but they "strongly feel that more independent assessment of the effectiveness of firms’ systems and controls is warranted." - No guarantee exists that a sufficiently comprehensive review of appropriateness of firms’ risk management systems, asset allocation limits, internal controls, capital and reserves, and reinsurance programs will take place in light of the nature and amount of business underwritten—particularly where bank-based large groups with significant insurers are involved, or bank supervisors have been given very large insurance-based groups to supervise and assimilate. - The skills requirement will become more evident when the envisaged risk-based approach and fair value accounting are introduced, requiring ability to review complex simulations using model offices. - Recommendation: FSA should ensure that the risk review team, on which the large group supervisors draw, formally contains specialist insurance expertise (either as establishment or through a solid line matrix) in areas such as reinsurance, actuarial modeling and long-tail non-life claims, in addition to generalist insurance people. - Some skills are scarce (for example non life actuarial skills) and long term consulting or staff exchange programs may be appropriate. - The present desk-based analysis of returns does not appear to adequately capture the risks of underlying exposures, largely because of availability and disposition of requisite skills. ### Principle-by-principle assessment conclusions - Assessors' view: IAIS CPs 5, 6, 7, and 12 are "broadly rather than fully observed." - The mission confirms the authorities’ self-assessment that CP 13, as formulated, is "materially non-observed," given the limited reliance on onsite inspections under current practice, while the core principles call for detailed onsite reviews of books, records, accounts and other documents. - By contrast, assessors feel that the standards achieved in the U.K. under the governance and market conduct CPs constitute "very good examples of international best practice." *Source: _cr03208 - 26. One idiosyncratic feature of the U.K. environment is that there is no insurance* ### 35. It is the assessors’ understanding that the FSA is currently in the process of rolling ### Table 7. Detailed Assessment of Observance of the IAIS Insurance Core Principles ### Principle 1. Organization of an Insurance Supervisor - Assessment: Observed - Key findings: - Responsibilities and objectives of the Financial Services Authority (FSA) are set out in the Financial Services and Markets Act 2000 (FSMA). - FSA is operationally independent, established as a private company limited by guarantee, responsible for its own budget and financed by direct levies on the industry. - FSA Handbook of rules and guidance (“the Handbook”) is publicly available; changes are subject to consultation. A decision-making manual forms part of the Handbook. - FSMA grants wide powers including ordering actuarial or general investigations and recruiting third-party expert assistance. - FSA Code of Conduct and Ethics Officer arrangements constrain staff holdings, gifts, hospitality, and require disclosure of significant relationships. - FSMA provides immunity from damages for actions in discharge of functions except where acts are in bad faith or unlawful. - Official integrated regulator commencement: December 1, 2001. - Comments / Recommendations: - Essential elements met but increasing competitive pressures require emphasis on resource needs and staff training. - FSA should strengthen core insurance expertise (reinsurance, actuarial science, long tail non-life claims), likely organized in a matrix structure and made available across supervisors (particularly MFGD). - Note: additional insurance experience has been gained in MFGD since initial assessment. ### Principle 2. Licensing - Assessment: Observed - Key findings: - Effecting and carrying out contracts of insurance as principal requires authorization; FSA must ensure applicants satisfy "threshold conditions" under FSMA (legal status, location of offices, close links, adequate resources, suitability). - Threshold conditions include assessment of financial resources, projected solvency, systems and controls, integrity and competence of senior management, and regulatory history. - Permission may carry specific requirements; EEA-authorized insurers may operate via passport arrangements under EU Insurance Directives. - Comments: - FSA has well-developed policies and procedures to ensure insurers meet regulatory requirements. ### Principle 3. Changes in Control - Assessment: Observed - Key findings: - Persons proposing to take or vary control must notify FSA; insurers must notify FSA of changes in control. FSA may object. - Documentation required parallels new license applications. - Suitability of new owners, directors, senior managers, and soundness of new business plans are checked; actuarial advice is critical for life insurers. - Approval assessed against Threshold conditions. - Comments: - FSA has well-developed systems and procedures for changes in control. ### Principle 4. Corporate Governance - Assessment: Observed - Key findings: - FSA’s Principles for Businesses (eleven principles) apply where not precluded by Home State under EC Directives. - Threshold conditions and high-level systems and controls encourage directors/senior managers to take practical responsibility. - Approved Persons’ Regime (APER) requires certain individuals to be fit and proper (FIT) under Statements of Principle and a Code of Practice. - Comments / Recommendations: - FSA has comprehensive rules and guidelines consistent with the core principle. - FSA should consider making a Financial Condition Report (FCR) mandatory to be signed off by the Board and made available to the FSA; Board should ensure resilience/scenario testing is appropriate to complexity and size. - FSA may develop guidance with professional bodies for preparing the FCR. - At conclusion of every review of high impact firms, senior FSA officials should meet formally with audit committees and request an in camera meeting with non-executive audit committee members. ### Principle 5. Internal Controls - Assessment: Broadly Observed - Key findings: - FSA’s eleven Principles for Businesses and Threshold conditions provide the framework for systems and controls. - Assessment of internal controls combines off-site and on-site monitoring, with current emphasis on off-site. - Firms must notify FSA of major restructurings, failures in systems/controls, and issues reported by external auditors. - Comments / Recommendations: - Rating Broadly Observed; implementation of new risk-based methodology will meet requirements. - Limited independent, on-site reviews currently; need more independent testing and balance between desk review and fieldwork. - Consider more effective use of external checks and balances (auditors, skilled persons, supervisors). - Encourage firms to establish risk management functions and Board risk committees where absent. - Standardize management letter procedures by requiring firms to provide a copy to auditors on a timely basis. ### Principle 6. Assets - Assessment: Broadly Observed - Key findings: - FSA Principles require firms to maintain adequate financial resources and provide guidance on asset diversification, matching assets and liabilities, valuation, safekeeping, and investment management systems. - Life insurers must identify assets suitable to cover obligations and apply resilience tests; appointed actuary plays significant role. - Integrated Prudential Sourcebook intended to introduce similar controls for non-life insurers. - Directors must certify annual compliance; reasonableness subject to external audit. - Comments / Recommendations: - Broadly Observed; implementation of proposed risk-based methodology expected to result in Observed. - Need more on-site review of risk management policies, systems, internal controls, and internal audit programs. - Tighter field assessment required given implications for technical provisions and solvency. ### Principle 7. Liabilities - Assessment: Observed (life firms); Broadly Observed (non-life firms) - Key findings: - FSA rule-making powers permit prescription of standards for technical provisions and liabilities. - Interim Prudential Sourcebook for Insurers covers long-term business; long-term liabilities determined on actuarial principles with prudent assumptions and margins for adverse deviation. - Non-life liabilities: responsibility lies with management and advisers; U.K. legislation does not generally lay down precise rules for non-life liabilities; auditors must certify reserves. - Discounting of outstanding long tail claims is allowed within a defined framework. - Annual returns include information on technical provisions and abstract of appointed actuary’s valuation report; FSA can require actuarial or general investigations and reports by skilled persons. - Reinsurance recoverable credit: insurers may take credit up to amounts reasonably expected to be recovered; in solvency margin calculation insurers allowed credit up to a maximum of 50 percent. - Comments / Recommendations: - Scarcity of qualified non-life personnel hampers follow-up; U.K. not fully compliant with Essential Criteria # 3. - Long-tail non-life liabilities warrant rules and guidance and rigorous oversight by a multi-discipline professional team; input should be considered in the Financial Condition Report. - For life firms, appointed actuary judgment is critical; assessors recommend implementation of a peer review process with professional bodies (e.g., Institute of Actuaries) and multi-discipline review teams as appropriate. ### Principle 8. Capital Adequacy and Solvency - Assessment: Observed - Key findings: - FSA rules require life and non-life insurers to maintain a margin of solvency reflecting EU solvency and minimum capital requirements. - Different levels of complexity or business risks are not currently reflected in specific EU or U.K. solvency requirements except to a very limited extent in fixed minimum capital requirements. - FSA has powers to set individual requirements under FSMA and monitors via financial returns and on-site inspections. - Directors must certify maintenance of required margin of solvency; auditors opine on reasonableness. - Information exchange with other regulators enabled by Financial Services and Markets Act 2000 (Disclosure of Confidential Information) Regulations 2001. - Comments / Developments: - In May 2002 the FSA issued consultation paper 136 “Individual Capital Adequacy Standards” for comprehensive review of capital requirements. - For non-life firms, capital requirements currently a combination of formal EU requirements and informal “rules of thumb”: - Typical informal norms: 200 percent of minimum requirements for less risky lines of business; about 300 percent to 400 percent of minimum requirements for more risky lines. - More formalized risk-based capital rules are required and recognized by the FSA. ### Principle 9. Derivatives and ‘Off-Balance Sheet’ Items - Assessment: Observed - Key findings: - FSA rules set principles governing derivatives use; guidance addresses systems and controls with particular reference to derivatives. - Insurers must have Board-approved written guidelines on derivatives consistent with investment strategy; guidelines must address objectives, types of instruments, prudent limits, staff competence, and segregation of functions. - Directors required to ensure monitoring, risk management systems capable of analyzing individual and aggregate transaction risks. - Annual returns must include brief description of investment guidelines for derivative contracts and related matters. - Off-site monitoring via annual returns supplemented by on-site checks and market risk review team use. - Comments: - U.K. approach seeks to prevent speculative use of derivatives that might materially weaken companies. ### Principle 10. Reinsurance - Assessment: Observed - Key findings: - Insurers must report reinsurance arrangements; FSA analyzes appropriateness and security of programmes. - Non-life insurers provide statements on major reinsurers including connections, reinsurance payments payable, and anticipated recoveries taken into account in technical provisions. - Reinsurers are subject to direct regulation in the U.K.; supervision of reinsurers parallels direct insurers with attention to aggregation risks. - Supervisory controls include reporting requirements, on/off-site monitoring, ability to intervene, class-based authorization, fit and proper requirements, and systems and controls. - Reinsurance recoverable credit: insurers may take credit up to amounts reasonably expected to be recovered; in solvency margin calculation credit limited to a maximum of 50 percent of claims. - FSA has powers to share confidential information with other supervisors. - Comments / Recommendations: - Reinsurance review requires specialized knowledge; FSA has used reinsurance specialists on an ad-hoc basis. - Complexity of reinsurance arrangements, including financial reinsurance and offshore cessions, complicates assessment of recoverability and adequacy relative to capital and underwriting risk. - Assessors strongly support the rapid development of supervisory capacity to address these complexities. *Source: Excerpt from the FSA assessment in Table 7. Detailed Assessment of Observance of the IAIS Insurance Core Principles.* ### introduction of an EU reinsurance directive and international standards. ### introduction of an EU reinsurance directive and international standards. ### Reinsurance data and supervisory response - A further challenge with respect to reinsurance is the limitation of the current data base system to capture meaningful data on reinsurance use within the insurance industry. This is a challenge for all regulators world-wide and does serve to make supervisors’ job very difficult. - The FSA may wish to consider implementing a thematic review of reinsurance operations across the firms for purposes of ensuring that, all firms and the industry in general, have put in place appropriate controls and systems to deal with this important risk. ### Principle 11. Market Conduct — requirements and FSA description - Insurance supervisors should ensure that insurers and intermediaries exercise the necessary knowledge, skills, and integrity in dealing with their customers. - Insurers and intermediaries should: - at all times act honestly and in a straightforward manner; - act with due skill, care, and diligence in conducting their business activities; - conduct their business and organize their affairs with prudence; - pay due regard to the information needs of their customers and treat them fairly; - seek from their customers information which might reasonably be expected before giving advice or concluding a contract; - avoid conflicts of interest; - deal with their regulators in an open and cooperative way; - support a system of complaints handling, where applicable; and - organize and control their affairs effectively. - Description highlights: - The FSA is responsible for the supervision of the sale and marketing of life insurance with an investment element. - Supervision of the sale and marketing of non-life insurance is in transition: the Government recently announced that the sale of non-life insurance will in future be regulated by the FSA. This will require considerable preparatory work by the FSA before the transfer from the existing - non-statutory – regulatory regime can be effected in 2004. - In the meantime the General Insurance Standards Council (GISC) will continue in its role as an independent, non-statutory organization to regulate the sales, advisory and service standards of its members. Those insurers and intermediaries that are not members of the GISC will continue to be subject to the provisions contained in the Association of British Insurers’ Code of Practice (ABI Code). - There is a continuing and enforceable requirement throughout the lifetime of all financial services firms authorized by the FSA, that all approved persons are fit and proper to hold their office. Controlled functions include governing functions, required functions, significant management functions, and certain customer functions. - The FSA’s Supervision Manual notes that on-site inspection is one of the tools that may be used to monitor compliance. - The FSA has rules relating to the internal handling of complaints; unresolved complaints can be referred to the Financial Services Ombudsman. - Assessment: Observed - Comments: The FSA requires supervised firms to have well-developed systems and controls in place to deal with issues relating to market conduct and follows up to ensure fair distribution and treatment of customers. ### Principle 12. Financial Reporting — scope, requirements, and assessment - Core objectives: - obtain information to form an opinion on the financial strength of each insurance company; - set scope and frequency of reports (financial, statistical, actuarial, other); - set accounting requirements for financial reports; - ensure external audits are acceptable; - set standards for technical provisions or policy and other liabilities. - Distinctions noted: - between disclosure reports for policyholders/investors and reports for the insurance supervisor; - between reports for companies incorporated in the jurisdiction and branch operations of companies incorporated elsewhere. - Description of FSA practice: - The FSA’s rule-making powers under the FSMA enable the Authority to prescribe rules for financial reporting. - Insurers are required to produce an annual return for the FSA in addition to their statutory accounts. - Outline contents of returns laid down in the rules are: - profit and loss account, revenue account and balance sheet, together with notes, statements and reports and directors’ certificates annexed thereto; - an abstract of the annual investigation of the appointed actuary; and - an auditor's report. - Accounts and balance sheets of every insurer must be audited by a person qualified in accordance with FSA Handbook rules. - Assets generally have to be valued at either net asset value or current market value, with specific rules for individual assets (e.g., real estate). - Liabilities must be determined in accordance with generally accepted accounting concepts and actuarial principles with prudent assumptions and appropriate margins for adverse deviation. - Companies carrying on life assurance business are required to conduct a periodic actuarial investigation by the appointed actuary who must certify proper records, provisions, and assessments. - Non-EEA insurers operating in the U.K. through a branch are required to maintain both a U.K. and global solvency margin and report accordingly. The EU Insurance Groups Directive provisions have been reflected in reporting requirements. Reporting of material connected-party transactions is required. - The annual returns of insurers are entered into FSA’s database and various ratios generated to indicate financial difficulties or deteriorating performance; ratio analysis helps determine priority for more detailed desk analysis. - The FSA has powers to require companies to report more frequently or accelerate reports. The annual return is public, while more frequent reports are usually confidential. - Assessment: Broadly Observed - Comments and recommended enhancements: - The rating is Broadly Observed based on current practices, which need enhancing to cope with the rapidly changing risk profile in the industry; the proposed implementation of the risk-based methodology for insurance firms will move the rating to Observed. - The risk level of the insurance industry is increasing due to pressure points including on-going underwriting losses (non-life); reduced returns on investment activities coupled with high expense pressures; and the uncertainty of long-tail liabilities. - Currently, firms are required to file regulatory returns annually and may still use a paper medium. A move towards quarterly reporting, at least for the higher priority firms, would significantly enhance supervisory monitoring. - Firms under the purview of MFGD, particularly listed firms, should be encouraged to file their MIS reports prior to public release. - To accommodate increased information flow, the FSA may need to review its financial reporting data base and systems capability; review the nature of existing data as some may no longer be relevant; changes to regulatory returns may be required. - There is an increasing need for firms to disclose more relevant information in published financial reports, including information on risk management practices, risk exposures and sources of gains and losses. The FSA has a role in encouraging improved disclosure practices. ### Principle 13. On-Site Inspection — powers, current practice, and assessment - The insurance supervisor should be able to: - carry out on-site inspections to review the business and affairs of the company, including inspection of books, records, accounts, and other documents; and - request and receive any information from companies licensed in its jurisdiction, specific to a company or requested of all companies. - Description of FSA approach: - The FSA’s approach involves a risk assessment of firms, applied to all firms with detail varying by firm and subject to continuing review. - The FSA places considerable reliance on annual returns and sees no need routinely to duplicate the work of the auditor and appointed actuary. - On-site inspections have not been a regular feature, particularly for non-life insurance firms; figures provided are carefully analyzed off-site and life insurers receive specialist actuarial analysis. - The FSA can disqualify an auditor or actuary if they have not performed appropriately and can request further information or require reports by skilled persons. - Policy is evolving: the FSA announced intention that risk specialists and supervisors will, in future, spend more time on-site at insurance firms, with greater proportion at higher impact firms in line with a risk-based approach. On-site inspections will address suspected deficiencies or specific risk/risk management factors. - It is not intended to inspect smaller, low risk insurers routinely; smaller insurers may be inspected as part of supervisory themes. - The FSA has authority to conduct full on-site inspections covering the criterion elements; a full-scale inspection would be undertaken if risk assessment suggested it is appropriate. - For life insurers conducting investment business, appointed representatives and independent financial advisers, the FSA carries out on-site inspections to determine compliance with conduct of business rules, focusing on information sufficiency and adequacy given to customers. - The FSA intends to use information on complaints and enquiries provided by the Financial Services Ombudsman to identify potential problem areas. - Assessment: Materially Non-Observed - Comments: - While the FSA has full authority to carry out on-site supervision, on-site reviews are not routine; they are conducted when a firm comes under stress or when prudential concerns arise and are tailor-made. - The FSA is undertaking a major review of its approach to insurance regulation, led by John Tiner (Managing Director, Consumer, Investment & Insurance Directorate). The review concerns practical aspects of supervision and is expected to place greater emphasis on on-site inspection in assessing risk exposures. - To comply with this CP, the FSA will need to increase resources and skill sets of supervisors responsible for the insurance industry, strengthening core insurance expertise with individuals experienced in reinsurance, risk management, actuarial science and long-tail, non-life claims. The Tiner project is expected to address these issues. ### Principle 14. Sanctions — powers and assessment - Legislation should set out remedial powers available to the insurance supervisor, possibly including: - the power to restrict business activities of a company; - the power to direct a company to stop unsafe or unsound practices or to take remedial action; and - the option to revoke a license or impose remedial measures where violations occur. - Description of FSA powers: - The FSA has powers under the FSMA to take remedial action and/or impose penalties on insurers depending on severity. Measures include fines, public censure, imposition of requirements or limitations on permission to carry on a regulated activity, and cancellation of a permission. - Approval for new activities can be withheld where appropriate. - The Regulatory Decisions Committee normally takes major regulatory decisions; the FSA can ensure these actions have immediate effect. - The FSA has criminal prosecution powers in certain circumstances (e.g., breaches of the money laundering regulations). - The FSA can withdraw an individual's approval to perform controlled functions if the person is not fit and proper. - Assessment: Observed - Comments: The FSA has powers to require remedial action when threats to solvency are noted. Although well-developed processes exist, firms placed on a watch list are not formally notified when such action is taken. ### Principle 15. Cross-Border Business Operations — rules and assessment - Insurance supervisor should ensure: - no foreign insurance establishment escapes supervision; - all insurance establishments of international groups are subject to effective supervision; - creation of a cross-border establishment is subject to host-home consultation; and - foreign insurers providing cross-border services are subject to effective supervision. - Description of FSA framework: - The FSMA includes a general prohibition on carrying on regulated activities in the U.K. without authorization or specific exemption. - An EEA insurer subject to prudential supervision in its home state may operate in the U.K. via a branch or on a cross-border services basis, subject to a notification procedure. - With the EEA exception, the FSA has sole responsibility for authorizing and supervising foreign insurers wishing to carry on insurance business in the U.K., including U.K. subsidiaries of foreign companies, joint ventures with foreign parents, and branches of companies with head offices outside the EEA (subject to limited lead supervision possibilities under EC Directives). - The FSA has a duty to take steps it considers appropriate to co-operate with other regulators and may discuss authorization applications with other regulators as appropriate. - For branches with principal place of business outside the EEA, the FSA will assess the applicant as a whole and may consider information supplied by the relevant overseas regulator. - Promotion of contracts of life insurance in the U.K. by non-EEA companies not authorized in the U.K. is not normally permitted where the rights constitute an investment, except where established in a designated territory affording adequate protection. - Promotion of non-life contracts on a cross-border basis is permitted, subject to disclosure requirements other than in respect of large risks and reinsurance. - Assessment: Observed - Comments: The FSA has well-developed systems and controls to ensure firms do not escape supervision and seeks cooperation with other regulators as necessary. ### Principle 16. Coordination and Cooperation — information exchange - Supervisory considerations include the ability to: - enter into agreements with other supervisors to share information or work together across jurisdictions and sectors; - share information with other jurisdictions subject to confidentiality arrangements; - be informed of findings of investigations where other bodies hold investigative powers (fraud, money laundering); and - set out types of information and basis on which information may be shared. - Description of FSA practice: - The FSA’s legislation permits disclosure of information to enable or assist an authority in a country or territory outside the U.K. to exercise corresponding functions, subject to equivalent professional secrecy/confidentiality requirements. - Procedures for collaboration in the EEA, including exchange of information under EC Directives on life and non-life assurance, are contained in a Protocol agreed between authorities; a further Protocol covers insurance group supervision. - The FSA has had little experience of regular liaison with supervisory authorities outside the EEA to date; contacts have mostly been problem-driven. Enhancement of information exchange is being actively pursued. - Agreed guidelines exist between the FSA and key criminal investigators and prosecutors in the U.K. (Serious Fraud Office, Department of Trade and Industry, Criminal Prosecution Service, Policy and Scottish/Northern Irish counterparts) to alert and communicate on cases of mutual interest and outcomes. - Assessment: Observed - Comments: The FSA maintains close relations with overseas supervisors and can exchange information relatively freely with competent authorities in other EEA Member States; it may conclude co-operation agreements with non-EEA authorities provided equivalent guarantees of professional secrecy. ### Principle 17. Confidentiality — legal constraints and assessment - Insurance supervisors should be subject to professional secrecy constraints regarding information obtained in their activities, including on-site inspections. - The insurance supervisor must hold confidential any information received from other supervisors, except where constrained by law or authorized for release by the providing supervisor. - Description: - The FSMA contains general restrictions on disclosure of information, applicable to information received from another supervisory authority. - Gateways in regulations under the Act allow the FSA to pass confidential information to other supervisors or law enforcement bodies in specified circumstances. - Confidentiality requirements are not overridden by freedom of information provisions. - Assessment: Observed - Comments: Treatment of confidential information is tightly controlled and well managed by the FSA. ### Table 8. Summary — observance counts - Observed 12 CP 1,2,3,4,8,9,10,11,14,15,16,17. - Broadly observed 4 5,6,7,12. - Materially non-observed 1 13 - Non-observed 0 - Not applicable 0 *Source: _cr03208 - introduction of an EU reinsurance directive and international standards.* ### 36. Table 9 sets out the actions recommended by the mission with respect to insurance ### _cr03208 - 36. Table 9 sets out the actions recommended by the mission with respect to insurance ### Recommended Action Plan to Improve Observance of IAIS Insurance Core Principles (Table 9) - Organization of an Insurance Supervisor (CP 1) - The FSA should consider building its core insurance expertise to include individuals with significant experience in reinsurance, actuarial practice, and long tail, non life claims. - These resources should be made available to all supervisors who are responsible for supervising insurance firms regardless of where they work within the FSA. - Because the addition of these individuals would likely be organized in a matrix set up, the availability of their technical skills to all supervisors should be actively promoted within the FSA. - Corporate Governance and Internal Controls (CP 4; CP 5) - CP 4 Corporate Governance: It is desirable that standards be established in the jurisdictions which deal with corporate governance. Where the insurance supervisor has responsibility for setting requirements for corporate governance, the insurance supervisor should set requirements with respect to: - the roles and responsibilities of the board of directors; - reliance on other supervisors for companies licensed in another jurisdiction; and - the distinction between the standards to be met by companies incorporated in his jurisdiction and branch operations of companies incorporated in another jurisdiction. - CP 5 Internal Controls: The insurance supervisor should be able to: - review the internal controls that the board of directors and management approve and apply, and request strengthening of the controls where necessary; and - require the board of directors to provide suitable prudential oversight, such as setting standards for underwriting risks and setting qualitative and quantitative standards for investment and liquidity management. - Recommended actions: - Make it mandatory for a Financial Condition Report (FCR) to be signed off by the Board and to be available to the FSA. - The Board should take responsibility for the analysis of the FCR and ensure that the level of stress/scenario testing is appropriate to the complexity and size of the organization. - The FSA may wish to work closely with the appropriate professional bodies to develop guidance for use by supervised firms when preparing the FCR. - At the conclusion of every review of high impact firms, senior officials from the FSA should formally meet with the audit committees to review and present the management letter points; request an in camera meeting with only the non-executive members of the audit committees at each such meeting. - Encourage firms to strengthen risk management practices (establish risk management function and a risk committee of the board). - Standardize procedures for processing management letters by including a requirement that firms provide a copy to their auditors on a timely basis. - Prudential Rules: Liabilities and Reinsurance (CPs 6–10; CP 6; CP 7; CP 10) - CPs 6–10 Liabilities: Insurance supervisors should establish standards with respect to the liabilities of companies licensed to operate in their jurisdiction. In developing the standards, the insurance supervisor should consider: - what is to be included as a liability of the company, for example, claims incurred but not paid, claims incurred but not reported, amounts owed to others, amounts owed that are in dispute, premiums received in advance, as well as the provision for policy liabilities or technical provisions that may be set by an actuary; - the standards for establishing policy liabilities or technical provisions; and - the amount of credit allowed to reduce liabilities for amounts recoverable under reinsurance arrangements with a given reinsurer, making provision for the ultimate collectability. - CP 6 / CP 7: See comments under CP 5. - The determination of policy liabilities in life firms is a highly specialized task and involves the use of considerable judgment by the appointed actuary. Judgment is required even though the appointed actuary is required to calculate the policy reserves within the guidelines set out by the professional body. - It would be good practice to require the implementation of a peer review process and the FSA may want to work with the institute of actuaries or other relevant professional bodies to implement such a review. Depending on the company-specific situation, a multi-discipline team may be required to do the review. - CP 10 Reinsurance: - The FSA may wish to consider implementing a thematic review of reinsurance operations across the firms for purposes of ensuring that appropriate controls and systems are in place. - Insurance supervisors should set requirements with respect to reinsurance contracts or reinsurance companies addressing: - the amount of the credit taken for reinsurance ceded. The amount of credit taken should reflect an assessment of the ultimate collectability of the reinsurance recoverable and may take into account the supervisory control over the reinsurer; and - the amount of reliance placed on the insurance supervisor of the reinsurance business of a company which is incorporated in another jurisdiction. - Financial Reporting and Public Disclosure (CP 12) - Observations: - It is important that insurance supervisors get the information they need to properly form an opinion on the financial strength of the operations of each insurance company in their jurisdiction. - The risk profile of the insurance industry is increasing due to pressure points from several fronts including on-going underwriting losses (non-life); reduced returns on investment activities coupled with high expense pressures and uncertainty about long-tail liabilities. - Recommended actions: - Move towards quarterly reporting, at least for higher priority firms; currently, firms are required to file statutory returns annually. - Firms that fall under the purview of MFGD, particularly listed firms, should provide their MIS reports prior to public release. - Review FSA financial reporting data base and systems capability, and require electronic returns from insurers. - Review the nature of the existing data being received; changes to the statutory returns may be required. - Encourage firms to disclose more relevant information in their published financial reports, including information on risk management practices, risk exposures and sources of gains and losses. - On-Site Inspection (CP 13) - The insurance supervisor should be able to: - carry out on-site inspections to review the business and affairs of the company, including the inspection of books, records, accounts, and other documents; and - request and receive any information from companies licensed in its jurisdiction, whether this information be specific to a company or be requested of all companies. - Recommended actions: - Increase the resources and skill set of supervisors who are responsible for supervising the insurance industry. - Strengthen core insurance expertise to include individuals with experience in reinsurance, risk management, actuarial science and long-tail, non-life claims. - Sanctions (CP 14) - Insurance supervisors must have the power to take remedial action where problems involving licensed companies are identified; a range of actions should be available to apply appropriate sanctions. - Observations/recommendations: - The FSA has powers under the FSMA to require firms to take remedial action when threats to the solvency of the institutions are noted. - Although there are well developed processes within the FSA for dealing with firms when prudential concerns are noted, firms which are placed on a watch list are not formally notified when such action is taken. - The FSA may way wish to consider notifying firms when, for prudential reasons, they are placed on a watch list. ### Authorities’ response to the assessment and implementation progress - Reform program context and timeline - The reform program (the Tiner project) was established in September 2001. - The FSA set out work completed or underway in a progress report published in October 2002. - The reform program aims to strengthen the prudential regime, including corporate governance, and to deliver a more proactive and challenging risk-based approach to regulating insurance, including significantly more on-site work. - Actions already taken or underway - The FSA has recruited in total 35 new insurance supervisors over the last year, the majority from insurance firms. These new recruits have brought with them a wide range of skills. - The Risk Review Department set up an insurance risk review team at the beginning of the year which includes secondees with strong technical skills and knowledge of the insurance market. - The FSA has given guidance on improving risk management in insurance firms (see Consultation Paper 140 and feedback statement). - The FSA is preparing an integrated prudential sourcebook. - The FSA has developed proposals on the role of actuaries in life assurance companies; initial consultation undertaken and more detailed proposals were published for consultation on January 24, 2003. - The FSA has published proposals to strengthen the regulation of insurance firms in the area of financial engineering, and has developed proposals on regulatory reporting which specifically address the type of reporting required from insurance companies under risk-based supervision. - Authorities’ specific comments on CP recommendations - CP1: The FSA agreed having a range of expert skills is important. The FSA’s risk review team includes insurance specialists as well as specialists in credit risk, operational risk and traded risk. The FSA’s actuarial and other specialist skills are already available to all those responsible for insurance firms. - CP4: The FSA will place increasing emphasis on appropriate stress and scenario testing within insurance firms; precise future requirements and links to reporting are under consideration. There is presently no clearly defined financial condition report for non-life insurers; the FSA would like the life one to be more clearly focused. - The FCR does not currently give rise to a capital requirement as such; it would be premature to replace the existing resilience test. - It is not standard practice for FSA supervisors to see the Board or Audit Committee after a visit, but the FSA does write to the main Board to present conclusions of its risk assessment. If significant issues arise it may pursue meetings; separate meetings with non-executive directors would generally involve all non-executives rather than selected committee members. - CP5: The FSA emphasized the importance of firms strengthening their risk management practices via the Tiner Reports (November 2001, progress report of October 2002) and Guidance on Systems and controls published in a Policy statement issued in December 2002. The Board should be responsible for appropriate governance for risk management functions. Risk assessment letters and risk mitigation programmes are already copied to auditors as standard practice. - CP7: The FSA is proposing changes to the role of actuaries in governance of life insurers; it published consultation paper CP167 in January 2003. Intention: policy reserves calculated by an actuary who advises the board on methods, bases and results; require an independent review of the calculation of policy reserves by the auditor, who must take actuarial advice independent of the regulated firm’s actuary. For non-life liabilities, the FSA will keep under review whether to introduce actuarial overview of the provisions. - CP10: Since the IMF visit the FSA has published a consultation paper with proposals to strengthen controls on financial engineering in insurance companies, tackling reinsurance and other issues. The possibility of a wider thematic review of reinsurance arrangements will be considered alongside other priorities. - CP12: The FSA is examining how it can reform regulatory reporting to ensure it receives key supervisory information while minimizing industry burden. The FSA published a Discussion Paper on a new approach to regulatory reporting as part of the Tiner project and proposes to launch a consultation paper in mid-2003. The FSA is enhancing IT capabilities and is in early stages of developing electronic reporting. - The proposal that listed firms should provide any reports to the market to the FSA prior to public release will be considered. - The FSA is participating actively in IAIS and Joint Forum discussions on enhanced public disclosure and will press for a three-pillar approach in forthcoming negotiations on a new EU insurance solvency regime. - CP13: On-site inspection is to be considered within the FSA’s overall risk-based approach. The FSA does not undertake on-site inspections of all insurance firms but follows a risk-based approach: close and continuing relationship with high impact firms; more pro-active supervision for prudential matters for high- and medium-impact firms; low impact firms supervised mainly through routine data analysis with on-site work in response to identified risks or sector-wide sample reviews. - The FSA has begun commissioning skilled persons reports from independent professional experts on specific aspects of a firm’s operation, systems or controls. - CP14: The authorities did not agree with formal notification of watchlist placement. They consider firms placed on the watchlist will already be aware of issues and remedial work will be underway; the FSA views the watchlist as an internal tool and does not believe telling firms that they are on the watchlist is appropriate. *Source: IMF mission report extract (Table 9 recommendations and authorities’ response).* ### 43. The principal regulator of securities markets in the United Kingdom is the Financial ### The principal regulator of securities markets in the United Kingdom is the Financial Services Authority (FSA). ### Information and Methodology used for Assessment - Assessment used the February 2002 version of the IOSCO Objectives and Principles of Effective Securities Regulation, and guidance issued by the IMF and the World Bank prepared in conjunction with the Implementation Committee of IOSCO. - Main information sources: - Self-assessments prepared by the FSA using the Questionnaires developed by IOSCO. - Documents furnished by the FSA: Annual Reports, publications relating to its policies, and its handbook. - Material from the FSA’s website: press releases and speeches by senior FSA officials. - The Financial Services and Markets Act 2000 (FSMA). - Interviews organized through the good offices of the FSA with market participants, industry groups, financial journalists, the FSA’s Consumer and Practitioner Panels, and others. - Lengthy discussions with senior staff of the FSA. - Principal assessors for securities: Mr. Alan Cameron, A.M., and Mr. David Shillman, Counsel to the Director of the Division of Market Regulation at the U.S. Securities and Exchange Commission. - The team received full cooperation from the FSA. ### Institutional and Macroprudential Setting, Market Structure - Key institutional facts: - The FSA was established by the U.K. Government in May 1997 and commenced operation in an interim or transitional way in June 1998. - The Financial Services and Markets Act 2000 (FSMA) took full legal effect on December 1, 2001 (referred to as N2). - The FSA absorbed initially the activities of nine previous regulators or government departments, and subsequently took on additional responsibilities. - The FSA is, in legal terms, the former Securities and Investments Board and took on the roles of the Securities and Futures Authority and the Investment Management Regulatory Organization; it has also incorporated the U.K. Listing Authority (UKLA), formerly a division of the London Stock Exchange (LSE). - Market trading venues and supervision: - Trading is conducted on securities exchanges, alternative trading systems, and in the over-the-counter (OTC) market. - Six securities exchanges in the United Kingdom: LSE, Virt-X, London Metal Exchange, London International Financial Futures and Options Exchange (LIFFE), OM London, and the International Petroleum Exchange. Each is supervised by the FSA as a ‘Recognised Investment Exchange’ and has certain self-regulatory responsibilities. - Alternative trading system providers (examples listed): Instinet, E-Crossnet, ITG Europe (Posit), BrokerTec — supervised by the FSA similar to investment firms, emphasizing prudential and conduct of business rules. - Significant OTC markets for foreign exchange, bullion, money market and fixed income products, and interest rate derivatives; participants supervised by the FSA as investment firms and required to comply with the FSA’s Code of Market Conduct and Inter-Professional Code. - Industry composition and market statistics (all figures as reported for 2001 unless otherwise noted): - Majority of the U.K. securities industry consists of subsidiaries of overseas financial institutions; parent companies of the top ten securities houses trading European shares in London are foreign and together account for approximately 75 percent of the U.K. equity market. - The LSE is the dominant U.K. stock exchange and, at the end of 2001, traded 2,975 equities. - Daily trading volumes for international equities in London are almost double those for domestic companies. - Annual turnover of domestic and foreign equities on the LSE was £5.5 trillion in 2001. - Aggregate market capitalization for domestic and foreign issues traded on the LSE was £4.1 trillion in 2001. - Funds raised on the LSE in 2001 totaled £149 billion. - LIFFE annual turnover in 2001 was more than 200 million contracts with a notional value in excess of £90 trillion. - London-based bookrunners are estimated to account for 60 percent of eurobonds issued, with 70 percent of secondary market trading in the international bond market. - London accounts for almost a third of world foreign exchange activity, with an average daily turnover of $504 billion. - London is the world’s most liquid spot market for gold and gold lending. - London is the most active trading centre for OTC derivatives, with a market share of 36 percent. ### General Preconditions for Effective Securities Regulation - Market attributes supporting effectiveness: - London’s prominence reflects openness and efficiency of its markets, concentration of skills and expertise, and pre-existing liquidity. - There appear to be no significant barriers to entry or exit from markets or products. - Regulatory policy orientation: - The U.K. approach is perceived as “proportionate” and designed to support investor protection, market fairness, efficiency and transparency, and reduction of systemic risk (the three IOSCO objectives). - Investor protection is delivered in part through required provision of information to investors and investor education, in addition to enforcement. - The FSMA charges the FSA with securing an “appropriate degree” of investor protection “while recognizing [investors’] own responsibilities.” - The FSA has issued comprehensive rules and guidance to implement its new statutory objectives under the FSMA. - The FSA’s ‘risk-based’ approach to supervision allocates resources to areas assessed as being of greater systemic importance; the effectiveness of this regime has yet to be tested in practice. - The U.K. regulatory scheme will be affected by European Union legislation and initiatives of the Committee of European Securities Regulators; the FSA’s powers need to be used and interpreted in light of the European Convention on Human Rights. *Assessment conducted as part of the Financial Sector Assessment Program of the International Monetary Fund and the World Bank between November 2001 and July 2002.