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---

### Macroeconomic and Financial Setting
- Guernsey is one of the three British Crown Dependencies; not part of the UK or the EU; has its own parliament, legal and regulatory system, and tax regime; uses the pound Sterling.
- Population: around 60,000.
- GDP: GBP 1.9 billion in 2009.
- Financial services account for nearly 40 percent of GDP and a quarter of total employment in 2009.
- Key financial activities: collective investment schemes (CIS), insurance (particularly captive insurers), trust and company services, and banking.
- Number of banks licensed: fell from 54 in 2002 to 43 at December 31, 2009.
- Recent macro outcomes:
  - Real GDP growth averaged 2 percent over the last decade but is volatile.
  - GDP growth: 5.2 percent in 2008; -2.2 percent in 2009.
  - Unemployment rate: 1.4 percent (noting unemployment doubled since mid-2007).
  - Retail price inflation: 2.2 percent for 2009.
- No central bank or independent monetary policy; adjustments rely on price and wage flexibility, labor mobility, and fiscal measures.
- In a customs union with the EU; physical exports enjoy access without tariff barriers.

### Financial Sector Structure and Key Statistics
- Sectoral shares (by value of assets):
  - CIS sector: 50 percent of total financial sector assets.
  - Banking: 43 percent.
  - Insurance: 7 percent.
- Funds and fiduciary:
  - Nearly 900 funds with GBP 133 billion under management (net asset value); reduction from nearly GBP 160 billion pre-crisis.
  - Gross assets (with leverage): GBP 161 billion.
  - Non-domiciled open-ended schemes: GBP 49 billion.
- Banking system (Balance sheet, End-2009, GBP millions):
  - Assets: GBP 135,803.
  - Loans to Banks: GBP 75,605.
  - Loans to parent: GBP 56,464.
  - Marketable Assets: GBP 24,353.
  - Loans and Advances: GBP 25,710.
  - Deposits due to: GBP 114,751.
  - Deposits due to Parent/holding company or group: GBP 65,508.
  - Capital: GBP 2,273.
  - Assets represent 7,893.9 percent of (end-2008) GDP as presented in the table.
- Insurance sector:
  - Two segments: domestic (21 insurers) and international (678 firms, including 323 cells).
  - Captive insurers account for around 60 percent of the market.
  - Total premiums in 2008: GBP 3.3 billion; sector gross assets: GBP 21 billion.
- Banking assets and deposits:
  - Deposits peaked at GBP 158 bn during 2008; dropped back to around GBP 120 bn (2007 level).

### Stability Issues, Crisis Impact, and Vulnerabilities
- Dependence on financial sector performance; CIS is the largest sector; banks primarily hold claims on parent group companies.
- Crisis impacts:
  - Banks affected mainly through stresses at parent groups (notably a Guernsey subsidiary of an Icelandic bank placed in administration).
  - 2009 economic growth dropped to -2 percent in response to the global downturn.
- Key vulnerabilities identified:
  - Concentration risk and intra-group contagion: "42 percent of the banks’ assets constitute direct credit exposure within the groups."
  - High credit relative to the economy: total credit is "about 400 percent of GDP."
  - Concentration of credit among local economy (almost 6 percent of assets) and other financial sector counterparts (13.5 percent of assets).
  - FX rate risk: "Total foreign currency-denominated loans to total loans" rose to 75.0 (2008) and 73.4 (2009) in FSIs; hedging common but large FX movements could reduce capital bases.
  - Parent-bank solvency/liquidity risk: likelihood "Assessment: Low" but impact "Assessment: High."
  - Failure of large exposures: "Assessment: Low to Medium" likelihood, "Assessment: High" impact.
  - Operational/internal risks: reputation risk, immigration restrictions, excessive outsourcing.