* ### 52. The United Kingdom has a developed and robust legal system and its accounting ### _cr03208 - 52. The United Kingdom has a developed and robust legal system and its accounting ### Market structure and tax-related market effects - Stamp Duty: a 0.5 percent tax on the buy side of each share transaction in the United Kingdom. - Observed effects: - Narrower spreads have increased the proportional impact of the Stamp Duty. - Demand for share substitutes free from the Stamp Duty (derivative products such as contracts for difference and spread betting systems) has increased, creating some distortions in the securities markets. - These developments are not perceived at this stage as likely to create vulnerabilities or cause systemic risks. ### Institutional framework and regulator (FSA) - Role and objectives: - Principal regulator: the FSA, functions and objectives set out in the FSMA. - Statutory objectives include: (a) maintaining confidence in the financial system; (b) promoting public understanding of the financial system; (c) securing the appropriate degree of protection for consumers while recognizing their own responsibilities; and (d) reducing the extent to which it is possible for an authorized business to be used for a purpose connected with financial crime. - Structure and accountability: - FSA is established as a private company, limited by guarantee, financed by direct levies on the industry, responsible for its own budget. - FSA board appointed and removable by the Treasury; FSMA requires annual report to the Treasury, an annual open meeting, an independent investigator of complaints, and public consultation on rules and guidance. - Resources and capacity: - Budget in the vicinity of £221.1 million in the 2002/2003 year. - Permanent staff of approximately 2200, with capacity to appoint skilled persons. - Significant staff turnover since mid-1998, particularly in the securities sector; turnover levels have recently abated. - Regulatory approach and processes: - Published ‘A New Regulator for the New Millennium’ (January 2000) and subsequent Progress Reports (December 2000, February 2002). - Uses a ‘risk-based’ approach; regulatory requirements set out in the FSA Handbook (including a ‘Regulatory Processes’ block). - FSA has a Code of Conduct, dedicated legal resources on confidentiality, and a Complaints Commissioner. - Implementation grading: - Principles Relating to the Regulator (CPs 1–5): Assessment = Implemented. ### Enforcement, inspection, and information-sharing - Powers: - FSMA provides rulemaking, authorization, information-gathering, investigation, intervention, appointment of skilled persons, powers to impose financial penalties, civil and criminal prosecution powers, and powers to combat market abuse. - Enforcement mechanisms: - Administrative powers include imposition of fines and statements of public censure; ability to cancel/vary permissions or withdraw individual approvals; administrative power to seek restitution. - Civil powers include injunctions, restitution orders, insolvency petitions, and civil market abuse offence (floating burden of proof). - Criminal proceedings possible for insider dealing and money laundering breaches, subject to liaison with prosecuting authorities. - Regulatory Decisions Committee with external participation for penalty decisions; subject to Financial Services and Markets Tribunal. - Surveillance and investigations: - Primary surveillance of trading on recognized markets is carried out by the exchanges, which report suspected breaches to the FSA. - FSA receives routine financial reports, conducts routine and cause-based inspections, uses on-site visits, and may engage skilled persons (external auditors) to validate information. - Information sharing: - FSMA defines ‘primary recipients’ of confidential regulatory information and statutory 'gateways' for disclosure to U.K. bodies and overseas regulators. - FSA has signed nearly 160 Memoranda of Understanding (MoUs) with overseas counterparts and is reviewing them to align with the FSMA regime. - FSMA permits the FSA to consider U.K. interests when providing assistance to overseas regulators; comments suggest reconsideration of these prioritization criteria. - Implementation grading: - Enforcement and cooperation Principles (CPs 8–13): Assessment = Implemented. ### Issuers, disclosure, accounting, and auditing - Listing and prospectus requirements: - Admission to LSE requires admission to the Official List maintained by the UKLA (division of the FSA); prospectus must meet UKLA Listing Rules and FSMA general obligation. - Continuing obligations require disclosure of information likely to cause a substantial movement in price; some confidentiality exceptions; Listing Rules and Companies Act set periodic reporting timeframes. - Reporting timeframes and planned changes: - Companies Act allows 180 days to prepare and circulate annual accounts (Listing Rules require less); Listing Rules allow 120 days to circulate a preliminary final statement; Semi-annual and quarterly reports due within 90 days. - Department of Trade and Industry plans to shorten statutory periods; proposed EU Directive on Regular Reporting would require 90 days for annual reports and 60 days for half yearly and quarterly reports. - From January 2005, subject to an EU accounting regulation, listed companies will be required to prepare group financial statements using international standards. - Accounting and auditing standards: - Annual accounts set by the Accounting Standards Board (ASB); audits undertaken to standards set by the Auditing Practice Board (APB); both under Financial Reporting Council oversight. - U.K. accounting and auditing standards described as high and internationally acceptable; phased alignment with international standards is under way. - Implementation grading: - Issuers and Accounting/Auditing Principles (CPs 14–16): Assessment = Implemented. - Key comments: - Time periods for release of preliminary final results and annual financial reports are too long; consideration of whether all prospectuses need UKLA review (risk-based approach could be applied). ### Collective investment schemes (CIS) - Types and authorization: - Publicly promoted CIS types: authorized unit trusts (AUTs) and investment companies with variable capital (ICVCs, aka OEICS). - FSA authorizes operators, trustees, depositories, and grants permission to market and operate CISs; CIS Sourcebook details powers and duties. - Operator standards and delegation: - Authorization factors include fitness and propriety, honesty and integrity, financial capacity, internal management procedures, competence, human and technical resources, and capacity to discharge operator duties. - Recommendations for refinements: - (a) specific requirement for disclosure of affiliated-party transactions to investors and the FSA; - (b) require delegates receiving delegations of core functions to be bound by law or delegated legislation to comply with the same regulatory standards as the operator (currently bound by contract); - (c) extend regulatory framework applicable to delegates to sub-delegates, or at least those located in the U.K. - Some suggested changes would require legislation; direct regulator access to delegates may be valuable. - Disclosure and investor information: - ‘Know your customer’ rules require advisers to establish investor circumstances and recommend suitable products. - Investors must be provided with a Key Features Document (KFD) containing material information. - No explicit ‘plain English’ requirement or mandated research to confirm comprehensibility of KFDs; no continuous disclosure requirement for CISs, though discussion is ongoing. - Valuation, pricing, and redemption: - FSMA and OEIC Regulations 2001 provide for redemption at a price not significantly different from net asset value, determined per trust deed/instrument and FSA rules. - CIS Sourcebook requires that prices relate properly to net asset value, manager dealings be fair, and investor pre-sale information be available; disclosure of charges/expenses required. - FSA reviewing single/dual pricing regimes for CISs. - Implementation grading: - CIS Principles (CPs 17–20): Assessment = Implemented. ### Market intermediaries and prudential safeguards - Authorization, threshold conditions, and disclosures: - Regulated activities cannot be carried out unless authorized or exempt; the FSMA (Regulated Activities) Order 2001 enumerates regulated activities including managing investments, arranging deals, dealing as principal or agent, and giving investment advice. - Approved persons performing "controlled functions" must be "approved" by the FSA. - FSA obliged to publish information about approved persons as it thinks appropriate. - Capital, prudential, and liquidity standards: - Prudential requirements depend on permissions held and cover capital adequacy, holding client money and assets, internal controls, and reporting/notification requirements. - Firms assessed as other than ‘low impact’ receive individual risk assessments and firm-specific risk mitigation programmes. - Under the ‘risk-based’ approach, approximately 80 percent of market intermediaries (the ‘low impact’ firms) are not automatically subject to regular examinations and submit only annual financial reports; closer attention arises from complaints, whistleblowers, or sample/thematic reviews. - FSA developing a liquidity standard for market intermediaries. - Conduct, internal controls, and failures: - FSA Handbook contains 11 Principles for Businesses applicable to all regulated firms; guidance covers conduct of business, senior management arrangements, systems and controls. - FSA has wide powers under FSMA to deal with insolvency: apply to court to wind up an authorized person, apply for administration orders, be heard in insolvency proceedings, impose requirements in permissions, vary/cancel permissions. - All RIEs and RCHs required to have default rules; Part VII of the Companies Act modifies insolvency law to protect market default procedures; Financial Services Compensation Scheme (FSCS) available for compensation where a defaulter cannot satisfy claims. - Implementation grading: - Market Intermediaries Principles (CPs 21–24): Assessment = Implemented. - Key concerns: - Effectiveness of ‘risk-based’ supervision for the large population of low impact firms in ensuring ongoing compliance with capital and prudential requirements remains to be determined. ### Secondary markets, trading systems, transparency, and market integrity - Authorization and oversight: - Provision of trading systems/exchanges captured as regulated activities; authorization required and oversight by the FSA with rules in the FSA Handbook. - RIEs subject to recognition requirements to ensure orderly conduct, investor protection, market access safeguards, and rulemaking procedures including user consultation. - Surveillance and transparency: - Ongoing monitoring mainly conducted by exchanges as SROs; FSA encourages transparency and keeps arrangements under review. - FSA recognizes that optimum transparency may vary by market and is conducting an internal review; may consider more vigorous encouragement of RIEs to improve price transparency. - Risks identified: competitive pressures at RIEs could undermine trading visibility; pre-negotiation/internalization and delays in trade reporting could degrade price discovery. - Market abuse and unfair practices: - Insider dealing and market manipulation are criminal offences; FSMA broadens and strengthens market abuse regime, provides for FSA Code of Market Conduct, and creates a financial penalties regime alongside criminal sanctions. - FSA and RIEs have authority and practices to detect and deter manipulation; FSA monitors OTC markets using the ‘risk-based’ approach. - Large exposures, default risk, and market disruption: - FSA Handbook contains large exposure reporting requirements for investment firms. - RIEs and RCHs required to have default rules and adequate financial resources; regarded as potential ‘high impact’ institutions under FSA scrutiny. - FSA looks to RIEs/RCHs to monitor large exposures and inform the FSA when significant. - Clearing and settlement: - Clearing and settlement services are regulated activities; providers must be authorized or recognized as RCHs. - RCH requirements prescribe sufficient financial resources and adequate systems/controls; RCHs are treated as ‘high impact’ institutions. - See Assessment of IOSCO/CPSS Recommendations for Securities Settlement Systems for further details. - Implementation grading: - Secondary Market and Clearing Principles (CPs 25–30): Assessment = Implemented. - Observed aggregate outcome: - Table 11 summary: Implemented 30 — CPs 1 - 30. ### Recommended actions and open issues highlighted - Maintain focus: - FSA should retain clear focus on principal responsibilities set out in the FSMA given its wide remit and the risk of dispersion of effort. - Staffing and expertise: - Special efforts recommended to make FSA organization structure and remuneration more attractive to retain specialist skill and knowledge, given earlier high turnover and concerns about loss of expertise in the securities sector. - Enforcement toolkit: - Consider adding the court-enforceable undertaking (accepting detailed commitments binding as if by court order) to the FSA’s enforcement devices. - Early testing of wide enforcement powers and the novel civil market abuse offence is encouraged to establish credibility. - International cooperation: - Reconsider the weight given to U.K. national interest factors when deciding to assist overseas regulators outside the European Community to better align with priorities of a major international financial centre. - Review and update nearly 160 MoUs to reflect legal and role changes since they were signed. - Reporting and disclosure reforms: - Shorten statutory reporting periods for annual and preliminary results (ongoing Department of Trade and Industry plans and pending EU Directive timelines noted). - Consider applying the FSA’s ‘risk-based’ methodology to prospectus review to improve efficiency. - Collective investment schemes: - Consider statutory refinements: disclosure of affiliated-party transactions to investors and FSA; legally binding standards for delegates; extension of regulatory reach to sub-delegates or U.K.-based delegates. - Supervision of low-impact firms: - Evaluate whether the ‘risk-based’ approach effectively ensures ongoing compliance for approximately 80 percent of market intermediaries classified as ‘low impact.’ *Source: Detailed assessment of observance of the IOSCO Objectives and Principles of Securities Regulation as presented in the provided IMF content unit.* ### 53. Although the United Kingdom observes all of the IOSCO objectives and principles, ### _cr03208 - 53. Although the United Kingdom observes all of the IOSCO objectives and principles, ### Securities markets — technical recommendations - Although the United Kingdom observes all of the IOSCO objectives and principles, some technical recommendations to further improve the U.K.’s regulation of securities markets are outlined. - Recommendations: - When policy in the area of co-operation in international enforcement is next under review, consideration might be given as to whether the requirement in the FSMA to take account of the U.K.’s own interest when assessing whether or not to provide assistance to foreign regulators, is consistent with the priority a major international financial centre like the United Kingdom ought to place on securing effective enforcement across national borders. - Consideration could be given as to whether it is economic or efficient for the law to require all prospectuses to be reviewed by the UKLA; the FSA’s ‘risk-based’ assessment methodology could also be appropriate in this context. ### Collective investment schemes — potential enhancements - Matters suggested for consideration: - Introducing a specific requirement for transactions with affiliated parties to be disclosed to investors and the FSA. - Introducing a requirement that delegates receiving delegations of functions such as portfolio management, investment advisory and other core functions be bound not only by contract with the operator, as at present, but also by law to comply with the same regulatory standards imposed on the operator itself. - Extending the regulatory framework applicable to delegates, to sub-delegates. - Requiring delegation arrangements for custody to also be notified in annual reports at least. - Introducing continuous disclosure requirements for CISs. - The FSA presently is conducting an internal review of transparency matters, and may wish to ensure that competitive pressures do not undermine the visibility of trading interest in the future. ### Authorities’ response to IOSCO technical recommendations - General response: - The authorities welcomed the positive assessment of the U.K.’s observance of the IOSCO principles and noted that the United Kingdom has fully implemented all 30 principles. - They regard the FSAP team’s technical recommendations as helpful and constructive, and are considering how best to take them forward. - Specific comments: - Co-operation in international enforcement: - The authorities feel that in practice the recommendation concerning co-operation on international enforcement may be overstated, given both their record of effective co-operation and the requirements in FSMA to co-operate and to look beyond U.K. interests. - Review of all prospectuses by the UKLA: - The authorities consider the recommendation to apply their risk-based approach to their approval of documents to be useful. - They are seeking to develop a more risk-based approach to this work, although they would emphasize that they must still meet their obligations under European Directives that require approval of documents. - Collective investments — disclosure of transactions with affiliated parties and requirement of delegation arrangements: - The authorities noted that the U.K. has a very comprehensive and detailed regime for the regulation of Collective Investment Schemes (CIS) and in some areas they feel that their regime already provides sufficient protections equivalent to those suggested by the recommendations. - On the recommendations on the use of delegates, and for continuous disclosure by CIS, they believe these measures are already undertaken within their regime. - They are reviewing their current requirements for continuing disclosure. - On transactions with affiliated parties, the FSA is satisfied that the present requirements for information about such transactions to be passed to the FSA are consistent with their risk based approach to supervision and a proportionate regulatory regime. - They are considering further refinements to their CIS regime through an ongoing current review and noted that, in this respect, the FSAP recommendations more generally provide support for work already ongoing. - Encouraging RIEs to improve price transparency: - The authorities recognize the importance of sustaining improvements in an increasingly competitive environment. - They have been working to underpin high levels of transparency in a more fragmented marketplace, while also paying due attention to the need not to damage liquidity. ### CPSS Core Principles for SIPS and central bank responsibilities — NewCHAPS (General) - Assessment context: - Assessment undertaken in the context of an IMF Financial Sector Assessment Program (FSAP) exercise for the United Kingdom over the period February-July 2002 covering, inter alia, the Core Principles for Systemically Important Payment Systems. - This assessment covers the NewCHAPS system, the basis for two schemes—CHAPS sterling and CHAPS euro, providing real-time gross settlement facilities for sterling and euro transactions, respectively. - Inputs: - The Bank of England conducted a formal self-assessment of the NewCHAPS system’s observance of the Core Principles and provided detailed answers to an IMF questionnaire and documents. - Extensive meetings were held with officials from the Bank, CHAPS Company, APACS, six NewCHAPS members and two non-member institutions. - The CPSS Report on Core Principles for Systemically Important Payment Systems Parts I and II and an IMF guidance note were used for assessment. ### Payment infrastructure in the United Kingdom — components and roles - Major clearing systems (operating under APACS): - NewCHAPS: CHAPS Sterling and CHAPS euro — RTGS basis for high-value payments; currently 21 participants, of which 20 are members of CHAPS euro and 13 of CHAPS Sterling. - BACS: Automated Clearing House (ACH) for large volumes of relatively low-value (retail) payments including direct debits, direct credits, standing orders, and other non-urgent automated credit transfers. - Paper debit and credit payment items cleared through two parallel systems run by the Cheque & Credit Clearing Company (C&CCC). - CHAPSCo roles: - CHAPSCo is the governing body for CHAPS Sterling and Euro systems. - CHAPS Sterling started operations in 1984; developed into an RTGS system in April 1996; handles nearly all large-value same-day sterling payments between banks other than securities settlement (handled through CREST). - CHAPS euro began in January 1999 and is connected to TARGET; NewCHAPS moved both systems onto the same SWIFT-based technical platform in August 2001. - NewCHAPS main components: - Message exchange within two closed user groups (CHAPS euro and Sterling members and the Bank) over SWIFT FIN Copy Financial Application service (used in ‘Y-Copy’ mode). - Computer Based Terminals (CBTs – SWIFT interfaces) at members’ systems and at the Bank (the RTGS CBT). - Sterling and euro settlement accounts within the Bank’s real-time accounting system (the RTGS processor). - Enquiry Link facility provided by the Bank to interact with the RTGS processor to monitor payments, manage queues, and make funds transfers. - Responsibilities: - The Bank is responsible for provision and maintenance of the central scheduling and settlement accounting environment, the Enquiry Link network (based on SWIFTNet subject to bilateral contractual arrangements between the Bank and SWIFT), and intraday liquidity provision through an intraday repo facility (subject to bilateral contractual arrangements between the Bank and members). - CHAPSCo is responsible for the messaging network conveying CHAPS payment information between CHAPS members and to/from the Bank over SWIFT (subject to contractual arrangements between CHAPSCo and SWIFT). ### Functioning of the NewCHAPS system — processing, filters, queues, priorities - Message flow and settlement: - Payment message types: MT100, MT103 or MT202 submitted to SWIFT network; held in FIN Copy service; settlement request forwarded as MT096 via RTGS CBT to RTGS Processor. - Validation process at RTGS Processor (e.g., duplicate check). - Valid payment requests routed via a Central Scheduler to the RTGS processor. - Payments forwarded for settlement only after meeting conditions in Central Scheduler ‘filters’ set by individual banks (not compulsory). - Central Scheduler filters (three; any combination may be set): - Value ‘threshold:’ Payments equal to or greater than this value are held with status ‘blocked by value.’ - Individual payment ‘filter’: submitted payments with status ‘held’ are held until status removed by that bank. - Individual domestic counterparty ‘switch:’ banks can temporarily hold all payments to another CHAPS member with status ‘held for counterparty.’ - Funds Queue processing order: - Payments on the Funds Queue are processed first by priority, then by value (with the lowest value settlement request queued ahead of higher value settlement requests), then by time input to the funds queue, then by time of input to the RTGS Processor. - Priority allocation: - Settlement requests can be allocated a ‘Priority’ number within the range of 1-99 with Priority 1 being the highest. - Settlement requests within the range of 1 to 19 are able to use ‘headroom.’ - Priority levels 1-9 and 90-99 are reserved for use by the Bank; individual banks can allocate other priority levels to individual payment messages. - If no Priority is allocated, the system default Priority of 50 is allocated. - Priority may be changed at any time provided the request has not settled; changing Priority moves the item in the funds queue. - Finality and confirmations: - RTGS Processor settles payments by simultaneously debiting the sending member’s Settlement Account and crediting the receiving member’s Settlement Account. - Any payment may not be revoked by the sending member after the Bank has debited its Settlement Account; once entries are made, settlement is final. - After settlement, a Settlement Confirmation (MT097) is sent from the RTGS Processor to the SWIFT FIN Copy service; the initial payment message is then automatically released with full details plus settlement confirmation to the receiving member who must validate and accept it. - The sending member may request FIN Copy produce a Sender Notification (MT012) or a Delivery Notification (MT011). - MoU transmission time target: - Transmission time between one member’s internal system and another should be no longer than 60 seconds (30 seconds for network processing and 30 seconds for processing by the RTGS processor excluding delays caused by queuing in the Central Scheduler or lack of liquidity). - Headroom: - Members can reserve part of total available liquidity within the RTGS settlement process for time-critical payments (headroom). - Member-parameterized default allows banks to reserve a set amount at start of each business day; members can change amount intraday. - Priorities indicate payments which may use this reserved balance. - Liquidity usage guidelines (measured over a calendar month) to prevent hoarding: - Average of 50% of value throughput By 12.00 U.K. Time - Average of 75% of value throughput By 14.30 U.K. Time - Experience: - At an aggregate level, CHAPS Sterling appears to be meeting the throughput guidelines quite easily (some 30–40 minutes in advance of the deadlines). - Enquiry Link functionality: - Interactive link between Members and RTGS processor based on SWIFTNet Interact service. - Can adjust Central Scheduler settings, select payments to override thresholds, cancel payments queued in Central Scheduler and Funds Queue, alter priority of payments. - Used intraday by CHAPS members to fund and defund separate CREST RTGS account for DvP; Automatic Liquidity Transfer (ALT) Mechanism also available. - Cross-border TARGET flow: - Cross-border TARGET payments: sender’s account debited → RT TARGET account credited → settlement confirmation returned to FIN Copy → full payment message released in SWIFT to Interlinking component → RT TARGET account debited and recipient NCB credited → TARGET message sent through SWIFT to destination NCB → destination NCB credits recipient’s settlement account and relays message in domestic format. ### Statistical information — NewCHAPS average daily volumes (000’s) and values (£ millions) - 1999 - Sterling Vol 78.5 Val 177,396 - Euro Vol 9.7 Val 85,367 - Domestic Vol 2.5 Val 11,926 - Cross-border Vol 7.2 Val 73,441 - 2000 - Sterling Vol 86.1 Val 195,023 - Euro Vol 12.9 Val 99,277 - Domestic Vol 3.0 Val 12,143 - Cross-border Vol 9.9 Val 87,134 - 2001 - Sterling Vol 91.7 Val 202,857 - Euro Vol 14.5 Val 118,368 - Domestic Vol 3.4 Val 15,534 - Cross-border Vol 11.1 Val 102,834 ### Average transaction values (£) - 1999 - Sterling 2,259,420 - Euro Domestic 4,810,022 - Euro Cross-border 10,415,628 - 2000 - Sterling 2,264,212 - Euro Domestic 4,136,902 - Euro Cross-border 8,881,953 - 2001 - Sterling 2,211,854 - Euro Domestic 4,628,028 - Euro Cross-border 9,253,968 ### Intraday pattern of payment flows - Sterling: - Three peaks: morning around 07:30 (volume), 10:00 (value), and an afternoon peak between 14:30 and 15:30. - A trough generally observed between 08:30 and 09:30, probably reflecting a pause between payments input ahead of settlement date and payments generated during the day. - Euro: - Peaks from 07:30 to 08:00 and again from 15:00 to 15:30. - Number of payments drops steadily until 12:00 and stays low until 14:00. - Generally, euro payments are processed earlier in the day than sterling payments with 20 percent of euro payments processed by 08:00 compared to 13 percent for sterling. - The late peak largely reflects cross-border TARGET payments, with banks placing surplus liquidity in the euro area. *Source: IMF FSAP assessment text provided in the content unit.* ### 77. For CHAPS Sterling, financial transactions account for 76 percent by value ### _cr03208 - 77. For CHAPS Sterling, financial transactions account for 76 percent by value ### CHAPS Sterling transaction composition and values - Financial transactions: 76 percent by value transmitted and 38 percent by volume. - Financial transactions' market share by volume declined from 45 percent in 2000 to 38 percent (CHAPS Sterling). - Commercial and consumer transactions account for the remainder. - Payment size distribution: - 21 percent of CHAPS Sterling payments are below ₤1,000. - 47 percent of CHAPS Sterling payments are below ₤10,000. - Purpose of CHAPS payments (Source: CHAPS Traffic Survey 2001; figures indicative only): - FX: 5-7 percent by volume; 16 percent by value; Average value of transaction (£000s): 4,900 - Total financial: 38 percent by volume; 76 percent by value; Average value of transaction (£000s): 4,600 - Inter-account transfer: 10 percent by volume; 22 percent by value; Average value of transaction (£000s): 4,700 - Housing & legal: 16 percent by volume; 1 percent by value; Average value of transaction (£000s): 300 - Business: 29 percent by volume; - percent by value; Average value of transaction (£000s): 9 ### CHAPS euro - Less detailed data available. - Payments related to foreign exchange activity account for approximately 50 percent of euro values. ### Peak volume and value days (three peak days within last year) - Sterling volumes (000’s): - 29/06/01: 188.806 - 28/09/01: 186.535 - 30/03/01: 178.086 - Sterling values (£ billions): - 28/09/01: £318.95 - 29/06/01: £311.30 - 29/09/00: £296.82 - Euro volumes (000’s): - 20/02/01: 23.982 - 16/01/01: 22.687 - 30/05/01: 21.767 - Euro values (€ billions): - 29/06/01: €302.99 - 16/01/01: €253.95 - 29/09/00: €232.93 ### Concentration of CHAPS payment flows - CHAPS Sterling (payments originated within system): the 5 biggest banks account for over 80 percent of both value and volume. - CHAPS euro/TARGET: the 5 biggest banks account for just over 67 percent of volumes (less concentrated than CHAPS Sterling). ### Institutional framework and preconditions - The United Kingdom has a stable macroeconomic environment and a well-developed public infrastructure supporting the financial market. - Several key EU directives (including the Settlement Finality Directive) have been incorporated into Member States’ laws and cover the payment system. - Association for Payment Clearing Services (APACS): - Set up in 1985 as a non-statutory association of major banks and building societies. - Acts as an umbrella body and representative for the U.K. payments industry with 31 members. - APACS is an unincorporated association; its tasks include promoting operational efficiency and financial integrity of the U.K.’s payments infrastructure, including CHAPS. - Until recently, all members of CHAPS also had to be members of APACS (but not vice-versa). There is no legal relationship between the two organizations. - CHAPS Clearing Company (CHAPSCo): - Responsible for setting operational rules for CHAPS Sterling and euro systems and for system development. - Settlement members participate via Board membership and committees. - CHAPS Board governance: - Usually meets on a bimonthly basis. - Each member entitled to appoint one Director; members of same corporate group share a single seat. - A Director appointed by a Member whose clearing volume exceeds 10 percent of the Company’s total clearing volume is eligible for an extra vote at Board meetings. - Directors have fiduciary responsibility to all shareholders, must understand legal responsibilities, and commit their institution where company decisions require member agreement. - The Board appoints the Company Manager for day-to-day management and policy implementation. - Rule changes: - Any settlement member, or the Company Manager, may propose rule changes via the CHAPS Operational Committee; proposals are consulted with settlement members and relevant technical committees before Board consideration. - Under the Settlement Finality Directive, all changes to the Rules must be formally advised to the Bank in its capacity as designating authority. - Representation and consultation: - All Members are represented at the CHAPS Board and are consulted on Board decisions; indirect members and end-users are not consulted directly. - The Bank of England is a Member of CHAPS, is represented as of right at APACS Council and the CHAPS Board, and maintains close liaison between CHAPS senior management and the Bank’s Oversight Team. - The Bank of England has published its oversight role vis-à-vis U.K. payment systems on its web site. ### Changes, reforms, and strategic development - CHAPSCo committees and the Strategic Planning Working Group review and develop NewCHAPS functionality in parallel with ESCB discussions on TARGET 2 development; potential features and timelines remain unclear and any significant development will take time to implement. - APACS role reform: - APACS had become influential in scheme strategy, raising concerns about scheme governance effectiveness. - Proposals were developed to clarify that operational responsibility and development of each clearing lie with the relevant Clearing Company, while allowing APACS to continue industry-wide initiatives. - In September 2002, reforms were introduced: each clearing company under APACS, including CHAPSCo, now has full and explicit responsibility for its own governance, and the previous requirement for CHAPS members to be members of APACS has been removed. *Source: Extract from CHAPS assessment and CHAPS Traffic Survey 2001 contained in the referenced document.* ### 90. The mission has found that NewCHAPS observes the applicable Core Principles, ### _cr03208 - 90. The mission has found that NewCHAPS observes the applicable Core Principles ### Overall assessment - Initial phase: NewCHAPS fully observed seven Core Principles, and two Core Principles were broadly observed. One Core Principle was not applicable, while the four responsibilities of the central bank were observed. - Following reforms involving APACS, the NewCHAPS service is recognized as fully compliant with the applicable Core Principles. - Some technical refinements and margin areas remain, which the mission recommends be pursued. ### Detailed findings by Core Principle (CP) - CP I — Legal basis - Description: NewCHAPS Rules governed by laws of England and Wales; members submit to exclusive jurisdiction of the courts of England and Wales. - Statutory protection: Designation under the Financial Markets and Insolvency (Settlement Finality) Regulations 1999 (implementing Directive 98/26/EC) protects settlement of transfer orders and provision of “collateral security”. - NewCHAPS has been designated by the Bank as within scope of these protections. - CHAPS euro operations must comply with ECB TARGET Guideline, TARGET Agreement, and TARGET Manual of Procedures; compliance verified by the ECB. - RTGS Mandate Agreement and Master Repo Agreement (MRA) between each CHAPS member and the Bank are important in legal/operational framework. - Assessment: Observed - CP II — Rules and participant understanding of risks - Description: CHAPS Rules cover operational timetable, membership criteria, members’ responsibilities, withdrawal/exclusion, governing law/jurisdiction; incorporate other documents: - NewCHAPS Procedural Documentation (“the Procedures”) - RTGS Reference Manual (“the Manual”) - RTGS Payment Mandate Agreement, ILS Master Repurchase Agreement, DVP framework Agreement, RTGS CREST Mandate Agreement, RTGS CREST Master Self-Collateralizing Repurchase Agreement, NewCHAPS Security Code of Conduct, NewCHAPS Functional Specification, Information Guide for credit institutions using TARGET, SWIFT User Handbook - Assessment: Observed - CP III — Credit and liquidity risk management - Description: As an RTGS system, credit risk between members arises only in rare move to Bypass mode; main user risks are legal, operational, and liquidity. - Legal risk mitigants: designation under FMIRs; Rules specify points of input, irrevocability, and finality. - Overseas members: fewer protections; Bank requires legal opinions for Mandate and MRA execution. - Controls to minimize liquidity risk: throughput guidelines (sterling only); circles processing by Bank System Control; transfer of liquidity in sterling contingency; timing of ancillary system settlement; intraday collateralized liquidity by the Bank with eligible collateral specified. - Contingency: RTGS by-pass mode exists for business continuity. - Assessment: Observed - Comment: See comment on RTGS by-pass under CP VII. - CP IV — Prompt final settlement - Description: Individual payments settled on a real-time gross basis in CHAPS Sterling and CHAPS euro. - Assessment: Observed. - CP V — Multilateral netting (if applicable) - Description: Both CHAPS Sterling and CHAPS euro are RTGS schemes. - Assessment: Not applicable. - CP VI — Settlement assets - Description: Settlement in both CHAPS Sterling and CHAPS euro takes place in central bank money. - Assessment: Observed - CP VII — Security, operational reliability, contingency - Description: Security architecture founded on policies and procedures for Bank, SWIFT, and CHAPS Members; hierarchy of control documents (APACS policies, CHAPS Clearing Company Security Policy, Security Code of Conduct, annual self-certification). - Member controls: encryption, authentication, contingency, physical/logical access, segregation of duties, audit trails, dual control for production environment. Compliance via annual self-certification. - Incident management: CHAPS and Bank maintain error/incident logs; incidents reviewed at Operations Manager, Operational Committee, Company Manager, Audit Committee, Board; Bank RTGS team maintains Incident Log; RTGS Liaison Group and weekly operator/IT meetings review incidents. - SWIFT security described in User Handbooks (FIN Policy, FIN and FIN Copy Service Descriptions, FIN Security Guide, Network Access Guide, Technical Security Features). - Control/audit: CHAPS Board responsibility; Audit Committee reports; APACS oversight role; annual independent external review — no weaknesses found in reviews undertaken. - Availability target: settlement facilities available for 99.95% of the operating day on average over each month; Bank generally surpasses this standard. - Contingency: RTGS by-pass mode (end-of-day net settlement) and special mechanism to allow very limited payments to CLS with immediate finality in by-pass circumstances. - Operational history: system suffered a few longer outages during the last year; cut-off extensions frequent in Sterling service. - Assessment: Observed - Comments: - RTGS by-pass mode involves end-of-day (bilateral) net settlement; prior to reforms no centralized financial risk management rules applied in by-pass mode and members were not required or recommended to apply their own rules. - Board concluded by-pass risks remote but agreed post-live to review; Board agreed changes based on sending banks applying limits to amounts sent into the system to limit exposures in by-pass mode — to be implemented during 2003. - Plans to consider a loss-sharing agreement and to agree procedures for settlement of net positions in all circumstances. - Recommendation: pay due attention to assurance of high availability given increased time sensitivity of intraday payments (DVP securities settlement and forthcoming payment-versus-payment settlement of foreign exchange transactions). - Recommendation: monitor cut-off extensions and consider more stringent enforcement criteria if peer-pressure disciplinary mechanisms fail. - CP VIII — Practicality and efficiency - Description: RTGS practical for large-value and time-critical payments; MoU target transmission times: - transmission time between one Member’s payment system and another: no longer than 60 seconds (30 seconds network processing, 30 seconds RTGS processor) - TARGET maximum total processing time: 30 minutes (debit in sending RTGS until credit in receiving NCB) - TARGET processing in normal circumstances: no longer than a few minutes; objective under optimal circumstances: delay < one minute between debiting and crediting - Indirect members: can be advised online and initiate outgoing CHAPS payments; for non-indirect members no standard timeframes to customer accounts beyond non-binding service level codes: outward and inward payment transmission times should not exceed one and a half hours. - Charges and cost recovery: - CHAPS Company charges distributed pro rata among members via “Company Call” with minimum charge of 2% (applied up to an overall maximum of 26% of costs being charged in this manner). - Bank of England RTGS fee objectives: - to recover the Bank’s investment and running costs, including all allocated overheads attributed to the members - to recover attributable costs taking one year with another - and to avoid cross-subsidization of one service by another - Bank practice: not all investment costs are ‘recoverable’; did not seek to recover non-hardware-related development costs for RTGS, domestic CHAPS euro element, intraday DvP for CREST. - APACS: not for profit; sets fees to recover costs; work carried out for CHAPSCo charged directly to that Company and recovered from members. - SWIFT membership and per item charges are additional. - Assessment: Observed - Comments: - RTGS Reference Manual previously showed Account Management fees nearly three times higher for sterling than euro; following 2003 tariff review fees made identical for both services at £15,000. - Transaction fees set at same level for sterling and euro despite differing memberships and much larger payments volumes in sterling service — raises question whether euro service could fully recover costs if facilities not shared. - CP IX — Participation criteria, fair and open access - Description: Membership criteria in NewCHAPS Rules: - applicant must be an ‘appropriately supervised’ financial institution engaged in payment/transmission services (or a public authority or company wholly owned by Government) - ‘appropriately supervised’ = supervision as a credit institution (or equivalent) in an EU or EEA member state or G10 country - applicant must meet technical/operational requirements and adhere to Procedures and Security Codes of Conduct - minimum volume criterion removed - members must be SWIFT member or become SWIFT “Payment System Participant” - applicant must have settlement account facilities at Bank of England - Bank’s criteria: necessary operational expertise, willingness/ability to pay account maintenance costs (aimed at full cost recovery), and membership of a system Bank is prepared to provide settlement facilities to; only regulated financial institutions will be granted access to collateralized credit - CHAPS Rules available on request; Rules explain withdrawal and exclusion procedures - Assessment: Observed - Comments: - Initial assessment: access criteria objective but not all relevant information publicly available; membership application had to be made to APACS which had no legal relationship with CHAPSCo and obligated applicants to APACS fees. - Reforms (effective from September 8, 2002) addressed publication of membership criteria on the internet and governance changes, allowing this principle to be rated observed. - CP X — Governance - Description: CHAPS Board formally determines rules; Legal Committee vets rules changes; Operational Committee considers operational changes. - CHAPSCo responsibilities: setting operational rules for CHAPS Sterling and Euro; settlement members involved via Board and committees. - CHAPSCo authorized share capital: £10,000 divided into 100,000 shares of 10p each. - Issued capital: each member currently has a single share regardless of volumes; shares issued equals number of members. - Board governance: - Board usually meets bimonthly. - Each member entitled to appoint one Director regardless of clearing membership; corporate groups entitled to single seat between them. - A Director appointed by a Member whose clearing volume exceeds 10% of Company’s total clearing volume is eligible for an extra vote at Board meetings. - A three quarter’s majority required for a vote to pass; in practice decisions generally by consensus. - Company Manager appointed by Board for day-to-day management; Chair previously drawn from APACS Council with term of 3 years. - Rule change process: any settlement member or Company Manager may propose changes to Operational Committee, consultation with members and committees, recommendation to Board; under Settlement Finality Directive, all Rule changes must be advised to Bank as designating authority. - Assessment: Observed - Comments: - Initial phase had shortcomings in boundaries of CHAPSCo and APACS responsibilities and cost allocation; addressed by governance changes effective September 8, 2002. - Governance effective and accountable but not transparent to non-members: CHAPSCo does not publish its own reports; payments statistics published by APACS — improvements in public transparency could be considered. ### Central Bank responsibilities (Bank of England) - Responsibility A — Define objectives and disclose role/policies - Bank published “Oversight of Payment Systems” in November 2000 outlining oversight objectives and distinction between SIPS and SWIPS. - Bank responsibilities include overall financial stability, advising Chancellor, and designation of systems under FMIRs. - Oversight objectives: ensure risk reduction and promote improvements in U.K. payment/settlement infrastructure; Core Principles primary basis for assessment. - Bank undertook to publish statement on settlement account policy and report on oversight activities annually; statement published and public review in progress at time of writing. - Assessment: Observed - Comment: Aside from brief summary in Annual Report, Bank had not yet published a follow-up/annual account of oversight activities; June 2002 FSR included a useful box; recommendation that a regular (annual) account evolve. - Responsibility B — Ensure systems it operates comply with Core Principles - Bank operates RTGS Central System developed with CHAPSCo and CRESTCo; oversight process accounts for Bank operation’s effect on compliance. - Assessment: Observed - Responsibility C — Oversee observance by systems it does not operate - Bank created an Oversight Team in Market Infrastructure Division (MID); quarterly meetings with senior management of each U.K. payment system. - Bank began assessing key U.K. systems against Core Principles, focusing initially on CHAPS and BACS; self-assessments produced. - Assessment: Observed - Comments: - Recommendation: publicize main thrust of Core Principles assessments to increase public awareness of Bank’s oversight activities. - Recommendation: consider more formal statutory articulation of Bank’s critical payments and settlement systems oversight responsibility; current legal powers limited — reliance on moral suasion may be insufficient in some circumstances. - Responsibility D — Cooperate with other central banks and authorities - Bank has close contacts with European and G10 counterparts and domestic authorities (Tripartite Standing Committee; liaison with Office of Fair Trading). - Bank party to MoU between Payment Systems Overseers and Banking Supervisors in Stage Three of EMU. - Assessment: Observed ### Summary observance counts and governance notes - Table 13 summary: - Observed: 9 + 4 (CP I, II, III, IV, VI, VII, VIII, IX and IX; Responsibilities A – D) - Broadly observed: - - Partly observed: - - Non-observed: - - Not applicable: 1 (CP V) ### Key numeric and timetable items (preserved exactly) - Initial phase: NewCHAPS fully observed seven Core Principles; two Core Principles broadly observed; one Core Principle not applicable; four responsibilities observed. - Availability target: 99.95% of the operating day (average over the course of each month). - MoU transmission target between Members: no longer than 60 seconds (30 seconds network processing and 30 seconds for processing by the RTGS processor). - TARGET maximum total processing time: 30 minutes. - TARGET objective under optimal circumstances: delay less than one minute. - Non-binding service level codes: outward and inward payment transmission times should not exceed one and a half hours. - Company Call minimum charge: 2% (applied up to an overall maximum of 26% of costs charged in this manner). - Account Management fee (post-2003 tariff review): £15,000 for both services. - CHAPSCo authorized share capital: £10,000 divided into 100,000 shares of 10p each. - Extra vote eligibility threshold: clearing volume exceeds 10% of the Company’s total clearing volume. - Governance change effective date: September 8, 2002. - Publication date of Bank oversight paper: November 2000. - June 2002 FSR referenced as containing oversight detail. ### Principal recommendations and authorities’ responses (from mission comments) - Implement technical refinements and margin-area improvements identified by mission. - Implement agreed changes to CHAPS rules and procedures to limit financial exposures in RTGS by-pass mode (sending banks applying limits) — to be implemented during 2003. - Consider and agree a loss-sharing agreement and detailed procedures for settlement of net positions in all circumstances. - Enhance assurance of high availability given increased intraday time sensitivity (DVP and upcoming payment-versus-payment FX settlement). - Monitor cut-off extensions and consider more stringent enforcement mechanisms if peer-pressure discipline is ineffective. - Increase public disclosure of Bank’s oversight activities and Core Principles assessments (move toward a regular annual account). - Consider formal statutory articulation of Bank’s oversight responsibilities to complement moral suasion where appropriate. *Source: IMF staff mission assessment as presented in _cr03208 (NewCHAPS detailed assessment).* ### 91. The mission conducted an assessment of the NewCHAPS system relative to the Core ### _cr03208 - 91. The mission conducted an assessment of the NewCHAPS system relative to the Core ### Assessment of NewCHAPS relative to the Core Principles - The mission confirmed observance of the Core Principles for Systemically Important Payments Systems and central bank Responsibilities. - Initial assessment identified opportunities for further improvements in fair and open access and governance; subsequent changes that became effective addressed these issues. - The mission judged the applicable Core Principles and central bank Responsibilities to be already observed, but recommended a number of technical refinements to further improve arrangements. ### Recommended technical refinements and operational concerns - Contingency “by-pass” mode - The RTGS documentation identifies as a contingency measure the move of the payments processing to a so-called RTGS “by-pass” mode. - Currently this implies a move to an unprotected end-of-day (bilateral) net settlement procedure where no centralised risk management rules apply. - There is currently no requirement that banks apply risk management rules of their own, and it is unclear whether and/or how they may do so. - Since the initial FSAP assessment, the CHAPS Board has agreed procedures, to be implemented during 2003, to limit the financial exposures which could build up in by-pass mode. - Recommendation: Elaborate more fully in the RTGS documentation the means by which financial risks will be controlled and by which end-of-day net settlement will be achieved in all circumstances. - System availability and outages - NewCHAPS has suffered a few longer outages during the last year. - Specific problems behind some episodes have since been rectified. - Given the increase in time critical intraday payments (due to DVP settlement of securities and the forthcoming payment-versus-payment settlement of foreign exchange transactions), the mission recommended due attention to assuring continued high availability of the system. - Cut-off extensions and participant discipline - Within the sterling service, cut-off extensions have been quite frequent. - Participants feel existing disciplinary mechanisms (largely peer pressure) work well, but the mission recommended close monitoring and consideration of more stringent enforcement criteria if problems persist. - Tariff and fee consistency - Account management and transaction fees for the two RTGS services are set in a way that raises the question of whether the current tariff would enable the euro service to recover costs fully, were some facilities not shared with the sterling service. - Recommendation: The Bank should check the consistency of fees charged for the two RTGS services with its pricing objectives. - Transparency and governance of CHAPS Clearing Company / NewCHAPS - Recommendation: The CHAPS Clearing Company should take measures to increase external transparency in the governance and activities of NewCHAPS. - Oversight reporting - The Bank’s paper “Oversight of Payment Systems” (November 2000) committed to report annually on payment systems oversight activities. - The box on payments oversight in the June 2002 FSR is a useful step; recommendation to further develop this (or a similar vehicle) into a regular (annual) account of developments. - Such an account could elaborate the evolving relationship between the Bank’s oversight role and its operational role as a member of both NewCHAPs and BACS. - Public disclosure of self-assessments - The Bank has begun assessing key U.K. systems (focus initially on CHAPS and BACS) and produced self-assessments against the Core Principles. - Recommendation: Make public the main thrust of the assessment against the Core Principles of different U.K. payment schemes to increase public awareness of the Bank’s oversight activities and implementation of oversight policies. - Legal/statutory clarity of oversight powers - Recommendation: When appropriate, lay out more fully and formally in statute the Bank’s critical payments and settlement systems oversight responsibility arising from its central banking functions. - Observation: The Bank has few formal legal powers in relation to payment and settlement systems and currently relies on moral suasion; formal authority may be a precondition for effective enforcement in some circumstances. ### Authorities’ response - The authorities welcomed the constructive IMF review of risk management in the U.K.’s main payment systems and the insights provided. - Much of the recommended work has already been completed since the IMF’s initial review; a number of earlier concerns have been addressed. - Authorities note that CHAPS was subsequently found to comply fully with the relevant Core Principles and that oversight of U.K. payment systems meets international standards. - CHAPS’ continued observance of the Core Principles is a high priority for the U.K. authorities and for CHAPS members. - The authorities took note of the recommendation to increase transparency of the Bank’s oversight work; the Bank has taken steps in this direction. ### IMF’s MFP Transparency Code — Transparency of Monetary Policy (overview) - This report assesses consistency of U.K. monetary policy with the monetary policy portion of the Code of Good Practices on Transparency in Monetary and Financial Policies, in the context of an FSAP mission to the United Kingdom from February 6–20, 2002. - Assessment was based on: - An updated self-assessment prepared by the Bank of England in January 2002. - Review of Bank documents on its website: Annual Report, quarterly Inflation Report, Quarterly Bulletin, minutes of MPC meetings, the 1998 Bank of England Act, operational notices. - Discussions with Bank and HM Treasury staff, MPC members, market participants, private-sector economists, journalists, and an academic. - The U.K. authorities fully cooperated with the assessment; all required information and documents were provided. ### Institutional and market structure — key facts and framework - Timeline and policy framework - October 1992: U.K. adopted inflation targeting after exit from the European Exchange Rate Mechanism one month earlier. - October 1992–June 1995: monetary policy target range of 1 to 4 percent. - June 1995–May 1997: target was 2½ percent or less. - May 1997: Chancellor delegated operational responsibility for monetary policy to the Bank of England’s MPC while retaining the right to set the inflation target. - 1998: New regime formalized in the Bank of England Act 1998 (Act). - Monetary Policy Committee (MPC) - Task: set the Bank’s official lending rate (two-week repo rate) by majority vote to achieve the inflation target—currently 2½ percent for RPIX inflation. - Composition: the Governor and two Deputy Governors of the Bank, two other internal members appointed by the Bank after consulting the Chancellor, and four external members appointed by the Chancellor for renewable three-year terms. - A representative of HM Treasury may attend and speak at MPC meetings but has no vote. - The MPC is required to meet at least once a month. - The Act requires the MPC to publish minutes within six weeks (in practice within two weeks) and a quarterly Inflation Report. - Inflation targeting characteristics - The inflation target is symmetric (deviations below target treated same as above target). - Mortgage interest costs are excluded from the target. - Inflation has consistently been within one percentage point of target since 1997. ### Operational arrangements and statistics - Implementation and liquidity operations - The Bank implements policy by lending to counterparties in the sterling money market at interest rates tied to the official repo rate chosen by the MPC. - Liquidity forecasts are published and market operations are conducted several times each business day. - Reserve and deposit arrangements - No statutory reserve requirements; settlement banks required to maintain positive balances at day end. - Banks and building societies with average eligible liabilities in excess of £400 million are required to hold noninterest bearing ‘cash ratio deposits’ at the Bank set at 0.15 percent of their domestic deposit base. - These deposits provide revenue to finance unrecovered costs associated with monetary policy and financial stability activities. - Settlement banks can obtain intraday collateralized credit from the Bank to facilitate RTGS functioning. ### Practice-by-practice assessment — general findings - U.K. monetary policy is grounded in an inflation targeting framework considered one of the most transparent in the world. - Major 1997 reforms: operational independence for the Bank; point-target for inflation; creation of the MPC with external participants; individual accountability for policy votes. - The Bank uses probabilistic fan-charts in the quarterly Inflation Report to highlight uncertainty and discusses its economic outlook probabilistically. - Evidence of success: inflation expectations appear well anchored; uncertainty in markets regarding future policy actions has declined; the Bank scores well in public opinion polls. - Overall: the Bank of England observes most elements of the monetary policy portion of the Transparency Code. ### Practice-by-practice assessment — specific sections and observations - Section 1: Clarity of Roles, Responsibilities, and Objectives - The Bank observes all elements of this principle. - Some external observers noted a tendency of inflation to run just below target, introducing perceived uncertainty about objectives; the MPC addressed this in minutes of its February 2002 meeting (published February 20, 2002). - Section 2: Open Process for Formulating and Reporting Monetary Policy Decisions - The Bank observes all elements of this principle. - Meeting schedule publicized; interest rate changes announced immediately after MPC meetings (normally monthly). - Minutes contain individual votes and a nonattributed summary, released within 13 days of the meeting (legal requirement is within six weeks). - The Bank collaborates with market participants and provides data reporting forms and regulations on its website. - Observers praised use of probabilistic fan-charts, but some outside uncertainty remains about whether the charts represent MPC consensus forecast uncertainty versus the range of MPC members’ views; the Bank sought to clarify this in Inflation Report boxes and a table summarizing MPC members’ assumptions. - Bank was criticized for not pre-announcing the extraordinary MPC meeting in September 2001; the decision was consistent with other central banks in similar circumstances. - Section 3: Public Availability of Information on Monetary Policy - The Bank observes all elements except: - Timeliness of data published in accordance with IMF data dissemination standards (SDDS timeliness is 14 days; the Bank publishes after 21 working days and uses a ‘flexibility’ option for Analytical Accounts of the Central Bank). - Disclosure of aggregate information on emergency financial support provided by the central bank (broadly observed but the Bank does not provide enough information to enable outsiders to fully discern effects on revenues and expenses for the year(s) in question). - The Bank has an extensive public relations program; MPC members make numerous public presentations and media appearances. - Section 4: Accountability and Assurances of Integrity by the Central Bank - The Bank observes all elements except: - Disclosure of information on expenses and profit in operating the central bank (not published in detailed profit and loss accounts; outsiders cannot fully discern effects of lender-of-last-resort operations on revenues and expenses). - Publication of conflict of interest guidelines (the Bank has stringent guidelines that are not formally published; as a policy the Bank will provide oral briefings in response to external requests). *Source: IMF Financial Sector Assessment Program mission report (excerpts provided).* ### 1.1 The ultimate objective(s) and institutional framework of monetary policy should be clearly ### _cr03208 - 1.1 The ultimate objective(s) and institutional framework of monetary policy should be clearly ### Legal framework and ultimate objectives - The Bank of England Act 1998 (which amended the 1946 Act) gives the Bank operational authority and responsibility for monetary policy. - The Act states the Bank’s monetary policy objective is to deliver price stability (currently defined as an inflation target, set by the government) and, without prejudice to that objective, to support the government's economic policy, including its objectives for growth and employment. - The Act provides for the establishment of a Monetary Policy Committee (MPC) and prescribes the operational framework for that Committee. - Assessment: Observed. - External comment: The 1998 Act represents a significant improvement over the previous arrangements when the government was responsible for monetary policy and the Bank’s role was advisory. ### Specification, disclosure, and explanation of objectives - The objective of monetary policy to maintain price stability is set out in the Bank of England Act 1998 (Part II, Section 11). - In practice, the Bank sets short-term interest rates to achieve the government’s inflation target, confirmed annually in the Chancellor of the Exchequer’s Budget statement. - The Act details are published on the Bank of England’s public web site; the full document is available from The Stationery Office. - The Act’s monetary policy provisions are regularly explained in the Bank’s Quarterly Bulletin, Inflation Report and Annual Report. - Assessment: Observed. - External comment: Observers applauded the point-target for inflation; some questioned a prior tendency of inflation to run just below the target and noted the MPC clarified its approach in the minutes to its February 2002 meeting. ### Central bank responsibilities and authority (statutory) - The Bank of England Act 1998 (Part II) sets out the statutory basis for the Bank’s operational responsibility for monetary policy. - The Act assigns the Bank authority to intervene in financial markets and to take other actions necessary to achieve its monetary policy objectives. - Assessment: Observed. - External comment: This is a significant improvement over the pre-1997 period when the Chancellor set interest rates; the MPC now has discretion to set its policy interest rate with accountability and disclosure requirements. ### Institutional responsibility for foreign exchange policy - The government determines the exchange rate regime and may instruct the Bank, acting as its agent, to intervene using the government’s foreign exchange reserves. - The government publishes at Budget time the broad framework for how the Bank is to manage the government’s foreign exchange reserves. - The Bank also holds a separate pool of foreign exchange assets to use at its discretion to support its monetary policy objective. - Provisions relating to foreign exchange policy are discussed in the Bank’s Annual Report and Quarterly Bulletin and publicized on the Bank’s website. - Assessment: Observed. ### Accountability modalities and publication requirements - The Chancellor sets the inflation target; the MPC determines interest rates to meet the target. - The Governor and other Committee members are regularly called to appear before the Treasury Select Committee of the House of Commons. - If out-turn inflation is more than 1 percentage point away from the government’s target, the Governor, on behalf of the MPC, must write an open letter to the Chancellor explaining the divergence, policy action, expected period to return to target, and how this meets government objectives for growth and employment. - The MPC reports to a monthly meeting of the Bank’s Court of Directors; the Court reviews MPC procedures and commissions external peer-reviews. Conclusions are presented in the Bank’s Annual Report. - The Act requires the MPC to meet regularly; operational decisions are announced immediately; minutes, including voting records, must be published within six weeks (in practice usually within two weeks). - The Bank, with the approval of the MPC, is legally required to publish a quarterly report explaining the basis for its operational decisions. - Assessment: Observed. - Comment: The Court commissioned the ‘Kohn’ report as an external peer review; the Bank published the report and its response. ### Government override powers (exceptional circumstances) - The Bank of England Act 1998 (Part II, Section 19) assigns the Treasury reserve powers to instruct the Bank on interest rates for a limited period if deemed in the public interest and in extreme economic circumstances; any instruction would be in consultation with the Governor. - Reserve powers would be exercised through subordinate legislation approved by Parliament. - Since operational independence was granted in 1997, the government has not exercised its power to override the MPC’s interest rate decisions. - Assessment: Observed. ### Appointment, terms, and removal of governing body members - The Bank of England Act 1998 (Schedule 1) sets procedures for appointment, terms of office, and removal of the Bank’s Court of Directors. The Annual Report includes Court membership and a report from Court Members. - The Court’s functions include general management of the Bank’s affairs (other than formulation of monetary policy), reviewing MPC procedures, and assessing whether the MPC has collected necessary regional, sectoral, and other information. The Court must meet at least once a month. - A subcommittee of non-executive Directors (NedCo) reviews the Bank’s performance, financial management objectives, and MPC procedures. A summary of NedCo’s findings is presented in the Annual Report each year. - Assessment: Observed. ### Institutional relationship between monetary and fiscal operations - Fiscal operations carried out by the Bank (e.g., as banker and agent for the government) are disclosed in the Bank’s Annual Report; these roles do not, in practice, affect conduct of monetary policy. - Responsibility for management of the government’s debt and domestic cash balances transferred to HM Treasury’s Debt Management Office (DMO) in 1998 and 2000, respectively. - The Bank continues to manage the government’s foreign exchange reserves and maintain the gilt-edged stock register. - Assessment: Observed. ### Credits, advances, and government deposits - The Bank’s balance sheet includes the Ways and Means advance to the National Loans Fund (an advance to the government). Under the U.K. protocol to the Maastricht Treaty this advance may exist unless, and until, the U.K. enters the third stage of EMU. - When Exchequer cash management transferred to the DMO in April 2000, the level of the advance was frozen at £13.4 billion and is still outstanding. Repayment timing is at the Treasury’s discretion unless the U.K. enters the third stage of Monetary Union. - The existence of the Ways and Means advance is reported in public sector debt statistics, the Bank’s Annual Report and HM Treasury’s annual Debt and Reserves Management Report. - The level of the Ways and Means advance at end-February is published in the Bank’s Annual Report; the proposed level at end-March is published in HM Treasury’s annual Debt and Reserves Management Report. Government deposits with the Bank are published in the Bank’s Annual Report and in the Bank’s weekly summary balance sheet (the ‘Bank Return’). - Beginning in March 2002, the terms and conditions of these facilities were published in the Debt and Reserve Management Report. - The interest rate payable on the Ways and Means Advance and on deposits held by the Debt Management Office on behalf of the government is set at the Bank’s official repo rate. - Assessment: Observed. ### Central bank participation in government securities markets - The Bank does not participate in the primary market for gilts (not permitted under the Maastricht Treaty). - The Bank buys and sells gilts in the secondary market for its own account, on behalf of central bank customers, and operates a brokerage service for U.K. retail investors. Details of the brokerage service are available on the Bank’s website; the service for central bank customers is described in a prospectus. The Bank’s own holdings of gilts are disclosed in the Bank’s Annual Report. - Assessment: Observed. - Comment: The retail brokerage service allows private investors to buy and sell gilts in small amounts, often charging commission less than banks or stock brokers. ### Central bank involvement in the rest of the economy; procurement and services - The Bank holds shares in its subsidiaries and various bodies related to central bank and payments activities; it holds no other equity. Bank staff do not sit on private sector company boards except in relation to central bank and payments activities. Equities held by the Bank’s staff pension fund are managed off-balance sheet by in-house investment managers with no access to market-sensitive information collected by the rest of the Bank. - Procurement of fixed assets from the private sector is conducted in an open, public, and competitive manner. - The Bank provides banking and custodial services to some private sector customers for a fee and tenders these services on a competitive basis. - Assessment: Observed. - Comment: Banking and custodial services for private sector customers mainly reflect dealings that are a holdover from pre-1946 when the Bank was a private company. ### Allocation of profits and capital maintenance - The Bank’s Annual Report discloses allocation of the Bank’s profits between the government and the Bank’s ‘capital and reserves’. - In practice, a 50:50 split of the Bank’s profits between itself and HM Treasury is adhered to. If Court and HM Treasury agree on a different split (per the 1998 Act), the Bank would reveal why in its Annual Report. - Assessment: Observed. ### Agency roles performed by the Bank - (i) The Bank manages the U.K.’s external public debt and foreign exchange reserves. HM Treasury provides a formal annual remit to the Bank, published in the Treasury’s annual Debt and Reserves Management Report. Domestic public debt has been managed by the U.K. Debt Management Office since April 1998. - (ii) The Bank acts as principal banker to central government (public record; see the Bank’s Annual Report). - (iii) The Bank is required under statute to provide the stock registration service for certificated British government securities (Stock Transfer Act 1963 and earlier versions and Government Stock Regulations). - (iv) There is no formal requirement for the Bank to serve as an advisor on economic and financial policies and international cooperation. In practice, since May 1997 the MPC has had operational responsibility for setting interest rates to meet the government’s inflation target. The Bank participates with the government on an ad hoc basis in international fora (for example the IMF/World Bank). - Assessment: Observed. - Comment: Examples of advisory work include sovereign debt restructuring (joint Bank of Canada–Bank of England working paper, 2000) and G-7 issues when informally asked by the government. The Bank acts as an agent for HM Treasury in implementing financial sanctions per a Memorandum of Understanding. ### Allocation of market infrastructure responsibilities - The allocation among the central bank, ministry of finance, and separate agencies for primary debt issues, secondary market arrangements, depository facilities, and clearing and settlement arrangements is disclosed in HM Treasury’s annual Debt and Reserves Management Report and on the web sites of the U.K. Debt Management Office and CRESTCo. - Assessment: Observed. ### Open process for formulating and reporting monetary policy decisions - The framework, instruments, and any targets used to pursue monetary policy objectives are described in the Bank’s Annual Report, quarterly Inflation Report, and on the Bank’s website; also discussed in HM Treasury’s 2002 book Reforming Britain’s Economic and Financial Policy: Towards Greater Economic Stability. - Operational instruments used to implement MPC interest rate decisions are regularly described in the Bank’s Quarterly Bulletin; the technical framework of money market operations is set out in the Bank’s Operational Notice for sterling money market operations. - Assessment: Observed. - Comment: The Inflation Report presents projections for inflation and GDP over a two-year horizon in probabilistic fan charts; external observers commended this and the effort to emphasize uncertainty rather than point-estimates. Some public confusion exists over whether fan-charts reflect MPC consensus uncertainty or diversity of members’ views; the Bank has addressed this in Inflation Report boxes and a table summarizing MPC members’ different economic assumptions. ### Procedures and practices for monetary operations and counterparties - Details of the Bank’s sterling money market operations are set out in the Bank’s Operational Notice and reported in the ‘Markets and Operations’ article in the Quarterly Bulletin. - Since 1997 the Chancellor authorized the Bank to undertake foreign exchange operations on its own balance sheet to intervene in support of its monetary policy objective. Under the 1998 Act the Bank has discretion about revealing decisions to intervene if publishing would impede the purpose of the intervention; this discretion applies to domestic open market operations and foreign exchange intervention, but in practice applies only to the latter. There is a presumption the Bank will publish any MPC decision to intervene in foreign exchange markets alongside other monetary policy decisions. Minutes relating to the decision to intervene must be published within six weeks of an announcement (see Sections 14 and 15 of the Act). - Assessment: Observed. - Comment: Since 1997 the Bank has not intervened in the foreign exchange market for domestic monetary policy purposes; no practical example exists of such an operation. - The rules and procedures guiding the Bank’s dealings with counterparties and market operations are set out in the Bank’s Operational Notice. The ‘functional criteria’ for counterparties were published in February 1997 (‘Reform of the Bank of England’s operations in the sterling money markets’) and republished in May 2002 (‘The Bank of England’s Operations in the Sterling Money Markets’). - The list of counterparties is not made public to avoid perceptions of special treatment in the event of financial distress, though some market participants believe they have a fair understanding of which institutions are on the list. Functional criteria include a counterparty’s market presence, ability to handle the Bank’s operations, participation degree, and quality of information on market conditions provided to Bank staff. - Assessment: Observed. *Source: _cr03208 - 1.1 The ultimate objective(s) and institutional framework of monetary policy should be clearly* ### 2.2 Where a permanent monetary policy making body meets to assess underlying economic ### 2.2 Where a permanent monetary policy making body meets to assess underlying economic developments, monitor progress toward achieving its monetary policy objective(s), and formulate policy for the period ahead, information on the composition, structure, and functions of that body should be publicly disclosed. ### Composition, structure, and disclosure - The Bank of England Act 1998 (Part II, Section 13) assigns operational responsibility for monetary policy to the MPC, and specifies the composition, structure and functions of the Committee. - Details are published in the Bank’s Annual Report and Quarterly Bulletin and on the Bank’s public web site. - Assessment: Observed ### Meeting schedule, convening, and exceptional meetings - The MPC normally meets monthly to discuss its monetary policy decision. - The schedule of meetings is published as a press release in the autumn of each year for the calendar year ahead, and is available on the Bank’s web site. - The Governor of the Bank (or in his absence the Deputy Governor with responsibility for monetary policy) may summon an unscheduled policy meeting at any time giving such notice, which in his judgment the circumstances may require. - Since the MPC’s inception, only one such meeting has been called, following the extraordinary events of September 11, 2001 and their immediate aftermath. - External commentary: a Lehman Brothers report (August 2001) suggests market uncertainty about future policy actions declined since the introduction of the current framework in 1997. External observers criticized the Bank for not announcing the September 2001 extraordinary meeting in advance; the Bank responded that deciding to preannounce represented a difficult judgment and noted consistency with practices of the European Central Bank and the Federal Reserve. - Assessment: Observed ### Decision announcements, minutes, and member disclosure - At noon on the final day of the MPC’s monthly policy meeting, the Bank releases a press statement to announce the decision made at the meeting. - Minutes identify how each member of the Committee voted and explain any dissent from the majority vote; minutes also contain a summary of recent economic developments considered and the level of interest rates preferred by dissenters. - Additional meetings (exceptional circumstances) are announced immediately after the meeting and minutes must be published within six weeks. - The Bank discloses votes of individual MPC members, but views expressed during the meeting are not attributed to individuals in the minutes to encourage frank discussion. - External observers argue non-attribution may hinder accountability; market participants report they can often associate non-attributed statements with individual members, aiding interpretation of public comments. - Assessment: Observed ### Timeliness of disclosure of considerations - Minutes of the MPC policy meetings, which contain the main considerations underlying monetary policy decisions, are normally published 13 days after the meeting even though the 1998 Act only requires that they be released within six weeks. - Assessment: Observed ### Periodic reporting on progress toward objectives - The Bank publishes a quarterly Inflation Report as required by the Bank of England Act 1998. The Report discusses the MPC’s progress towards achieving the government’s inflation target, accounts for its monetary policy actions, and sets out and justifies its outlook for the economy and inflation. - Assessment: Observed ### Public presentation of objectives, rationale, and assumptions - The Bank conducts continuous education and public relations programs on monetary policy, including speeches, written material, and a monetary policy competition for schools to explain objectives and processes. - The Bank of England/Times Target 2Point5 schools competition increases outreach and publicity through regional heats, national final coverage in The Times, regional newspapers, and broadcast media. - Assessment: Observed ### Schedule and content of macroeconomic reports - The quarterly Inflation Report describes and analyses the MPC’s assessment of the current macroeconomic situation, with sections on recent developments and a synthesis of the macroeconomic outlook. - The schedule for publishing the Report is published in the autumn of each year for the following calendar year and is publicized in the Bank’s Quarterly Bulletin and on its website. - Assessment: Observed ### Consultation on substantive technical changes - The Bank consults participants in the sterling money markets on substantive technical changes to its operations. - The last substantive change to the Bank’s system of operating in the sterling money markets was in March 1997; proposals were set out in a consultative paper published in December 1996. - The Bank liaises with market participants through three key committees: the Foreign Exchange Joint Standing Committee, the Sterling Money Markets Liaison Group, and the Stock Lending and Repo Committee, chaired by senior Bank officials. - Assessment: Observed ### Disclosure of data reporting regulations - All reporting forms and accompanying definitions are available on the Bank’s web site. Updates to the definitions are immediately posted on the website. - The General Notes and Definitions make clear that the data are collected in accordance with the Bank of England Act 1998. - Assessment: Observed --- ### III. PUBLIC AVAILABILITY OF INFORMATION ON MONETARY POLICY ### Compliance with IMF data dissemination standards - Data for the Analytical Accounts of the Banking Sector (Broad Money components and counterparts) and for the Analytical Accounts of the Central Bank both meet the IMF’s Data Dissemination Standards. - A ‘flexibility option’ is taken in respect of one of the prescribed components of the Analytical Accounts of the Central Bank. - Assessment: Broadly Observed - Comment: The prescribed timeliness is 14 days, but the data are published after 21 working days because the data are an integral part of the balance sheet of all monetary financial institutions and are published as a complete package at the earliest opportunity. ### Balance sheet disclosure and accounting - The Bank of England’s accounts take the form of two balance sheets: the Issue Department (note issue functions) and the Banking Department (all other assets and liabilities). - The Bank has a statutory requirement to prepare a weekly return of its accounts under section 6 of the Bank Charter Act 1844; the weekly return is published in the London Gazette and is available each Thursday. - Detailed balance sheets are prepared for the Bank’s annual accounts. - The Bank of England Act 1998 requires the Banking Department balance sheet to be prepared according to U.K. standards for commercial banks (apart from some disclosures); full accounting policies are disclosed in the Bank’s Annual Report. The Issue Department balance sheet is prepared according to rules agreed with HM Treasury, the main ones being disclosed. - Assessment: Observed ### Monetary operations and market transaction disclosure - Details of the refinancing provided at each of the Bank of England’s daily dealing rounds are immediately published on the wire services. - Factors influencing the market’s daily cash position are also published. - Table D2.1 in the monthly Bank of England: Monetary and Financial Statistics provides a daily summary of the Bank’s market operations by amount, interest rate and collateral instrument. - Table D2.2 gives a monthly summary by amount and collateral instrument, including the amounts outstanding. - Assessment: Observed ### Disclosure of emergency financial support (lender of last resort) - In exceptional circumstances the Bank may act as “lender of last resort” to financial institutions in difficulty; all such support operations are disclosed and disclosure happens in a timely manner. - There is a presumption in favor of disclosing support in the Bank of England’s first annual report following the support operation; if disclosure would be damaging to financial stability or the support operation, disclosure may be postponed and reconsidered after a further year and, if necessary, in subsequent years until disclosure takes place. - When published, explanations will set out factors that made earlier disclosure unsafe; some items may be disclosed earlier than others if safe. - Assessment: Broadly Observed - Comment: When the Bank publishes information on lender-of-last-resort support operations, it does not provide enough information to enable external observers to fully discern the effects of these operations on the Bank’s revenues and expenses for the year(s) in question. ### Foreign exchange reserve disclosure - The foreign exchange assets, liabilities and commitments of the U.K. Government and the Bank of England are published in accordance with IMF methodology and G10 central bank guidance. - The U.K. began to disclose additional information on its foreign currency assets and liabilities in accordance with the IMF template from July 1999. - Data are published on a done date basis to remove the distinction between the spot and forward books; the template integrates on-balance sheet and off-balance sheet international financial assets and liabilities. - With effect from August 2001, data on foreign currency holdings of central government (not classed as reserve assets) have been included in section I-B and IV of the template; associated foreign currency drains are scored against the U.K. Government in Section II. - The data are published by HM Treasury and the Bank at 9.30am on the third working day of every month and are available on both HM Treasury’s and the Bank’s web sites. - Assessment: Observed ### Public information services and outreach - The Bank maintains an extensive public information service and by law must publish the minutes of monthly MPC meetings (including the vote) and a quarterly Inflation Report. - The press conference to introduce the quarterly Inflation Report is televised and web cast live. - The MPC makes regular speeches throughout the U.K.; the Bank’s 12 regional agents explain policy to the business community and other members of the public. - The Bank has a program to build a constituency for low inflation among the general public, including an education program and a successful economics competition for schools, a regular program of talks for visitors, a comprehensive website, and a Public Enquiries Group to respond to letters, e-mails, and telephone calls. - There is also an information program for members of parliament and a community relations program. - Assessment: Observed ### Publications program - By law the Bank must publish an annual report, which includes a separate report from the non-executive directors. - The Bank issues a wide range of other regular documents including an Inflation Report, a Quarterly Bulletin, staff working papers, statistics releases, occasional policymaking publications, and a regular Financial Stability Review. - Assessment: Observed ### Senior officials’ public communications - Senior officials appear regularly in public (often televised) before the House of Commons Treasury Committee and the House of Lords Economic Affairs Committee and have a comprehensive public speaking and media interview program. - Senior officials have a presumption in favor of releasing the text of their statements to the public. - Statistics for the 12 months ending October 2001: - about 35 published speeches and lectures on monetary policy and related economic issues by the Governor and other MPC members, - typically more than 100 other private and public speeches, lectures, and informal talks on the economy each year, - MPC members gave just over 200 interviews to the media on monetary policy issues, of which 122 were on the record (on the record interviews were evenly split between national and regional press and broadcasting media), - MPC members planned a total of 50 regional visits for the financial year 2001/2002. - Assessment: Observed *Source: _cr03208 - 2.2 Where a permanent monetary policy making body meets to assess underlying economic developments, monitor progress toward achieving its monetary policy objective(s), and formulate policy for the period ahead* ### 3.4 Texts of regulations issued by the central bank should be readily available to the public. ### 3.4 Texts of regulations issued by the central bank should be readily available to the public. ### Publication of Bank rules and instruments - Rules and instruments having legal status that are issued by the Bank to the general public are published and available on the Bank's web site, including lists of names of individuals and organizations published under United Nations sanctions legislation. - Assessment: Observed ### Accountability and public reporting by senior officials (Section 4.1) - Senior officials appear regularly in public before the House of Commons Treasury Committee and the House of Lords Economic Affairs Committee to: - report on the conduct of monetary policy, - explain the Bank’s objectives, - describe performance in achieving them, - exchange views on the state of the economy and the financial system. - Committees publish reports and transcripts of evidence. - The Bank’s Annual Report is laid before Parliament by the Chancellor of the Exchequer. - Assessment: Observed - Comment: In the first 10 months of the 2001–2002 fiscal year ending February, MPC staff appeared in public before the House of Commons Treasury committee on two occasions, and before the House’s Public Accounts Committee on one occasion. In addition, there were two occasions where MPC members appeared before the House of Lords Economic Affairs Committee. ### Audited financial statements and audit procedures (Sections 4.2 and 4.2.1) - Audited financial statements are published in the Bank’s Annual Report. - Assessment: Observed - The Bank’s financial statements are audited by an independent auditor; accounting policies are published in the Annual Report. - In 2001 the Bank introduced a public tender process for choosing the auditor, advertised in the European Union journal. The selection panel consisted of a Deputy Governor, the Finance Director, and a nonexecutive director from the Audit Committee. The panel interviews interested firms and recommends to the full Bank’s Court of Directors. - Assessment: Observed - Comment: Currently, Price Waterhouse Coopers is the Bank’s auditor, with an appointment of four years, so 2002 will be the second year under the new framework. Two firms were ruled out in the last tender due to conflicts of interest. ### Internal governance and disclosure (Section 4.2.2) - Internal governance procedures are described in the Bank’s Annual Report. - Court of Directors manages the Bank’s affairs other than monetary policy (MPC function). - NedCo (sub-committee of Court of non-executive Directors) reviews Bank performance, internal controls, MPC procedures, and determines Governor’s and Deputy Governor’s remuneration and pensions. - Formal audit and remuneration committees exist. - Governor’s Committee is the senior policy-making body under Court; Management Committee handles internal management (Deputy Governor (Financial Stability), Deputy Directors, Finance Director, Director of Personnel). - Assessment: Observed ### Disclosure of expenses and revenues (Section 4.3) - The Bank’s Annual Report contains information on profit and expenditure. - The Bank does not publish revenue numbers when disclosure would reveal provisions that could indicate lender-of-last-resort activity; consequently revenue information is withheld to avoid alerting readers to the possibility that the Bank had engaged in a lender of last resort activity. - When circumstances permit, details of support operations are published (see Note 1 to the Bank’s Accounts). - Assessment: Broadly Observed - Comment: When the Bank publishes information on lender-of-last-resort operations, external observers are not able to fully discern the impact on the Bank’s revenues and expenses for the year(s) in question. ### Standards and rules on personal financial conduct and conflicts of interest (Sections 4.4 and 4.4.1) - The Bank has internal rules on personal financial dealings set by Court to address possible, actual or perceived conflicts of interest or misuse of confidential information. - Rules require MPC members and staff to obtain prior authorization for every financial transaction (including new mortgage borrowing, switching between fixed and floating rate mortgages, switching between funds in a personal pension plan). - Exception: investments placed at arm’s length under fully discretionary management (these arrangements must be approved when set up). - Assessment: Broadly Observed - Comment: Conflict of interest guidelines are contained in a number of documents which have not been published. The Bank provides oral briefings on the rules in response to external requests. Rules were tightened further in 2002, when MPC members and some staff will be required to disclose information on asset holdings as well as the flows associated with financial transactions. - Legal protections: Bank staff have statutory immunity in respect of banking supervisory acts or omissions before June 1998; statutory immunity under the Settlement Finality Regulations 1999; the Bank indemnified members of its Court of Directors against personal civil liability arising from carrying out their functions. These immunities are publicly disclosed. - Text of Regulation 11 (Exemption from liability in damages) from the Financial Markets and Insolvency (Settlement Finality) Regulations 1999 is reproduced in the source: - (1) neither the designating authority nor any person who is, or is acting as, a member, officer or member of staff of the designating authority shall be liable in damages for anything done or omitted in the discharge, or purported discharge, of the designating authority’s functions under these Regulations. - (2) paragraph (1) does not apply (a) if the act or omission is shown to have been in bad faith; or (b) so as to prevent an award of damages made in respect of an act or omission on the ground that the act or omission was unlawful as a result of section 6(1) of the Human Rights Act 1998 (acts of public authorities). - Assessment: Observed ### Summary observance and counts (Table 15) - Observed: 42 - Broadly observed: 4 (Principles 3.1, 3.2.3, 4.2.1, 4.4) - Partly observed: (none listed) - Not observed: (none listed) - Not applicable: (none listed) ### Recommended Action Plan (items 108–110; Table 16) - Section 3.1: - When feasible, shorten the publication period of the U.K. monetary statistics from 21 days to 14 days. - Sections 3.2.3 and 4.2.1: - When disclosing lender-of-last-resort support provided to distressed financial institutions, consider providing enough information to enable external observers to fully discern the effects of these operations on the Bank’s revenues and expenses for the year(s) in question. - Section 4.4: - Consider publishing a summary of the conflict of interest guidelines and make clear how members of the public can obtain further information (or the underlying documents) if they so wish. - Table 16 (Selected recommended actions): - 3.1: When feasible, shorten the publication period of the U.K. monetary statistics form 21 days to 14 days. - 3.2.3: When disclosing lender-of-last-resort support provided to distressed financial institutions, consider providing enough information to enable external observers to fully discern the effects of these operations on the Bank’s revenues and expenses for the year(s) in question. - 4.2.1: Same as 3.2.3 - 4.4: Although the conflict of interest guidelines are contained in a number of documents, the Bank should consider publishing a summary of them, and make it clear how members of the public can obtain further information (or the underlying documents) if they so wish. ### Authorities’ response (items 111–112) - The authorities noted interrelationships between monetary policy transparency assessment and financial policy functions and provided a combined response covering both Bank of England assessments. - On Principle 3.1: - Shortening the publication period could only be achieved by imposing significant additional costs on some contributors. - U.K. monetary statistics meet SDDS timeliness requirements except for the Analytical Accounts of the Central Bank. - Narrow money data are published on the third working day after the final Wednesday of the reference month; Broad money and credit data are published after 14 working days. - Sectoral breakdowns of broad money and credit, and the consolidated balance sheet of monetary financial institutions, are published after 21 working days; accelerating this would impose unjustifiably high costs on contributors. - SDDS requirements are met by using a 'flexibility' option for the Analytical Accounts of the Central Bank. - On Principles 3.2.3, 4.3, 7.3.1 and 8.3 (lender-of-last-resort disclosure): - In exceptional circumstances the Bank may act as lender of last resort; all support operations are disclosed in a timely manner. - Presumption in favor of disclosure in the Bank of England's first annual report following the support operation; disclosure may be postponed if damaging to financial stability or the operation itself, with re-consideration after a further year and, if necessary, in subsequent years. Factors causing postponement will be explained when disclosure occurs. Note 1 of the Bank's Annual Accounts explains the policy in more detail. - On Principles 4.4 and 8.4 (conflict of interest rules): - Court has set rules on personal financial dealing; MPC members and executive directors are required to disclose the stock of financial assets, and some liabilities, to the Personnel Director (or for Governors to the Chairman of the Committee of Non-Executive Directors). - MPC members are strongly advised to place investments at arms length under fully discretionary management; where impracticable they must seek prior agreement before every transaction. - Briefings on these rules have been provided in response to external requests. In November 2002 the Bank sent a detailed summary of the rules as they apply to MPC members to the Treasury Committee of the House of Commons, on the assumption that the Treasury Committee will in due course publish them as evidence; once published, the Bank will place a copy of the summary on its web site. *Source: _cr03208 - 3.4 Texts of regulations issued by the central bank should be readily available to the public.* ### 121. In addition, the Bank has also published separately its framework for payment ### _cr03208 - 121. In addition, the Bank has also published separately its framework for payment ### Payment systems oversight and related publications - The Bank has published: - "Oversight of Payment Systems, November 2000". - "Bank of England Settlement Accounts: consultative document, January 2002". - A Financial Stability section on the Bank’s website. - The Bank’s paper on Oversight of Payment Systems: - Distinguishes between Systemically Important Systems (SIPS) and systems of System Wide Importance (SWIPS). - Uses the BIS "Core Principles for Systemically Important Payment Systems" as the primary basis for assessing risk control. - States the Bank will report yearly on its payments systems oversight activities at the time of its Annual Report. - At the time of the assessment: - Annual reporting of oversight activities had been limited to a brief summary in the Annual Report until recently. - The June 2002 FSR contained a useful box on payments system oversight that broadened the Bank’s stated interest to include securities settlement systems and clearing houses (including central counterparties) beyond the "embedded payments systems" perspective. ### Transparency, publication, and public engagement - The Bank’s public communication and transparency: - The Annual Report 2001 recorded some 65,000 hits on the website for the stability assessment in the week following its publication. - The Bank publishes: - Monthly "Monetary and Financial Statistics". - Annual "Statistical Abstract". - Daily results of money market operations on wire services. - Aggregate monthly summary in Bankstats (tables D2.1/2.2). - Quarterly summary in the Quarterly Bulletin. - A highly aggregated weekly balance sheet, the ‘Bank Return’. - Most series are available via Datastream; Bloomberg, Knight Ridder and Reuters carry selected series. - The Bank supports an active speaking program by senior officials to complement publications. ### Roles, responsibilities, and statutory clarity - Existing framework documents: - Memorandum of Understanding (MoU) between Bank Governor, Chairman of the Financial Services Authority and Treasury Ministers. - The Annual Report, which sets out the Bank’s Core Purposes, Objectives and Strategy as determined by the Court of Directors under Section 2 of the Bank of England Act 1998. - The MoU identifies five financial stability roles for the Bank: 1. Stability of the monetary system. 2. Financial system infrastructure, in particular payments systems at home and abroad. 3. Broad overview of the system as a whole. 4. Being able in exceptional circumstances to undertake official support operations having informed HMT (under MoU arrangements). 5. The efficiency and effectiveness of the financial sector, with particular regard to international competitiveness. - Observation and recommendation: - Assessment labels in the detailed assessment: observed, broadly observed, partly observed, non-observed, and not applicable. - The assessment notes: "It would be desirable to lay out more fully and formally in statute the Bank’s financial stability and payments and settlement systems oversight responsibility, when an appropriate opportunity arises." - Public elaboration of the Bank’s role as provider of emergency liquidity assistance and its role under the tripartite structure has not been recently documented beyond a 1993 Governor’s speech; an updated and more accessible elaboration of broader principles would be desirable. ### Cooperation, crisis management, and division of roles - Institutional cooperation: - The MoU describes responsibilities of the Bank, the FSA and HM Treasury; it is published on the Bank of England’s website. - A Standing Committee (Chancellor, Governor and FSA Chairman) meets roughly monthly, generally at deputy level. - The FSA Chairman is a member of the Bank’s Court of Directors; the Deputy Governor (Financial Stability) is a member of the FSA’s Board of Directors. - In practice, co-operation in crisis situations is organized within the framework of the FSSC. - Concerns and suggestions: - The Bank’s central market role gives it market-based experience and capabilities critical in crises. - The possibility of the Bank acting in support operations to resolve a financial crisis is recognized in the MoU and the Annual Report, but practical elaboration on emergency liquidity assistance and market-solution roles is limited in recent public documentation. - The assessment suggests exploring further clarification on the division of roles, guiding principles and procedures used in crisis management. ### Internal governance, accountability and integrity - Governance and accountability: - The Bank is accountable to the Court of Directors (appointed by the Crown), and to Parliament through the Chancellor of the Exchequer. - Section 4 of the Bank of England Act: “as soon as practicable after the end of each of its financial years, the Bank shall make to the Chancellor of the Exchequer a report on its activities in that year.” - Senior officials appear before the House of Commons Treasury Committee and the House of Lords Economic Affairs Committee. - The Bank’s Annual Report is laid before Parliament by the Chancellor of the Exchequer. - Internal structures: - Financial Stability Committee (FSC) meets monthly to review major policy issues and risks to stability; discussions are open to a wide range of staff, with more sensitive issues discussed in narrower groups. - The Governor’s Committee and the Management Committee are senior policy-making and internal management bodies under the Court. - Integrity measures: - Data on balance sheet and income/expenditure are publicly disclosed regularly. - External audit of the Bank’s accounts is conducted in accordance with Companies Act requirements and U.K. Auditing Practices Board standards, except where inconsistent with Bank functions. - Internal rules on personal financial dealings set by the Court address conflicts of interest. - Bank staff have statutory immunity in respect of banking supervisory acts or omissions before June 1998; staff also enjoy statutory immunity under the Settlement Finality Regulations 1999. - The Bank has indemnified members of its Court of Directors against personal civil liability arising from the carrying out of their functions; these immunities are publicly disclosed. ### Assessment outcomes (Table 17—high-level findings) - 5.1 The broad objective(s) and institutional framework of financial agencies: Assessment — Observed. - Comment: Recommendation to lay out more fully and formally in statute the Bank’s financial stability and payments and settlement systems oversight responsibility. - 5.1.1 The broad objective(s) publicly disclosed and explained: Assessment — Observed. - 5.1.2 Responsibilities and authority to conduct financial policies publicly disclosed: Assessment — Observed. - 5.1.3 Broad modalities of accountability publicly disclosed: Assessment — Observed. - 5.1.4 Procedures for appointment, terms, removal of governing bodies publicly disclosed: Assessment — Observed. - 5.2 Relationship between financial agencies publicly disclosed: Assessment — Observed. - Comment: Public awareness of practical delineation of roles in crisis management may remain somewhat limited; possibility of further clarification could usefully be explored. - 5.3 Role of oversight agencies with regard to payment systems publicly disclosed: Assessment — Observed. - Comment: At the time of the mission, the Bank had not fully described its interest in securities settlement systems and clearing houses (including central counterparties) as clearly as it might; the June 2002 FSR box noted the broader dimension. *Source: _cr03208 - 121. In addition, the Bank has also published separately its framework for payment (IMF staff report content provided).* ### 5.4 Where financial agencies have oversight responsibilities for self-regulatory ### _cr03208 - 5.4 Where financial agencies have oversight responsibilities for self-regulatory ### Oversight of payment systems (Sections 5.4–5.5) - Description - The “Oversight of Payment Systems” paper clarifies the Bank’s oversight relationship with payments systems and notes the Bank’s membership, as the banking system’s bank, of the principal systems and its provision of a range of services to those systems. - APACS performs an ‘oversight’ function akin to advice on audit matters rather than regulation/supervision; responsibility for oversight rests with the Bank of England. APACS’ activities are disclosed to system operators and their members (who are also APACS members). - Assessment - 5.4: Observed - 5.5: Observed - Comments / Actions - The Bank’s objectives for payment systems oversight have been communicated clearly to the public; the June 2002 FSR box reiterated the Bank’s operational role in U.K. payment systems. - Recommendation: Future FSR boxes or similar vehicles might briefly elaborate on the relationship between the Bank’s operational and oversight roles in payments systems. - In the NewCHAPS assessment against the Core Principles for Systemically Important Payment Systems, recommendations were made concerning access rules and governance affecting APACS; APACS was considering changes but specific reforms had not yet been finalized at the time of writing. ### Open process for formulating and reporting financial policies (Section VI; 6.1–6.4) - General principle (6.1) - The Bank’s policy: be as open and transparent as possible about its financial stability work, recognizing occasions when confidentiality is needed. - The Bank’s overall financial stability framework was set out in the Governor’s 1993 London School of Economics lecture “The pursuit of financial stability” (Published in Bank Quarterly Bulletin, February 1994). - The U.K.’s Freedom of Information Act 2000 excludes from its application information held by the Bank with respect to: - (1) monetary policy - (2) financial operations intended to support financial institutions for the purposes of maintaining financial stability. - Assessment: Observed - Comment: (Re)publication of material similar to the 1993 lecture—or key parts—would help set out principles guiding the financial stability policy framework during periods of significant financial sector stress. - Specific provisions - 6.1.1 Regulatory framework and operating procedures - Description: Framework/procedures determined by the Court of Directors under Section 2 of the Bank of England Act 1998 are set out in the Annual Report; payment systems oversight explained in “Oversight of Payment Systems” (November 2000) and update in the June 2002 FSR (box 12). - Assessment: Observed - 6.1.2 Reporting regulations and statistical returns - Description: Data collected from banks are available for monetary policy and financial stability; Bank of England reporting requirements for statistical returns and copies of returns are available from the Bank’s website; hard copies available on request. - Changes to reporting requirements are communicated via statistical notices to each reporting institution and posted on the website. - The “Code of practice for Bank of England statistics” embodies these requirements and is available in hard copy and on the website. - Links available from www.bankofengland.co.uk/mfsd - Assessment: Observed - 6.1.3 Regulations for organized financial markets - Description: The Bank does not set regulations for financial markets (this is the FSA’s responsibility). The Bank issues guidance notices to promote orderly and efficient markets, often facilitating committees chaired or secretariat-provided by the Bank. The Bank chairs: - Sterling Money Markets Liaison Group (MMLG) - Stock Lending and Repo Committee (SLRC) - Foreign Exchange Joint Standing Committee (FXJSC) - The Bank has issued guidance on Certificates of Deposit issued in London. - All notices set out guidance, not regulations; there are no arrangements to monitor or enforce compliance. Codes and guidance are published on the Bank’s website or obtainable in hard copy. Minutes of MMLG and SLRC meetings are on the Bank website; an annual review of FXJSC appears in the Bank’s Spring Quarterly Bulletin. - Assessment: Observed - 6.1.4 Fee structures - Description: The Bank does not charge direct fees in its financial agency role (funded from general income). - Much of the Bank’s income comes from Cash Ratio Deposits (CRDs), which are non-operational, non-interest bearing deposits by banks and building societies with eligible liabilities in excess of a threshold, currently £400 mn. The deposit ratio is currently 0.15% of eligible liabilities. The legal basis for CRDs is published, and the size of deposits by banks, the threshold and the deposit ratio are published by the Bank’s Monetary and Financial Statistics Division. - Assessment: Not applicable - Comments: The CRD arrangement amounts to an indirect form of fee for covered financial institutions; it is well-understood and transparent, with the magnitude of the implicit fee explicitly reviewed at regular intervals. - 6.1.5 Information-sharing MoUs - Description: The tripartite Bank/FSA/HMT MoU sets out principles for information exchanges between these institutions. The EU MoU on co-operation between payment system overseers and banking supervisors describes principles/procedures for cross-border information exchange; the MoU itself is not published but the ECB issued a press release (April 2001) noting cooperation and information sharing are specifically foreseen in several circumstances. - Assessment: Observed - 6.2 Announcement of significant policy changes - Description: The Bank would publish any significant changes relevant to the system (for example, changes in oversight of payment systems). Example: “Bank of England Settlement Accounts: consultative document” on policy for provision of settlement facilities is available in the Financial Stability section of the Bank of England’s website. - Assessment: Observed - 6.3 Periodic public reports on policy objectives - Description: The Bank reports its work in the Annual Report (tabled before Parliament) and the biannual Financial Stability Review (FSR) is the flagship publication for financial stability work, containing conjunctural assessment and analytical articles. Financial stability work is also published in the Quarterly Bulletin. - Assessment: Observed - 6.4 Presumption in favor of public consultations - Description: Whenever appropriate the Bank would consult publicly on matters within its power where there could be a material effect on financial stability. - Assessment: Observed ### Public availability of information on financial policies (Section VII; 7.1–7.4.2) - 7.1 Periodic public reports on major developments - Description: The Bank’s principal action is the Financial Stability Review article on the Financial Stability Conjuncture and Outlook (twice-yearly), surveying incipient risks and system capacity to absorb shocks. Surveillance also appears in Quarterly Bulletin articles and senior officials’ speeches. - The Bank contributes to international surveillance (IMF, FSF, BIS) and participates in BIS fora (Committee on the Global Financial System; Basel Committee on Banking Supervision; Committee on Payment and Settlement Systems). - The Bank’s surveillance reflects concerns with the financial system in London and globally; the Bank also publishes material on structural developments (new instruments, exposures, payments system developments, regulatory changes). - Assessment: Observed - 7.2 Public reporting of aggregate data - Description: Met by the Bank’s banking statistics and BIS contributions. The Bank reports aggregate data via the FSR, Bulletin, Annual Report, monthly “Monetary and Financial Statistics”, annual “Statistical Abstract”, press releases, and data distribution channels including Datastream; Bloomberg, Knight Ridder and Reuters carry selected series. - For payment systems, APACS publishes monthly aggregate data for systems operated by the three clearing companies (including CHAPS), and a Yearbook of Payment Statistics. The ECB publishes aggregate monthly data on the EU’s high-value euro payment systems, including CHAPS Euro. - Assessment: Observed - Comments: Links to externally produced payments-related data can be readily found on the Bank’s website. - 7.3 Public disclosure of balance sheets and market transactions - Description: The Bank’s accounts take the form of two balance sheets: the Issue Department (note issue functions) and the Banking Department (all other assets/liabilities). The Bank must prepare a weekly return of its accounts under section 6 of the Bank Charter Act 1844; the weekly return is published in the London Gazette each Thursday. More detailed balance sheets are prepared for the Bank’s annual accounts. - The Bank of England Act 1998 requires the Banking Department balance sheet to be prepared according to U.K. standards for commercial banks (apart from some disclosures). Full accounting policies are disclosed in the Annual Report. The Issue Department balance sheet is prepared according to rules agreed with HM Treasury, with main rules disclosed. - The Bank publishes money market operations results daily on wire services; an aggregate monthly summary in Bankstats (tables D2.1/2.2); a quarterly summary in the Quarterly Bulletin; and a highly aggregated ‘Bank Return’ weekly. - Assessment: Observed - 7.3.1 Aggregate disclosure of emergency financial support - Description: The Bank may act as lender of last resort to prevent loss of confidence