### Financial Soundness Indicators (selected exact figures)
- Regulatory capital to risk-weighted assets: 19.8 (2003); 20.4 (2004); 18.8 (2005); 19.0 (2006); 17.6 (2007); 14.9 (2008); 19.3 (2009).
- Regulatory Tier I capital to risk-weighted assets: 19.5 (2003); 20.1 (2004); 18.4 (2005); 18.3 (2006); 17.0 (2007); 13.8 (2008); 18.0 (2009).
- Capital to assets: 2.0 (2003); 1.9 (2004); 1.5 (2005); 1.4 (2006); 1.2 (2007); 1.2 (2008); 1.7 (2009).
- Domestic geographical distribution of loans to total loans: 7.5 (2003); 8.0 (2004); 5.6 (2005); 5.3 (2006); 5.0 (2007); 4.8 (2008); 9.7 (2009).
- Cross-border distribution of loans to total loans: 92.5 (2003); 92.0 (2004); 94.4 (2005); 94.4 (2006); 95.0 (2007); 95.2 (2008); 90.3 (2009).
- Of which: UK: 48.5 (2003); 47.2 (2004); 50.8 (2005); 43.8 (2006); 40.8 (2007); 43.0 (2008); 46.4 (2009).
- Nonperforming loans (NPLs) to total gross loans /10: 0.0 (2003); 20.0 (2004); 20.0 (2005); 20.0 (2006); 40.0 (2007); 10.0 (2008); 30.0 (2009).
- Loan-loss provisions to nonperforming loans: 21.7 (2003); 21.2 (2004); 55.4 (2005); 19.3 (2006); 20.0 (2007); 16.5 (2008); 7.5 (2009).
- Sum of ten largest exposures to capital: 201.7 (2003); 198.6 (2004); 224.1 (2005); 304.4 (2006); 270.9 (2007); 233.2 (2008); 132.9 (2009).
- Insurance sector statutory coverage ratio (share capital basis): Life companies: more than 1200 percent; Non-life firms: more than 800 percent.
- Banking system capitalization dropped "by 4-5 percentage points compared with pre-crisis levels (to 14.9 percent by end 2008)." By end-2009, asset quality, profitability and capitalization "were back at pre-crisis levels."

### Stress Testing: Methods, Coverage, and Outcomes
- Approaches: both top-down (TD) and bottom-up (BU) stress tests; severity based on historical stress scenarios and expert assumptions.
- Coverage: "About two thirds of the sector assets were covered, including 19 out of 21 subsidiaries and 5 out of 21 branches."
- Principal risk drivers: credit risk (parental claims, large concentrated exposures), foreign exchange risk, asset price risk; interest rate risk considered minor.
- Selected solvency stress test outcomes (verbatim table excerpts):
  - Pre-shock capital: CAR 18.1 (In GBP m 10.0; Max. 75.0; No. banks breaching min. CAR 0.0; Min. CAR 18.5; In percent 9.8; In GBP m 90.8; In percent of GDP 10.9; Recapitalization needs 0.1).
  - Credit shock C3 (Default of the three largest exposures excluding the parent bank): CAR outcome entries include "15.7 -106.3 75.0 3244.3 14.2 12.0 -21.6 59.9 6371.9 21.6".
  - Credit shock C7 (10 percent of banks’ claims on their parent banks fail): CAR outcome entries include "7.6 -109.1 69.6 9749.8 43.6 0.3 -15.0 73.9 131,294.1 75.2".
  - Scenario analysis (I4 & F3 & A2 & C2 & O2) summary: "15.4 -64.5 73.1 366.3 3.9".
- Conclusion: main vulnerabilities center on credit exposures to parents and large concentrated counterparties; some scenarios imply substantial recapitalization needs for affected banks.
- Banking sector resilience:
  - Aggregated shocks (combined severe macro shock): three banks (of 19) at risk; recapitalization needs limited except for one bank.
  - Test A3 noted as "probably the most conservative test" and shaped assessment of asset price risk as "relatively limited."