spreading. All lender of last resort support operations are disclosed in a timely manner. There is a presumption to disclose support in the Bank’s first annual report following the operation; if disclosure would be damaging, disclosure is postponed and reconsidered after a further year and subsequently until disclosure occurs. When disclosing, factors that made earlier disclosure unsafe will be explained; some items may be safely disclosed earlier than others. - Assessment: Broadly Observed - Comment: When the Bank publishes information on lender-of-last-resort operations, it does not provide enough information to enable external observers to fully discern the effects of these operations on the Bank’s revenues and expenses for the year(s) in question. - 7.4 Public information services and publications program - Description: The Bank makes information available through its publications programme, website, Public Enquiries Group and Press Office. - 7.4.1 Publications program: The Bank’s programme includes the Quarterly Bulletin, Financial Stability Review and Annual Report; other material includes Working Papers series. - 7.4.2 Senior officials and public statements: Governors and Directors give speeches on financial stability-related issues which are released to the press and are available on the Bank’s website. - Assessment (both): Observed *Source: _cr03208 - 5.4 Where financial agencies have oversight responsibilities for self-regulatory* ### 7.5 Texts of regulations and any other generally applicable directives and guidelines issued ### _cr03208 - 7.5 Texts of regulations and any other generally applicable directives and guidelines issued ### Public availability of regulations and related protections (Practices 7.5–7.7) - 7.5 Texts of regulations and any other generally applicable directives and guidelines issued by financial agencies should be readily available to the public. - Description: Bank notices, for example relating to statistics and market guidance, are readily available – see 6.1.2 and 6.1.3 above. - Assessment: Observed - Comments: (no additional comments in source) - 7.6 Disclosure of deposit guarantees, policy holder guarantees and other client asset protection schemes - Description: See corresponding point in the assessment of the transparency of the Financial Services Authority. - Assessment: Not Applicable - Comments: (none) - 7.7 Disclosure of consumer protection arrangements overseen by financial agencies - Description: See corresponding point in the assessment of the transparency of the Financial Services Authority. - Assessment: Not Applicable - Comments: (none) ### Accountability and assurances of integrity by financial agencies (Practices 8.1–8.4.1) - 8.1 Officials appearing before designated public authority - Description: Senior officials appear in public before the House of Commons Treasury Committee and the House of Lords Economic Affairs Committee. - Assessment: Observed - Comments: (none) - 8.2 Public disclosure of audited financial statements on a preannounced schedule - Description: The Bank’s Annual Report contains information on profit and expenditure. It is not possible to publish revenue numbers without revealing information about provisions. The latter would alert readers to the possibility that the Bank had engaged in a lender of last resort activity, when such an operation had indeed taken place. Consequently, the Bank does not wish to publish revenue information for reasons, which it believes are entirely consistent with Section 3.2.3 of the Code. When circumstances permit details of support operations are published (see Note 1 to the Bank’s Accounts). Central bank support operations are very rare in the United Kingdom, but details of these are published once the need for confidentiality has ceased. - Assessment: Observed - Comments: When the Bank publishes information on lender-of-last-resort support operations, it does not provide enough information to enable external observers to fully discern the effects of these operations on the Bank’s revenues and expenses for the year(s) in question. - 8.2.1 Independent audit and accounting policy disclosure - Description: The Bank’s accounts are audited by PricewaterhouseCoopers. Audit is conducted in accordance with Companies Act requirements and auditing standards issued by the U.K. Auditing Practices Board, except where this would be inconsistent with the Bank’s functions, in particular in relation to any support operation. Statements of accounting policies are an integral part of the published financial statements. - Assessment: Observed - Comments: (none) - 8.2.2 Public disclosure of internal governance procedures necessary to ensure integrity - Description: Internal governance procedures are described in the Bank’s Annual Report. The Court is responsible for managing the Bank’s affairs, other than the formulation of monetary policy, which is the function of the MPC. The Court subcommittee of non-executive Directors (NedCo) is responsible for reviewing the Bank’s performance in relation to its objectives and strategy and monitoring the extent to which the Bank’s financial management objectives are met. NedCo is also responsible for reviewing the procedures of the MPC, reviewing the Bank’s internal controls, and determining the Governor’s and Deputy Governor’s remuneration and pensions. In addition, there are formal audit and remuneration committees. Under the Court, the Bank’s senior policy-making body is the Governor’s Committee, comprising the Governors and Executive Directors. The internal management of the Bank is the responsibility of the Management Committee, comprising the Deputy Governor (Financial Stability), the Deputy Directors, the Finance Director, and the Director of Personnel. - Assessment: Observed - Comments: (none) - 8.3 Annual disclosure of operating expenses and revenues - Description: The Bank’s Annual Report contains information on profit and expenditure on individual business units, including the Financial Stability function. It is not possible to publish revenue numbers without revealing information about provisions. The latter would alert readers to the possibility that the Bank had engaged in a lender of last resort activity, when such an operation had indeed taken place. Consequently, the Bank does not wish to publish revenue information for reasons, which are entirely consistent with Section 7.3.1 of the Code. When circumstances permit details of support operations are published. Note 1 of the Bank’s Annual Accounts explains the Bank’s difficulty in disclosing more details of the constituent elements of the profit and loss account. - Assessment: Broadly observed - Comments: When the Bank publishes information on lender-of-last-resort support operations, it does not provide enough information to enable external observers to fully discern the effects of these operations on the Bank’s revenues and expenses for the year(s) in question. - 8.4 Standards and rules to prevent conflicts of interest for officials and staff - Description: The Bank has internal rules on personal financial dealings set by Court, which are designed to address the issue of possible, actual or perceived financial conflict of interest or misuse of confidential information. These rules require MPC members and staff to obtain prior authorization for every financial transaction, including new mortgage borrowing switching between fixed and floating rate mortgages and switching between funds in a personal pension plan. The only exception to the internal reporting of every transaction is if members place their investments at arms length under fully discretionary management. Any such arrangements must also be approved by the Bank when they are set up. - Assessment: Broadly Observed - Comments: As noted in the Monetary Policy Transparency assessment, the rules were tightened further in 2002, when MPC members and some staff will be required to disclose information on asset holdings as well as the flows associated with financial transactions. As also noted in the Monetary Policy Transparency assessment (4.4), the Bank has a policy of providing oral briefings on the rules in response to external requests, but has not published the rules. - 8.4.1 Legal protections for officials and staff - Description: Bank staff have statutory immunity in respect of banking supervisory acts or omissions before June 1998 when supervision was transferred to the Financial Services Authority. Bank staff also enjoy statutory immunity under the Settlement Finality Regulations 1999. The Bank has indemnified members of its Court of Directors against personal civil liability arising from the carrying out of their functions. These immunities are publicly disclosed. - The Financial Markets and Insolvency (Settlement Finality) Regulations 1999, Regulation 11 (Exemption from liability in damages) states: - (1) neither the designating authority nor any person who is, or is acting as, a member, officer or member of staff of the designating authority shall be liable in damages for anything done or omitted in the discharge, or purported discharge, of the designating authority’s functions under these Regulations. - (2) paragraph (1) does not apply (a) if the act or omission is shown to have been in bad faith; or (b) so as to prevent an award of damages made in respect of an act or omission on the ground that the act or omission was unlawful as a result of section 6(1) of the Human Rights Act 1998 (acts of public authorities). - The Bank is a ‘designating authority’ for this purpose. - Assessment: Observed - Comments: (none) ### Summary observance and counts (paragraph 139 / Table 18) - Table 18. Summary Observance of IMF’s MFP Transparency Code—Financial Policy - Assessment Grade counts: - Observed: 29 - Broadly observed: 3 Principles 7.3.1, 8.3, 8.4 - Partly observed: (none listed) - Not observed: (none listed) - Not applicable: 3 Principles 6.1.4, 7.6, 7.7 ### Recommended Action Plan and Authorities’ Response (paragraphs 140–142; Table 19) - Recommended actions (excerpt from Table 19) - VII. Public Availability of Information on Financial Policies - 7.3.1 When disclosing lender-of-last-resort support provided to distressed financial institutions, consider providing enough information to enable external observers to fully discern the effects of these operations on the Bank’s revenues and expenses for the year(s) in question. - VIII. Accountability and Assurances of Integrity by Financial Agencies - 8.3, 8.4 The conflict of interest guidelines are contained in a number of documents, which have not been published. However, the Bank has a policy of providing oral briefings on the rules in response to external requests, even though it does not formally published them. The rules were tightened further in 2002, when MPC members and some staff will be required to disclose information on asset holdings as well as the flows associated with financial transactions. - Additional refinements recommended (paragraph 141) - (5.1) When an appropriate opportunity arises, it would be desirable to lay out more directly and formally in statute the Bank’s financial stability and payments/settlement system responsibilities. - (5.2 and 6.1) Some further, readily accessible, elaboration would be desirable on the general principles for emergency liquidity assistance, and on the Bank’s role more generally in financial crisis situations. - (5.3.1 and 5.4) The recently published FSR box on payments system oversight (June 2002), or some other similar vehicle, should evolve into a regular (annual) account of the Bank’s activities in payments system oversight. From time to time, such an account could usefully include some more elaboration on particular oversight issues or arrangements. For example, while the June 2002 box reiterated the Bank’s operational role as a member in its own right of some systems, future boxes could elaborate further on the Bank’s oversight role with regard to securities clearing and settlement issues, and on the relationship between its oversight and operational roles. - Authorities’ response (paragraph 142) - The authorities response to this assessment of transparency in respect of the Bank of England’s financial policy responsibilities is incorporated into that for the monetary policy transparency assessment (see Part E above). ### Assessment of the Financial Services Authority (FSA) transparency (paragraphs 143–151) - Scope and methodology - The assessment was made in the context of a Financial Sector Assessment Program (FSAP) mission to the United Kingdom from May 8-24, 2002. - The assessment was mainly based on a self-assessment prepared by the Financial Services Authority (FSA) in April 2002 plus a review of relevant documents maintained on FSA’s website, including: the Financial Services and Markets Act 2000 (FSMA); the 2002 Handbook of Rules and Guidance; the 2000/01 Annual Report; the 2002/03 Plan & Budget; the 2002 Financial Risk Outlook; the 1997 Memorandum of Understanding between HM Treasury, the Bank of England and the FSA; public speeches by senior FSA officials; and various operational notices. Discussions were held with FSA staff and informed external observers. Input was provided by colleagues who conducted assessments of U.K. banking, insurance, and securities market supervisory practices against various international standards and codes. - The U.K. authorities fully cooperated with the assessment, and all required information and documents were provided. - Institutional overview - On December 1, 2001 the FSA became the single statutory regulator for the majority of financial services in the United Kingdom, replacing previous sectoral regulators. Responsibility for banking supervision under the Banking Act 1987 had passed from the Bank of England to the FSA in June 1998. From January 1999 the FSA had also undertaken prudential insurance supervision on behalf of HM Treasury, and now does so as its own responsibility. - The FSA exercises statutory powers under the Financial Services and Markets Act 2000 (FSMA). The FSA is an independent non-governmental body structured as a limited company and financed by direct levies on the financial services industry. It is accountable to Treasury Ministers, and through them, to Parliament. The FSA’s governing body is the Board, currently consisting of a Chairman, three executive directors, and eleven non-executive directors, all appointed by HM Treasury. - The FSMA requires the FSA to pursue four objectives: - To maintain confidence in the U.K. financial system; - To promote public understanding of the financial system; - To secure an appropriate degree of protection for consumers while recognizing their own responsibilities; and - To reduce the potential for regulated business to be used for a purpose connected with financial crime. - The legislation requires the FSA, in carrying out activities, to take into account factors including: using resources in the most economic and efficient way; recognizing regulated firms’ own management responsibilities; being proportionate; taking into account the international character of financial services and the U.K.’s competitive position; facilitating competition among regulated firms; minimizing adverse effects of regulation on competition; and facilitating innovation. - The FSA applies a risk-based approach to regulation, monitors risks to its objectives, adjusts resources and supervisory focus over time, and undertakes thematic reviews across industry sectors. - Practice-by-practice assessment summary - General comment (paragraph 151): The FSA observes all of the elements of the financial policies section of the Code. External observers praised the current framework, and the FSA in particular, for making the regulatory process more transparent and accountable than the previous regime. The FSA’s roles, responsibilities, and objectives are clearly defined in the FSMA, and explained through various channels, including public speeches, conferences, and publications available on the FSA’s website. The policy formulation and reporting process is transparent and involves regular consultation with consumers and industry. Extensive information on the relevant policies is available in FSA publications, the level of accountability is high, and the degree of assurance of integrity is appropriate. *Source: _cr03208 - 7.5 Texts of regulations and any other generally applicable directives and guidelines issued* ### Section 5: Clarity of Roles, Responsibilities, and Objectives ### Section 5: Clarity of Roles, Responsibilities, and Objectives ### Observance and institutional clarity - The Financial Services Authority (FSA) "observes all of the elements of this principle." - The FSA’s roles, responsibilities, and objectives are defined in the Financial Services and Markets Act 2000 (FSMA) and explained through publications, the FSA website, and public speeches. - The relationship between the FSA, HM Treasury, and the Bank of England is outlined in a Memorandum of Understanding (MoU). ### Stakeholder understanding and communication challenges - External observers report "significant uncertainty in the financial community about the process used by the FSA to manage the various objectives assigned to it." - The FSA has used publications, open public meetings, seminars, workshops, and meetings with trade associations to explain its risk-based approach and how risk assessments drive priorities. - The continuing uncertainty indicates a need for further efforts to improve regulated institutions’ and the general public’s understanding of the new regulatory framework. - Consultation process observations: - Financial institutions generally praise close consultation, but some note the consultation process can be "onerous and costly." - The FSA is encouraged to "continuously look for ways to streamline the consultation process" to collect and incorporate stakeholders’ views cost-effectively. - FSA officials are awaiting feedback from the Practitioner Panel’s annual survey, which includes questions addressing consultation burdens. ### Public availability of information and consumer outreach - The FSA "observes all of the elements of" public availability of financial policy information. - Key publications cited: - Annual Report (overview of main developments during the year under review). - Annual Plan & Budget (overview of the external environment for the coming period). - Reports on regulatory themes and a publication called Financial Risk Outlook. - Consumer education: - The FSA has an "extensive consumer education program" and senior officials give numerous public presentations and media interviews. - Consumers’ awareness of their rights under the Financial Services Compensation Scheme (FSCS) is limited. - The FSA issued a consultation paper in May 2002 proposing business-rule changes requiring firms to disclose information about the FSCS, its coverage, and limits. - The FSCS has enhanced its website and produced booklets and consumer information reviewed by the Plain Language Commission. ### Accountability and integrity mechanisms - The FSA "observes all of the elements" of accountability and provides high levels of accountability and assurance of integrity. - Parliamentary engagement: - The FSA appears twice a year before the Treasury Committee of the House of Commons: once to discuss its Annual Report and once to answer questions on plans for the coming year. - The Committee publishes the FSA’s evidence as part of its proceedings. - The FSMA establishes multiple accountability mechanisms and checks and balances (described in detail below). ### FSMA objectives and guiding factors (as set out in the FSMA) The FSMA requires the FSA to pursue four objectives: - Market confidence, i.e., maintaining confidence in the financial system; - Public awareness, i.e., promoting public understanding of the financial system; - The protection of consumers, i.e., securing the appropriate degree of protection for consumers (which broadly covers consumers of regulated activities); - The reduction of financial crime, i.e., reducing the extent to which it is possible for a business carried on - (a) by a regulated person, or (b) in contravention of the general prohibition - to be used for a purpose connected with financial crime. Legislation requires the FSA, in carrying out rulemaking, codes, guidance, and policy determination, to take into account: - Using its resources in the most economic and efficient way; - Recognizing the responsibilities of regulated firms’ own management; - Being proportionate in imposing burdens or restrictions on the industry; - Taking into account the international character of financial services and the U.K.’s competitive position; - Facilitating competition among regulated firms; - The need to minimize the adverse effects of regulation on competition; - Facilitating innovation in connection with regulated activities. ### Detailed accountability provisions (FSMA references preserved) - Schedule 1 para 10: FSA must at least once a year make a report to HM Treasury (HMT) on, inter alia, the discharge of its functions; the government can direct topics to be covered; the report is laid before Parliament and published on the FSA’s website. FSA must (Schedule 1 para 11) hold an annual public meeting to discuss its report. - Schedule 1 para 4: Non-executive directors committee of the FSA Board keeps under review internal financial controls and use of resources and reports to HMT. - Sections 8 & 9: Requirement to publicly consult practitioners and consumers “on the extent to which its general policies and practices are consistent with its general duties” under s. 2 of the FSMA; establishment of Practitioner and Consumer Panels. - Schedule 1 para 7: Requirement to make arrangements for investigation of complaints (“the complaints scheme”). - Section 12: Power for HMT to appoint an independent person to review economy, efficiency and effectiveness of FSA resource use. - Section 14: Power for HMT to arrange for an inquiry in certain cases of serious failure in the system of regulation established by the FSMA. - Chapter III of Part X: Powers of the Director General of Fair Trading to keep FSA’s regulatory provisions and practices under review; Section 162: related role for the Competition Commission. - Establishment of an independent Financial Services and Markets Tribunal (run by the Lord Chancellor's Department) to consider afresh case-related decisions referred by firms or individuals. ### Governance, appointments, and safeguards - Composition and constitutional requirements set out in Schedule 1 of the FSMA. - Schedule 1 para 2: Chairman and other governing body members appointed and liable to removal by HMT; appointments follow Nolan Principles. - Composition of the FSA Board and periods of office publicized on the FSA website and in the Annual Report. - Comment: Formal safeguards governing removal are limited; officials are appointed for terms but contracts indicate they can be removed at any time. A dismissed official could pursue judicial review in certain circumstances. Public scrutiny by independent media acts as an important safeguard. ### Relationships with other agencies and self-regulatory organizations - The 1997 MoU between HM Treasury, the Bank of England, and the FSA explains cooperation toward financial stability; the MoU is published on the FSA’s website. - Payment systems oversight: Assessment recorded as "Not applicable." - Recognized Investment Exchanges (RIEs) and Recognized Clearing Houses (RCHs): - FSMA gives the FSA responsibility for supervising RIEs and RCHs; these entities are "to a degree" self-regulatory but are not fully autonomous. - Responsibilities and FSA powers vis-à-vis RIEs and RCHs are set out in the FSMA, the Financial Services and Markets Act (Recognition Requirements for Investment Exchanges and Clearing Houses) Regulations 2001, and the Recognized Investment Exchanges and Recognized Clearing Houses Sourcebook (REC). - Takeover Panel: - Operates as a self-regulatory organization not subject to formal FSA oversight. - Regulates takeovers and mergers to protect minority shareholders; lacks formal enforcement powers but is widely respected. - Remedies for violations range from private reprimands and public censure to referral to another regulatory authority such as the FSA. - The FSA has stated it will not exercise enforcement powers in takeover situations except in exceptional circumstances (e.g., at the request of the Panel). *Source: _cr03208 - Section 5: Clarity of Roles, Responsibilities, and Objectives — https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2003/_cr03208.pdf* ### 5.5 Where self-regulatory organizations are authorized to perform part of the regulatory and ### 5.5 Where self-regulatory organizations are authorized to perform part of the regulatory and supervisory process ### Transparency and disclosure by RIEs and RCHs - RIEs and RCHs are required to provide the FSA with notifications on a broad range of subjects (changes in internal organization, constitution and governance; financial information; complaints; hours of operation, etc.). The FSA does not require publication of such notifications, but RIEs/RCHs are free to publish them and some do so (annual reports, websites). - The regulatory and supervisory objectives of RIEs and RCHs are specified in the Recognition Requirements; the FSA Handbook provides interpretive guidance. - RIEs and RCHs make texts of regulations and guidelines readily available to the public. - Recognition Requirements mandate appropriate procedures for making and amending rules, including consultation procedures that may include: - informal early-stage discussions with users or representative bodies; - publication of a formal consultation paper including clearly expressed reasons and an appropriately detailed assessment of likely costs and benefits; - adequate time for responses and for the U.K. recognized body to take responses properly into account; - arrangements for making responses available for inspection unless the respondent requests otherwise; - arrangements ensuring proper regard to representations received; - publication, no later than the publication of amended rules, of a reasoned account of the decision to amend rules (REC 2.14.6). - The FSA allows RIEs/RCHs to restrict consultation where it is essential to make a change without delay to ensure continued compliance with the Recognition Requirements or other obligation under the FSMA. - RIEs/RCHs must provide a copy of their annual reports and accounts to the FSA under the Notification rules; annual reports include audited financial statements, operating expenses and revenues. - If publicly listed, RIE/RCH must disclose its annual report and accounts publicly on a pre-announced schedule (Listing Rules). - If a mutual, the annual report and accounts are disseminated to members. - Most RIEs and RCHs publish statistics on trading volumes and other market data. - Recognition Requirements require safeguards for investors, including complaints and disciplinary procedures; these procedures are typically made public or at least disclosed to members. - Officials from RIEs and RCHs appear before parliamentary committees to give evidence. - The FSA will consider arrangements, systems and controls RIEs/RCHs have to manage conflicts of interest when determining compliance with Recognition Requirements; public dissemination of details of such arrangements is left to the individual RIE/RCH. - Assessment: Observed ### Open process for formulating and reporting financial policies (FSA practices) - The FSA is generally required to consult practitioners and consumers “on the extent to which its general policies and practices are consistent with its general duties” (s 8). - The FSA uses rule making powers (e.g., Chapter 2 of Part X), power to issue guidance (Chapter II of Part X), and statements of principle and codes in relation to approved persons (s 64). - The FSA must consult publicly on proposals to make rules (s.155), give general guidance (s.157 (3)), and issue statements/codes in relation to approved persons (s.65). - The FSA publishes consultative papers, statements of policy, and a statement of its open approach to regulation (“The Open Approach to Regulation” (1998)) on its website. - Proposals to make rules must be accompanied by a cost benefit analysis, an explanation of purpose, and reasons why the proposal is compatible with general duties. - The FSA has power (s.148) to modify or waive specified rules in relation to an authorized person; unless inappropriate or unnecessary, modifications/waivers must be published. In publishing the FSA must consider whether publication would prejudice, to an unreasonable degree, commercial interests (s.148 (7)). - The FSA consults across a wide range of stakeholders (consumers, industry, trade associations, advisory groups, voluntary organizations, academics, professional bodies, media). - The FSA publishes policies via multiple media (publications, electronic media including CD ROMs and website) and publicizes/explains policies through press. - Observations and issues: - External observers note uncertainty in the financial community about how FSA policies will be implemented in practice, partly reflecting limited experience with the new framework. - The FSA has published materials and held conferences explaining its risk-based approach and enforcement plans. - Regulated institutions seek clarity on the extent to which the FSA applies judgment and tailors supervision rather than adopting a mechanical rules-based approach. - Assessment: Observed ### Specific transparency elements and disclosures - 6.1.1 Regulatory framework and operating procedures: - The FSA conducts public consultations to obtain information, receive alternative suggestions, promote understanding, and obtain feedback on policies, practices and performance. - Consultation is public and involves the full range of interested parties. - Assessment: Observed - Comment: Despite transparency and regular consultations, uncertainty remains about implementation. - 6.1.2 Financial reporting regulations: - Rules for authorized firms' reporting requirements and guidance are published in the FSA’s Handbook of rules and guidance. - Assessment: Observed - 6.1.3 Regulations for operation of organized financial markets: - Regulations published as rules (Interim Prudential Sourcebook for Investment Business; Conduct of Business Sourcebook; Market Conduct Sourcebook including the Code of Market Conduct and Price Stabilizing rules). - Investment exchanges and clearing houses must have rules covering certain areas for recognition (The Financial Services and Markets Act 2000 (Recognition Requirements for Investment Exchanges and Clearing Houses) Regulations (SI 2001 No. 995); Recognized Investment and Recognized Clearing Houses Sourcebooks). - The FSA is the competent authority for the Official List and has power to make listing rules (e.g., s 76 FSMA); listing rules are published on the FSA’s website and available in hard copy. - Assessment: Observed - 6.1.4 Fee structures: - The FSA’s power to charge fees is set out in the FSMA (principal power in Schedule 1 para 17). Fee rules follow public consultation procedures (s.155). See FSA Consultative Paper 111 on proposed fees. The FSA publishes its Budget and operating plans determining financing requirement. - Assessment: Observed - 6.1.5 Information sharing and consultation procedures: - FSMA (Part XXIII) restricts FSA’s ability to disclose restricted information. The FSA has negotiated MoUs with overseas supervisors/regulators and with the Bank of England and HM Treasury covering exchange of information; the MoU with Bank of England and HM Treasury has been published. - Assessment: Observed ### Timely announcement of significant changes and consultation burden - The FSA must consult publicly on proposals to make or amend rules and give general guidance, and publish cost-benefit analyses (procedures in FSMA). - Consultation activity: - There were 41 consultations in 2001 and 22 in the first five months of 2002. - Observations: - Financial institutions generally praised consultation efforts, but some observers noted the consultation process can be onerous and costly for institutions. - FSA officials continue to obtain good stakeholder feedback despite high consultation volume and are encouraged to streamline consultation processes for efficiency. - The FSA is sensitive to consultation burden and awaits feedback from the Practitioner Panel’s annual survey. - Assessment: Observed ### Public reporting and communications - 6.3 Periodic public reports: - FSMA requires the FSA to report annually to Government on the extent to which its regulatory objectives have been met; Government lays the report before Parliament and the FSA publishes it and places it on its website. - The FSA’s Annual Report and other publications (A new regulator for the new millennium; policy statements; annual Plan & Budget; evidence to parliamentary committees; speeches; press releases) describe how it pursues objectives. - Assessment: Observed - 6.4 Presumption in favor of public consultations for substantive technical changes: - All significant changes to regulations made by HM Treasury under the FSMA are subject to public consultation, consistent with HM Government practice. - Assessment: Observed ### Public availability of information on financial policies (section VII) - 7.1 Periodic public report on major sector developments: - The FSA’s Annual Report contains an overview of main developments in the U.K. financial services sector for the year under review. - The annual Plan & Budget includes an overview of the external environment for the coming period. - Other publications report on major developments (reports on regulatory themes, Financial Risk Outlook). - Comment: Financial Risk Outlook introduced in 2002; refers to IMF economic projections for the U.K. rather than those underpinning the Bank’s Inflation Report. FSA explained choice on timing and global coverage. - Assessment: Observed - 7.2 Public reporting of aggregate data: - The FSA publishes data in its Annual Report and elsewhere on regulatory activity (number of firms authorized and individuals approved; number of disciplinary proceedings). - Aggregate data on volumes of business appear in ad hoc reports, speeches and on the FSA’s website. - The FSA introduced Financial Risk Outlook carrying a range of financial data. - Many RIEs and RCHs publish statistics on trading volumes and other market data. - See also Bank of England response for further published data details. - Assessment: Observed - 7.3 Balance sheet disclosure: - The FSA’s balance sheet is published in its Annual Report. - Assessment: Observed - 7.3.1 Aggregate information on emergency financial support: - Assessment: Not applicable - 7.4 Public information services: - The FSA maintains an extensive public information service with publications available on its website and in hard copy. - Consumer resources: guides, fact sheets, information packs, CD-ROM, consumer alerts, dedicated website and telephone help line; Comparative Tables for product comparisons. - Educational resources for schools and colleges; conferences and seminars for educational specialists. - Website vetted by the Plain Language Commission and awarded the ‘Clear English Standard’. - Active program to explain policies and activities to the media. - Assessment: Observed - 7.4.1 Publications program: - The FSA issues Discussion Papers, Consultation Papers, Feedback and Policy Statements, Occasional Papers, Annual Report and annual Plan & Budget; all available on its website and in hard copy. - Assessment: Observed - 7.4.2 Senior official communications: - Senior FSA staff appear frequently in public (including an annual public meeting) and speeches are often press-released and sometimes made available in full on the website. - Public outreach metrics: - There were 16 published speeches on financial regulation policies and related regulatory issues by the Chairman and other FSA senior officials in 2001, and 11 in the first five months of 2002. - Senior FSA officials gave more than 170 on the record interviews to the media on regulatory and supervisory issues in 2001 and 50 in the first five months of 2002. - Assessment: Observed *Source: 5.5 Where self-regulatory organizations are authorized to perform part of the regulatory and supervisory process (excerpts).* ### 7.5 Texts of regulations and any other generally applicable directives and guidelines issued by ### _cr03208 - 7.5 Texts of regulations and any other generally applicable directives and guidelines issued by ### Availability of regulations and guidance - The FSA’s rules and guidance are publicly available in a number of media – on its website, on CD ROM and in hard copy. - Assessment: Observed ### Deposit insurance, policyholder guarantees, and client asset protection (FSCS) - The Financial Services Compensation Scheme (FSCS) pays compensation, in appropriate cases, where a regulated firm is unable to meet its liabilities. - The FSA is responsible for making the FSCS rules and for approving its annual budget. Those rules are available publicly in the same way as other FSA rules (see availability above). - Both the FSA and the FSCS publish information for consumers on the coverage of the FSCS and on the protection it provides – in booklets and on both organizations’ websites (www.fsa.gov.uk and www.fscs.org.uk). - The FSCS makes detailed information available to consumers on how to make a claim under the Scheme. - The FSMA requires the FSA to approve the FSCS annual budget and to make the rules, following consultation, governing the funding of the Scheme. The FSCS budget is disclosed. The rules on funding the Scheme are publicly available through the usual channels (see availability above). - The FSCS publishes an annual report on its discharge of its responsibilities, including: - information on finances (with auditor sign off), - directors, - committees, - highlights and summaries of the activities through the year, including on claims decisions and compensation payments. - Assessment: Observed - Comments: - External observers noted, and FSCS officials conceded, that consumers’ awareness of their rights and privileges under the FSCS is limited. - The FSA issued a consultation paper in May 2002 including proposed changes to conduct of business rules that would require firms to disclose relevant information about the compensation scheme, its coverage, and limits. - The FSCS is working with the FSA, trade associations, consumer advice organizations, and journalists to increase awareness. Its website has recently been enhanced, and in recent months it has produced a range of booklets and other information for consumers that have been reviewed by the Plain Language Commission. ### Consumer protection arrangements and dispute settlement (FOS) - The FSMA requires the FSA to establish a scheme for resolving complaints between consumers and firms; under this requirement the FSA has set up the Financial Ombudsman Service (FOS). - The FSA makes rules governing complaints handling by firms and approves rules the FOS makes under the FSMA regarding its operation; these rules are publicly available in the usual ways (see availability above). - Both the FSA and FOS provide information to consumers – over the web, in brochures and by telephone – on how the arrangements work and on how to make a complaint. - FSA rules require firms to display in branches and sales offices a notice explaining that they are covered by the FOS and to provide a written copy of their complaints procedure to consumers on request, or when a complaint is made. - The FOS annual budget is approved by the FSA and publicly consulted on yearly, before being published together with the FOS’s business plan for that year. - FOS reports publicly each year on how it has fulfilled its statutory functions. - FOS publishes monthly newsletters which outline interesting cases and judgments and issues occasional discussion papers on adjudications with wider ramifications. - Assessment: Observed ### Accountability and assurances of integrity by financial agencies - 8.1 Parliamentary appearances: - The FSA regularly gives evidence to parliamentary committees. - Convention: FSA appears twice a year before the Treasury Committee of the House of Commons, once to discuss its Annual Report and once to answer questions on plans for the coming year. - From time to time the FSA gives evidence to other parliamentary committees on specific regulatory issues. - Assessment: Observed - Comments: See 7.4.2 for data and comments on public appearances. - 8.2 Audited financial statements and reporting: - As part of its Annual Report (referred to in 6.3), the FSA publishes, within 3 months of the financial year end, audited financial statements and information on its accounting practices. - The Annual Report includes information on internal governance and control procedures, including the role of the Audit and other Committees. - The FSA reports against standards of good corporate governance applied in the U.K. to all listed companies and complies with those which are appropriate. - Assessment: Observed - 8.2.1 Independent audit and accounting policies: - Financial statements are audited by an independent auditor and information on accounting policies is publicly disclosed in the Annual Report (referred to in 6.3). - Assessment: Observed - Comments: The FSA’s financial statements are fully consistent with U.K. private sector accounting practices. - 8.2.2 Internal governance disclosure: - The Annual Report includes information on internal governance and control procedures necessary to ensure the integrity of operations, including on the role of the Audit and other Committees (FSMA Schedule 1). - Assessment: Observed - 8.3 Operating expenses and revenues: - Information on the operating expenses and revenues of financial agencies is included in the FSA’s Annual Report (referred to in 6.3). - Assessment: Observed - 8.4 Standards for staff conduct and conflicts of interest: - Employment contracts include standards for conduct of personal financial affairs of officials and staff and rules to prevent exploitation of conflicts of interest. - All staff are required to comply with a code of conduct designed to address possible, actual or perceived financial conflict of interest or misuse of confidential information. This code is published on the FSA’s website. - Assessment: Observed - Comments: The FSA’s Code of Conduct for staff is clear and comprehensive with stringent disclosure requirements for all staff. - 8.4.1 Legal protections for officials and staff: - FSMA (Schedule 1 paragraph 19) provides that the FSA and any person who is, or is acting as, a member, officer or member of staff of the FSA is not to be liable in damages for anything done or omitted in the discharge, or purported discharge, of the FSA’s function. - This protection does not apply if the act or omission is shown to have been in bad faith, or unlawful as the result of section 6(1) of the Human Rights Act 1998. - Assessment: Observed ### Summary observance and recommended actions - Table 21. Summary Observance of IMF’s MFP Transparency Code—Financial Policies (FSA): - Observed: 33 - Not applicable: 3 (5.3, 5.3.1, 7.3.1) - Broadly observed: (none listed) - Partly observed: (none listed) - Not observed: (none listed) - Recommended Action Plan (technical suggestions): - Some continuing uncertainty in the financial community about the process used by the FSA to manage the various objectives assigned to it suggests the need for further efforts to help regulated institutions and the general public improve their understanding of the new regulatory framework. - It would be desirable to continue to look for ways to streamline the consultation process so that stakeholders’ views can be collected and incorporated in a cost-effective fashion. - Authorities’ response: - Authorities welcomed the positive assessment and noted the FSA observes all elements of the financial policies section of the Code. - They accepted that under Sections 5 and 6 there may remain some uncertainty about how the FSA manages its various objectives and how it will implement its policies in practice, and considered this inevitable under a new regulatory regime. - They noted that industry understanding has increased since the IMF visits in May 2002 and that many uncertainties raised with IMF assessors will have been answered over time. ### CPSS/IOSCO Recommendations for Securities Settlement Systems (RSSS) — introduction and CREST system overview - General: - IMF missions visited the United Kingdom in the period February–July 2002 as part of the Financial Sector Assessment Program. - The objective included an assessment of observance of the Recommendations for Securities Settlements Systems (RSSS) prepared by CPSS and IOSCO. - The initial assessment was revised at the end of 2002 according to the newly agreed methodology for CPSS-IOSCO RSSS. - The assessor was Martin Andersson from Sveriges Riksbank (Bank of Sweden) in collaboration with Tom Kokkola from the ECB. - Scope of assessment: - Assessment focused on the overall process of securities clearing and settlement in the United Kingdom, with substantial focus on CRESTCo settlement systems. - Recommendation-by-recommendation assessment was made for the CREST system (bonds and equities) and a more limited assessment for the Central Money Markets Office system (CMO) for money market instruments (MMI). - At the time of the assessment, work was underway to prepare for migration of MMIs from CMO to CREST, with a suggested timetable to complete this migration during 2003. - The London Clearing House (LCH) undertakes the central counterparty clearinghouse role in the United Kingdom and is the focus of Recommendation 4 but is not covered in detail here. - Institutional and market structure (CREST/CMO): - CRESTCo operates two securities settlement systems—CREST (gilts and equities) and CMO (MMIs including T-bills, Bank Bills and CDs). - CREST acts as the central securities depository (CSD) for U.K. securities; since November 2001, a transfer of securities in the book-entry system of CREST has constituted the legal transfer of title, with CREST records being the register for dematerialized securities under U.K. law. - For remaining securities held in paper form and for those under other laws (e.g., Irish), applicable external registrars must separately register changes of ownership according to changes effected in CREST settlement. - For the CMO system, the Bank of England acts as depository for immobilized securities. - CRESTCo runs a fully-owned subsidiary—CREST International Nominees Limited—which acts as depository/custodian for international securities settled in CREST. - CREST Depository Limited issues CREST Depository Interests, with exactly the same characteristics as the underlying international securities, but which can be settled in CREST according to English law. - CREST operates cross–border links with DTCC (the U.S. CSD), Euroclear (the international CSD based in Belgium) and SIS (the Swiss CSD and securities settlement system). - Trading, settlement, and volumes: - Trading of securities in the United Kingdom is mainly bilateral between market participants; equities can also be traded on the London Stock Exchange electronic order book (SETS). - Equity transactions traded electronically are cleared by LCH acting as central counterparty before settlement in CREST. - In November 2001, real-time settlement was introduced between CREST settlement banks, across accounts at the BoE. This replaced end-of-day multilateral net settlement and instituted securities settlement in central bank money. - CREST’s average daily transaction volume (for gilts and equities) in December 2001 was about 308,000 with an average daily value of £208 billion. - CMO’s daily settlement averages £7 billion, with less than around 1,000 transactions. - CREST–Euroclear merger: - On July 4, 2002, Euroclear and CRESTCo announced plans for an agreed merger. - Following approval by both groups of shareholders during August and the decision on September 16 of the U.K. government not to refer the merger to the competition authorities, the merger was completed on September 23. - Under the terms of the merger, CRESTCo shareholders received a 19 percent shareholding in Euroclear plc. - CRESTCo became a wholly-owned subsidiary of Euroclear Bank, itself a subsidiary of Euroclear plc and the operator of the Euroclear system. - The merged entity aims to deliver efficient low-cost cross-border settlement through a combination of rationalized central infrastructure, standardized procedures and high transaction volumes, with a two-phase business model published at the time of the merger announcement. - In practice there had not been significant changes in CREST operations yet at the time of assessment; the assessment was therefore done on the CREST system as an individual system. - Regulatory structure: - The Financial Services Authority (FSA) is the single supervisor in the U.K. for market participants, clearinghouses, CSDs and exchanges. - The Bank of England takes an active role as overseer of payment systems and in financial stability policymaking. - Information and methodology used for assessment: - Information included relevant laws, rules and procedures, and a questionnaire completed by CRESTCo in cooperation with the FSA. - Discussions were held with the Bank of England, the FSA, CRESTCo Crest, London Stock Exchange, LIFFE, and a number of bank representatives and brokers. - Information on websites of the FSA and CRESTCo was extensively analyzed. - The assessment used the key questions for implementation in section 5 of the Recommendations, complemented by additional key questions from the RSSS methodology, and was structured in accordance with the Assessment Methodology for Recommendations for Securities Settlement Systems, September 2002. *Source: _cr03208 - 7.5 Texts of regulations and any other generally applicable directives and guidelines issued by (IMF PDF).* ### 176. Each Recommendation was assessed on a qualitative basis based on a five-fold ### _cr03208 - 176. Each Recommendation was assessed on a qualitative basis based on a five-fold ### Assessment methodology and categorization - Each Recommendation was assessed on a qualitative basis based on a five-fold assessment categorization: observed, broadly observed, partly observed, non-observed, and not applicable. - The categorization follows the guidelines in the assessment methodology. - A Recommendation is considered observed whenever all assessment criteria are generally met without any significant deficiencies. - A Recommendation is considered broadly observed whenever only minor shortcomings are found, which do not raise major concerns and when corrective actions to achieve full observance with the Recommendation are scheduled and realistically achievable within a prescribed period of time. - A Recommendation is considered partly observed whenever the shortcomings are sufficient to raise doubts about the ability to achieve observance within a reasonable time frame. - A Recommendation is considered non-observed whenever major shortcomings are found in adhering with the assessment criteria. - Whenever a Recommendation is assessed to be broadly, partly or non-observed with a Recommendation, suggestions are proposed for achieving full observance. - A Recommendation is considered not applicable whenever it does not apply given the structural, legal, and institutional conditions. - In accordance with the assessment methodology the assignment of an assessment category with respect to a recommendation is based on the current situation existing without regard to any proposed or ongoing actions. Material changes underway are presented in the description and/or comment sections. ### Executive summary — The CREST System - The overall assessment is that the CREST system itself is reliable and effective in providing delivery versus payment settlement on a real time gross basis. - The CREST system started its operations in 1996, but it was not until November 2001 that the transfer of title in CREST’s book-entry system became the legal transfer of title to securities constituted under U.K. law. - At the same time, full DVP in central bank money was introduced. - Those recommendations where full observance is not achieved have more to do with aspects outside the scope of the CREST system, or of CRESTCo itself, and more related to others. - In all these cases the grading is broadly observed, and it should not be too difficult to make the required improvements for observance. - These recommendations concern the following issues: Pre-settlement risks, Central counterparty, Settlement risks, Regulation and oversight. ### Pre-settlement risks - CREST has together with exchanges been able to improve the performance with regard to confirmation, matching and settlement performance over the last year. - This work needs to be continued in order to achieve full observance with this recommendation. ### Central counterparty - Given the importance of LCH for the U.K. and the international financial market, high priority should be given to replacing the payments scheme with one based on settlement across the books of the BoE, for settlements in sterling and Euro. - In addition, the placement of funds in the money market should be converted from the current unsecured basis to a collateralized basis, in order to limit unnecessary credit risk exposure of LCH. - Losses from these particular risk exposures can not be covered by the default arrangements in place. - Initiatives to address both these weaknesses were underway during the period of the FSAP exercise and when completed will significantly remove much of this risk. - It is also important that U.K. authorities give a very high priority to ensuring that the legal uncertainties are rectified, especially with respect to the default fund. ### Settlement risks - Most actively traded securities are dematerialized. - However, MMIs are not. - There are plans to introduce that in 2003 (legal amendments and certain operational and market practice changes are necessary and are underway) after which observance with this recommendation will be achieved. *Source: _cr03208 - 176. Each Recommendation was assessed on a qualitative basis based on a five-fold* ### 183. There is currently no specific framework for cooperation with relevant authorities ### _cr03208 - 183. There is currently no specific framework for cooperation with relevant authorities ### Legal risk — Recommendation 1: legal framework - CREST is a designated system under the Settlement Finality Directive, protecting securities and payment transfers and default arrangements from the ordinary operation of U.K. insolvency law. - The legal framework for CREST consists of statutory provisions and contractual agreements between CRESTCo and CREST participants; these contractual agreements are exclusively governed by English law. - The Uncertificated Securities Regulations 2001 (effective November 26 2001) re-enacted with modifications the USRs 1995 and make electronic transfer within CREST’s book-entry system represent the legal transfer of title, removing the interval between settlement in CREST and registration of ownership. - Assessment: Observed ### Pre-settlement risk — Recommendation 2: Trade confirmation - For direct participants: - Trades executed on LSE’s order book (SETS) are automatically fed into LCH and onwards to CREST; the percentage of trades matched within CREST on T+0 is over 95%. - For bilateral trades direct participants will input settlement instructions into CREST; 90 percent of all trades will be confirmed on T+0. - For indirect members: - 42 percent of trades between indirect members are confirmed in CREST on T+0, 75 percent at T+1 and 97 percent are confirmed on intended settlement day. - Regulatory framework: - Monitoring participants’ timely confirmation and matching and settlement performance is the responsibility of the exchanges; there is no regulatory requirement on CREST for this and no regulatory requirement for confirmation of trades involving indirect market participants. - Assessment: Broadly observed - Recommendation/Comment: Continue work with exchanges and market participants to improve confirmation, matching and settlement performance, particularly for indirect participants. ### Pre-settlement risk — Recommendation 3: Settlement cycles - Rolling settlement cycle for equities is T+3. - For cash bonds (approximately 70 percent of value of settlement through CREST) the cycle is generally T+1 with a significant T+0 component. - 70 percent of stock lending and repos are settled on a T+0 basis; the other 30 percent on T+1 or T+2. - Settlement fails: normally less than 2% by numbers; figures by value are not recorded but are much lower than 2%. - CREST operates a settlement discipline regime penalizing late matching and late settlement; FSA requires firms to mark settlement fails to market and take a capital charge. - Assessment: Observed ### Central counterparty — Recommendation 4: CCP (LCH) - LCH acts as counterparty for derivative exchanges, SETS and OTC derivatives; applies a conservative view in setting margin requirements and performs daily stress testing of members’ positions. - Identified weaknesses: - LCH’s payment scheme settles cash payments across accounts held at various commercial banks, rather than in a default-risk free settlement asset, creating material intraday risk exposures. - LCH has traditionally invested cash resources in the unsecured deposit market, exposing it to credit risk. - Legal uncertainties about parts of funds paid into LCH’s default fund and cross-margining link with CME (currently immaterial exposures). - Assessment: Broadly observed - Recommended actions: - High priority to replace the payments scheme with one based on settlement across the books of the BoE for sterling and Euro. - Convert placement of funds from unsecured deposits to a collateralized basis to limit credit risk. - Rectify legal uncertainties, especially with respect to the default fund. ### Securities lending — Recommendation 5 - Active markets for securities lending, repos and other collateralized borrowing for U.K. and Irish corporate securities and U.K. government debt. - CREST offers an automated repo facility under which members may repo eligible securities to the BoE for intraday sterling liquidity. - Tax/regulation: - Tax treatment of equities lending requires one party to be member of a recognized exchange to benefit from exemptions (otherwise lending is highly uneconomic due to Stamp Duty Reserve Tax). - Regulation of securities lending in collateral market is undertaken by the FSA and within exchange rules where activity is on exchange. - Market practice: - No restrictions on range of securities or participants other than supervisory restrictions on individual firms. - The majority (70%) of securities are lent and executed on a same day basis (T+0) with the remainder for T+1 or T+2. - Assessment: Observed ### Settlement risk — Recommendation 6: CSDs / dematerialization - Over 85 percent of the value of equities in the U.K. and Irish stock market are dematerialized; the figure for gilts is 99 percent. - At point of settlement 100 percent of securities are dematerialized in CREST’s book entry system. - Money Market Instruments (MMI) are not dematerialized and thus cannot be settled within CREST; plans to introduce dematerialization in 2003 (legal amendments necessary and in hand). - Assessment: Broadly observed - Comment: As much as 15% of the value of equities and 1% of gilts not dematerialized involves operational costs and risks; consider measures (including mandatory dematerialization) to lower these numbers. ### Settlement risk — Recommendation 7: Delivery versus Payment (DVP) - For sterling and Euro-denominated securities, CREST operates a DVP mechanism on an RTGS basis since November 2001 (trade-by-trade, “model 1” DVP) with 200-300 batches a day and blocking of funds in CREST accounts at the BoE to ensure final and irrevocable transfers. - For USD transactions: - Settlement banks make assured payments on behalf of participants and settle payments at the end of the day using correspondent banks, leaving participants with full DVP but settlement banks have intraday exposures between themselves. - Value of USD settlement was US$1.5 bn/day in December 2001. - Assessment: Observed - Comment: Interbank credit risk remains for USD transactions; CRESTCo and U.K. authorities should evaluate alternative payment schemes or ensure supervisors consider this exposure in bank risk assessments. ### Settlement finality — Recommendation 8 - CREST offers real-time finality for transfers against sterling and Euro; for USD final settlement occurs at the end of the settlement day. - Transfers of Irish, Jersey, Guernsey, and Manx securities confer statutorily backed equitable title pending registration; registration must occur within two hours of CREST settlement and generally occurs within 30 minutes. Reversals are possible if registrar rejects registration; this has never happened to date. - Transactions in these jurisdictions account for approximately three percent by value and approximately £6 billion a day in absolute terms. - Assessment: Observed - Comment: Potential revocability risk in the two hours following settlement for these securities should be kept in supervisory focus. ### CSD risk controls — Recommendation 9 - CREST does not extend intraday credit to participants, does not permit debit balances in securities, and operates on a gross basis. - Assessment: N/A ### Settlement assets — Recommendation 10 - CREST uses an intermediated banking model; all members must have a CREST settlement bank which guarantees members’ obligations. - For sterling and Euro, inter-bank obligation is immediately discharged by central bank money across banks’ CREST settlement accounts within the BoE. - For USD, interbank obligations are settled at end of day between correspondent accounts; settlement banks have intraday exposure until discharged. - Availability of funds to members depends on contractual arrangements with settlement bank; CREST believes larger members generally have arrangements for immediate intraday funds availability. - Almost 50 percent of interbank payments within CREST are concentrated in two settlement banks; current CREST rules require approval of current settlement banks for new settlement banks. - Assessment: Observed - Recommended actions/comments: - Authorities should obtain specific information on payment finality arrangements between members and their banks and examine adequacy. - Explore interbank credit risk from USD settlements in more depth. - Banking supervisors should note concentration in two settlement banks. - Remove rule requiring settlement banks to approve new settlement banks as it is of no relevance with today’s RTGS DVP settlement and risks limiting competition. ### Operational risk — Recommendation 11 - CREST systems are highly reliable; maximum interruption last year was approximately one hour and settlement could be done on settlement day. - CREST publishes settlement performance and availability monthly. - CREST has a full hot remote backup contingency site with regular live testing; uses data encryption and message authentication codes; accredited network providers must meet CREST’s message security requirement. - Internal and external audit: - Independent Internal Audit Department; external auditors undertake annual SAS 70 assessment. - Audit and Compliance Committee (including non-executive directors and two audit co-optees) reviews audit work. - Capacity management: short-term capacity function and team for medium/long-term capacity projections. - Contracts/service level agreements with service partners and outsourced providers are in place and monitored; key service providers are subject to internal audit review. - Assessment: Observed ### Custody risk — Recommendation 12 - For domestic services members hold securities in their own name or with one of the members; CRESTCo intermediates ownership of international securities through a wholly owned subsidiary with securities held under an English law trust. - Reconciliation: balances reconciled monthly with full reconciliation quarterly; CRESTCo reconciles the CDI register and CSD positions daily. - Assessment: Observed - Comment: Need to better communicate safeguards and legal support for custodial activity to market participants. ### Governance — Recommendation 13 - CREST Annual Report and Accounts describe ownership, board and management structure and corporate governance, risk management and board committee roles. - Board comprises 14 members, two executive directors; board composition drawn largely from system users with two independent directors; rebalancing of shareholder shares according to use every two years. - Staff appraisal and reporting: staff appraised annually; key managers make monthly reports; bonus arrangements linked to objectives. - Public interest: regular meetings between CREST and government, the BoE, the FSA, other authorities and key industry bodies. - Assessment: Observed - Comment: Assessment pre-dates merger between Euroclear and CrestCo (agreed September 2002); new Euroclear business plan emphasizes user ownership and governance. ### Access, Efficiency, Communication, Transparency — Recommendations 14–17 - Recommendation 14 (Access): CRESTCo’s Terms and Conditions set objective participation criteria and are publicly available; applicants incorporated outside the U.K. must appoint an agent for service of process; CREST cannot monitor underlying clients of its members. Assessment: Observed - Recommendation 15 (Efficiency): CRESTCo analyses financials and tariffs against peers and competitors; feedback obtained via Relationship Management and stakeholder surveys. Assessment: Observed - Recommendation 16 (Communication): Customers can use ISO 15022 or CREST proprietary standards; SWIFT FIN network used for cross-border transactions conforming to ISO 15022. Assessment: Observed - Recommendation 17 (Transparency): CRESTCo completed the CPSS/IOSCO disclosure questionnaire and published it; rights and obligations arise from USR 2001, CREST agreements and CREST Manual; periodic reviews ensure disclosure accuracy. Assessment: Observed ### Regulation and oversight — Recommendation 18 - FSA supervises CRESTCo under Financial Services and Markets Act 2000 with four statutory objectives; supervision based on Recognized Investment Exchanges and Recognized Clearing Houses handbook (June 01). - BoE takes the lead on systemic risk discussions and is CRESTCo’s main strategic interlocutor; BoE’s role in SSS and clearinghouse oversight was clarified publicly in its Financial Stability Report of June 2002. - Supervision challenges: - Difficult to supervise entities with negligible financial risks but significant reputational, operational and strategic business risks; FSA needs to adapt supervisory regime accordingly. - Supervision of clearinghouses and SSS may be more rule-based than the risk-based approach used for banks. - Key deficiency: There is currently no framework for cooperation with relevant authorities outside the U.K.; this is part of Recommendation 18 and should be established. - Assessment: Broadly observed - Recommended actions: - FSA should continue to adapt supervisory regime to risks inherent in CREST and LCH; consider whether a single supervisory handbook is appropriate for diverging institutions. - Establish a framework for cooperation with relevant authorities outside the U.K. - Further develop supervisory processes with respect to actual risks in CREST and LCH. - Focus oversight attention on challenges from consolidation of CSDs/SSSs and CCPs in European and global contexts and whether internal controls keep pace with business developments. ### Risks in cross-border links — Recommendation 19 - CREST cross-border links follow ECSDA standards and principles; CRESTCo conducts extensive legal due diligence before establishing links, including authorization from local authorities and finality of transactions in linked CSDs. - In all CREST cross-border links, no settlement is initiated unless stock or cash has been blocked; current DVP-link relies on clean payments rather than credit being extended. - No provisional transfers exist within cross-border links; transfers into CREST via these links are final and irrevocable. - Assessment: Observed ### Summary statistics and grading (Table 22) - Recommendations grouped by assessment grade: - Observed: 14 — Rec. 1, 3, 5, 7, 8, 10, 11, 12, 13, 14, 15, 16, 17, and 19 - Broadly observed: 4 — Rec. 2, 4, 6, and 18 - Partly observed: 0 - Non-observed: 0 - Not applicable: 1 — Rec. 9 ### Table 24 — Key recommended actions (selected) - Rec. 2 (Confirmation): Continue improvements with exchanges and market participants to achieve full observance; focus on indirect participants. - Rec. 4 (CCP/LCH): Replace payment scheme with BoE book settlement for sterling and Euro; convert fund placements to collateralized basis; rectify legal uncertainties, especially re default fund. - Rec. 6 (Dematerialization): Implement MMI dematerialization (plans in 2003) and consider measures to reduce 15% of equities and 1% of gilts remaining uncertificated; consider mandatory dematerialization. - Rec. 18 (Regulation & oversight): Establish cross-border cooperation framework; adapt FSA supervisory regime to CREST and LCH risks; monitor consolidation impacts on internal controls. *Source: _cr03208 - 183. There is currently no specific framework for cooperation with relevant authorities* ### 184. In addition to the above, some further technical improvements or refinements would ### _cr03208 - 184. In addition to the above, some further technical improvements or refinements would ### Technical improvements and immediate supervisory concerns - Rec. 7 - USD transactions presently are small, but there is an interbank credit risk stemming form the securities settlement mechanism. - CRESTCo together with the U.K. authorities should evaluate alternative payment schemes that can reduce this exposure. - If no such mechanism is found, supervisors should be aware of this risk exposure and discuss it with banks in their risk assessments. - Rec. 10 - CREST believes larger members generally have arrangements for immediate finality, but there is currently no specific information to verify this. - Authorities should seek specific information from CREST or its members about current payment finality arrangements between members and their banks and examine whether and how they should ensure finality arrangements are appropriate. - Additional supervisory notes - Even though USD transactions presently are small, there is interbank credit risk from the securities settlement mechanism; recommended that CREST together with the U.K. authorities explore this issue in more depth. - High concentration of activities in two settlement banks should be noted by banking supervisors; current rule requiring settlement banks to approve new settlement banks is irrelevant with today’s RTGS DVP settlement and should be removed because it risks limiting competitive pressure on existing settlement banks. - Rec. 12: Need to better communicate the safeguards and the legal support for custodial activity to market participants, some of whom have expressed concern. ### The CMO system — Executive summary - A recommendation-by-recommendation assessment was made of the Central Money Markets Office system (CMO). - CMO settles trades in money market instruments (treasury bills, bank bills, and CDs) in sterling and Euro. - Major shortcoming: settlement is not on a full delivery versus payment (DVP) basis. - Securities leg: settled gross on a real time basis and irrevocable upon settlement. - Payment leg: settles on a net basis at end of day, in settlement banks’ accounts with the Bank of England. - Unlike assured USD payments in CREST, banks are not obliged to make payments on behalf of their customers in CMO, exposing participants to full principal risk intraday until end-of-day payments settle. - Migration plan - Work underway to migrate MMI from CMO to CREST; suggested timetable was to complete migration during 2003. - Legislative changes needed: change status of money market instruments from bearer instruments (not fungible) to enable integration into CREST. - As long as CMO remains, U.K. authorities should take account of this risk exposure in financial stability and supervision. ### Summary observance (Table 25) - Assessment grade counts and lists: - Observed: 6 — Rec. 2, 3, 11, 12, 13, and 14 - Broadly observed: 3 — Rec. 1, and 18 - Partly observed: 4 — Rec. 5, 6, 8, 10, and 17 - Non-observed: 4 — Rec. 7, 9, 15, and 16 - Not applicable: 2 — Rec. 4 and 19 ### Detailed assessment — Legal risk - Recommendation 1 – Legal framework - Key points: Legal framework is contractual among issuers and CMO members; English law governs agreements. - Issue: Money market instruments are bearer and not fungible, complicating trading and settlement; legislative changes needed. - Assessment: Broadly observed - Comment: Legislative changes to make instruments fungible should be a high priority for HMT to include CMO fully within CREST and achieve true DVP. ### Detailed assessment — Pre-settlement risk - Recommendation 2 – Trade confirmation - CMO provides electronic book-entry transfer; seller inputs details and buyer must input acceptance (positive acceptance). - Settlement occurs on T+0. - CMO lacks information on trades not settled on due date because of late confirmation. - Assessment: Observed - Recommendation 3 – Settlement cycles - Trading conducted for same-day (T+0) settlement. - If buyer does not send positive acceptance, transaction deleted at end-of-day; details made available to members for bilateral discussion. - Assessment: Observed - Recommendation 4 – Central Counterparty (CCP) - No counterparty service for CMO. - Assessment: N/A - Recommendation 5 – Securities lending - No significant securities lending market because instruments are bearer and not fungible. - Active repo market: 20 percent of instruments within CMO are held as collateral or on repo. - Assessment: Partly observed - Comment: Prevalence of bearer instruments is a major shortcoming for developing securities lending. ### Detailed assessment — Settlement risk - Recommendation 6 – Central Securities Depositories (CSDs) - Instruments issued in physical, bearer form can be immobilized within CMO; BoE acts as depository for immobilization. - Once introduced into CMO, transfers are by book-entry. - Instruments within CMO are not fungible and are not registered. - Assessment: Partly observed - Comment: Mandatory dematerialization for money market instruments would be beneficial. - Recommendation 7 – Delivery versus Payment (DVP) - Securities leg settled gross in real time and irrevocable; payment leg nets at end-of-day in settlement banks’ BoE accounts. - In contrast to CREST USD assured payments, banks are not obliged to pay on behalf of customers, exposing participants to full principal risk intraday. - Assessment: Non-observed - Comment: Since principal risk is not eliminated, CMO is not compliant with international standards. Planned change involves amending the Uncertificated Securities Regulations in 2003; obstacle: instruments not fungible. Once changed, money market instruments can move into CREST and settle on DVP basis. - Recommendation 8 – Settlement finality - Securities leg finality is real time; payment leg finality is end-of-day. - Assessment: Partly observed - Comment: Settlement of securities leg is in real time and payments leg at end-of-day. - Recommendation 9 – CSDs risk controls - CMO does not extend intraday credit, nor permit debit balances in securities. - Settlement banks are exposed to principal risk since securities are settled irrevocably in real time. - CMO provides no facilities for settlement banks to monitor customer and interbank payment obligations before end-of-day. - Assessment: Non-observed - Comment: CMO adds risk to participants and provides them no means to manage those risks. - Recommendation 10 – Settlement assets - CMO operates an intermediated banking model; all members must have a CMO settlement bank; settlement bank does not guarantee members’ obligations. - Cash leg settles net at end-of-day in central bank money over settlement banks’ accounts within the BoE. - Almost 50 percent of the interbank payments within CMO are concentrated in two settlement banks. - Assessment: Partly observed - Comments: - At end-of-day, settlement takes place in central bank money. - No procedures for managing settlement bank risk exposures until then. - High concentration in two settlement banks should be noted by banking supervisors. ### Detailed assessment — Operational risk - Recommendation 11 – Operational reliability - CMO systems seem reliable; no failure of key systems during last year. - Hot backup ensures availability in minutes with full site switch within an hour. - Operational capacity requirements are limited; current volumes within capability. - Assessment: Observed ### Detailed assessment — Custody risk and governance - Recommendation 12 – Custody risk - BoE acts as depository for immobilization and as bailee for each CMO member, maintaining instruments within their CMO Instruments Account. - Bank required to keep instruments properly identified or identifiable by reference to CMO Instruments Account; instruments held non-fungibly and separate from assets of other members. - Assessment: Observed - Recommendation 13 – Governance - Annual Report and Accounts disclose ownership, board, management, and corporate governance; risk management procedures and board committee roles defined. - CRESTCo shareholders are system users; shares rebalanced every two years according to use. - Customer feedback obtained and acted on via Relationship Management team and stakeholder surveys. - Public interest upheld through regular meetings between CREST and government, the BoE, the FSA, other authorities and key industry bodies. - Assessment: Observed ### Other issues — access, efficiency, standards, transparency, oversight, cross-border links - Recommendation 14 – Access - Access determined by CMO Membership Agreements; accessible via website. - Non-U.K. applicants must appoint an agent for service of process incorporated in England and Wales. - CRESTCo cannot monitor underlying clients of its members. - Assessment: Observed - Recommendation 15 – Efficiency - CMO handles nonfungible instruments and is a manual system perceived as very costly and adding operational risk. - Assessment: Non-observed - Comment: Current CMO system expected to be replaced in 2003. - Recommendation 16 – Communication procedures and standards - CMO uses proprietary communications standards. - Assessment: Non-observed - Comment: Issue to be solved when money market instruments can be included in CREST; CMO expected to be replaced in 2003. - Recommendation 17 – Transparency - CMO completed CPSS/IOSCO disclosure framework questionnaire and published it on its website. - Complete rules and procedures comprised of CMO Membership Agreement and CMO Reference Manual. - External audit reports are not available for review by CMO participants. - Assessment: Partly observed - Comment: CRESTCo previously claimed CMO provides DVP settlement; this was misleading and removed from the disclosure framework since DVP should eliminate principal risk, which CMO does not. - Recommendation 18 – Regulation and oversight - Assessment: Broadly observed - Comment: As per Rec. 18 in the assessment for CREST (Table 1). - Recommendation 19 – Risks in cross-border links - CMO does not have any cross-border links. - Assessment: N/A *Source: _cr03208 - 184. In addition to the above, some further technical improvements or refinements would (IMF content provided).* ### 188. The following table sets out the recommended actions to improve the observance of ### _cr03208 - 188. The following table sets out the recommended actions to improve the observance of ### Recommended actions to improve observance of CPSS/IOSCO—CMO (summary of Table 27) - Broad theme: encourage authorities to proceed as planned, and as soon as possible, with the migration of MMI into the CREST system and requisite underlying legal changes. - Rec. 1 – Securities settlement systems should have a well-founded, clear and transparent legal basis in the relevant jurisdictions. - Recommended action: The legislative changes necessary to make the instruments fungible should be a high priority issue for the HMT, since this is necessary to fully include CMO within CREST and thereby achieve true DVP. - Rec. 5 – Securities lending and borrowing (or repurchase agreements and other economically equivalent transactions) should be encouraged as a method for expediting the settlement of securities transactions. Barriers that inhibit the practice of lending securities for this purpose should be removed. - Recommended action: Being bearer instrument is a major shortcoming for developing the CMO system and developing an active securities lending market, which should be rectified. - Rec. 6 – Securities should be immobilized or dematerialized and transferred by book entry in CSDs to the greatest extent possible. - Recommended action: A mandatory dematerialization, at least for gilts and money market instruments, would be beneficial for the market. - Rec. 7 – CSDs should eliminate principal risk by linking securities transfers to funds transfers in a way that achieves delivery versus payment. - Recommended action: Since principal risk is not eliminated CMO is not compliant with international standards. A fundamental change is planned for 2003 to bring CMO transactions fully into the CREST system: it is important that this change be pushed through on schedule, and it will need to be supported by action to address the fact that instruments are not fungible. In that regard, appropriate legislative changes should be made to allow achievement of DVP settlement. It is also important that these exposures receive supervisor’s attention. - Rec. 8 – Final settlement should occur no later than the end of the settlement day. Intraday or real-time finality should be provided where necessary to reduce risks. - Recommended action: See above. - Rec. 9 – CSDs that extend intraday credit to participants, including CSDs that operate net settlement systems, should institute risk controls that, at a minimum, ensure timely settlement in the event that the participant with the largest payment obligation is unable to settle. The most reliable set of controls is a combination of collateral requirements and limits. - Recommended action: See above. - Rec. 10 – Assets used to settle the ultimate payment obligation arising from securities transactions should carry little or no credit or liquidity risk. If central bank money is not used, steps must be taken to protect CSD members from potential losses and liquidity pressures arising from the failure of the cash settlement agent whose assets are used for that purpose. - Recommended action: As above, it is important that the planned fundamental overhaul of the CMO arrangement should be pushed through as scheduled. As per the CREST assessment, it is also important that the high concentration of interbank transaction in two settlement banks should be noted by banking supervisors. - Rec. 15 – While maintaining safe and secure operations, securities settlement systems should be cost-effective in meeting the requirements of users. - Recommended action: This should be addressed with the replacement of current CMO arrangements in 2003. - Rec. 16 – Securities settlement systems should use or accommodate the relevant international communication procedures and standards in order to facilitate efficient settlement of cross-border transactions. - Recommended action: This will also be solved when money market instruments can be included in the CREST system under the changes planned for 2003. - Rec. 17 – CSDs and central counterparties should provide market participants with sufficient information for them to identify and accurately evaluate the risks and costs associated with using the CSD or central counterparty services. - Recommended action: In the past, CMO has claimed that it provides DVP settlement, since a payment instruction is issued in real time when the securities leg of the transaction is settled. This was misleading since the rationale behind DVP is that it should eliminate principal risk. As noted above, this is not the case in the CMO system, and a correction to the CREST website in this regard has since been made. Pending the fundamental overhaul noted above, it is important that the risk in the current system is not understated. This is not prudent. - Rec. 18 – Securities settlement systems should be subject to transparent and effective regulation and oversight. Central banks and securities regulators should cooperate with each other and with other relevant authorities. - Recommended action: As per Rec. 18 under the assessment for CREST (Table 3). ### Authorities’ response to the assessments of CREST and CMO (paragraphs 189–192) - Authorities’ view: - The assessment has been a valuable and effective review of the observance by U.K. SSSs of the CPSS/IOSCO recommendations. - Some identified risks can be effectively monitored rather than removed given relatively low impact and cost/benefit considerations. - Example: very low value of US$ settlement in CREST — authorities, CREST and APACS will monitor US$ flows and consider actions only if values justify a significant solution. - Progress reported by authorities: - Priority given to replacing LCH’s payment scheme with one based primarily on settlement across the books of the Bank of England; detailed discussions underway between the Bank and LCH. - LCH has started to deposit its cash margin on a secured basis. - Discussions ongoing regarding legal certainty for the small proportion of the default fund where treatment in member insolvency is uncertain. - Substantial progress toward implementation of money market instrument dematerialization: - HM Treasury published a consultation paper on September 13, 2002 incorporating detailed proposed changes to the Uncertificated Securities Regulations 2001. - Comments were asked for by December 6, with the aim of achieving necessary Parliamentary approval by end H1 2003, so that dematerialized money market instruments can start being issued and settled in CREST from September 2003 and CMO can be closed at end-2003. - This work addresses Recommendation 6 of the CREST assessment (dematerialization of MMIs) and makes most recommended actions in the CMO assessment redundant. - Supervisory regime and international cooperation: - Authorities noted IMF observations on the supervisory regime and application of the sourcebook to CREST and LCH; FSA believes its current approach provides sufficient flexibility and compares favorably with other European regulators. - Committee of European Securities Regulators provides a mechanism for cooperation across the EU and with ECB on central bank/stability issues; authorities supplement this with bilateral MoUs as necessary. ### AML/CFT assessment overview (paragraphs 193–202) - Assessment team composition and methodology: - Detailed assessment prepared by a team including IMF staff, an expert under IMF supervision, and an expert not under IMF supervision (selected by the authorities) to assess criminal law enforcement aspects. - Assessment examined AML/CFT laws, regulations, supervisory and regulatory systems for prudentially regulated financial institutions and money service businesses (MSBs: bureaux de change, money transmitters and check cashers). - Assessment based on information available as of December 20, 2002. - IMF staff members named: John Abbott (MAE) and Rhoda Weeks-Brown (LEG). Team included Paolo Constanza (Ufficio Italiano dei Cambi) under IMF supervision, and Ted Greenberg (U.S. Department of Justice) as Independent Anti-Money Laundering Expert (IAE) not under IMF supervision. - Materials and discussions reviewed: - Statutes reviewed include: Proceeds of Crime Act 2002 (“PCA 2002”), Drug Trafficking Act 1994 (“DTA”), Criminal Justice Act 1988 (amended) (“CJA”), Criminal Justice (International Cooperation) Act 1990 (“CJICA”), Terrorism Act 2000 (“Terrorism Act”), Anti-Terrorism, Crime and Security Act 2001 (“ATCS 2001”), Police Act 1997 (“Police Act”), Extradition Act 1989 (“Extradition Act”), Regulation of Investigatory Powers Act 2001 (“RIPA”), and Financial Services and Markets Act 2000 (“FSMA”). - Statutory instruments reviewed include: Money Laundering Regulations 1993 (the “1993 Regulations”), Money Laundering Regulations 2001 (the “2001 Regulations”), and the Terrorism (United Nations Measures) Order 2001. - Supervisory materials reviewed include FSA materials (FSA Money Laundering Sourcebook, Money Laundering Theme Report, FSA Handbook) and HMCE supervisory materials for MSBs. - Discussions held with officials and technical experts from FSA, HMT, U.K. Home Office, HMCE, NCIS, Crown Prosecution Service, Serious Fraud Office, City of London Police, Charity Commission, financial institutions and private sector AML/CFT compliance experts. - Key findings and status: - PCA 2002 will simplify U.K.-wide AML legislation; PCA 2002 received Royal Assent in July 2002. - PCA 2002 ML offence provisions become effective on February 24, 2003; remaining provisions effective by May 24, 2003. - U.K. has a strong and comprehensive legal, institutional and supervisory regime for AML/CFT. - Recent strengthening measures include PCA 2002, new legislation on terrorist financing (2000 and 2001), regulations for registration and limited supervision of MSBs (2001), and FSA Money Laundering Sourcebook (2001). - Anticipated reforms expected to further improve the regime: legal requirements concerning inclusion of originator information on money transfers, expansion of AML regime under the Second EU Directive on Money Laundering. - Compliance with FATF: U.K. is compliant or largely compliant with all FATF 40+8 Recommendations, other than Special Recommendation VII concerning inclusion of originator information on wire transfers. - Institutional complexity and coordination: - Key institutions include: FSA; HMCE; HMT; U.K. Home Office; NCIS (Economic Crime Unit serving as FIU); over 50 national and local law enforcement agencies; Crown Prosecution Service; Serious Fraud Office; National Crimes Squad; Asset Recovery Agency (provided under PCA 2002); and others. - Multiplicity of institutions could result in inefficiencies and undermine effective implementation; government’s November 2001 Asset Recovery Strategy cites poor interagency cooperation as a reason for underperformance enforcing confiscation orders. - MLAC (Money Laundering Advisory Committee) established to improve strategic coordination. HMT preparing a strategy document on tackling money laundering. - Supervisory coverage and enforcement: - Supervisory regime applies to most persons and firms regulated by the FSA, with a notable gap: general insurance companies are excluded from coverage. - FSMA strengthened enforcement by listing prevention of financial crime among the four statutory objectives of the FSA and giving broad enforcement powers including ability to bring criminal prosecutions for breach of the 1993 Regulations. - Conclusion re: need for refinement: - Despite overall strength, room for improvement and refinement exists across areas covered under the Fund/Bank AML/CFT Methodology; detailed analysis follows in the report. ### Detailed assessment framework (paragraphs 203–204 and Table 28 intro) - Methodology: - Detailed assessment conducted using the October 11, 2002 version of the Methodology for assessing compliance with FATF 40 Recommendations and 8 Special Recommendations. - Definitions for compliance gradations: - Compliant: requirement fully observed. - Largely compliant: discrete and non-systemic shortcomings; corrective actions readily identified and scheduled within a reasonable period. - Materially non-compliant: discrete or non-systemic shortcomings not addressed, or numerous/systemic shortcomings with corrective actions scheduled within a reasonable period. - Non-compliant: jurisdiction has not addressed the issue or addressed it in a manner that cannot reasonably lead to substantial observance. - Not applicable: requirement does not apply given structural, legal and institutional features. - Next section signposted: - C. Assessing the Criminal Justice Measures and International Cooperation — Table 28: Detailed Assessment of the Criminal Justice Measures and International Cooperation; Criminalization of ML and FT; Detailed Assessment of Criteria 1-6; Overall Description and Analysis; Recommendations and Comments. *Source: IMF staff report excerpts (paragraphs 188–204) from the assessment document provided.* ### 1. The U.K. should ratify as soon as possible the UN Convention Against Transnational Organized Crime 2000 ### 1. The U.K. should ratify as soon as possible the UN Convention Against Transnational Organized Crime 2000 (Palermo Convention) ### Recommendations - The U.K. should ratify as soon as possible the UN Convention Against Transnational Organized Crime 2000 (Palermo Convention). - The definition of ML under the 1993 Regulations (section 2(3)) should be updated to: - include references to the full range of ML laws currently in effect; - include references to the more recent laws on FT including in particular the Terrorism Act and the ATCS 2001; - delete obsolete cross-references. - The U.K. should seriously consider the creation of a national law enforcement organization that has both: - investigation of criminal acts; and - foreign counter-intelligence responsibilities. - Consideration should be given to passing legislation that makes wiretap evidence admissible in judicial proceedings. - Special legislative considerations should be given to protecting national security information while balancing the defendant’s right to have access (in some form) to relevant evidence. ### International and treaty status - The U.K. has signed and ratified: - the UN Convention Against Illicit Traffic in Narcotic Drugs and Psychotropic Substances 1988 (Vienna Convention); - the UN International Convention for the Suppression of the Financing of Terrorism 1999; - the Strasbourg Convention. - The U.K. has signed and is in the process of ratifying the Palermo Convention. - The U.K. has entered into force the 1990 Council of Europe Convention on Laundering, Search, Seizure and Confiscation of the Proceeds of Crime. - The U.K. implements UN Security Council Resolution 1373 via the Terrorism (United Nations Measures) Order 2001. ### Changes and provisions under the PCA 2002 - When effective, the PCA 2002 would: - update, unify and expand U.K. ML offenses; - expand the criminal intent requirement for failure to report in the regulated sector to include having reasonable grounds for knowledge or suspicion of ML; - remove distinctions between drug and non-drug ML and between one’s own and another’s proceeds of crime; - consolidate dispersed provisions into one statute. - PCA 2002 institutes new principal money laundering offenses related to: - concealing, disguising, converting, transferring, or removal from jurisdictions within the U.K. of criminal property (sections 327-329); - entering into arrangements to facilitate the acquisition, retention, use or control of criminal property by or on behalf of another person; - acquiring, using or possessing criminal property. - PCA 2002 includes a tipping-off offense (section 333). - PCA 2002 defines criminal conduct broadly to include any conduct that is a crime in any part of the U.K. or that would constitute an offense in any part of the U.K. if it were to occur there (section 340(2)). - PCA 2002 defines money laundering to include principal offenses and related inchoate conduct (section 340 (11)). - PCA 2002 provisions will generally come into force by order of the Secretary of State; Part 7 (establishing ML offences) had an intended effective date of February 24, 2003, with remaining provisions intended to be fully in effect by May 24, 2003. ### Existing criminalization and statutory regime (pre-PCA 2002) - Currently effective U.K. legislation criminalizing money laundering includes: - sections 49-53 of the DTA; - sections 93A-93D of the CJA; - the Terrorism Act. - CJA criminalizes: - assisting another person to retain the benefit of criminal conduct; - acquiring, possessing or using property representing another person’s proceeds of criminal conduct; - concealing, disguising, converting or transferring property that is or represents one’s own or another’s proceeds of criminal conduct; - tipping-off another person by providing information about an actual or prospective money laundering investigation. - DTA criminalizes similar ML conduct but in connection only with drug trafficking predicate offenses and contains a separate failure-to-disclose offense related to drug trafficking. - U.K. law criminalizes inchoate offenses (attempt, counseling, procuring, conspiracy, aiding and abetting); conviction of a predicate offense is not required for an ML prosecution. - ML offenses generally apply to extraterritorial predicate crimes if such conduct would constitute a crime if it had occurred in the U.K. ### Gaps in the 1993 Regulations and CFT regulation - The 1993 Regulations (Regulation 5) impose criminal liability on prudentially regulated financial institutions, MSBs and other financial services providers for failure to maintain certain internal AML controls. - For AML control purposes, “money laundering” is defined as acts constituting offenses under various criminal statutes, but: - some important ML criminal provisions appear to have been inadvertently excluded, including sections 49-54 of the Drug Trafficking Act; - FT-related ML under the Terrorism Act and ATCS 2001 appear excluded. - The Regulations currently could not be applied where a financial institution’s failure to adopt AML controls leads to perpetration of the excluded offenses. - There is no parallel regulation similar to the 1993 Regulations applicable to CFT systems and controls. ### Criminalization of Financing of Terrorism (FT) - The U.K. criminalizes FT under the Convention for the Suppression of the Financing of Terrorism and domestic laws: - inviting another person to provide or receive money or other property for the purposes of terrorism; - using money or other property for the purposes of terrorism; - being part of an arrangement as a result of which money or other property is made available to another for the purposes of terrorism (Sections 15-17 of the Terrorism Act 2000). - The Terrorism Act makes laundering of terrorist property a predicate crime for ML (TA section 18). - FT offenses apply when terrorists or terrorist organizations are located in another jurisdiction, and when terrorist acts take place in another jurisdiction. ### Mental state, corporate liability, and sanctions - State of mind standards: - most U.K. ML and FT offenses: “knowledge” or “suspicion”; - acquisition, possession and use of proceeds of crime: “knowledge” only; - concealing or transferring proceeds of crime: knowledge or having reasonable grounds to suspect; - FT under the Terrorism Act and ATCS 2001: knowledge, suspicion or existence of reasonable grounds for knowing or suspecting. - After PCA 2002, failure to report in the regulated sector expands to include having reasonable grounds for knowledge or suspicion. - “Knowledge” can be inferred from objective factual circumstances under U.K. law. - Legal entities can be charged and convicted of ML and FT; mens rea attributed to a legal person generally requires an officer with a high level of authority to possess the requisite mental state. - Sanctions: - DTA and CJA concealing/transferring/assisting/acquisition/possession/use provisions: statutory fine and/or six months imprisonment (summary) to an unlimited fine and/or imprisonment of up to 14 years (indictment) (DTA section 54(1); CJA sections 93A(6), 93B(9), 93C(4)); - Tipping-off: summary conviction statutory fine and/or jail term up to six months; conviction on indictment unlimited fine and/or five years imprisonment (DTA section 54(2); CJA section 93D(9)); - Prudentially regulated financial institution or other financial services provider that fails to comply with the 1993 Regulations: up to two years in prison and/or an unlimited fine (section 5(2)). - Similar sanctions to above would apply under PCA 2002 once Part 7 becomes effective. ### Institutional responsibilities and resources - International leadership and AML/CFT policy: - HMT leads internationally (e.g., FATF, EU), issues the U.K.’s Money Laundering Regulations (1993 and 2001), and has joint lead with the Home Office on AML policy. - The Home Office is responsible for primary legislation on ML and FT. - Financial Intelligence Unit (FIU): - NCIS is the U.K.’s central FIU and generally receives suspicious transaction reports; it also has a Terrorist Finance Unit to coordinate intelligence on terrorist financing. - Law enforcement and prosecution: - Police and HMCE are responsible for investigating ML and FT cases, with assistance from intelligence services when necessary. - HMCE supervises MSBs under the 2001 Regulations. - Crown Prosecution Service, Serious Fraud Office, HMCE and FSA are prosecuting authorities. - Regulatory: - FSA regulates nearly 11,000 financial firms; it can bring criminal prosecutions for breaches of the 1993 Regulations (but not for primary money laundering law). - The FSA did not provide a compelling argument why more regulated institutions have not had on-site ML compliance program reviews given available resources. - Law enforcement structure: - 43 Police Constabularies in England & Wales, 8 in Scotland and 1 in Northern Ireland. - Metropolitan Police Service has limited national functions and is not overall responsible for ML or FT. - Other national-remit agencies include HMCE, Serious Fraud Office, FSA and the Secret Intelligence Service. - Resource concerns and strategy: - It is unclear whether there are sufficient resources to investigate ML. - There is no single law enforcement entity covering all aspects of ML in the U.K. (HMCE is the nearest for drugs ML). - With the exception of HMCE’s strategy for drug money launderers, there is no national strategy to attack ML and FT; one is understood to be in preparation. ### Statistics and confiscation/freeze actions - Provided statistics (2000): - 117 drug cases involving the proceeds of drug trafficking and 39 convictions. - Confiscation order receipts: - 2000-01: 19,833,000 pounds; - 1999-2000: 25,0444,000 (as provided). - Assets frozen under the Taliban, Al-Qaeda and Terrorism (UN Measures) Orders in 2000-2001: ₤ 70 million. ### Investigative techniques and evidentiary issues - Legislation permits a wide range of investigative methods: - RIPA authorizes interception of communications, access to communications data, covert surveillance and covert human intelligence sources for listed public authorities for statutory criteria (e.g., prevention of crime, national security). - RIPA has not been successfully challenged under the European Convention on Human Rights and The Human Rights Act; applications are pending at the ECHR. - Wiretap admissibility: - Wiretaps are conducted under Ministerial authorization and are not admissible as evidence in judicial proceedings. - This restriction: - deprives prosecutors of direct voice evidence of witnesses and defendants; - adds burdens on investigators and delays prosecutions due to need to develop parallel sources. - Recommendation: consider legislation to make wiretap evidence admissible in judicial proceedings, with special provisions to protect national security information and balance defendant access to relevant evidence. - Production of bank records, search and seizure: - Domestic legislation provides powers to serve summonses, obtain witness statements on oath, obtain authenticated documentary evidence including banking evidence and financial transaction records through production orders, and exercise search and seizure powers. - Main provisions for terrorism-related accounts or records: - customer information orders under Schedule 6 of the Terrorism Act (require banks to provide existence of accounts, account numbers, customer addresses, evidence of identity, joint account holder details); - account monitoring orders under Schedule 2 of the ATCS 2001 (require specified information at specified times for specific accounts). - The 2001 Regulations allow HMCE to require MSBs to furnish documentation necessary to assess compliance with the 1993 Regulations; HMCE can levy a civil penalty under the 2001 Regulations (but not under the 1993 Regulations). - When effective, PCA 2002 will enable customer information and account monitoring orders to be obtained for all offences which are the subject of a confiscation or money laundering investigation. ### Analysis and operational observations - The U.K. has the undercover means to conduct productive investigations; HMCE is particularly innovative in identifying targets and executing investigations. - However, authorities appear generally reactive rather than engaging in proactive targeting of money launderers. - The IAE was not provided with examples of proactive use of investigative tools to investigate ML or FT. - Account Monitoring Orders under PCA 2002 are an important and innovative tool; appropriate and consistent use should materially increase investigations, prosecutions and confiscations. *Source: IMF staff report content provided in the supplied PDF excerpt.