### Liquidity Stress Tests (selected verbatim results)
- Severe run scenario: daily withdrawal of 30 percent of deposits for five consecutive days.
- Table 7 excerpts (as in source) — Test L1 (interbank funding remains available, no additional intragroup funding):
  - Day 1 0 1 1033
  - Day 2 0 1 1235
  - Day 3 1 2 37411
  - Day 4 3 2 510414
  - Day 5 7 2 913417
- Test L2 (interbank funding essentially closed, no additional intragroup funding):
  - Day 1 0 1 1336
  - Day 2 1 2 36410
  - Day 3 2 9 12416
  - Day 4 1 1 21315419
  - Day 5 1 2 31516521
- Notes in source:
  - (i) All Marketable Securities are Liquid (as is Cash)
  - (ii) Only Government Securities Remain Liquid (and Cash)
- Footnote: "The exercise included deposits available within a month."
- Liquidity conclusion: under a highly severe run and limited parental support, some Guernsey banks could run out of liquidity within a week; DCS helps mitigate name crisis but general run cannot be precluded given lack of lender of last resort.

### Deposit Compensation Scheme (DCS) — Design and Recommendations
- Coverage: deposits of individual depositors, wherever located, up to a maximum of £50,000 per person.
- Scheme features:
  - Not funded; has government-guaranteed liquidity back-up.
  - Aim to pay compensation within three months of a bank failure.
  - Maximum total amount of compensation capped at £100 million in any five-year period; payouts would be scaled back if multiple banks or one of the largest banks fail in the period.
- As at September 2008: some 180,000 depositors had deposits covered.
- Coverage analysis: near 100 percent coverage in case of a single bank failing for subsidiaries; 62 percent coverage for bank branches.
- Funding: Scheme paid for by banks through annual charges and special charges in event of failure.
- Recommendations:
  - Make limitations clear to depositors and complete practical preparations for payouts.
  - Ensure banks have IT systems to identify covered deposits promptly.
  - Board of the DCS should develop policies on use of powers (including financial support to prevent failure) and coordinate with GFSC powers (CP 23).
  - Medium-term review recommended: consider reducing payout period, reviewing cap on total payouts, ex ante funding, and risk-based assessment of banks.

### Policy Priorities and Recommendations (Action Agenda)
High priority (short-term, within 12 months)
- Monitor financial position of bank parent companies, using FSIs relating to solvency; add and monitor data on large exposures (for borrower units).
- Add senior analyst level expertise to GFSC staff to analyze risk across sectors using supervisory data and other information.
- Establish a forum devoted to monitoring financial stability and coordinating policy responses.
- Complete preparations on potential deposit compensation payouts.

Medium priority (medium-term, 1–3 years) and short-term items identified
- Amend the Financial Services Commission (Bailiwick of Guernsey) Law (FSC Law) to provide for longer terms of office for the chairman of the GFSC. (Medium-term, 1–3 years)
- Broaden the range of enforcement powers for insurance regulation. (Medium-term, 1–3 years)
- Consider how best to implement the public disclosure standards established by the IAIS for insurance regulation. (Short-term, within 12 months)
- Collect and publish statistics on assets held by trusts and companies serviced by the Guernsey fiduciary sector. Make more comprehensive insurance sector data available. (Medium-term, 1–3 years)
- Further develop assessments of economic capital requirements (OSCA) and stress tests for insurers. (Medium-term, 1–3 years)
- Create an ombudsman service for adjudicating complaints by individual retail consumers. (Medium-term, 1–3 years)
- Extend investor compensation arrangements beyond current limited scope. Review the DCS in light of international standards. (Medium-term, 1–3 years)

Additional supervisory and financial stability guidance
- GFSC should be prepared to progressively limit exposures of a bank (subsidiary) to its parent as strains become apparent.
- Improve corporate governance at financial institutions.
- Engage more extensively with supervisors of parent groups, recognizing practical cooperation limits in stress times; consider applying to become members of colleges for important banks.
- Within GFSC, dedicate resources to financial stability work covering the full scope of GFSC responsibilities.
- Mitigate liquidity risks by strengthening the DCS and increasing holdings of marketable liquid assets in light of absence of lender of last resort.
- For insurers, pursue risk-based stress testing, standardize solvency measures, and move toward a risk-based solvency regime (Solvency II or equivalent).