* ### 1. The PCA 2002 provisions governing confiscation, seizure, assets recovery and civil recovery should be made ### _cr03208 - 1. The PCA 2002 provisions governing confiscation, seizure, assets recovery and civil recovery should be made ### Summary of PCA 2002 enhancements - PCA 2002 would: improve procedures governing confiscation of the proceeds of crime; provide for the restraint (freezing) of assets at any time during a criminal investigation; expand the scope for civil recovery of property obtained through unlawful conduct; and make available in all criminal proceedings the investigative tools of account monitoring orders and customer information orders. ### Legal provisions and scope - DTA and CJA allow for freezing (“restraint”) and confiscation of proceeds of all ML predicate crimes (DTA section 2 (confiscation), 25-26 (restraint); CJA section 71 (confiscation), 76-77 (restraint)). - Court must determine whether the defendant has benefited from a crime and order payment of the amount by which he has benefited; an “assumption” procedure permits assuming assets/transfers/expenditure were derived from crime under certain circumstances (DTA section 4; CJA section 72AA). - PCA 2002 would generally make the assumptions procedure mandatory (subject to certain exceptions). ### Seizure, restraint and confiscation - Terrorism Act: forfeiture proceedings following conviction for FT offenses (Schedule 4); seizure of cash intended for use in terrorism, including FT. - ATCS 2001: pre-proceedings seizure of terrorist cash and issuance of restraining orders (Part 1, Schedules 1 and 2). - Terrorism (United Nations Measures) Order 2001 (pursuant to UNSCR 1373): authority for HMT to freeze accounts where HMT has reasonable grounds to suspect involvement in terrorism. - Assets used in FT have been caught under section 143 of the Criminal Courts Act 2000 (forfeiture of property used to perpetrate a crime). - Previously, restraint orders (except FT-related pre-proceeding ones) could not be obtained until criminal proceedings had been initiated or were imminent; PCA 2002 would permit restraint orders at any time during a criminal investigation. - Confiscation can take place only after conviction of the relevant crime. ### Border and domestic cash seizure powers - HMCE and police authority under the DTA (section 42) to seize cash being imported or exported if reasonable ground to suspect proceeds of drug trafficking or intended for drug trafficking; seized cash can be detained up to two years and forfeited by judicial order where Court is satisfied origin or intended use is drug trafficking. - PCA 2002 would expand seizure powers to cover movements of suspect cash within the U.K. (cash broadly defined to include postal orders, cheques, bankers’ drafts, bearer bonds and shares, and certain kinds of monetary instruments). - PCA 2002 would authorize seizure of property related to crimes other than drug trafficking (section 289). ### Civil recovery and Asset Recovery Agency (ARA) - Current U.K. laws have limited civil recovery provisions; PCA 2002 provides broader civil recovery powers and establishes a new Asset Recovery Agency (ARA) with broad powers to seek civil recovery of property obtained through unlawful conduct. - Civil recovery would not be conditional on conviction. - ARA would also: exercise functions focused on increasing criminal confiscation and taxing the proceeds of crime (generally in cases where confiscation and civil recovery are not available). - PCA 2002 allows the new ARA to follow and recover tainted property transferred (including by contract or gift), subject to safeguards for innocent third parties. ### Investigative powers (Criterion 8) - ATCS 2001: customer information orders (approach financial institutions to find accounts held by person under investigation for FT) and account monitoring orders (require transaction information on an FT-suspected account for up to 90 days) (Schedule 2). - DTA section 55, CJA section 93H: production orders requiring named persons to produce specified material; DTA section 56, CJA section 93I: search and seizure warrants. - Serious Fraud Office (and under PCA 2002, the ARA) can obtain disclosure orders requiring persons to explain information and produce documents. - When PCA 2002 becomes effective, customer information and account monitoring orders would be available for use in all ML-related criminal investigations (previously limited to FT and terrorism investigations). ### Protections for innocent or bonafide third parties (Criterion 9) - Any person affected by a restraint order under DTA or CJA can apply to vary or discharge the order (DTA section 26(6); CJA section 77(7)). - Legislative steer provisions require third parties be allowed to recover their interest where property in which they hold an interest is subject to restraint or realization action (DTA section 31(4), 62(5); CJA section 82(4), 102(7)). - Criminal court duty to consider issuance of a “compensation order” where victim or third party claims exist and civil proceedings have been or will be instituted; compensation order has first call on confiscated funds (CJA section 71(1C)). - Schedule 4 of TA 2000: persons with an interest in property subject to forfeiture or restraint under the Schedule can apply for compensation in specified circumstances. - Terrorism (United Nations Measures) Order 2001: right of appeal to the High Court by any person whose funds are frozen following a direction by HMT (Article 4 (7)). ### Recovery of gifts and transferred property (Criterion 10) - U.K. confiscation legislation allows recovery of gifts in satisfaction of a confiscation order, including property passed at undervalue by means of a contract. - PCA 2002 permits ARA to follow and recover tainted property transferred (including by contract or gift), with appropriate safeguards for innocent third parties. ### Restraint implementation and enforcement (Criterion 11) - A restraint order prevents dealing in any “realizable property” (property held by defendant or person to whom defendant made a gift). - Generally no assessment of value of assets under restraint at that stage; courts may appoint a receiver to manage property; value may later be assessed. - Purpose of restraint is to preserve sufficient realizable property to satisfy any confiscation or forfeiture order; maximum amount of realizable property that can be restrained is the maximum amount in which any confiscation or forfeiture order can be made. - No central record of amounts of assets held under restraint. Analysis points (verbatim where present): - Confiscation has not been a priority of the U.K. Crown Prosecution Service (CPS). Even now the CPS has virtually no resources to handle confiscation matters. Of the 600 cases that were presented to the Central Confiscation Branch in [‘91] only 300 were considered for enforcement and only when there was no likelihood that the case would be seriously contested or complicated. There is no government property management system so the confiscation of perishable items like air and water craft is not pursued. ### Training and resources (Criterion 12) - Selected individuals within law enforcement agencies currently receive a three phase training program in financial investigation, which includes aspects of money laundering. Upon completion they are included on a National List of Financial Investigators. - PCA 2002 prompted a national review of financial investigation training and created a Centre of Excellence with responsibility for its delivery. - Key features of training initiatives: - the setting up by the Government of a national Centre of Excellence in Financial Investigation. The Centre will be part of the new Assets Recovery Agency and its role will be to train financial investigators in the Police, HMCE and other Government bodies and to accredit them to perform various functions provided for in the PCA 2002; - in-house training programs for staff in the Crown Prosecution Service, HMCE and other prosecutors; - training initiatives for the judiciary in the implications for them of the new legislation. - Financial investigators operating within law enforcement were scheduled to receive training in the PCA 2002 between September and December 2002. The aim of this program is to ensure that all current financial investigators are fully equipped to use the confiscation, ML and restraint/freezing powers, which will be available to them following the implementation of the PCA 2002. - A separate new training program is being developed for all newly appointed financial investigators, which will be delivered from December 2002. Training will also be available for accredited (certified) financial investigators working within other enforcement agencies. - ARA personnel will be trained to a higher level in tracing criminal assets, built on law enforcement and Accredited Financial Investigators’ programs. - U.K. has had ML provisions since 1986 allowing police and customs investigators to investigate ML. Best practice: only those with specific training are placed on an ‘approved’ list of financial investigators (overseen by NCIS). PCA 2002 would place this practice on a statutory footing. Analysis point (verbatim where present): - Apparently outside a core group in HMCE and the NCIS/ ECU, there is no current comprehensive training program that addresses ML or FT in the law enforcement agencies or the FSA. The proposed plans should rectify this situation and provide the U.K. with a full range of experienced officers to investigate and prosecute ML and FT. ### Terrorist financing measures and listings (Criteria 13–15) - Terrorism (United Nations Measures) Order 2001 (pursuant to UNSCR 1373) provides HMT authority to freeze accounts of suspected terrorists where HMT has reasonable grounds to suspect involvement in terrorism or acting on behalf of such a person. - U.K. has fully implemented the terms of all UNSCRs relevant to prevention and suppression of FT. - The U.K. has listed over 100 organizations and over 200 individuals. - Prior to the fall of Kabul, the U.K. froze a total of £70 million relating to the Taliban, Osama Bin Laden and Al-Qaeda. £7 million of this was frozen after the events of 11 September 2001. - Details of amounts frozen and numbers of individuals/entities whose assets have been frozen are held by the Bank of England. - U.K. law authorizes identification and restraint of property of suspected terrorists, those who finance terrorism and terrorist organizations even where names do not appear on UN Security Council lists. ### International sharing of confiscated assets (Criterion 16) - U.K. law does not contain express provisions prohibiting sharing of confiscated property with other jurisdictions. - Government is free to enter into arrangements, on a case-by-case basis, for sharing proceeds of an external confiscation order enforced in the U.K. - Specific arrangements exist with the United States and Canada for sharing confiscated assets resulting from coordinated law enforcement actions. ### Recommendations and comments (verbatim) - 1. The PCA 2002 should be made effective as soon as possible, given its substantial enhancements to the arrangements under which NCIS exercises its functions (inter alia, by requiring all financial institutions and MSBs to file suspicious transactions reports only with NCIS; by providing for issuance of a standard form for suspicious transactions reporting and for the possibility for NCIS to receive additional information from filers; and by giving NCIS broader powers to prevent the carrying out of suspicious transactions where reports are filed with it before the transaction has been executed.) - 2. NCIS (or another appropriate government agency) should be given authority to impose civil fines on reporting parties—other than prudentially regulated financial institutions—that fail to comply with their reporting obligations under the 1993 Regulations. As it is now, the FSA has significant authority to impose civil sanctions on financial institutions, but the only STR-related sanctions for non-FSA firms is criminal. (HMCE can impose civil fines on MSBs only for a narrow range of matters that do not include STRs.) *Source: _cr03208 - 1. The PCA 2002 provisions governing confiscation, seizure, assets recovery and civil recovery should be made* ### 3. Consideration should be given to providing NCIS with the power to get supporting documents (rather than only ### _cr03208 - 3. Consideration should be given to providing NCIS with the power to get supporting documents (rather than only ### NCIS / U.K. FIU role and functions - The Economic Crimes Branch of NCIS currently functions as the U.K.’s FIU. - Statutory functions under the Police Act (section 2(2)) include: - gathering, storing and analyzing information to provide criminal intelligence; - providing criminal intelligence to U.K. police forces, the National Crime Squad and other law enforcement agencies in the U.K.; - acting in support of these agencies in carrying out their criminal intelligence activities. - In practice NCIS: - acts as the national point for receipt, analysis and dissemination of suspicious transaction reports (STRs); - maintains a financial intelligence database; - conducts strategic analysis of ML trends and issues within the U.K.; - engages in proactive intelligence development of high-profile ML cases; - acts as technical advisor to Government departments on ML-related matters and as liaison to financial institutions; - provides advice to HMT and other government departments on ML and FT policy and necessary amendments to legislation; - provides training to law enforcement and the financial sector within the U.K. and abroad on ML issues; - is responsible for the co-ordination of law enforcement input into the U.K.’s FATF delegation; - acts as the secretariat of the Egmont Group, and chairs one of its sub-groups; - contributes to production of case studies and material assisting government and industry (e.g. JMLSG Guidance Notes typology input). ### Legal framework and reporting arrangements (1993 Regulations, PCA 2002, FSA) - Under current 1993 Regulations, financial institutions and MSBs are required to file suspicious reports with any “constable” in the U.K.; FSA-regulated firms are expressly required under the FSA Sourcebook to file suspicious reports with NCIS. - PCA 2002 would change filing so that “nominated officers” in the regulated sector or otherwise file STRs only with a person authorized by NCIS to receive such reports. - The statute does not per se mandate filings with NCIS, but authorities indicate NCIS is likely to designate itself for receiving STRs once PCA 2002 provisions enter into force. - The PCA 2002 (section 339) authorizes the Secretary of State to prescribe the form and manner in which suspicious ML reports are to be made both by persons in the regulated sector or otherwise; the form may include requests for specified additional information necessary to decide whether to start an ML investigation. - Under existing arrangements: - There is no standard nationwide form for reporting STRs (NCIS has a recommended format reportedly used by most financial institutions and MSBs). - High-volume reporting institutions have electronic links to NCIS; a project is under development to expand electronic reporting to medium-level disclosing institutions. - A telephone ‘hotline’ exists for urgent queries with an NCIS desk officer. ### NCIS powers to obtain information and limitations - NCIS encourages reporting parties to provide detailed information in STRs but currently lacks authority to mandate production of additional information or documentation from reporting parties. - NCIS can obtain additional information and documents by seeking a court order where there are reasonable grounds to suspect ML, FT or other serious crimes. - PCA 2002’s provisions potentially allow the reporting form to request specified additional information from disclosers. - NCIS lacks power to order sanctions or penalties against reporting parties for failure to comply with reporting obligations; enforcement and sanction powers lie with other agencies (e.g., FSA, HMCE). - Criminal sanctions may be imposed for failure to observe STR reporting and other AML controls aspects of the 1993 Regulations. - Freezing or blocking transactions are prerogatives of a limited number of law enforcement agencies; PCA 2002 expanded some powers to include qualifying “financial investigators” approved by the new ARA. - If a regulated entity files an STR before a transaction, PCA 2002 gives NCIS power to issue “consent” or withhold consent; if withheld, NCIS has 31 working days to seek a restraint order from a court. - NCIS gathers information on quality of STRs, peer comparisons, and evidence of non-reporting by institutions and can pass such information to the FSA and HMCE for sanctions and regulatory action. ### Access to data sources and analysis capabilities - NCIS has authority to access a broad range of data sources, including: - credit reporting records; - business/corporate registries; - real property registries; - vehicle registries; - police charge sheets and criminal records; - immigration and customs records. - NCIS records and conducts strategic analysis and can initiate cases and undertake independent ML intelligence analyses. ### Dissemination, interagency cooperation, and confidentiality - Dissemination of criminal intelligence and other information to U.K. law enforcement agencies is a core statutory function of NCIS; dissemination can be on NCIS’ initiative or on request. - NCIS and FSA entered into an agreement (2001) defining scope of cooperation; the memorandum of understanding: - does not supersede or modify legal obligations; - allows NCIS to provide the FSA with information on the investigating agency to which NCIS submitted information from STRs filed by the FSA; - coordinates when feedback on such reports is received from investigating agencies; - allows NCIS to inform the FSA of matters relevant to the FSA’s functions, subject to disclosure restrictions; - NCIS routinely provides the FSA with general STR information, including rates of reporting and evaluations of report quality; - FSA provides NCIS with up-to-date statistics and other information to assist NCIS analyses. - Legislative and administrative provisions relevant to confidentiality and proper use of disseminated information include: Data Protection Act 1998, Human Rights Act 1998, Official Secrets Act 1989. ### International cooperation - NCIS has authority to request intelligence and other information from, and disseminate material to, foreign authorized government officials. - Sharing is routinely undertaken with Egmont member counterparts, normally by way of Memoranda of Understanding (MOUs), although MOUs are not a necessary condition for sharing. - MOUs normally contain provisions that: - information shall be used only for the specific purpose for which it was sought or provided; - information shall not be shared with a third party without the FIU’s prior consent; - information shall not be used in an administrative, prosecutorial, or judicial purpose without prior consent. ### STR statistics, timeliness, and effectiveness - NCIS keeps statistics on: - the use by law enforcement of STRs; - the number and types of requests for assistance received by the FIU from domestic and foreign authorities; - the number and types of responses provided. - Reported STR and enforcement figures: - 31,251 STRs were filed in 2001, including from 418 banks. - The Police report that in 2000 there were 18,400 STRs; they provided feedback on 11,000 and 9,000 were of value. - The CPS advises that there were 117 drug ML prosecutions 2000. - There apparently have been no non-narcotic ML prosecutions in the U.K. - Process and timeliness concerns: - Authorities indicate NCIS is the only agency that receives STRs in practice and STRs are not transmitted directly to law enforcement; NCIS reviews and analyzes and then passes summary information to police. - In many cases it can take NCIS up to three months to transmit their review of STRs to appropriate agencies, which can significantly diminish usefulness of disseminated reports. - NCIS monitors progress after dissemination, looks for new/ongoing links, and may reevaluate and reallocate investigations based on subsequent intelligence. - Analytical limitations and measurement challenges: - U.K. interlocutors could not provide the IAE with the total number of ML or FT investigations or correlate available numbers. - Statistics limited to ML prosecutions, seizures and forfeitures do not present an accurate view of overall efforts and do not measure disruption activities by law enforcement and intelligence components. - Authorities keep and publish records of the number of STRs submitted each year and break them down in detail. - The authorities were not able to supply statistics on the extent to which STRs had been helpful in general criminal investigations. - NCIS monitors STR progress and assesses their value as an intelligence tool assisting law enforcement in fighting predicate crime and money laundering. - The Home Office is responsible for monitoring prosecutions and confiscation statistics. - The overall effectiveness of the regime depends also on a properly implemented and supervised regulatory regime that creates a better audit trail and makes it harder for money launderers to move funds. ### Recommendations and comments (from source) - 1. There is no law enforcement entity that has as its mission the investigation of criminal acts and foreign counter-intelligence. The U.K. should seriously consider the creation of a national law enforcement organization which has both these elements. - 2. In order to be successful in using the new tools provided under the PCA 2002, and to more effectively fight ML in the United Kingdom, NCIS and others must undertake trend and vulnerability analysis on a regular basis to study inter alia, how and where money, especially cash, is being laundered in the U.K. and then to use that information to build a national strategy with targeted, time sensitive priorities. *Source: _cr03208 - 3. Consideration should be given to providing NCIS with the power to get supporting documents (rather than only* ### 3. Prosecutors and judges need to be trained on ML and asset confiscation law so that they can adequately apply ### 3. Prosecutors and judges need to be trained on ML and asset confiscation law so that they can adequately apply U.K. legislation. ### Legislative review and institutional responsibilities - All elements of U.K. legislation relating to ML and FT have been substantially reviewed in the last two years, producing new legislation in the Terrorism Act, the ATCS 2001, and the PCA 2002. - Reviews preceding legislative changes involved all agencies and authorities with an interest in ML and FT, and identified deficiencies and barriers that were reviewed and addressed by the appropriate agency. - Relevant legislative references and dates: - ATCS 2001 - PCA 2002 - Terrorism Act - 1993 Regulations - ML provisions in effect since 1986 - PIU Study: nine-month study resulting in report “Recovering the Proceeds of Crime” (June 2000); draft legislation March 2001; PCA 2002 received Royal Assent in July 2002. - Law enforcement architecture: - 43 Police Constabularies in England & Wales, eight in Scotland and one in Northern Ireland. - The Metropolitan Police Service (MET) has some national functions but is not the overall force for ML or FT. - Other agencies with national remits (without the ‘national’ designation) include HMCE, Serious Fraud Office (SFO), FSA, Security Service, and the Secret Intelligence Service (SIS). - Analysis finding: - It is unclear whether there are sufficient resources to investigate ML. - No single law enforcement entity covers all aspects of ML in the U.K.; HMCE is the nearest for drugs ML. - No law enforcement entity has the dual mission of investigating criminal acts and foreign counter-intelligence; the U.K. should seriously consider creation of a national law enforcement organization with both elements. ### Investigative powers, evidentiary issues, and operational tools - U.K. law provides agencies with a wide range of investigative techniques, including controlled delivery and undercover operations. - Wiretaps: - Wiretaps are carried out under Ministerial authorization and are not admissible as evidence in judicial proceedings. - Analysis: This inadmissibility deprives prosecutors of voice evidence and may contribute to few prosecutions. Consideration should be given to passing legislation making wiretap evidence admissible in judicial proceedings. - Compulsion powers: - Law enforcement agencies have the power to compel production, through lawful process, of bank account records, financial transaction records, customer identification records, and other records maintained by financial institutions and other entities or persons. - Once PCA 2002 comes into force, account monitoring orders and customer information orders will become available for use in all ML investigations (currently limited to FT-related investigations). ### Coordination, task forces, and resource allocation - Multiple agencies undertake ML and FT investigations and prosecutions; the Government reviews resources and provides additional resources where required. - NCIS (National Criminal Intelligence Service): - Investment and expansion of NCIS’ Economic Crime Unit (ECU) is cited as evidence of resourcing. - The Economic Crime Unit generally receives all suspicious transaction reports in the United Kingdom and maintains links with investigation/prosecution units. - NCIS operates a Terrorist Financing Unit to coordinate intelligence on terrorist financing. - National Crime Squad (NCS): - NCS is the only national policing body, composed of officers seconded from local forces. - Strategic aim includes partnership with other law enforcement agencies in prevention and detection of serious crime. - Examples of partnership/task force working: - Joint NCS–HMCE unit at Customs House for drug related ML; discussions to create further teams. - NCS creating a department to deal with all financial crime investigations under a Head of Profession to develop partnerships with local police forces for PCA 2002 implementation. - Strategic document agreed by NCS, HMCE and ACPO to ensure a joint approach to ARA; working group to develop practical agency responses to PCA 2002. - NCS control of joint immigration authorities and police Project Reflex team, including financial investigation targeting proceeds of human trafficking. - NCS is developing a financial intelligence “desk” within its central intelligence unit to identify cases referable to the ARA. - Home Office funding: - Budget for 2002-03 increased by 17.5% to £134 million for the NCS; a sizeable percentage of this money will be spent on financial investigations. - This funding complements PCA 2002 provisions allowing non-police “Accredited Investigator” staff to carry out investigations. - Analysis finding: - With the exception of HMCE operational multi-agency task forces are the exception rather than the rule. - There is very limited use of task forces because of turf battles and a historical reluctance to share data. - Investigative agencies and prosecutors do not routinely or effectively use information-sharing gateways. - Routine information sharing and interagency task force use require a significant cultural change in “police culture.” ### Typologies, vulnerability analysis, and intelligence products - NCIS analysts produce typology reports and, on behalf of U.K. agencies, the U.K.’s response to the annual FATF Typologies exercise. - Information exchange mechanisms include the ‘EPI Centre’ computer system to inform financial investigators of trends and legal judgments. - Analysis finding: - NCIS produces high-quality typology presentations, but there is limited effort—other than at HMCE—to identify the U.K.’s national vulnerabilities to ML and FT. - NCIS and others must undertake a U.K. trend analysis and vulnerability study, including how and where cash is laundered in the U.K., to focus priorities and use new legislative and Assets Recovery Agency powers successfully. ### Training, accreditation, and capacity building - Existing training and accreditation: - Selected individuals in law enforcement receive a three phase training program in financial investigation, including aspects of money laundering; upon completion they are included on a National List of Financial Investigators. - Best practice: only trained individuals have been placed on an ‘approved’ list of financial investigators (overseen by NCIS); PCA 2002 would place this best practice on a statutory footing. - PCA 2002 and the Centre of Excellence: - The introduction of PCA 2002 prompted a national review of financial investigation training and the creation of a Centre of Excellence with responsibility for delivery. - Key features of the training program: - Government set up a national Centre of Excellence in Financial Investigation as part of the new ARA to train and accredit financial investigators in Police, HMCE and other Government bodies for PCA 2002 functions. - In-house training programs for Crown Prosecution Service, HMCE and other prosecutors. - Training initiatives for the judiciary on implications of the new legislation. - Scheduling and rollout: - Financial investigators within law enforcement were scheduled to receive training in the new legislation between September and December 2002 to ensure capability to use confiscation, ML and restraint/freezing powers after Act implementation. - A separate new training program for all newly appointed financial investigators was to be delivered from December 2002. - Training will also be available for accredited (certified) financial investigators working within other enforcement agencies. - ARA staffing: - Individuals working within the ARA will be trained to a higher level in competencies built on law enforcement and Accredited Financial Investigators’ programs. - Analysis finding: - Apparently outside a core group in HMCE and the NCIS/ECU, there is no current comprehensive training program that addresses ML or FT in the law enforcement agencies or the FSA. - The FSA: - Has authority to prosecute criminal cases based on breaches of the 1993 Regulations. - Appears to have limited interest in using criminal prosecution authority and intends to rely on it only as a last resort. - Unless the FSA intensively trains examiners and prosecution staff to investigate and prosecute these offenses and uses the authority in appropriate cases, it risks undercutting enforcement and squandering an opportunity to enhance compliance culture and identify institutions/individuals for criminal prosecution. - Additional analysis and recommendation: - The Crown Prosecution Service prosecutes narcotic ML but believes non-narcotic ML is too hard to prove under existing law. - The view of U.K. interlocutors was that judges have difficulty understanding ML; assessors did not meet a U.K. jurist nor were details provided on any judicial training. - Recommendation: Prosecutors and judges need to be trained on ML and asset confiscation law so that they can adequately apply U.K. legislation. ### Key findings and policy recommendations - Key findings: - No single law enforcement entity covers all ML aspects; HMCE is closest for drug-related ML. - Lack of admissibility for wiretap evidence is an impediment to prosecutions. - Multi-agency task forces are limited by turf issues and poor routine information sharing. - NCIS provides valuable typologies but national vulnerability and trend analyses are lacking. - Training has been expanded in preparation for PCA 2002, but comprehensive, system-wide training across agencies, prosecutors, and judiciary is not yet evident. - FSA’s existing criminal prosecution authority risks underuse unless accompanied by training and a change in enforcement posture. - Policy recommendations: - Consider creation of a national law enforcement organization with both criminal investigation and foreign counter-intelligence missions. - Amend legislation to permit admissibility of wiretap evidence in judicial proceedings. - Encourage and institutionalize multi-agency task forces and routine use of information-sharing gateways to overcome turf battles. - Conduct a U.K.-wide ML/FT vulnerability and trend analysis, including cash laundering patterns, to set priorities and target resources. - Ensure aggressive and targeted use of FSA criminal prosecution authority through intensive training of examiners and prosecution staff. - Implement comprehensive training programs for law enforcement, prosecutors, and judges on ML and asset confiscation law to ensure effective application of PCA 2002 and related legislation. *Source: _cr03208 - 3. Prosecutors and judges need to be trained on ML and asset confiscation law so that they can adequately apply (excerpt).* ### 1. Legislation to enhance the statutory provisions on extradition should be adopted as soon as possible. ### 1. Legislation to enhance the statutory provisions on extradition should be adopted as soon as possible. ### Mutual legal assistance framework (Criterion 34) - The U.K. has laws and informal arrangements that allow provision of a broad range of mutual legal assistance in AML/CFT matters. - Key statutes and provisions: - DTA (sections 39 and 40) and CJA (sections 96 and 97) address government powers to enforce external restraint and forfeiture orders where countries are designated by an Order of Council. - Criminal Justice (International Cooperation) Act 1990 (CJICA) procedures include: - Section 1: requests for service on a person in the U.K. of a summons or other foreign process. - Section 4: requests for assistance in obtaining evidence (including documents and other articles). - Section 5: issuance of a warrant to transfer a prisoner serving a U.K. sentence to give evidence abroad (with prisoner consent). - Sections 7 and 8: issuance of a warrant authorizing search of premises in the U.K. in connection with certain overseas investigations. - Section 9: enforcement of overseas forfeiture orders concerning instrumentalities of specified drug trafficking and other serious crimes, available only for countries designated in an Order of Council. - Treaties and designations: - 33 bilateral agreements covering restraint and confiscation of proceeds and instruments of drug trafficking. - 13 bilateral agreements covering the proceeds and instruments of all crimes. - Designated for assistance under the Vienna Convention: 162 countries. - Designated under the 1990 Council of Europe Convention on Laundering, Search, Seizure and Confiscation of the Proceeds from Crimes: 41 countries. - Operational practice and concerns: - Vast majority of mutual legal assistance is provided through informal processes rather than formal criminal statutes and international treaties. - Informal processes provide flexibility but can lead to inconsistent application (potential preferential assistance to larger or politically closer countries). - Other than freezing/confiscation of proceeds of crime, the U.K. generally can provide mutual legal assistance to any country or territory without bilateral or international agreements; freezing/confiscation requires agreements. - Dual criminality is required for requests involving search and seizure or use of special investigation powers of the Serious Fraud Office in serious or complex fraud; for requests involving fiscal matters from countries outside the Commonwealth or without treaty; and for requests for restraint and confiscation (CJICA sections 4(3), 9(6)). ### Coordination, Central Authority and response targets (Criterion 35) - Coordination: - International co-operation in relation to suspicious transaction reports is coordinated by the Economic Crime Unit at NCIS through counterpart FIUs. - Criminal investigations are undertaken by individual police forces; HMCE pursues enquiries through 'police' to 'police' channels, followed by letters of request when evidence is required. - Exchange of suspicious transaction reports is handled on an FIU-to-FIU basis, following Egmont Group principles and EU Decision on exchange of information between FIUs. - Liaison officer networks and Europol assist officers undertaking criminal investigations. - All exchanges—number, purposes, and outcomes—are recorded. - U.K. Central Authority (Home Office) responsibilities and Code of Practice: - Acknowledge all requests for evidence upon receipt and provide contact details and reference number. - Respond to enquiries about execution of requests within 10 working days of receipt. - For "urgent" requests, or no later than 20 working days after receipt in other cases, either provide assistance, or inform requesting authority of actions being taken or explain why assistance cannot be executed. - Provide progress reports within 20 working days when notified as necessary. - Arrange execution of requests for service of summonses within 10 working days of receipt. - Execute requests for service of process insofar as compatible with U.K. law and acknowledge receipt/execution as specified. - Performance metrics (January–March 2002): - U.K.CA achieved its target to action outgoing requests in less than ten working days in an average of 95% of cases. - An average of 92% of incoming requests were actioned within 20 working days of receipt. - Analysis summary: - The U.K. has a comprehensive system for mutual legal assistance coordinated by the U.K.CA that operates effectively. - Response rates and turnaround times improved through extra resources devoted to the activity. - HMT’s efforts supporting the FATF and regional FATF-style bodies have been essential to enhanced global effectiveness in addressing money laundering and terrorist financing. ### Information sharing and statutory gateways (Criterion 37) - NCIS can share intelligence and other information with foreign law enforcement agencies. - Financial Services and Markets Act (FSMA) provisions: - FSMA authorizes the FSA to cooperate and share information with national and foreign regulators and with domestic and foreign persons related to prevention and detection of financial crime (sections 348, 354). - Section 348 places a duty not to disclose confidential information without consent; disclosure prohibition is lifted by gateways in the Financial Services and Markets Act 2000 (Disclosure of Confidential Information) Regulations 2001, including for "the purposes of criminal proceedings and investigations." - These gateways cover suspected as well as actual criminal activities and enable the FSA to exchange information relating to suspicious transactions with domestic and foreign supervisors and law enforcement agencies without court authorization. - Anti-Terrorism, Crime and Security Act 2001 (ATCS 2001): - Provides broad “gateway” powers for disclosure by HMCE and other U.K. public authorities to assist criminal investigations or proceedings in the U.K. or abroad, or to facilitate determinations concerning such investigations or proceedings (sections 17, 19). - Some limitations apply (e.g., proportionality and possible prohibition where overseas investigation would be more appropriately handled in the U.K. or a third country). - Gateway legislation broadens disclosure powers but does not limit other disclosure powers under other laws. ### Controlled deliveries and cooperative investigations (Criterion 38) - U.K. law enforcement agencies are authorized to engage in controlled delivery and other cooperative investigations with counterparts from other countries. ### Resources, institutional arrangements and operational initiatives (Criterion 39) - Multiple agencies undertake investigation and prosecution of ML and FT; the U.K. is committed to ensuring law enforcement, supervisory, and judicial systems are properly resourced and keeps resource levels under review. - NCIS Economic Crime Unit has received investment and expansion. - National Crime Squad (NCS) structure and strategic aims: - NCS is the only national policing body, composed of officers seconded from local forces; published strategic aim includes partnership with other law enforcement agencies in prevention and detection of serious crime. - Examples of partnership and task force initiatives: - NCS and HMCE joint unit at Customs House dealing specifically with drug-related ML; discussions to create further teams. - NCS creating a new department to handle all financial crime investigations under a Head of Profession to develop partnership arrangements with local police and implement PCA 2002. - Strategic document agreed by NCS, HMCE and ACPO expressing need for a joint approach to ensure ARA success; forms basis for a working group to develop practical agency responses to PCA 2002. - NCS control of joint immigration authorities and police Project Reflex team with a financial investigation element targeting proceeds of human trafficking. - NCS developing a financial intelligence “desk” within its central intelligence unit to identify cases referable to the ARA. - Resource allocation: - Home Office budget for 2002-03 increased by 17.5% to £134 million. - Increase will raise number of staff carrying out financial investigations; a sizeable percentage of the additional funding will be spent on this purpose. - PCA 2002 provision allows use of non-police “Accredited Investigator” staff to carry out investigations. - Within the financial year, NCS will report numbers of staff exclusively dealing with financial crime and provide statistics on effectiveness of allocated resources. ### Extradition framework and recommended legislative enhancement (Criterion 40) - Current extradition arrangements: - U.K. parties to two multilateral extradition schemes: European Convention on Extradition and Commonwealth Scheme for the Rendition of Fugitives (covering virtually all Council of Europe states and the majority of the Commonwealth, respectively). - If an ML or FT crime exists in equivalent form in both requesting and requested states and carries a sentence of at least 12 months in both states, it is extraditable, subject to Extradition Act 1989. - U.K. has entered into 23 bilateral treaties with countries not covered by the multilateral agreements. - Ratification of the International Convention for the Suppression of the Financing of Terrorism via the Terrorism Act 2000 added relevant FT offences to the list for extradition from bilateral treaty partners. - When the International Convention for the Suppression of the Financing of Terrorism becomes effective between states, extradition between the U.K. and other Convention States would be possible in connection with Convention crimes without further bilateral or multilateral agreements. - U.K. law allows establishment of ad hoc agreements with states lacking general extradition relations (Extradition Act 1989, section 15); these one-off arrangements are cumbersome. - A bill to improve extradition procedures was recently submitted to Parliament. - Alternatives to extradition: - Subject to applicable criminal laws and dual criminality requirements, the U.K. has authority to launch ML or FT prosecutions where extradition is not possible. ### Key recommendation and institutional comment - Primary recommendation: - Legislation to enhance the statutory provisions on extradition should be adopted as soon as possible. - Preventive measure recommendation (from later section): - Financial institutions and MSBs should be cautioned against doing business with attorneys and accountants that are unable to provide information about the customers for whom they are opening accounts. *Source: _cr03208 - 1. Legislation to enhance the statutory provisions on extradition should be adopted as soon as possible.* ### 2. The 2001 Regulations’ supervisory scheme for money services businesses represents a significant step in the ### 2. The 2001 Regulations’ supervisory scheme for money services businesses represents a significant step in the ### Overview - The 2001 Regulations extend AML/CFT supervision beyond prudentially supervised financial institutions to money service businesses (MSBs), creating a "light touch" supervisory regime under HMCE effective November 2001 (Regulation references as in source). - The self-financing scheme for HMCE supervision of MSBs requires ongoing review to determine whether it can reasonably be expected to produce sufficient resources for effective AML/CFT oversight. ### Criterion 43 — Legal and Institutional - Legal confidentiality requirements applicable to attorneys and accountants can prevent financial institutions and MSBs from obtaining or lawyers/accountants from divulging the identity of the underlying clients when an attorney or accountant opens an account to hold clients’ funds. - These confidentiality rules may prevent compliance with customer identification and other information requirements in the 1993 Regulations and FSA Sourcebook, especially where: - the particular lawyer or accountant is not subject to FSA supervision, or - the activities conducted on behalf of a client are not supervised activities. - The 1993 Regulations and Sourcebook impose AML requirements only with respect to specific businesses that are subject to supervision, rather than all business of lawyers or accountants. - Assessors are not aware of any other confidentiality, secrecy law, agreement, or other law (beyond those described) that would inhibit implementation of the Methodology’s criteria. ### Criterion 43 — Implementation - Assessors were unable to determine whether financial institutions and MSBs open accounts for attorneys and accountants who cannot provide information concerning the customers for whom they are opening the accounts. - If such accounts are opened, they would impede implementation of the customer identification criteria in the Methodology, except where the attorney, accountant, or underlying client falls within an applicable exception. ### Criterion 44 — Legal and Institutional - The FSA supervises banks, securities firms and insurance companies and has authority to ensure compliance with AML/CFT requirements, including customer identification, for FSA-regulated firms and individuals (excluding general insurance). - FSA supervisory tools include on-site and off-site activities and a broad range of enforcement powers adequate to ensure compliance where applied. - HMCE’s responsibilities under the 2001 Regulations for MSBs include: - Definition of MSBs to include businesses operating a bureau de change; transmitting money or any representation of monetary value by any means (covering informal remitters, such as hawala and hundi); or cashing checks payable to customers (Regulation 3(2)). - Requiring all MSBs to register with HMCE by June 1, 2002 (or existing MSBs to have an application pending by such date) (Regulation 5). - HMCE to maintain a register of MSBs and allocate to every registered MSB a registered number (Regulation 4). - Authority for HMCE to charge an application fee and an annual registration fee (Regulation 9). - Entry and inspection rights with respect to MSBs (Regulations 10-14). - The 2001 Regulations impose a limited supervisory scope: - HMCE can refuse registration only if application/supplementary information requirements are not complied with or information provided is materially false or misleading (Regulation 7). - HMCE can cancel registration only where it would have had grounds to refuse registration (Regulation 8). - No “fit and proper” requirement for MSBs; ML convictions must be disclosed in applications but are not a basis for denial. - HMCE’s primary powers relate to entry/inspection of premises, inspection of information, and requesting information (sometimes via judicial order). - Civil money penalty power limited to imposing up to ₤5,000 for failures concerning registration, provision of information, payment of fees, and entry/inspection rights (Regulation 15). - No civil penalties for failures to comply with AML systems and controls; HMCE can institute criminal prosecutions for such violations (Regulation 19). ### Criterion 44 — Implementation (sector summaries) - Banking: Fully implemented - Securities: AML/CFT compliance checking by FSA of small, low impact securities firms is too limited to verify compliance with customer identification requirements; otherwise implementation in securities is satisfactory. - Insurance: Exclusion of general insurance is a significant gap. For insurance subsectors under FSA oversight, AML/CFT awareness appears low and FSA supervisory efforts are perfunctory. - MSBs: - The 2001 Regulations were recently effective; HMCE had only recently begun supervisory activities. - As of early July 2002, total MSB registrations numbered 1,375, representing total premises of 28,183 (of which 17,436 were Post Office premises). - HMCE has prepared and distributed guidance and educational materials to MSBs and intends to organize training sessions. - HMCE began a program of “assurance visits” — spot-check compliance visits to ensure MSBs are complying with obligations. - Given the recent implementation, it is too early to assess HMCE’s effectiveness comprehensively; MSB implementation issues are therefore addressed only to a limited extent. ### Customer identification — Overall description and analysis - Sector-specific customer identification criteria are located in the Methodology: banking (Criteria 68-83), insurance (Criteria 101-104), securities (Criterion 111). - The overall assessment should consider those sector-specific analyses in evaluating customer identification implementation across sectors. ### Recommendations and Comments - 1. Financial institutions and MSBs should be required by law to include accurate and meaningful originator information on funds transfers and related messages that should be retained with the transfer or message through the payment chain. Any exclusions from such a requirement should be designed narrowly (e.g., not to exclude all ACH transfers, but rather only recurring transfers). - 2. Procedures should be developed for systematically, even if on a randomized basis, verifying compliance with AML/CFT requirements by small, low impact securities firms. General insurance should be brought within the scope of the 1993 Regulations and FSA Sourcebook, with compliance verified by FSA. Compliance checking of the insurance sector by FSA should be intensified. - 3. The “financial exclusion” provision of the FSA Sourcebook should be drafted more narrowly so as to cover financially disadvantaged persons (as intended), but not everyone else who “cannot reasonably be expected to produce detailed evidence that helps to confirm identity.” - 4. Existing legal constraints should be relaxed on the ability of attorneys and accountants to identify their clients when acting on behalf of those clients, and financial institutions and MSBs should be cautioned against doing business with attorneys and accountants that are unable to provide information about the customers for whom they are opening accounts. - 5. Industry groups representing MSBs should be encouraged to prepare relevant and comprehensive guidance for their members as quickly as possible concerning customer identification and other AML requirements of the 1993 Regulations. If such detailed guidance is not forthcoming, consideration should be given to the feasibility of having HMCE provide detailed guidance on what MSBs should do to ensure observance of the high-level customer due diligence requirements of the 1993 Regulations. - 6. Consideration should be given to limiting the cases in which financial institutions and MSBs are allowed to accept funds from applicants before satisfactory evidence of identity is obtained. *Source: _cr03208 - 2. The 2001 Regulations’ supervisory scheme for money services businesses represents a significant step in the* ### 7. Consideration could be given to assigning a supervisory agency to ensure compliance with the 1993 ### 7. Consideration could be given to assigning a supervisory agency to ensure compliance with the 1993 ### Criterion 45 — Anonymous accounts / accounts in fictitious names: description and analysis - Legal and institutional - U.K. law imposes broadly specified customer identification requirements on prudentially regulated financial institutions and MSBs under the 1993 Regulations; these requirements contain no exceptions that appear to authorize the holding of anonymous accounts or accounts in fictitious names. - Legal requirements applicable to attorneys and accountants may prevent financial institutions and MSBs from inquiring into (and preclude lawyers and accountants from divulging) the identity of underlying clients when a lawyer or an accountant opens an account to hold clients’ funds. - Implementation - Assessors were unable to ascertain whether financial institutions and MSBs open accounts for attorneys and accountants who are unable to provide information concerning the customers for whom they are opening these accounts. If done, such accounts could be de facto anonymous accounts or accounts in fictitious names (except where an applicable exception to customer identification applies). - Monitoring compliance with AML/CFT requirements, including restrictions on anonymous accounts or accounts in fictitious names, is an integral component of FSA activities as a financial supervisor, extending to FSA regulated firms and individuals. FSA has a wide range of on-site and off-site tools and broad enforcement powers adequate to ensure compliance. - Sector assessments - Banking: Fully implemented - Securities: AML/CFT compliance checking by FSA of small, low impact securities firms is too limited to verify compliance with restrictions on anonymous accounts or accounts in fictitious names; otherwise implementation in the securities sector is satisfactory. - Insurance: Exclusion of general insurance is a significant gap in the AML/CFT regime implemented by FSA. For parts of the insurance sector subject to FSA oversight, awareness of AML/CFT requirements appears low and FSA supervisory efforts are perfunctory. ### Criterion 46 — Customer due diligence: description and analysis - Legal and institutional - Customer due diligence requirements are found in the 1993 Regulations (as amended) and, for certain FSA-supervised firms, in the FSA’s Money Laundering Sourcebook. - The 1993 Regulations cover banks and other deposit-taking institutions; firms engaging in investment-related business; and life insurance companies. They also apply to MSBs and persons engaged in specified financial activities (Regulation 4), including persons (e.g., attorneys and accountants) engaging in specified activities as ancillary to other business. - Entities other than prudentially-regulated financial institutions and MSBs that are subject to the 1993 Regulations are not subject to supervisory oversight by any government agency to ensure observance of the Regulations. - Authorities expect the scope of the 1993 Regulations to be expanded by June 2003, pursuant to the Second EU Money Laundering Directive, to include casinos, other high-value dealers, trust and company service providers, and to cover attorneys and accountants more broadly. - 1993 Regulations require covered entities to maintain AML procedures and client identification procedures (Regulation 5(1)(a)); failure is punishable as a criminal offense (Regulation 5(2)). - Identification procedures deemed compliant if they require production of “satisfactory evidence of his identity” or measures producing such evidence (Regulation 7(1)); evidence is “satisfactory” if it “is reasonably capable of establishing that the applicant is the person he claims to be” (Regulation 11(1)). - Evidence must be produced “as soon as is reasonably practicable” after first contact; a firm may accept funds before satisfactory evidence is obtained provided the firm returns funds and proceeds no further if evidence is not obtained (Regulations 7(1), 11(2)). - Identification procedures apply only to customers applying for a habitual or regular relationship where total payments cannot be ascertained at arrangement time (Regulation 3(2), 7(2)). One-off transactions are covered only where there is actual suspicion of ML or where the transaction (alone or combined with linked one-off transactions) is for an amount of €15,000 or more (Regulation 7(3)-(5)). - Exemptions to identification requirements include specified postal/electronic payments, where applicant is covered by the 1993 Regulations or EU AML Directive, certain introduced one-off transactions, employment-related pension schemes with no surrender clause, and certain insurance transactions where premiums do not exceed specified amounts (Regulation 8; Regulation 10(1)(a)-(g)). - The FSA Sourcebook is “parallel to, but separate from,” the 1993 Regulations, mandatory for all FSA-regulated persons with certain exceptions (including general insurance and “pure protection” long-term insurance falling outside EC First Life Insurance Directive). Sourcebook requires firms to “take reasonable steps to find out who its client is by obtaining sufficient evidence of the identity of any client” (section 3.1.3(1)); where client acts on behalf of another, obtain identities of both (section 3.1.3(2)). The Sourcebook includes a “financial exclusion” exemption allowing acceptance of a letter from a person in a “position of responsibility” under certain conditions (section 3.1.6). - Both the 1993 Regulations and the FSA Sourcebook contemplate supplementing broad duties by industry guidance. The 1993 Regulations allow courts to “take account of” guidance issued by a “supervisory authority” (Regulation 5(3)). The Sourcebook provides that FSA “will have regard to” firm compliance with the Guidance Notes issued by the Joint Money Laundering Steering Group (“JMLSG”) (section 3.1.4). - The Guidance Notes are not legal requirements; they are not mandatory, and firms may adopt other procedures. Part 7 of the PCA 2002 (Section 330) provides that a court “must consider” industry guidance approved by HMT when deciding whether a person committed the PCA’s failure-to-disclose offense; HMT approved the December 2001 version of the JMLSG Guidance Notes. HMT approval does not make the Guidance Notes mandatory; courts retain discretion on weight to accord observance of Guidance Notes. - Neither the 1993 Regulations nor the Sourcebook contain specific provisions on renewal of customer identification when doubts arise, or identification procedures where the client is a legal entity. No exclusions related to maintenance of numbered accounts are present. - Attorney-client privilege law and professional conduct for accountants may prevent financial institutions and MSBs from inquiring into or lawyers/accountants from divulging underlying client identities when lawyers or accountants open client-fund accounts (Guidance Notes section 4.143-4.145). Guidance Notes leave this as a “commercial decision” for financial institutions where the lawyer/accountant is not itself covered by the 1993 Regulations. - Implementation - MSBs: High-level nature of 1993 Regulations is a concern for MSBs; no industry-specific guidance akin to JMLSG currently exists for MSBs. Check Cashers Association is preparing its own Guidance Notes (assessors understand). - Financial institutions: Monitoring compliance with AML/CFT requirements including customer identification is integral to FSA supervisory activities; where applied, FSA oversight assures customer identification requirements are fully implemented. Criterion 68 discusses gaps in FSA AML/CFT oversight for securities and insurance. - Sector assessments - Banking: Fully implemented. - Securities: AML/CFT compliance checking by FSA of small, low impact securities firms is too limited to verify compliance with customer identification requirements; otherwise satisfactory. - Insurance: Exclusion of general insurance is a significant gap. For insurance parts under FSA oversight, awareness of AML/CFT requirements appears low and FSA supervisory efforts are perfunctory. ### Criterion 47 — Identification of beneficial owner / customer acting on behalf of another: description and analysis - Legal and institutional - 1993 Regulations require “reasonable measures” to establish identity of any person on whose behalf an applicant appears to be acting (Regulation 9(1)). “Reasonable measures” are determined by circumstances and best practice applicable in the relevant field (Regulation 9(2)). - A firm may accept an applicant’s written assurance that identity evidence of any principal has been obtained and recorded where the applicant is regulated by an overseas regulatory authority and based in a country (other than an EU member state) with provisions at least equivalent to the EU AML Directive (Regulation 9(4), (5)). - Implementation - Assessors were unable to ascertain whether financial institutions and MSBs open accounts for attorneys and accountants unable to provide information about underlying customers. - Financial institutions: Monitoring compliance with AML/CFT requirements including customer identification required by criterion 47 is integral to FSA supervisory activities; where applied, FSA oversight assures full implementation. Gaps for securities and insurance sectors discussed at Criterion 68. - Sector assessments - Banking: Fully implemented - Securities: AML/CFT compliance checking by FSA of small, low impact securities firms is too limited to verify compliance with customer identification requirements called for in criterion 47; otherwise satisfactory. - Insurance: Exclusion of general insurance is a significant gap; for parts subject to FSA oversight, AML/CFT awareness is low and FSA supervisory efforts are perfunctory. ### Criterion 48 — Originator information on funds transfers: description and analysis - Legal and institutional - U.K. law does not currently require prudentially regulated financial institutions or MSBs to include originator information on funds transfers and related messages. - In May 2002, government issued a consultative document proposing to require all money remitters (whether regulated by FSA or HMCE) to include originator information (name, address and, where applicable, account information) on all money transfers sent from the U.K. to foreign or domestic destinations. Money transfer would be defined to include transmission of money or any representation of monetary value by any means. - Consultative document notes option of voluntary originator-information provision reinforced by industry guidance, but prefers legally mandatory obligation. - Government is considering exempting payments to and from automated clearing houses (“ACHs”) from requirements on a risk-assessment basis because “typical” ACH transactions (regular bill, credit card and salary payments) likely present low ML risk and are “outside the scope of the spirit” of FATF Special Recommendation VII. - FATF Interpretative Note on Special Recommendation VII was issued for comments after the U.K. consultative document; authorities will await FATF consultation outcome to determine precise U.K. obligations under Special Recommendation VII. - Implementation - Monitoring compliance with AML/CFT requirements including any originator information requirements that may become applicable is integral to FSA activities for FSA regulated firms and individuals; HMCE likely to be responsible for MSB compliance if such requirements apply to MSBs. - As of the assessment, originator information requirements called for under criterion 48 are not currently required to be implemented by either FSA supervised institutions or MSBs. ### Ongoing monitoring of accounts and transactions — overview - Note: Sector-specific criteria on ongoing monitoring appear in Criteria 84-87 (banking) and Criterion 105 (insurance). Overall description and analysis should consider sector-specific assessments. - The document instructs assessors to describe and analyze (a) legal and institutional and (b) implementation aspects for Criteria 49-51 across banking, insurance, securities, and other financial sectors. ### Recommendations and comments (as introduced) - The text concludes: "In light of the descriptions and analyses below, the following is recommended:" (recommendations not included in provided excerpt). *Source: IMF assessment text as provided in the supplied content unit.* ### 1. The 1993 Regulations and FSA Sourcebook should be revised (or other appropriate legal instrument issued) to ### _cr03208 - 1. The 1993 Regulations and FSA Sourcebook should be revised (or other appropriate legal instrument issued) to ### Obligations to detect and scrutinize unusual transactions - Recommendation: impose an affirmative legal obligation on financial institutions and MSBs to pay special attention to "all complex, unusual large transactions, or unusual patterns of transactions that have no apparent or visible economic or lawful purpose." - Assessment (Criterion 49, Legal and Institutional): - U.K. law presently imposes criminal liability on financial institutions and MSBs for failure to report knowledge or suspicion of ML or FT, but "neither the criminal statutes, the 1993 Regulations nor the Sourcebook imposes an affirmative obligation on financial institutions and MSBs to pay special attention to all complex, unusual large transactions, or unusual patterns of transactions, that have no apparent or visible economic or lawful purpose, or otherwise to have specified procedures in place to recognize such transactions." - U.K. law does not require institutions "to examine as far as possible the background and purpose of these kinds of transactions; or to set forth their findings in writing and keep such findings for review by the competent authorities." - Implementation (Criterion 49, Implementation): - FSA oversight "assures that account monitoring guidelines are implemented" where applied; gaps exist in FSA AML/CFT oversight with respect to the securities and insurance sectors (see Criterion 68). - Sector implementation notes: - Banking: Fully implemented - Securities: "AML/CFT compliance checking by FSA of small, low impact securities firms is too limited to verify the observance of those firms with the account monitoring guidelines. Otherwise, implementation in the securities sector is satisfactory." - Insurance: "Exclusion of general insurance is a significant gap ... For the other parts of the insurance sector that are subject to FSA oversight, awareness of AML/CFT requirements appears to be low and FSA supervisory efforts are perfunctory." ### Obligations regarding business with persons in deficient jurisdictions - Recommendation: revise the 1993 Regulations (or issue other instrument) to "impose an affirmative legal obligation on financial institutions and MSBs to give special attention to business relations and transactions with persons in jurisdictions that do not have adequate systems in place to prevent or deter ML or FT." - Sourcebook alternative: "The Sourcebook could also be amended to include a more explicit and affirmative obligation in this regard, in lieu of the seemingly more limited 'proper use' standard described below (Criterion 50)." - Assessment (Criterion 50): - Legal: "Neither the criminal statutes nor the 1993 Regulations require financial institutions or MSBs to give special attention to business relations and transactions with persons in jurisdictions that do not have adequate systems in place to prevent or deter ML or FT." - The Sourcebook currently requires covered financial institutions to "obtain and 'make proper use' of any U.K. government or FATF findings of material deficiencies," with "proper use" examples listed (Sourcebook section 5.1 and section 5.1.2(2)(a)). - Implementation: FSA oversight "effectively implemented via the Sourcebook requirement described above and various guidance provided in the JMLSG Guidance Notes," but gaps remain for securities and insurance. - Sector implementation notes: - Banking: Fully implemented - Securities: "AML/CFT compliance checking by FSA of small, low impact securities firms is too limited to verify the compliance of those firms with the requirement to make proper use of findings of material deficiencies in particular countries or jurisdictions." - Insurance: "Exclusion of general insurance is a significant gap ... awareness of AML/CFT requirements appears to be low and FSA supervisory efforts are perfunctory." ### Enhanced scrutiny of wire transfers lacking originator information - Recommendation: "impose an affirmative legal obligation on financial institutions and MSBs to give enhanced scrutiny to wire transfers that do not contain complete originator information." - Assessment (Criterion 51): - Legal: "U.K. law does not currently require prudentially regulated institutions or MSBs to give enhanced scrutiny to wire transfers that lack complete originator information. Indeed, ... U.K. law does not currently require that originator information be included in wire transfers originating in the U.K." - Implementation: As originator information is not required for U.K.-originating wire transfers, "criterion 51 is not implemented." - Supervisory role: FSA has authority over AML/CFT implementation for FSA regulated firms, but the absence of originator-information requirements means the criterion is unmet. ### Verification of compliance by small, low impact securities firms and insurance coverage - Repeated recommendation: "Procedures should be developed for systematically, even if on a randomized basis, verifying compliance with AML/CFT requirements by small, low impact securities firms." - Insurance recommendation: "General insurance should be brought within the scope of the AML/CFT Regulations and FSA Sourcebook, with compliance verified by FSA. Compliance checking of the insurance sector by FSA should be intensified." - Rationale: Multiple sections (Criteria 49, 50, 52, 53, 54) note that FSA compliance checking of small securities firms is "too limited" and that exclusion of general insurance is "a significant gap" with "perfunctory" supervisory efforts for other insured parts. ### Record keeping: minimum content, retention, and inspection - Recommendation (explicit list): 1. "The 1993 Regulations and Sourcebook should be revised to specify, as contemplated in the Methodology, the minimum information that financial institution and MSBs must include in their transaction records (i.e., the customer’s (and beneficiary’s) name, address (or other identifying information), the nature and date of the transaction, the type and amount of currency involved, and the type and identifying number of any account involved in the transaction)." 2. "Given the important exceptions to the customer due diligence requirements under the 1993 Regulations and FSA Sourcebook (see Criterion 46), consideration should be given to revising the Regulations and Sourcebook to require financial institutions and MSBs to keep records of the basis on which a particular customer or transaction was considered to be exempt from the customer identification requirements. (Such a requirement is already included in the Sourcebook, but only in connection with the Sourcebook’s financial exclusion exception.)" 3. Repeat of verification procedures for small securities firms and extension of general insurance into scope of AML/CFT Regulations and FSA Rules. - Legal and institutional summary (Criterion 52 and Criterion 53): - Regulation 12(1) and 12(2): record keeping procedures are in accordance with the Regulations if they require certain records; "Records are generally required to be kept for a period of at least five years from the date on which the relevant business relationship or activity was completed." - Sourcebook: imposes substantially similar requirements (Section 7.3.2(1)(a)); Sourcebook also requires firms keep records for five years of: (1) reasons for treating a client as excluded under financial exclusion provisions; (2) actions taken under internal and external reporting provisions; and (3) suspicious transactions information or matters an MLRO considered but did not report to NCIS. - Neither the 1993 Regulations nor the Sourcebook currently "specify minimum information (such as customer name and address, and nature and date of the transaction) that is to be included in transactions records." - Implementation: - MSBs: "too early to meaningfully assess" implementation under new supervisory framework. - Financial institutions: FSA monitoring "is an integral component" and "where applied, FSA oversight assures that the record keeping requirement discussed above is fully implemented." - Sector implementation notes: - Banking: Fully implemented - Securities: "AML/CFT compliance checking by FSA of small, low impact securities firms is too limited to verify the compliance of those firms with record keeping requirements." - Insurance: "Exclusion of general insurance is a significant gap ... awareness of AML/CFT requirements appears to be low and FSA supervisory efforts are perfunctory." ### Inspection and access to records - Legal authority: - The Financial Services and Markets Act gives FSA "broad authority to inspect and/or require the production of any documents reasonably required by the FSA in the exercise of its functions"; records maintained pursuant to requirements "are available to the FSA." - HMCE is empowered under the 2001 Regulations to "enter and inspect the premises of MSBs or suspected MSBs, and to inspect information found on the premises and/or request the MSB to furnish information to HMCE." - Implementation: - MSBs: "too early to meaningfully assess the scope and effectiveness of HMCE’s efforts" to ensure MSBs make records available. - Financial institutions: FSA monitoring "is an integral component" and "where applied, FSA oversight assures that the record keeping standards discussed above is fully implemented." - Sector implementation notes: - Banking: Fully implemented - Securities: "AML/CFT compliance checking by FSA of small, low impact securities firms is too limited to verify the compliance of those firms with the record keeping standards discussed above." - Insurance: "Exclusion of general insurance is a significant gap ... awareness of AML/CFT requirements appears to be low and FSA supervisory efforts are perfunctory." ### Suspicious transactions reporting: legal improvements and FT-related coverage - Recommendations and comments: 1. "Part 7 of the PCA 2002 should be made effective as soon as possible, given its significant improvements in the legal regime for suspicious transactions reporting (inter alia, by imposing broader criminal reporting obligations on the regulated sector, requiring all regulated entities to file STRs with NCIS (rather than any 'constable' in the U.K.), and providing for a uniform form to be used in the reporting of suspicious transactions)." 2. "Consideration should be given to revising the 1993 Regulations and Sourcebook to impose FT-related suspicious reporting obligations, or to drafting parallel regulations for this purpose. In addition, the 1993 Regulations and Sourcebook should be revised to include a more current range of FT-related ML predicate offenses, including those under the Terrorism Act and ATCS 2001." *Source: _cr03208 - 1. The 1993 Regulations and FSA Sourcebook should be revised (or other appropriate legal instrument issued) to* ### 3. Procedures should be developed for systematically, even if on a randomized basis, verifying compliance with ### 3. Procedures should be developed for systematically, even if on a randomized basis, verifying compliance with AML/CFT requirements by small, low impact securities firms. General insurance should be brought within the scope of the AML/CFT Regulations and FSA Rules, with compliance verified by FSA. Compliance checking of the insurance sector by FSA should be intensified. ### Criterion 55 — Description and Analysis: Legal and Institutional - Financial institutions and MSBs are required to report suspicions of ML and FT under the criminal laws and the 1993 Regulations, and under the Sourcebook for financial institutions subject to the Sourcebook. - When it enters into force, Part 7 of the Proceeds of Crime Act 2002 would make it a crime for persons in the regulated sector (defined, inter alia, to include financial institutions and MSBs) to fail to disclose knowledge or suspicion of ML, or reasonable grounds for knowing or suspecting ML, either to a “nominated officer” (compliance officer) of the financial institution or MSB, or directly to a person authorized by NCIS to receive such reports. - Nominated officers working within or outside of the regulated sector who receive suspicious transactions reports may also be found criminally liable if they fail to disclose the information to a person designated for this purpose by NCIS. - The “reasonable grounds” criterion amounts to a negligence standard for failure to report ML and is an expansion of the pre-PCA 2002 failure to report offense (which covered only actual knowledge or suspicion of ML). - The requirement to report to a person designated by NCIS is new; pre-PCA 2002 statutory requirements allowed disclosure to any constable. - Summary of pre-PCA 2002 statutory regime (remains applicable until Part 7 PCA 2002 becomes effective): - DTA makes it a crime for any person to fail to report knowledge or suspicion of drug trafficking-related ML as soon as is reasonably practicable after the information comes to the attention of the person where the information is acquired in the course of the person’s trade, business, profession or employment (DTA section 52(1)). - DTA provides disclosure to a constable or an appropriate person (“compliance officer”) designated by an employer to receive such disclosures shall not be treated as a breach of any restriction imposed by statute or otherwise (DTA sections 50(3), 52(4), (6)). - Terrorism Act 2000 requires financial institutions and MSBs to report knowledge or suspicion of FT-related activities that come to their attention in the course of a trade, profession, business or employment (section 19). - Terrorism Act (as amended by the ATCS 2001) makes it a crime for a person in a regulated sector not to file a suspicious transaction report if he has reasonable grounds for knowing or suspecting that another person is engaged in FT (section 21A(2), Schedule 2, Part 3). - DTA and CJA provide defenses for reporting (and even intended disclosure) to a constable or compliance officer against criminal prosecution for certain money laundering offenses (DTA sections 50(3)-(5); 51(5)-(8); CJA sections 93A(3)-(5); 93B(5)-(8)). - DTA, CJA and Terrorism Act 2000 make it an offense to “tip-off” a suspect that a suspicious transactions report has been filed. - 1993 Regulations: - Internal reporting procedures are in accordance with the Regulations if they designate an “appropriate person” to whom reports of knowledge or suspicion of ML are to be made and include provision for ensuring that internal reports are disclosed to a “constable” where the designated appropriate person knows or suspects another person is engaged in ML (Regulation 14). - 1993 Regulations currently require STRs be filed with any “constable” in the U.K., not specifically NCIS. - PCA 2002 will require nominated officers to file STRs only with a person authorized by NCIS; authorities expect NCIS to designate itself once PCA 2002 provisions enter into force. - Sourcebook requirements: - Financial institutions must take reasonable steps to ensure internal reports of knowledge or suspicion of ML made by staff are considered by the MLRO (or authorized delegate) and promptly reported to NCIS whenever the MLRO or delegate suspects that a person has been engaged in ML (section 4.3.2R). - Persons subject to the Sourcebook must permit the MLRO access to “know your business” or other relevant information and ensure the MLRO can report suspicion without consent or approval of any other person (section 4.3.3E). - A record must be kept where an MLRO has considered information concerning knowledge or suspicion of ML but decides not to make a report to NCIS (section 7.3.2). - Reporting of terrorist financing: - Current duty under U.K. law to report suspicions of FT is statutory but not regulatory; neither the 1993 Regulations nor Sourcebook require reporting of suspicions of FT as such (only ML, including ML related to an FT predicate crime). - Concern: doubtful obligation covers FT where no ML is involved (e.g., where source of funds used for FT is legitimate). - FT predicate crimes covered by the 1993 Regulations and Sourcebook are limited to older definitions (Prevention of Terrorism (Temporary Provisions) Act 1989) rather than recent, broader definitions in Terrorism Act and ATCS 2001. - PCA 2002 authorizes Secretary of State to prescribe form and manner for STRs (section 339); until in force, no standard nationwide form. NCIS has a recommended but not mandatory format used by most institutions. Authorities expect a standard form for STRs pursuant to PCA 2002 will be issued in 2003. ### Criterion 55 — Description and Analysis: Implementation - MSBs: - Vast majority of STRs filed with NCIS even under pre-PCA 2002 regime. - Bureaux de change accounted for 14% of all suspicious reports filed with NCIS in 2001. - High volume reporting institutions have electronic links to NCIS; project under development to expand electronic reporting to medium-level disclosing institutions. - Telephone ‘hotline’ exists for urgent queries with an NCIS desk officer. - Given recent adoption of new supervisory framework for MSBs, too early to assess HMCE’s efforts to ensure MSBs observe reporting requirements. - Financial Institutions: - Monitoring compliance with AML/CFT requirements, including suspicious transactions reporting, is integral to FSA supervisory activities and extends to FSA regulated firms and individuals. - Where applied, FSA oversight assures prompt reporting of suspicious transactions to NCIS. - Discussion at Criterion 68 addresses gaps in FSA AML/CFT oversight for securities and insurance sectors. - Banking: Fully implemented - Securities: - AML/CFT compliance checking by FSA of small, low impact securities firms is too limited to verify compliance of those firms with the suspicious transactions reporting requirement. - Otherwise, implementation in the securities sector is satisfactory. - Insurance: - Exclusion of general insurance is a significant gap in the AML/CFT regime implemented by FSA. - For other parts of the insurance sector subject to FSA oversight, awareness of AML/CFT requirements appears to be low and FSA supervisory efforts are perfunctory. ### Criterion 56 — Description and Analysis - Legal and Institutional: - DTA provides that disclosure of knowledge or suspicion of drug trafficking-related ML to a constable or a compliance officer designated to receive such disclosures shall not be treated as a breach of any restriction imposed by statute or otherwise (DTA sections 50(3), 52(4), (6)). - Similar provisions apply under the PCA 2002 (section 337), CJA (sections 93A(3), 93B(5)), ATCS 2001 (Section 21B), and Terrorism Act (Section 19). - Implementation: - Implemented via legislation. ### Criterion 57 — Description and Analysis - Legal and Institutional: - PCA 2002, DTA, CJA and Terrorism Act make it an offense to “tip-off” a suspect that a suspicious transactions report has been filed with a government agency. - Implementation: - Monitoring compliance with AML/CFT requirements including prohibitions on tipping-off is integral to FSA supervisory activities and extends to FSA regulated firms and individuals. - Where applied, FSA oversight assures the prohibitions on tipping-off are fully implemented. - Discussion at Criterion 68 discusses gaps in FSA AML/CFT oversight with respect to securities and insurance sectors. - Banking: Fully implemented - Securities: - AML/CFT compliance checking by FSA of small, low impact securities firms is too limited to verify compliance with prohibitions on tipping-off. - Otherwise, implementation in the securities sector is satisfactory. - Insurance: - Exclusion of general insurance is a significant gap in the AML/CFT regime implemented by FSA. - For other parts of the insurance sector subject to FSA oversight, awareness of AML/CFT requirements appears to be low and FSA supervisory efforts are perfunctory. ### Internal controls, Compliance and Audit — Overall Description and Analysis - Sector-specific detailed criteria referenced: - Banking sector: Criteria 89-92 - Insurance sector: Criteria 109 and 110 - Securities sector: Criterion 113 - Overall analysis should consider assessments of sector-specific criteria. ### Recommendations and Comments (as provided) - 1. Consideration should be given to requiring financial institutions and MSBs to adopt internal controls and procedures, and designate an appropriate compliance person, to prevent their institutions from being used for FT as such (rather than only for ML and the FT-related predicate offenses covered thereby). - 2. Consideration should be given to expressly requiring that the AML/CFT programs of financial institutions and MSBs must include an audit function. - 3. The 1993 Regulations should be revised to expressly require that the “appropriate person” required under the Regulations to handle the internal and external reporting requirements of the Regulations must be at management level. - 4. MSBs should be required to put in place adequate screening procedures to ensure high standards when hiring employees. *Source: _cr03208 - 3. Procedures should be developed for systematically, even if on a randomized basis, verifying compliance with* ### 5. Procedures should be developed for systematically, even if on a randomized basis, verifying compliance with ### _cr03208 - 5. Procedures should be developed for systematically, even if on a randomized basis, verifying compliance with ### Criterion 58 — Systems and controls; AML/CFT scope - Legal and institutional framework: - The FSA Sourcebook requires financial institutions to have effective AML systems and controls and to designate a senior-level MLRO. MLRO responsibilities include receiving internal reports of knowledge or suspicion of ML; taking reasonable steps to access relevant “know your business” information; making external reports to the NCIS where appropriate; maintaining employee awareness and training arrangements; and making annual reports to senior management on compliance (sections 7.1, 7.2). - The 1993 Regulations prohibit financial institutions and MSBs from forming a business relationship or carrying out a one-off transaction unless they maintain appropriate AML procedures and controls for customer identification, record keeping, suspicious transactions reporting, employee awareness and training, and other aspects of ML prevention (Regulation 5). - Financial institutions and MSBs must identify an “appropriate person” responsible for receiving and considering reports of knowledge or suspicion of ML and reporting where that person knows or suspects another is engaged in ML (Regulation 14). - The 1993 Regulations require employee awareness and training measures (Regulation 5(1)(b), (c)). - Neither the 1993 Regulations nor the Sourcebook expressly require an AML audit function, though authorities argue an audit function is implicit. - The 1993 Regulations and Sourcebook are limited to AML and do not per se require internal controls specifically aimed at preventing FT where no ML is involved; a CFT internal controls requirement could be added to the 1993 Regulations or the FSA Sourcebook. - Implementation: - The 1993 Regulations and Sourcebook governing internal systems and controls to prevent ML are comprehensive, except for the lack of a specific AML audit function requirement. - JMLSG is developing typologies to address internal systems and controls to prevent FT. - Sectoral implementation findings: - Banking: Fully implemented - Securities: - AML/CFT compliance checking by FSA of small, low impact securities firms is too limited to verify compliance with required internal procedures to prevent use of firms for ML. - Otherwise, implementation in the securities sector is satisfactory. - Insurance: - Exclusion of general insurance is a significant gap in the AML/CFT regime implemented by FSA. - For parts of the insurance sector subject to FSA oversight, awareness of AML/CFT requirements appears low and FSA supervisory efforts are perfunctory. ### Criterion 59 — MLRO designation and seniority - Legal and institutional framework: - The Sourcebook requires designation of a “senior” level MLRO; the MLRO is a “controlled function” and persons proposed as MLRO must be individually reviewed and approved by the FSA (Section 7.1.1). - The 1993 Regulations require identification of an “appropriate person” to receive and consider ML reports and report to a constable, but do not require this person be at management level. - No legal requirement specifically designates a high-level CFT compliance officer; AML compliance officer functions are expected to cover FT as an AML predicate crime but do not strictly cover FT as such. - Implementation: - FSA oversight assures MLRO requirement is fully implemented where applied. - Sectoral implementation findings: - Banking: Fully implemented - Securities: AML/CFT compliance checking by FSA of small, low impact securities firms is too limited to verify compliance with the MLRO requirement; otherwise satisfactory. - Insurance: Exclusion of general insurance is a significant gap; where FSA oversight applies, awareness is low and supervisory efforts are perfunctory. ### Criterion 60 — Employee screening and “fit and proper” tests - Legal and institutional framework: - FSA has detailed suitability and “fit and proper” tests under its “approved persons” regime. - Financial institutions have broad obligations to assess suitability of anyone who acts for them, normally at recruitment. - The 1993 Regulations require MSBs to adopt internal AML procedures governing employee awareness and training but do not address screening of MSB employees. - Implementation: - FSA monitoring assures employee screening procedures are implemented where applied. - Sectoral implementation findings: - Banking: Fully implemented - Securities: AML/CFT compliance checking by FSA of small, low impact securities firms is too limited to verify compliance with employee screening procedures; otherwise satisfactory. - Insurance: Exclusion of general insurance is a significant gap; where FSA oversight applies, awareness is low and supervisory efforts are perfunctory. ### Criterion 61 — Overseas branches and subsidiaries - Legal and institutional framework: - FSA systems and controls requirements apply prudentially to U.K. firms with respect to activities wherever carried out (Handbook, SYSC 1.1.9 R). - For firms subject to consolidated supervision, AML systems and controls in overseas subsidiaries must meet the higher of local standards or U.K. standards. - The Sourcebook’s requirements apply only to activities conducted from an establishment in the U.K., but firms must notify the FSA of matters that could significantly impact their reputation, including inability of foreign branches or subsidiaries to observe applicable U.K. AML standards (Handbook, SUP 15.3.1 R (2)). - The 1993 Regulations do not address foreign branches and subsidiaries of persons subject to the Regulations; limited significance for MSBs given most do not have foreign locations. - Implementation: - FSA oversight assures overseas branches and subsidiaries comply with AML/CFT procedures where applied. - Sectoral implementation findings: - Banking: Fully implemented - Securities: AML/CFT compliance checking by FSA of small, low impact securities firms is too limited to verify compliance with the requirement that overseas branches and subsidiaries comply with AML/CFT procedures; otherwise satisfactory. - Insurance: Exclusion of general insurance is a significant gap; where FSA oversight applies, awareness is low and supervisory efforts are perfunctory. ### Recommendations and identified gaps - General findings: - AML systems and controls framework is robust in many respects but has gaps: no explicit AML audit requirement; limited FSA compliance checking of small, low impact securities firms; exclusion of general insurance from AML/CFT regime; low awareness and perfunctory supervision in parts of the insured sector subject to FSA oversight; absence of explicit CFT internal controls requirements. - Explicit recommendation provided: - 1. The 1993 Regulations, Sourcebook or other appropriate legal provisions should be revised to expressly prohibit criminals from holding or controlling a significant investment in financial institutions and MSBs. *Source: Excerpt from IMF assessment document (_cr03208), Criteria 58–61 and Recommendations.* ### 2. The 2001 Regulations should also be revised to give HMCE powers to deny or cancel the registration of MSBs ### 2. The 2001 Regulations should also be revised to give HMCE powers to deny or cancel the registration of MSBs ### Legal and institutional framework: fit and proper, registration, and powers - The FSMA requires that in giving or varying permission the FSA be satisfied that the applicant will meet five Threshold Conditions (“TC”); TC5 (Suitability) requires the applicant firm to be “fit and proper” to have FSMA Part IV permission. - The FSA Handbook (COND, 2.5.6G) lists matters for TC5, including “whether the firm has been convicted, or is connected with a person who has been convicted, of any unspent offence” involving specified dishonesty and financial crimes. - The FSA assesses suitability of individuals under the “approved persons” regime; FIT 1.3.1 G requires regard to “honesty, integrity and reputation; competence and capability; and financial soundness.” - There is no legal prohibition in FSMA, Sourcebook or other law that per se prevents persons with criminal records from holding or controlling a significant investment in prudentially regulated financial institutions or from holding management functions. - For MSBs: - There are no “fit and proper” requirements concerning MSB controlling shareholders or managers. - MSB applicants must provide HMCE with information on whether any person involved in management, control or operation of the MSB has been convicted of ML (Regulation 5(3)(b)(vii)). - HMCE can deny an MSB application “if and only if” an applicant fails to comply with the Regulations’ information requirements, or if any of the information provided is materially false or misleading (Regulation 7(1)). - HMCE cannot cancel an MSB’s registration on integrity grounds per se; it can cancel only where there would have been grounds to reject the registration in the first place (Regulation 8(1)). ### Implementation and supervisory coverage - FSA oversight implements fit and proper requirements for FSA-regulated firms and individuals; this oversight extends to banking, securities and insurance where applicable. - Banking: Fully implemented. - Securities: AML/CFT compliance checking by FSA of small, low impact securities firms is limited. Fit and proper requirements are effectively implemented via the FSA Approved Persons Regime. - Insurance: Exclusion of general insurance is a significant gap in FSA’s AML/CFT regime. Fit and proper requirements for these firms are effectively implemented via the FSA Approved Persons Regime. - HMCE has begun limited scope “assurance visits” to MSBs (spot-check compliance visits). - HMCE’s budget has not been augmented; the supervisory scheme is intended to be self-financing (Regulation 9(2)). - HMCE has proposed fees of ₤100 for each branch or premise of an MSB. - Assessors note uncertainty whether the ₤100 per premises fee will support a sufficiently robust program of assurance visits. ### Enforcement powers and sanctions - The 1993 Regulations do not provide for civil penalties; violations of the Regulations’ AML requirements are criminal offenses with penalties including an unlimited fine, up to two years imprisonment, or both (Regulation 5(2)). - Punishment may be imposed on legal entities and on designated officers under certain circumstances (Regulation 6). - The FSA has criminal prosecution powers over FSA-supervised persons for 1993 Regulations violations; HMCE has similar powers for MSBs. - The FSA has a broad range of civil enforcement tools for Sourcebook breaches, including public censure, monetary penalties, disqualification orders, and variation or cancellation of permission. - HMCE can: - Deny an MSB application for failure to comply with 2001 Regulations’ information requirements or for materially false or misleading information (Regulation 7(1)). - Cancel registration on similar grounds (Regulation 8(1)). - Impose a fine of up to ₤5,000 on any MSB that fails to comply with the 2001 Regulations’ requirements concerning registration, provision of information, payment of fees, and entry and inspection rights (Regulation 15). - The absence of a fit and proper standard for MSBs means sanctions for failures to meet such standards are not applicable for these entities. - Assessors understand HMCE has not yet imposed fines or undertaken criminal actions for failure to observe the 2001 and 1993 Regulations; too early to assess HMCE’s practical use of powers. ### Cooperation, information-sharing and gateways - FSMA authorizes the FSA to cooperate and share information with national and foreign regulators and with domestic and foreign persons related to prevention and detection of financial crime (sections 348, 354). - Section 348 places a duty not to disclose confidential information without consent, but disclosure is permitted via a “gateway” in the Financial Services and Markets Act 2000 (Disclosure of Confidential Information) Regulations 2001 for “the purposes of criminal proceedings and investigations.” - The ATCS 2001 provides broad “gateway” powers for HMCE and other U.K. public authorities to disclose information to assist criminal investigations or proceedings in the U.K. or abroad (sections 17, 19), subject to proportionate disclosure and some overseas-use limitations. - FSA gateways enable exchange of information relating to suspicious transactions with domestic and foreign supervisors and law enforcement without court authorization. - For MSBs, it is too early to assess the scope and effectiveness of HMCE’s cooperation and information exchange in practice. ### Key policy recommendations and comments - Revise the 1993 Regulations to provide for civil penalties (administrative fines) in addition to existing criminal penalties for failures to adopt appropriate AML procedures and controls. - Current civil fine option for MSBs is limited to a ₤5,000 maximum and only for limited procedural violations (e.g., failure to register, file information), not for failure to maintain adequate AML systems and controls. - Reliance only on criminal sanctions for MSB systems and controls violations risks no sanctions being possible in many cases because of evidentiary and intent-proving difficulties. - Keep the self-financing scheme for HMCE supervision of MSBs under close review to determine whether fees (currently proposed as ₤100 per premises) will produce enough revenue to enable HMCE to carry out its functions under the 2001 Regulations. - If the ₤100 fee supports only a very limited number of assurance visits, consider increasing the fee or alternative non self-financing schemes. *Source: 2. The 2001 Regulations should also be revised to give HMCE powers to deny or cancel the registration of MSBs* ### 208. The core assessment criteria for the legal and institutional framework of an ### _cr03208 - 208. The core assessment criteria for the legal and institutional framework of an ### Core assessment framework and sources - Core assessment criteria for the legal and institutional framework of an AML/CFT system for financial institutions are set out in 2.2.1 and are largely drawn from the FATF Recommendations. - Sector-specific AML/CFT criteria for banking, insurance, and securities also draw from: - Basel Committee (Part A: Assessing the Banking Sector based on Sector-Specific Criteria) - IAIS (Part B: Assessing the Insurance Sector based on Sector Specific Criteria) - IOSCO (Part C: Assessing the Securities Sector based on Sector Specific Criteria) - Assessors must verify both that legal and institutional requirements exist (sections 2.2.2–2.2.4 / Parts A–C) and that effective supervisory/regulatory measures ensure proper and effective implementation in the banking, insurance and securities sectors. - Sector-specific assessments should inform the overall description and analysis parts of the core criteria assessments. ### FSA role, scope, and authorities - The Financial Services Authority (FSA) functions as an integrated regulator of the U.K. financial services sector and acts as the AML/CFT supervisor for banking, securities, and insurance (except general insurance). - General insurance: - Is not subject to the 1993 Regulations nor to prudential oversight by the FSA for AML/CFT compliance. - The EU Money Laundering Directive (basis of the U.K.’s AML regime) does not include general insurance. - FSA considered including general insurance in the ML Sourcebook but concluded costs could not be justified given Directive/Regulations scope; policy will be kept under review. - Assessors recommend that general insurance be brought within the coverage of the 1993 Regulations and the Sourcebook. - Coverage and guidance: - Laws, regulations and non-legally-mandatory JMLSG Guidance Notes apply across entities subject to FSA supervision (apart from the exclusion of general insurance). - AML/CFT framework administered by FSA addresses: organizational and administrative arrangements, customer due diligence, suspicious transactions reporting, record keeping and controls, information sharing and cooperation, licensing and authorizations. ### Legal and regulatory framework details - FSMA: prevention of financial crime is one of four statutory objectives of FSA. - 1993 Regulations (Regulation 5) and FSA’s Money Laundering Sourcebook require regulated firms to have effective AML systems and controls covering: - (a) adequate processes for identifying customers, - (b) procedures for internal and external reporting of suspicious transactions (to the NCIS), - (c) training of relevant staff. - FSA Handbook obligations: - Systems and controls requirements apply in a prudential context to U.K. firms with respect to activities wherever carried on [Handbook, SYSC 1.1.9 R]. - Firms’ overseas branches should have AML systems and controls appropriate and effective as within the U.K.; for consolidated supervision, overseas subsidiaries should meet the higher of local or U.K. standards. - The Sourcebook’s requirements apply only to activities conducted from an establishment in the U.K.; firms must notify FSA of matters that could have a significant impact on their reputation (Handbook, SUP 15.3.1 R (2)). - Threshold Conditions (TC): - Firms must satisfy FSA that they are fit and proper to carry out regulated activities; this extends to qualifications and integrity of staff. - Prior law violations and disqualifications are considered in relation to TC 5 (Suitability). - FSA considers whether the firm has competent and prudent management and exercises due skill, care and diligence (FSA Handbook, COND 2.5.4 G). - Guidance (COND 2.5.7.G) expects governing bodies to be organized to address and control regulated activities and to put in place an adequate system of internal control. ### Training, Principles, and Guidance - 1993 Regulations (Regulation 5(1)(b) and (c)) require regulated firms to carry out appropriate AML awareness and training of staff. - Sourcebook (6.1.1G) states staff in relevant firms should be (i) made aware of; and (ii) given regular training about expectations in relation to prevention of money laundering; training must be given at least every 2 years. - JMLSG Guidance Notes address Awareness and Training but are not legally mandatory. - Firms must comply with FSA’s Principles for Businesses (e.g., Principle 1: conduct business with integrity; Principle 2: conduct business with due skill, care and diligence). There is no specific FSA requirement that these Principles be communicated to all staff. ### FSA implementation, supervisory tools and resources - FSA uses a range of supervisory tools to assure compliance: fit-and-proper evaluations, on-site monitoring of systems and controls, theme supervision (horizontal evaluations), off-site reviews of internal reports, risk mitigation programs, public censure, fines, disciplinary actions, and outreach activities. - FSA operates a risk-based approach to assess AML controls, concentrating resources where threats to regulatory objectives are greatest; reduction in financial crime is the key objective. - Industry-wide risk assessment draws on: scale of the sector, number of customers, nature and complexity of products, perceived quality of control environment, capability of sector, number of NCIS referrals, nature of customer base. - For the current year the money laundering theme identified six clusters of activities for priority attention: - international banking, - domestic banking, - independent financial advisers handling client money from abroad, - on-line broking, - spread betting, - credit unions. - FSA’s capacity and specialized units: - Risk Review Team includes approximately eleven staff with expertise in both AML and fraud issues; - An Intelligence and Records Department liaises with national and international law enforcement agencies; - A Financial Crime Policy Unit provides advice on AML compliance issues and guidance on the Sourcebook requirements. - FSA can appoint “skilled persons” to investigate compliance issues (SUP 5). - Enforcement powers: - FSA may withdraw or vary permission to carry out regulated activities, impose fines or public censure on firms and individuals, and has criminal prosecution powers for violation of the 1993 Regulations (criminal prosecution is distinct from other enforcement measures). - MLRO in each authorized firm must meet fit and proper requirements on an ongoing basis. ### Sector-level observations and implementation intensity - FSA applies a risk-based intensity of oversight that varies across sectors. - Banking: - Oversight of AML/CFT requirements, including KYC, is active and comprehensive. - Banking industry awareness is high. - No significant issues identified with respect to FSA implementation for the banking industry. - Securities: - Oversight of AML/CFT requirements, including KYC, is active and comprehensive among securities firms of any significant size; awareness is high among these firms. - Compliance checks among the large number of very small, low impact securities firms are limited; awareness among these small firms is less well developed. - The assessment mission considers the low level of compliance checking among these small, low impact firms a significant gap in overall implementation. - Insurance: - Exclusion of general insurance from the 1993 Regulations and FSA prudential oversight is a significant gap in the U.K. AML/CFT regime. - The methodology underlying the assessment anticipates the entire insurance industry will be subject to supervision for AML/CFT purposes. ### Role and effect of JMLSG Guidance Notes - The JMLSG Guidance Notes are a basic reference for expected AML standards for financial sector firms and are comprehensive. - Guidance Notes are not mandatory but the 1993 Regulations allow a court to “take account” of such guidance; the ML Sourcebook states FSA “will have regard to” a firm’s compliance with the JMLSG Guidance Notes when assessing AML/CFT compliance. - FSA follows a “comply or explain” approach to the Guidance Notes; in practice they serve as a “safe harbor” and most firms follow them strictly. - In evaluating sector-specific criteria for banking, securities and insurance, evidence is sought that the subject matter is addressed in the 1993 Regulations, FSA Rules, or the JMLSG Guidance Notes, and whether the FSA supervisory regime is applied to the sector-specific criterion. ### Part A: Banking sector — context and criteria - The Basel Committee’s Core Principles for Effective Banking Supervision (BCP) relevant to AML/CFT include: - BCP1 (arrangements for sharing information between supervisors), - BCP3-5 (licensing and structure), - BCP14 (adequate internal controls), - BCP15 (adequate policies to prevent use by criminal elements), - BCP23-25 (co-operation between home and host supervisors). - October 2001 Basel Committee paper “Customer due diligence for banks” provides detailed AML/CFT recommendations; specific criteria for banks here are drawn extensively from that paper. - No additional criteria for sections I (General framework), V (Suspicious transactions reporting), VII (Integrity standards). - Additional specific criteria for banks cover customer identification and related areas; assessors must describe and analyze each of Criteria 67-83. ### Criterion 68 — Customer identification (summary) - Customer identification requirements specified in sections 7-9 of the 1993 Regulations; duty to identify clients addressed in Chapter 3 of the FSA Money Laundering Sourcebook. - JMLSG Guidance Notes provide for a risk-based approach to customer identification; firms must establish satisfactory “Know your Customer” procedures to identify users, principal beneficial owners and origin of funds. - Procedures must include knowing the nature of business the customer normally expects to conduct and being alert to transactions abnormal within the relationship. - Extent of information required varies by nature of business, product/service, and whether personal contact is maintained; commercial judgment permissible in some cases. - Higher risk products and accounts require more extensive checks on identity and source of wealth; Guidance Notes provide examples. - FSA Guidance 3.1.4: in assessing compliance with ML 3.1.3R, FSA will have regard to compliance with JMLSG Guidance Notes and guidance on financial exclusion at ML 3.1.5G. - Implementation of this criterion by FSA follows procedures outlined in the introduction to the sector section. ### Criterion 69 — Higher risk business relationships (summary) - Business relationships with higher risk individuals addressed in JMLSG Guidance Notes. - Example: section 2.30 calls for “senior management approval for the opening of an account for a ‘politically exposed person’” and regular oversight by senior management, including scrutiny of unusual features such as receipts of large sums from government bodies, state-owned activities, or government and central bank accounts. - Implementation by FSA follows procedures outlined in the introduction to the sector section. *Source: _cr03208 - 208. The core assessment criteria for the legal and institutional framework of an* ### introduction to this section. ### _cr03208 - introduction to this section ### Customer identification requirements - Legal basis: 1993 Money Laundering Regulations, sections 7-11. - Scope: covers persons and entities, beneficial owners and transactions on behalf of others. - Exceptions: provided in section 10 of the 1993 Regulations. - FSA implementation: Chapter 3 of the FSA Money Laundering Sourcebook specifies customer identification requirements for relevant firms subject to FSA supervision. - Detailed guidance: JMLSG Guidance Notes (Chapter 4) cover customer identification procedures for: - private individuals, trusts, nominees and fiduciaries, powers of attorney and third party mandates, executorships accounts, client accounts opened by professional intermediaries, corporate customers, unincorporated businesses/partnerships, and additional entities; - reliance on intermediaries or third parties. - Record retention: customer identification records must be maintained for five years (1993 Regulations and FSA rules). - Timing: section 7 requires satisfactory customer identification “as soon as is reasonably practicable after contact is first made between that person and an applicant for business concerning any particular business relationship or one-off transaction.” Procedures should require that where that evidence is not obtained the business relationship or one-off transaction shall not proceed further. ### Risk-based vigilance and high-risk categories - General: JMLSG Guidance Notes repeatedly emphasize extra vigilance for higher risk business; Sections 1.6-1.12 provide guidance on factors for money laundering risk assessments. - Non-resident / foreign jurisdictions: - FSA Rule: Chapter 5 of the FSA Money Laundering Source Book requires relevant firms to be aware of and make use of U.K. or Financial Action Task Force findings with respect to regulatory deficiencies in foreign jurisdictions. - JMLSG calls for extra VIGILANCE for: offshore trusts (4.120-4.126), International Business Companies (4.169), non-EU regulated credit and financial institutions (4.170-4.173), introductions from non-EU regulated intermediaries and corporate introducers (4.198, 4.201), business by non-EU agents not subject to equivalent regulation (4.210), and foreign correspondent relations (4.216-4.221). - Private banking: - Private Banking not explicitly identified as high risk per se; activities typical to private clients (overseas trusts, use of agents, identification of beneficial owners, International Business Corporations, transactions with overseas accounts, unusual one-off transactions) are identified as requiring additional vigilance. - FSA oversight of private banking generally follows the procedures outlined in the introduction; FSA reported private banking will be a subject for theme supervision during the upcoming fiscal year. - Politically exposed persons and corruption: - Sections 2.26-2.31 of JMLSG deal with proceeds of corruption. - Section 2.29 calls for enhanced identification at account onset and on an ongoing basis where the firm knows, suspects, or is advised that the customer is a senior political figure or related party. - Section 2.28 defines senior political figure, immediate family, and close associate. - Section 2.30 calls for senior management approval and regular senior management oversight. - Section 2.27 warns of reputational risk and possible criminal charges for firms that handle proceeds of corruption. - Guidance strongly implies firms should not accept or maintain relationships if funds derive from corruption or misuse of public assets. ### Special situations: refusals, verification difficulties, trusts, and corporate vehicles - Refusal of banking facilities: - JMLSG does not explicitly address customers believed to be refused facilities; enhanced due diligence is implicit (see section 5.9 on questions staff might consider when transactions deviate from normal patterns; definitions in 5.4, 5.5, 5.6). - Difficulties verifying identity: - Section 7 of the 1993 Regulations and sections 5.47-5.51 of the Guidance Notes: if satisfactory identification is not obtained “the business relationship or one-off transaction in question shall not proceed further.” - JMLSG 4.43: “The failure or refusal by an applicant to provide satisfactory identification evidence within a reasonable timeframe and without adequate explanation may lead to a suspicion that the depositor or investor is engaged in money laundering. In such circumstances, firms should consider making a suspicion report to NCIS based on the information in their possession and, following this, should obtain NCIS consent before any funds are returned to where they came from.” - Firms may exercise commercial judgment to terminate relationships but should liaise with NCIS to avoid tipping off or prejudicing an investigation. - Trusts, nominees and fiduciaries: - Sections 4.116-4.134 of JMLSG address identity establishment for trusts, nominees and fiduciaries. - Risk-based approach recommended; verify identity of settlor, trustees, controllers who can remove trustees; ascertain nature and purpose of the trust and original source of funding (4.118). - Corporate customers and “look behind” principle: - Sections 4.150-4.169 address corporate complexities, distinguishing high risk and low risk corporates, and publicly registered versus private companies. - 4.150 highlights confirming that a company is not a “brass plate company.” - For high risk private companies where the principal owner is another corporate entity or trust, objective is to “undertake measures to look behind that company or vehicle and verify the identity of the beneficial owner(s) or settlors.” ### Reliance on intermediaries, client-account issues, and professional intermediaries - Reliance on intermediaries/third parties: - Sections 4.191-4.215 of JMLSG govern reliance on intermediaries. - 4.46: overall legal responsibility to ensure procedures and evidence are satisfactory rests with the account-holding firm. - 4.198 (introductions from non-EU regulated intermediaries): identification checks must be undertaken to U.K. standards and an intermediary certificate completed with certified copies of identification documents. - 4.192-4.197: procedures when introducer is a U.K. or EU regulated financial intermediary; firms should assess introducer’s identification systems and complete identification certifications (4.192). - Client accounts and professional intermediaries: - Sections 4.141-4.145: identification procedures for client accounts. - 4.143 and 4.42: unless the professional intermediary is regulated under the U.K. Money Laundering Regulations or equivalent, the firm must verify both the intermediary and the person on whose behalf the intermediary acts. - Waiver: 4.142 allows procedures to be waived if the U.K. or EU intermediary is covered by the Money Laundering Regulations or their equivalent. - Solicitors’ general omnibus accounts and accountants: Section 85 of the Solicitors’ Act and accountants’ professional codes may preclude inquiries or disclosure about underlying clients; JMLSG 4.144 advises the firm must make a commercial JUDGMENT based on knowledge of the intermediary and the nature of business (see criterion 45 reference). ### Non-face-to-face business and correspondent relationships - Non-face-to-face: - JMLSG addresses non-face-to-face business: 4.153-4.155 for corporate customers; 4.49 requires private individual procedures to be robust whether face to face or remote; 4.114 for accounts opened on behalf of a minor; telephonic or electronic applications referenced in 4.196. - Correspondent accounts: - Sections 4.216-4.221 address correspondent accounts. - 4.216: firms must ascertain whether correspondent bank or counterparty is regulated for money laundering prevention and whether it verifies customers to FATF standard; if not, additional due diligence required. - 4.217: close monitoring of transactions through correspondent accounts against expected levels and checking material variances. - Appendix B (typologies) describes use of “payable through accounts” as vulnerable to abuse (appendix b, section 1). - 4.219: banks should guard against establishing correspondent relationships with high risk foreign banks, e.g., shell banks with no physical presence or correspondent banks that permit their account to be used by such banks. ### On-going monitoring, systems and controls (Criteria 84-87) - Recordation and aggregation: - JMLSG 7.11: “internal procedures need to ensure that all transactions undertaken on behalf of an existing customer are recorded within the customer’s records.” No distinction for on-shore/off-shore, on balance sheet/off balance sheet, or fiduciary holdings. - FSA consolidated supervision policies reinforce oversight of banks’ ability to aggregate and monitor significant balances on a worldwide consolidated basis beyond AML-specific requirements. - Systems to detect unusual/suspicious activity: - Banks required to maintain systems and controls appropriate to their business (IPRU SYSC 3.1.1R). - Threshold Condition on Suitability: regulated firms expected to have identified risks and installed appropriate control systems. - IPRU Banks Chapter AR Section 3 guidance: design and operate internal controls to provide reasonable assurance over revenues, authorized expenditure, asset safeguarding, liabilities recording, and statutory/supervisory compliance; management information to show state of affairs and exposures relative to limits. - JMLSG emphasizes necessity for firms to identify unusual/suspicious patterns; 4.9 requires sufficient information on expected/predictable transaction patterns and expected origins of funds. - Staff training: required by 1993 Money Laundering Regulations (5(1) (c)); FSA Rule 6.3.1 addresses money laundering prevention training. - Enhanced monitoring of high-risk accounts: - JMLSG and FSA endorse risk-based approach with intensified monitoring for high risk accounts, including non-resident accounts and off-shore trusts (criteria 72), corporate vehicles (criterion 77), politically connected persons (criteria 80), and correspondent accounts (criteria 83). - Guidance identifies numerous other higher risk accounts and transactions calling for enhanced scrutiny. *Source: _cr03208 - introduction to this section* ### Chapter 5 of the Money Laundering Sourcebook contains the requirement to make use of ### Chapter 5 of the Money Laundering Sourcebook contains the requirement to make use of ### National and international findings on countries with inadequacies - FSA Guidance 5.1.1: purpose is to enable government and Financial Action Task Force findings of inadequacy, concerning the approach to money laundering, of individual countries or jurisdictions to be brought to bear on relevant firm’s decisions and arrangements. - Implementation by FSA of these policies follows the procedures outlined in the introduction to this section. ### Enhanced vigilance in dealing with customers located in certain countries (Section 1.11) - Section 1.11 calls for enhanced vigilance in dealing with customers located in countries: - “without adequate anti-money laundering strategies, or - where cash is the normal medium of exchange, or - where there is a politically unstable regime with high levels of public or private corruption,...,or, - that are known to be drug producing or drug transit countries; or - that have been classified as countries with inadequacies in their anti-money laundering strategies,...” ### Record keeping (Criterion 88 and related guidance) - FSA SYNC 3.2.20: requires a firm to take reasonable care to make and keep adequate records (including accounting records) which are appropriate to the scale, nature and complexity of its business. - Regulation 12 and FSA Rule 7.3.2: require firms to retain records concerning customer identification and transactions for use as evidence in any Investigation into money laundering. - JMLSG Guidance Notes (section 7.3) expected standards for firms' record keeping: - requirements of legislation and FSA Rules are fully met; - competent third parties will be able to assess the effectiveness of the firm’s observance of money laundering policies and procedures; - any transactions effected via the firm on behalf of any individual customer can be reconstructed; - any customer can be properly identified and located; - all suspicion reports received internally and those made externally can be identified; - the firm can satisfy, within a reasonable time, any enquires or court orders from the appropriate authorities as to disclosure of information. - Further detailed guidance on record keeping is provided in sections 7.5-7.32 of the Guidance Notes. - Implementation by FSA of these policies follows the procedures outlined in the introduction to this section. ### Internal controls, compliance and audit (Criteria 89–92) - Criterion 89 — Internal control expectations: - Banks expected to have adequate internal controls to manage risks, including appointment of a Money Laundering Control Officer and responsibilities of the MLRO. - High level controls to include: setting strategy and plans; establishing and reviewing organizational structure and delegation (including segregation of duties); management approval of risk policies; review of high level management information; monitoring implementation of action points from reviews. - Internal control systems should provide reasonable assurance over capital, liquidity, profitability, asset quality, risk monitoring and provisions for bad and doubtful debts. - Expectation for internal audit function (outsourcing permitted in some cases) and an audit committee. - Implementation by FSA follows the introduction procedures. - Criterion 90 — Responsibilities and accountability (Regulation 5, FSA Rule 2.1.1): - Financial sector firms required by Regulation 5 to establish clear responsibilities and accountabilities to ensure policies, procedures, and controls deter criminals from using facilities for money laundering. - FSA Rule 2.1.1: relevant firm must set up and operate arrangements, including appointment of a Money Laundering Reporting Officer, designed to ensure compliance with the FSA Money Laundering Sourcebook. - MLRO duties include preparation of an annual report that: - (a) assesses the relevant firm’s compliance with the money laundering sourcebook, - (b) that the report is considered by the firms senior management, - (c) that any necessary action are taken to remedy deficiencies identified by the report. - Implementation by FSA follows the introduction procedures. - Criterion 91 — Global application of KYC standards (JMLSG sections 3.29–3.31): - Section 3.29: U.K. regulations and policies do not have extraterritorial applicability; however, where a U.K. financial institution has overseas branches, subsidiaries or associates, or control can be exercised over business outside the United Kingdom, or elements of U.K. business have been outsourced offshore, a U.K. firm should consider a group money laundering strategy to protect its global reputation and U.K. regulated business. - Section 3.30: group policy recommended to ensure overseas branches and subsidiaries undertake identification and record keeping procedures at least to U.K. law standards or higher host-country standards where applicable. - Implementation by FSA reinforced by consolidated supervision practices for U.K. banks. - Criterion 92 — Testing compliance with home and host country KYC standards: - Expectation implicit that banks will have routine procedures testing for compliance against both home and host country KYC standards (not explicitly required). - Section 3.30: reporting procedures and offences under host country money laundering legislation must be adhered to per local laws and procedures. - Implementation by FSA follows the introduction procedures. ### Enforcement powers and sanctions (Criteria 93–96) - Criterion 93 — Supervisory tools and examination scope: - FSA compliance assurance tools include: fit-and-proper evaluations, on-site monitoring, theme supervision, off-site reviews, risk mitigation programs, public censure, fines and disciplinary actions, and outreach activities. - Examinations may address: client classification, terms of business, “know your customer” information, customer suitability, disclosure, dealing and managing rules, customer reports and client assets; also internal measures such as internal audit, compliance arrangements, risk management systems, AML controls, and escalation procedures. - Criterion 94 — Information-gathering powers (FSMA section 165 and related): - FSMA gives FSA authority to obtain any information or documents from banks under section 165. - FSA can request internal audit reports and minutes of audit committee meetings. - FSA may obtain information through an authorized person under section 166 and may appoint investigators under sections 167–176. - Processes for obtaining information are set out in the enforcement manual (ENF) section of the FSA Handbook. - Criterion 95 — Remedial and sanctioning powers (FSMA Part XIV and Section 45): - FSA may withdraw a bank’s authorization, limit deposit-taking, or require cessation of certain activities. - Remedial action can be taken with immediate effect under FSMA Section 45 via a supervisory notice; notices are subject to referral to an independent FSM Tribunal (procedures in Part IX of FSMA). - FSA is a criminal prosecuting authority under the Regulations. - FSMA Part XIV provides power to fine or publicly censure via a decision notice; these actions are referable to the Tribunal generally within 28 days of the notice date. - FSA may not take specified actions until referral period ends or Tribunal disposes of appeal. - FSA may also use informal actions to discipline institutions and obtain compliance. - Criterion 96 — Consolidated supervision and overseas operations: - FSA carries out consolidated supervision of banks, emphasizing information systems and controls across business units worldwide. - FSA ensures overseas activities are structured for proper supervision and may impose restrictions or limits where unsatisfied. - If an overseas operation presents significant unmitigated risks, FSA would initiate discussions with senior management that could lead to closure of the overseas operation. ### Co-operation between supervisors and other competent authorities (Criteria 97–100) - Criterion 97 — Sharing supervisory information with foreign supervisors: - FSMA provides authority for FSA to share supervisory information with foreign supervisors subject to confidentiality safeguards. - Home country supervisors permitted to conduct on-site visits and examinations of U.K. branches and subsidiaries; FSA encourages this practice and permits access to customer files and account sampling. - FSA informs home country supervisors of risk assessments and supervisory actions; urgent remedial actions are promptly communicated. - Criterion 98 — See Criterion 97 description and analysis. - Criterion 99 — No barriers to sharing consolidated reporting: - No barriers to sharing consolidated reporting of deposit or borrower concentration information or notification of funds under management if needed by the home country supervisor. - Criterion 100 — Use and protection of information: - Information on individual accounts obtained through cooperative arrangements with overseas supervisors required to be used only for lawful supervisory purposes and to be protected satisfactorily. ### Assessing the insurance sector (Part B; paragraphs 212–214 and Table 31) - Paragraph 212: - Insurance entities are expected to adopt and enforce AML/CFT policies governing staff activities, ensure internal control systems implement board and management policies to prevent and deter ML and FT, and ensure prompt follow-up such as reporting suspicious transactions to the FIU or other competent authority. - Paragraph 213 — IAIS Core Principles relevant to AML/CFT: - IAIS Core Principles of Insurance Supervision (ICP) Principles 1, 2, 3, 4, 5, 10, and 16 contain criteria relevant for AML/CFT; internal controls are most important. - Experience shows internal control procedures in insurance entities often not well established and supervisors weak in promoting development; weak internal controls undermine effective AML/CFT controls. - Paragraph 214 — Sector-specific criteria sources and scope: - Sector-specific criteria draw extensively from IAIS “AML Guidance Notes for insurance supervisors and insurance entities” as of January 2002. - No additional criteria for sections I (General framework), VII (Integrity standards), VIII (Enforcement powers and sanctions), and IX (Financial Supervisors). - Additional specific criteria for insurance entities are set out in Table 31. ### Insurance sector: customer identification, ongoing monitoring, record keeping, and agents (Criteria 101–107) - Criteria 101–104 — Customer identification for insurers and intermediaries: - Relevant insurers and intermediaries subject to customer identification requirements summarized under criteria 68–83. - Regulations (10 (1)(e)) and FSA Rule 3.2.2 permit waivers of identification in some small long term life insurance contracts and some long term policies in connection with pension schemes. - Noted issues across Criteria 101–104: - U.K. AML/CFT regime has not been applied to general insurance. - Insurance industry awareness of AML/CFT requirements is limited. - FSA oversight of relevant insurance firms for AML/CFT compliance has been less active than in banking, reflecting perception of low money laundering risk in insurance. - FSA indicated ensuring compliance by relevant insurance industry is being given a higher priority; possibility of bringing general insurance under the AML/CFT regime is under review but no immediate plans. - Criterion 103: includes verification of parties entering into insurance contracts, identification of underlying principals where nominees are involved, and establishing nominee–principal relationships. - Criterion 104 — Payments to third parties and verification: - JMLSG Guidance Notes do not directly address claims, commissions, and monies paid to persons other than the policyholder; necessity to verify identity of proposed recipients can be inferred from examples (e.g., 4.134 on identification of trustees in life policies placed in trust). - Implementation concerns reiterated about general insurance coverage and oversight (see above). - Criterion 105 — Ongoing monitoring of accounts and transactions: - See Criterion 85 for procedures identifying significant, unexpected and unexplained changes in account or policyholder behavior. - JMLSG Guidance Notes do not specifically address risks from buying and selling second hand endowment policies or the use of single premium unit-linked policies. - Insurance entities are not instructed to check reinsurance or retrocession to ensure monies are paid to bona fide re-insurance entities at rates commensurate with risks undertaken. - Recommendations: JMLSG Guidance Notes should be updated to address procedures for AML/CFT risks from buying and selling second hand endowment policies and single premium unit-linked policies; guidance should require checking reinsurance or retrocession to ensure monies are paid to bona fide re-insurance entities at rates commensurate with risks undertaken. - Criteria 106–107 — Record keeping and reliance on agents: - Criterion 106: Record keeping requirements discussed under Criterion 88; U.K. regulations, FSA Rules and Guidance Notes not specified in same detail as Criterion 106 but Guidance Notes require sufficient detail to reconstruct transactions effected via the firm on behalf of any individual customer. - Criterion 107: Addresses ability of an insurance entity to rely on an appointed representative if the representative is licensed under insurance law in the supervisor’s jurisdiction. - Elements addressed across Regulations, Rules and JMLSG Guidance Notes (sections 4.205–4.215). - Sections 4.205–4.207: licensed entity may rely on agent where client is also subject to the Regulations and bound by FSA Sourcebook or is a U.K. regulated firm, subject to verifying client is a U.K. or EU regulated firm. - Where agent is not U.K. or EU regulated, 4.209 requires the entity to obtain written assurances that identification has been established in substantial accordance with procedures in the U.K. *Source: Chapter 5 of the Money Laundering Sourcebook (as provided in the supplied content).* ### Section 4.210 deals with the case where the agent is in a country with practices that are ### _cr03208 - Section 4.210 deals with the case where the agent is in a country with practices that are ### Application to the insurance sector - Section 4.210: addresses the case where the agent is in a country with practices recognized as being equivalent to the U.K. but is not regulated; the entity is required to take “reasonable measures” which can include following best practice in the industry (see further discussion in 4.212). - Section 4.214: states that, where the agent is in a non co-operating country or territory, or one which has material deficiencies, the business should not proceed unless the underlying beneficial owner of the funds have been identified to the satisfaction of the U.K. firm and in line with U.K. standards. - The U.K. AML/CFT regime has not been applied to general insurance. - Industry awareness and oversight: - Insurance industry awareness of AML/CFT requirements is limited. - FSA oversight of relevant insurance firms for compliance with AML/CFT requirements has been less active than in the banking sector, reflecting, in part, a perception that money laundering risks are low in the insurance sector. - FSA indicated that ensuring compliance by the relevant insurance industry with AML/CFT requirements is being given a higher priority. - While the possibility of bringing general insurance under the AML/CFT regime is being kept under review, there are no immediate plans to do so. ### Suspicious transaction reporting — Detailed Assessment of Criterion 108 - Criterion 108: calls for the supervisory or other competent authority to provide GUIDANCE to identify suspicious transactions with respect to three specific categories of insurance transactions: early redemption, unusual employment of an intermediary, and unusual method of payments involving parties where AML/CFT measures are viewed to be inadequate. - Guidance Notes and examples: - The Guidance Notes do not specifically address the particular circumstances of the identified insurance transactions. - Appendix B of the Guidance Notes uses the case of cash purchase of a life policy and the case of cash purchase and early redemptions of a general insurance policy to illustrate specific types of money laundering vulnerabilities (see case 11). - Sections 5.7-11 of the Guidance Notes provide general guidance on procedures for identifying suspicious transactions. - Section 5.9: firms need to consider: - Is the size of the transactions consistent with the normal activities of the customer? - Is the transaction rational in the context of the customer’s business or personal activities? - Has the pattern of transactions conducted by the customer changed? - Where the transaction is international in nature, does the customer have any obvious reason for conducting business with the other country involved? - Recommendations and comments: - The Guidance Notes have relatively few references to insurance business. - It would be useful to include more such references to orient relevant insurance firms in compliance with AML/CFT and to raise awareness of AML/CFT risks in the insurance sector. ### Internal controls, Compliance and Audit — Detailed Assessment of Criteria 109-110 - Criterion 109: - Calls for guidelines that recommend that insurance and reinsurance companies foster close working relationships between underwriters and claims investigators. The JMLSG Guidance Notes do not address this topic. - Calls for reporting systems to alert senior management and/or the board if AML/CFT procedures are not properly followed. This requirement is fully addressed by the requirement to appoint a money laundering reporting officer (MLRO) with duties specified in FSA rules and elaborated in the JMLSG notes. - Reiteration: the U.K. AML/CFT regime has not been applied to general insurance; industry awareness is limited; FSA oversight has been less active than in banking; FSA is giving higher priority to ensuring compliance; no immediate plans to bring general insurance under the regime. - Criterion 110: - States that the supervisor should have the authority to require that insurance entities have an ongoing audit function of a nature and scope appropriate to the nature and scale of the business, including ensuring compliance with applicable policies and procedures and reviewing whether the insurer’s policies, practices, and controls remain sufficient and appropriate. - FSA has such authority and the requirements of this criterion are satisfied. (See assessment of insurance core principle 5.8 in the separate assessment of the IAIS core principles for the U.K.) ### Securities sector assessment (Part C) — Overview and sector-specific criteria - Context: - Paragraphs 215–218: IOSCO “Objectives and Principles of Regulation” (IOSCO Core Principles) set international standards for securities regulation; IOSCO Public Document No. 26, Report on Money Laundering, IOSCO Technical Committee, October 1992, is especially relevant. - Assessors should view Sections 2.2.1 and 2.2.2 (Part C) as integral, and coordinate with the assessor responsible for IOSCO Core Principles for certain criteria. - No additional sector-specific criteria for sections I (General framework), III (Ongoing monitoring of accounts and transactions), and V (Suspicious transactions reporting). ### Customer identification, record keeping, internal controls, integrity, enforcement, and cooperation — Criteria 111–120 - Criterion 111 (Customer identification): - Securities firms need to seek information identifying circumstances and investment objectives relevant to services (see criterion 85 and JMLSG Guidance Notes section 4.9). - Section 4.9: “the second requirement of knowing the customer is to ensure that sufficient information is obtained on the nature of the business that the customer expects to undertake, and any expected, or predictable, pattern of transactions. A risk based approach will be needed in respect of the extent of the additional information that might be required or validated for this purpose.” - Implementation note: FSA follows a risk based approach to supervision which may tend to overlook money laundering risks in small firms because the scoring system gives greater weight to larger firms; limited compliance checks for very small, low impact securities firms. - Recommendation: Procedures should be developed for more systematic, if randomized, verification of compliance with AML/CFT requirements by the large number of small, low impact firms. - Criterion 112 (Record keeping): - FSA SYSC 3.2.20 requires a firm to take reasonable care to make and keep adequate records (including accounting records) appropriate to the scale, nature and complexity of its business. - Implementation: refer to criterion 111. - Criterion 113 (Internal controls, Compliance and Audit for securities companies): - See assessment of IOSCO principle 23; specific AML/CFT requirements addressed in Regulations, Rules and JMLSG Guidance Notes, particularly section 3: Internal controls, policies and procedures and the role/duties of the MLRO. - Implementation: see criterion 111. - Criterion 114 (Integrity standards): - See assessment of IOSCO principle 23 and discussion under criteria 62 and 63. - Criteria 115–117 (Enforcement powers and sanctions): - Criterion 115: FSA has broad authority under the Financial Services Markets Act to inspect and require production of documents reasonably required by the FSA. - Criterion 116: See assessment of IOSCO Core Principle 8.3 for comprehensive investigative and enforcement powers. - Criterion 117: See assessment of IOSCO Core Principle 8.4 for supervisory powers in cross-border misconduct. - Criteria 118–120 (Co-operation between supervisors and other competent authorities): - Criterion 118: FSA has full authority to share both public and non-public information with domestic and foreign counterparts (see section 6). - Criterion 119: Regarding international cooperative mechanisms, including MOUs, see section 6. - Criterion 120: Regarding the audit requirements for insurance companies see assessment of Insurance Core Principle criterion 5.8. *Source: _cr03208 - Section 4.210 deals with the case where the agent is in a country with practices that are (IMF assessment excerpt).* ### 219. This section, based on FATF 22-23, is designed to collect information on any ### _cr03208 - 219. This section, based on FATF 22-23, is designed to collect information on any ### Controls and monitoring of cash and cross-border transactions (FATF Recommendations 22–23) - FATF Recommendation 22 — Description: - The U.K. does not impose controls on the import and export of bank notes. - There are no reporting requirements for cross-border movements of currency or other negotiable instruments, or of high value commodities such as gold or diamonds, regardless of the amounts involved. - Consideration has been given to introducing such requirements, but it has generally been concluded that the law enforcement benefits were likely to be minimal compared with the high costs of implementing the requirements. - Cross-border movements are controlled through intelligence-based systems. - HMCE has authority under the DTA to seize cash being imported or exported if there are reasonable grounds to suspect the cash represents proceeds or instrumentalities of drug trafficking; seized cash can be held for up to two years or forfeited by means of a judicial order where the Court is satisfied that the origin or intended use of the funds is related to drug trafficking. - The Proceeds of Crime Act expands these seizure powers to cover movements of suspect cash within the U.K., and to allow seizure of property related to crimes other than drug trafficking. - FATF Recommendation 23 — Description: - The U.K. does not require reporting of information on domestic or international currency transactions above a fixed amount, and does not maintain systems for collecting and processing such information. - Authorities have considered automatic disclosure systems but generally concluded a suspicion-based reporting system is more cost-effective and that intelligence-led systems are more effective in the U.K. context than generic systems collecting all transactions above a certain amount. - Interpretative Note to FATF Recommendation 22 — Description: - U.K. authorities have considered requirements for cross-border transfers of cash, but concluded law enforcement benefits are likely minimal compared with high implementation costs; prefer intelligence-based control of cross-border movements. - HMCE statistics and macroeconomic reporting: - HMCE collects general information for statistical macroeconomic analysis and for reporting to the Fund and BIS as appropriate. - The U.K. Government does not normally keep statistics on shipments of items such as currency, negotiable instruments and precious metals. ### Ratings of Compliance with FATF Recommendations (selected entries from Table 34) - Selected Recommendation ratings (Based on Criteria — Rating): - 1 – Ratification and implementation of the Vienna Convention: 1 — COMPLIANT - 2 – Secrecy laws consistent with the 40 Recommendations: 43 — LARGELY COMPLIANT - 3 – Multilateral cooperation and mutual legal assistance in combating ML: 34, 36, 38, 40 — COMPLIANT - 4 – ML a criminal offense (Vienna Convention) based on drug ML and other serious offenses: 2 — COMPLIANT - 5 – Knowing ML activity a criminal offense (Vienna Convention): 4 — COMPLIANT - 7 – Legal and administrative conditions for provisional measures, such as freezing, seizing, and confiscation (Vienna Convention): 7, 7.3, 8, 9, 10, 11 — LARGELY COMPLIANT - 8 – FATF Recommendations 10 to 29 applied to non-bank financial institutions: See answers to 10 to 29 - 10 – Prohibition of anonymous accounts and implementation of customer identification policies: 45, 46, 46.1 — LARGELY COMPLIANT - 11 – Obligation to take reasonable measures to obtain information about customer identity: 46.1, 47 — LARGELY COMPLIANT - 12 – Comprehensive record keeping for five years of transactions, accounts, correspondence, and customer identification documents: 52, 53, 54 — LARGELY COMPLIANT - 14 – Detection and analysis of unusual large or otherwise suspicious transactions: 17.2, 49 — LARGELY COMPLIANT - 15 – If financial institutions suspect that funds stem from a criminal activity, they should be required to report promptly their suspicions to the FIU: 55 — LARGELY COMPLIANT - 16 – Legal protection for financial institutions, their directors and staff if they report their suspicions in good faith to the FIU: 56 — COMPLIANT - 17 – Directors, officers and employees, should not warn customers when information relating to them is reported to the FIU: 57 — COMPLIANT - 18 – Compliance with instructions for suspicious transactions reporting: 57 — COMPLIANT - 19 – Internal policies, procedures, controls, audit, and training programs: 58, 58.1, 59, 60 — LARGELY COMPLIANT - 20 – AML rules and procedures applied to branches and subsidiaries located abroad: 61 — COMPLIANT - 21 – Special attention given to transactions with higher risk countries: 50, 50.1 — LARGELY COMPLIANT - 26 – Adequate AML programs in supervised banks, financial institutions or intermediaries; authority to cooperate with judicial and law enforcement: 66 — COMPLIANT - 28 – Guidelines for suspicious transactions’ detection: 17.2, 50.1, 55.2 — LARGELY COMPLIANT - 29 – Preventing control of, or significant participation in financial institutions by criminals: 62 — LARGELY COMPLIANT - 32 – International exchange of information relating to suspicious transactions, and to persons or corporations involved: 22, 22.1, 34 — COMPLIANT - 33 – Bilateral or multilateral agreement on information exchange when legal standards are different should not affect willingness to provide mutual assistance: 34.2, 35.1 — COMPLIANT - 34 – Bilateral and multilateral agreements and arrangements for widest possible range of mutual assistance: 34, 34.1, 36, 37 — COMPLIANT - 37 – Existence of procedures for mutual assistance in criminal matters for production of records, search of persons and premises, seizure and obtaining of evidence for ML investigations and prosecution: 27, 34, 34.1, 35.2 — COMPLIANT - 38 – Authority to take expeditious actions in response to foreign countries’ requests to identify, freeze, seize and confiscate proceeds or other property: 11, 15, 16, 34, 34.1, 35.2, 39 — COMPLIANT - 40 – ML an extraditable offense: 34, 40 — COMPLIANT - SR I – Take steps to ratify and implement relevant United Nations instruments: 1, 34 — COMPLIANT - SR II – Criminalize the FT and terrorist organizations: 2.3, 3, 3.1 — COMPLIANT - SR III – Freeze and confiscate terrorist assets: 7, 7.3, 8, 13 — LARGELY COMPLIANT - SR IV – Report suspicious transactions linked to terrorism: 55 — LARGELY COMPLIANT - SR V – provide assistance to other countries’ FT investigations: 34, 34.1, 37, 40, 41 — COMPLIANT - SR VI – impose AML requirements on alternative remittance systems: 45, 46, 46.1, 47, 49, 50, 50.1, 52, 53, 54, 55, 56, 57, 58, 58.1, 59, 60, 61, 62 — rated where applicable — NA - SR VII – Strengthen customer identification measures for wire transfers: 48, 51 — NON-COMPLIANT ### Summary of effectiveness of AML/CFT efforts (selected findings from Table 35) - Criminal Justice Measures and International Cooperation — Key findings: - I—Criminalization of ML and FT: - U.K. law generally criminalizes money laundering on the basis of the Vienna and Palermo Conventions. - PCA 2002 updates, unifies, and expands ML offenses, broadens criminal intent requirement for certain crimes, removes distinctions between drug and non-drug ML, and consolidates dispersed provisions. - The U.K. has criminalized FT on the basis of the 1999 UN International Convention for the Suppression of the Financing of Terrorism. - Adequate and dissuasive sanctions are available for persons that commit ML or FT offences. - II—Confiscation of proceeds of crime or property used to finance terrorism: - U.K. law provides broad authority to confiscate property related to ML and FT, including laundered property and instrumentalities. - PCA 2002 would enhance powers by expanding restraint (freezing) orders, greatly expanding civil recovery powers, improving confiscation procedures, creating a new ARA focused on increasing criminal confiscation and taxing proceeds of crime. - Confiscation has not been a priority of the Crown Prosecution Services, which lacks resources to handle confiscation matters. - III—The FIU and processes for receiving, analyzing, and disseminating financial information and other intelligence: - NCIS functions as an effective FIU within the National Criminal Intelligence Service with functions related to all serious crimes. - NCIS has broad powers to gather, store and analyze information and to provide and disseminate criminal intelligence; systems are modern and sophisticated; cooperates effectively with national and overseas counterparts. - Implementation of PCA 2002 will substantially enhance NCIS operating arrangements and authority. - IV—Law enforcement and prosecution authorities, powers and duties: - U.K. law provides broad powers to investigate ML, FT and predicate offenses, including power to compel production of financial records and to use controlled delivery and undercover operations. - PCA 2002 will make customer information orders and account monitoring orders available in all criminal investigations. - Multiple agencies investigate and prosecute ML and FT; a national ML strategy drawing on all relevant agencies needs articulation. - Concerns: no single law enforcement entity covers all aspects of ML in the U.K.; Crown Prosecution Service does not prosecute matters other than narcotic ML; limited national vulnerability assessment activity beyond NCIS typologies; FSA willingness to use new criminal prosecution authority is unestablished. - V—International cooperation: - The U.K. has laws, informal arrangements and procedures allowing comprehensive cooperation in AML/CFT matters; most assistance is provided through informal processes. - Extradition arrangements exist but one-off statutory procedures are reported cumbersome; a bill to improve extradition procedures has been submitted to Parliament. - The U.K. has a comprehensive mutual legal assistance system coordinated by the U.K.CA and has improved response rate and turnaround times by devoting extra resources. - HMT’s support for FATF and regional FATF-style bodies has been essential. - Legal and Institutional Framework for All Financial Institutions — Key findings: - I—General framework: - Confidentiality and secrecy laws do not generally inhibit implementation of methodology criteria, with the exception of legal requirements applicable to attorneys and accountants that may prevent disclosure of the identity of underlying clients when attorneys or accountants open accounts to hold client funds. - FSA is the designated agency for ensuring FATF 40 + 8 Recommendations are effectively implemented in almost all prudentially regulated financial sectors; general insurance is not included. - FSA supervision is generally effective, though compliance checking of small securities firms is limited. - HMCE recently given responsibility for AML-CFT supervision of MSBs; HMCE applies a “light touch” supervisory regime to MSBs and oversight is too recent to be fully evaluated. - II—Customer identification: - Legal requirements for customer due diligence are contained in the 1993 Regulations and, for certain FSA-supervised firms, in the FSA Money Laundering Sourcebook. - Legal requirements are supplemented by non-mandatory Guidance Notes; together they provide a comprehensive standard effectively enforced or encouraged by supervisors. - III—Ongoing monitoring of accounts and transactions: - U.K. law imposes criminal liability to report knowledge or suspicion of ML or FT. - Neither law nor regulation imposes an affirmative obligation to pay special attention to complex transactions, to give special attention to transactions with persons in jurisdictions lacking adequate AML-CFT requirements, nor to give enhanced scrutiny to wire transfers. - Guidance Notes call for firms to monitor accounts and transactions in line with Methodology standards; FSA monitoring is effective. - IV—Record keeping: - With minor exceptions, the U.K. has comprehensive record keeping requirements in line with Methodology standards; FSA monitoring is effective subject to exceptions for general insurance and small securities firms. - V—Suspicious transactions reporting: - Financial institutions and MSBs are required to report suspicions of ML or FT under criminal laws and the 1993 Regulations, and under the Sourcebook for certain financial firms. - PCA 2002 will strengthen and streamline STR requirements, including requiring all STRs of regulated entities to be filed with NCIS and providing for a uniform system-wide STR form. - FSA implementation of STR requirement is effective subject to noted exceptions. - VI—Internal controls, compliance and audit: - U.K. requires internal controls and compliance functions applicable to AML that satisfy Methodology standards in most cases. - No express requirements concerning CFT internal controls and procedures; obligation to have AML systems may not extend to CFT where no ML is involved. - No comprehensive best practices or agreed approach concerning CFT controls currently. - FSA supervision provides effective implementation subject to qualifications for general insurance and small securities firms. - VII—Integrity standards: - Integrity standards under U.K. law and regulation generally conform to Methodology standards; FSA supervision achieves effective implementation among regulated firms. - Laws and regulations do not explicitly bar criminals from holding or controlling a significant investment in financial institutions or MSBs; no fit and proper or integrity-based regime for MSBs. - VIII—Enforcement powers and sanctions: - Violations of the Regulation’s requirements to adopt appropriate AML procedures and controls are punishable as a criminal offense. - No criminal sanctions apply for violation of regulatory requirements in the Sourcebook, but FSA has a broad range of enforcement tools under general authority. - The 1993 regulations do not provide for civil penalties for violations of AML-CFT systems and controls requirements. - HMCE has only limited civil sanctions to enforce compliance by MSBs with AML-CFT requirements. - IX—Co-operation between supervisors and other competent authorities: - FSA is generally adequately funded, staffed and provided with technical resources and specialized expertise to carry out AML-CFT responsibilities; additional resources would permit more thorough compliance checking. - HMCE has adequate technical resources and specialized expertise, but it is unclear if the planned self-financing scheme for MSB supervision will provide adequate funding to carry out responsibilities under the 2001 Regulations. - Under FSMA, FSA has broad authority to cooperate and share information with other competent authorities without court authorization; FSA is proactive in exercising this authority. - HMCE has similar authority although operational practices regarding MSBs are too early to evaluate. ### Recommended Action Plan (selected entry from Table 36) - Criminal Justice Measures and International Cooperation — I—Criminalization of ML and FT: - Recommended Action 1: The U.K. should ratify as soon as possible the UN Convention Against Transnational Organized Crime 2000 (Palermo Convention). *Source: _cr03208 - 219. This section, based on FATF 22-23, is designed to collect information on any* ### 2. The definition of ML under the 1993 Regulations ### 2. The definition of ML under the 1993 Regulations ### Definition and legislative cross-references - The definition of ML under the 1993 Regulations (section 2 (3)) should be corrected to cross-reference current laws (including recent FT legislation) and delete obsolete cross-references. ### II—Confiscation of proceeds of crime or property used to finance terrorism - The PCA 2002 provisions governing confiscation, seizure, assets recovery and civil recovery should be made effective as soon as possible, given the significant enhancements they make to the U.K. regime. ### III—The FIU and processes for receiving, analyzing, and disseminating financial information and other intelligence at the domestic and international levels - 1. The PCA should be made effective as soon as possible, given its substantial enhancements to the arrangements under which NCIS functions. - 2. NCIS (or other appropriate government agency) should be given authority to impose civil fines on reporting parties – other than prudential regulated financial institutions – that fail to comply with their reporting obligations under the 1993 Regulations. - 3. Consideration should be given to providing NCIS with the power to get supporting documents (rather than general information) from reporting parties that file STRs with it. ### IV—Law enforcement and prosecution authorities, powers and duties - 1. As there is no law enforcement entity that has as its mission the investigation of criminal acts and foreign counter-intelligence, the U.K. should seriously consider the creation of a national law enforcement organization which has both these elements. - 2. Consideration should be given to passing legislation that makes wiretap evidence admissible in judicial proceedings. - 3. Special legislative considerations should be given to protecting national security information while balancing the defendants right to have access (in some form) to relevant evidence. - 4. NCIS or other competent authorities should undertake a U.K. trend analysis and vulnerability study of how and where money—especially cash—is laundered in the United Kingdom, in order to focus priorities and successfully use the new PCA 2002 and ARA powers. - 5. Prosecutors and judges should be trained on ML and asset confiscation so as to ensure adequate application of U.K. legislation. ### V—International cooperation - Legislation to enhance the statutory provisions on extradition should be adopted as soon as possible. ### Legal and Institutional Framework for Financial Institutions #### I—General framework - 1. Existing legal constraints should be relaxed on the ability of attorneys and accountants to identify their clients when acting on behalf of those clients. Financial institutions and MSBs should be cautioned against doing business with attorneys and accountants that are unable to provide information about the customers for whom they are opening accounts. - 2. The self-financing scheme for HMCE supervision of MSBs should be kept under close review, to determine whether or not it can reasonably be expected to produce enough fees to enable HMCE to reasonably carry out its functions under the 2001 Regulations. #### II—Customer identification - 1. Financial institutions and MSBs should be required by law to include accurate and meaningful originator information on funds transfers and related messages that should remain with the transfer or message through the payment chain. - 3. General insurance should be brought within the scope of the 1993 Regulations and FSA Rules with compliance checking of the insurance sector strengthened. - 4. Small securities firms should be subject to systematic checks by FSA for compliance with AML-CFT due diligence and record keeping requirements, if only on a sampling basis. - 4. Industry Guidance Notes should be prepared for MSBs. - 5. Tighter limits should be placed on the circumstances in which firms may accept funds from applicants before satisfactory identity is obtained. In addition, the “financial exclusion” provision of the FSA Sourcebook should be drafted more narrowly so as to cover only financially disadvantaged persons. - 6. Consideration could be given to assigning a supervisory authority to ensure compliance with the 1993 Regulations by covered entities that are not financial institutions or MSBs. #### III—Ongoing monitoring of accounts and transactions - The 1993 Regulations and FSA Sourcebook should be revised (or other appropriate legal instrument issued) to impose an affirmative legal obligation for financial institutions and MSBs: - a) to pay special attention to unusual transactions with no apparent economic or lawful purpose; - b) to give special attention to business relations and transactions with persons in jurisdictions that do not have adequate systems in place to prevent or deter ML and FT; and - c) to give enhanced scrutiny to wire transfers that do not contain complete originator information. #### IV—Record keeping - 1. Minimum information requirements should be made mandatory by amending the 1993 Regulations and the Sourcebook. - 2. Financial institutions and MSBs should be required to keep records of the basis on which exceptions are granted to customer due diligence requirements. #### V—Suspicious transactions reporting - 1. Part 7 of the PCA 2002 will significantly strengthen the legal regime for suspicious transactions reporting and should be made effective as soon as possible. - 2. Consideration should be given to amending the 1993 Regulations and the Sourcebook, or to introducing new regulations, to impose FT-related suspicious transactions reporting requirements. #### VI—Internal controls, compliance and audit - 1. Consideration should be given to requiring financial institutions and MSBs to adopt internal controls and procedures, and designate an appropriate compliance person, to prevent their institutions from being used for FT as such (rather than only for ML and FT-related predicate offenses). - 2. Consideration should be given to expressly requiring that the AML/CFT programs of financial institutions and MSBs must include an audit function. - 3. The 1993 Regulations should be revised to expressly require that the “appropriate person’ required under the Regulations to handle the internal and external reporting requirements of the Regulations must be at management level. - 4. MSBs should be required to put in place adequate screening procedures to ensure high standards when hiring employees. #### VII—Integrity standards - 1. The 1993 Regulations, Sourcebook or other appropriate legal provisions should be revised to explicitly prohibit criminals from holding or controlling a significant investment in financial institutions and MSBs. - 2. The 2001 Regulations should also be revised to give HMCE powers to deny or cancel the registration of MSBs for integrity-related factors (e.g., previous convictions for ML, FT or similar serious crimes of the MSB, its controlling shareholders or managers). #### VIII—Enforcement powers and sanctions - The 1993 Regulations should be revised to provide for civil penalties (administrative fines), in addition to the existing criminal penalties, for failure to observe the Regulations’ requirements to adopt appropriate AML procedures and controls. This is particularly important with respect to strengthening HMCE’s enforcement authority over MSB’s. #### IX—Co-operation between supervisors and other competent authorities - (Section listed; recommendations cross-referenced in sector-specific sections below.) ### Sector-specific highlights #### Banking Sector - II—Customer identification: Financial institutions and MSBs should be cautioned against doing business with attorneys and accountants that are unable to provide information about the customers for whom they are opening accounts. - III—On-going monitoring of accounts and transactions - IV—Record keeping - VI—Internal controls, compliance and audit - VIII—Enforcement powers and sanctions - IX—Co-operation between supervisors and other competent authorities #### Insurance Sector - II—Customer identification - 1. General insurance should be brought under the 1993 Regulations and the FSA Money Laundering Rules. - 2. FSA monitoring of the insurance sector for compliance with AML-CFT requirements should be intensified. - 3. The JMLSG Guidance Notes should be updated to address the identification requirements where claims, commissions, and other monies are to be paid to persons (including partnerships, companies, etc.) other than the policyholder. - III—On-going monitoring of accounts and transactions - The JMLSG Guidance Notes should be updated to address specifically procedures for dealing with the AML/CFT risks from the practice of buying and selling second endowment policies, as well as the risks associated with use of single premium unit-linked policies. Similarly, the notes should be updated to include guidance that reinsurance or retrocessions should be checked to ensure that monies are paid to bona fide re-insurance entities at rates commensurate with the risks undertaken. - IV—Record keeping - V—Suspicious transaction reporting - The guidance notes have relatively few references to insurance business. It would be useful to include more such references, both to orient relevant insurance firms in compliance with AML/CFT and to raise awareness of AML/CFT risks in the insurance sector. - VI—Internal controls, compliance and audit #### Securities Sector - II—Customer identification - Procedures should by developed for more systematic, if randomized, verification of compliance with AML/CFT requirements by this group of firms. The U.K. AML/CFT regimes anticipates that financial service providers will be able to rely on the on the due diligence procedures followed by other entities subject to FSA supervision. (see discussion of criterion 79). The very limited oversight by FSA of AML/CFT compliance by the large number of small, low impact firms undermines the reliability of this system with respect to customer identification practices by these firms. - IV—Record keeping - VI—Internal controls, compliance and audit - VII—Integrity standards - VIII—Enforcement powers and sanctions - IX—Co-operation between supervisors and other competent authorities ### Authorities’ response to the assessment - 220. The U.K. authorities welcomed the assessment that the U.K. complies well with the FATF 40+8 Recommendations, with the exception of Special Recommendation VII concerning the inclusion of originator information on wire transfers. As the assessment acknowledges, the U.K. plans to legislate to implement this Recommendation when the FATF has issued an Interpretative Note clarifying some important details arising from this Recommendation. - 221. The authorities noted that many of the suggestions in the FSAP for further improvements would be implemented when the Proceeds of Crime Act is brought fully into effect in the early part of 2003. The Assets Recovery Agency, which will commence operations on 24 February 2003, will focus on increasing criminal confiscation proceeds, implementing the new civil recovery powers, and improving training through the establishment of a new Centre of Excellence. A review of the arrangements for dealing with suspicious transaction reports was underway and the government intended to publish a national Money Laundering Strategy in 2003. - 222. The authorities said that they would consider the rest of the FSAP recommendations, some of which would require new legislation, against their general policy of applying AML/CFT controls on a risk basis, with the tightest controls and greatest resources focused on the areas with the greatest vulnerability. Proposals for new measures would be assessed using cost-benefit principles. The authorities are not convinced that some of the recommendations contained in the FSAP could be justified applying risk-based principles. However, they stressed that all aspects of the system are kept under review and changes will be made to it in the light of emerging evidence about vulnerability to money laundering and terrorist financing. - 223. The authorities had the following specific comments on the recommendations: - On scope of the criminal offence of ML, the definitions of money laundering under the 1993 Money Laundering Regulations will be updated when the Regulations are revised in June 2003, to implement the 2nd EU Money Laundering Directive. The U.K. authorities note that the current technical deficiencies in the definition have no practical effect on the ability to detect and prosecute money laundering. - On provisional measures and confiscation, the referenced provisions will be made effective in the early months of 2003. - On general role of financial system in combating ML, consideration will be given to the proposal here, but the U.K. authorities are not convinced, at present, that this would be proportionate to the money laundering risk in this sector. - On customer identification and record-keeping rules, consideration will be given to all the suggestions. The basis will be whether they can be justified on cost-benefit principles given the extent of the vulnerability in these areas. Several of these proposals have been examined before and rejected because they have not been regarded as proportionate to the risk e.g. the risk of money laundering through general insurance business is generally acknowledged to be low. However, all these issues are kept under review. - On increased diligence of financial institutions, the PCA 2002 provisions governing suspicious transaction reporting will be implemented on 24 February 2003. Consideration will be given to the suggestions on suspicious transaction reporting and monitoring of accounts and transactions, applying the risk-based criteria discussed above. - On implementation & role of regulatory and other administrative authorities, the recommendations will be considered, applying the risk-based criteria discussed above. - On other forms of cooperation, legislation is currently before Parliament to do this. - On wire transfers, the U.K. will legislate to do this when the FATF Interpretative Note clarifying some details has been adopted by the FATF. - On law enforcement and prosecution, the proposal for a national law enforcement organization raises issues that go well beyond the investigation of and collection of intelligence about money laundering. It would also require new legislation and fundamental changes in policing and intelligence collection. The assessors’ comments are a valuable contribution to that wider discussion. With respect to wire-tapping legislation, there are good arguments for and against this suggestion which has been considered in the past and is kept under review. With respect to the proposed trend analysis and vulnerability study, NCIS is planning to conduct further analysis along those lines with contributions from partner agencies. On training of prosecutors and judges, such training programs are currently being arranged following the passage of the PCA 2002 and the new legislative provisions in these areas. *IMF staff assessment excerpt: _cr03208 - 2. The definition of ML under the 1993 Regulations_* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2003/_cr03208.pdf_