### Regulatory Framework, GFSC Role, and Implementation Steps
- GFSC mandate: effective supervision of financial services, maintain confidence, safety, soundness and integrity, combat financial crime and terrorist financing.
- Governance and resourcing:
  - Six commissioners elected by the States of Deliberation on nomination of the Policy Council.
  - GFSC funded by industry fees; had 96 staff at time of report (noted elsewhere as over 100 staff in later text).
- Reforms and legislative actions:
  - Banking Supervision (Bailiwick of Guernsey) Regulations 2010 came into operation on April 30, 2010; designed to address CP4, CP9, CP11, CP15, CP17 and other recommendations.
  - Financial Services Commission (Administrative Financial Penalties) (Bailiwick of Guernsey) Regulations, 2010 came into force on 1 September (2010) to permit administrative fines.
  - Implementation of Basel II for banks in January 2008.
- Observance assessments:
  - Assessments conducted for Basel Committee Core Principles (BCP) and IAIS Insurance Core Principles (ICP).
  - A separate FATF 40+9 assessment on AML/CFT was conducted; detailed assessment report nearing completion.

### Taxation Regime and International Tax Cooperation
- Individual income tax: 20 percent rate retained under 2007 review.
- Corporate income tax:
  - Reduced from start of 2008 to zero for most companies.
  - Exceptions: traditional banking profits taxed at 10 percent; utilities and property companies taxed at 20 percent.
- Other taxes: no capital gains, wealth, inheritance, or general sales taxes; residents pay social security contributions.
- EU Savings Directive and exchange of information:
  - Participated under transitional option; Policy Council announced movement to full automatic exchange of information from January 1, 2011 (to be completed by July 1, 2011).
- Tax-information exchange agreements:
  - OECD deemed Guernsey to have implemented international standards on exchange of tax information.
  - Signed 15 tax information exchange agreements (TIEAs); negotiating more (OECD minimum asked for is 12).
- Corporate tax regime review:
  - "Zero/ten" regime under review after UK communications and EU Code of Conduct concerns.
  - Guernsey consultation document published June 21, 2010 outlining technical options; one alternative discussed was a uniform 10 percent rate.

### Insurance, Investment Business, Trusts, AML/CFT, and Market Conduct
- Insurance supervision:
  - GFSC adopts risk-based approach; OSCA introduced and well received.
  - As at March 3, 2010 insurers’ loans to parents totaled £5.8 billion of which £5.2 billion was approved for solvency purposes (33 percent of net assets); excluding two large captives, loans to parents amount to £1.1 billion of which £392 million (2.2 percent of net assets) approved.
  - GFSC assessing Solvency II implications and commissioned independent review of equivalence.
  - Recommendations include expanding enforcement powers, implementing IAIS disclosure standards, and establishing cooperation with home/host supervisors.
- Investment funds and regulation:
  - Full quarterly statistics published on Guernsey funds.
  - Fast-track approvals for funds aimed at professional or non-Guernsey investors (within three days).
  - Investor compensation currently limited (GBP 60,000 max for losses from administrator/trustee/custodian defaults for retail funds marketed in the UK); review underway to consider extension and pre-funding.
  - AIFM Directive developments monitored due to EU orientation of business.
- Trust and company service providers:
  - Nearly 200 licensed service providers; around 1,500 new companies registered on average each year.
  - No collected data on value of trusts and companies’ assets; estimated at hundreds of billions of pounds.
  - Recommendation to reinstate collection of asset value data.
- AML/CFT:
  - Legal framework comprehensive and criminalizes ML and TF fully in line with international standard.
  - Financial Intelligence Service (FIS) adequate.
  - Supervisory powers adequate; sanctioning regime for discretionary financial penalties not considered sufficiently dissuasive and proportionate.
  - A separate FATF assessment mission held in May 2010; detailed AML/CFT ROSC nearing completion.
- Audit oversight and market conduct:
  - No official domestic oversight of audit quality for Guernsey companies; auditors reviewed by professional bodies.
  - Companies’ law amendments (April 2010) require Guernsey audit firms for companies listed on EU regulated markets to register with Guernsey Company Registry.
  - Ombudsman scheme recommended to handle unresolved customer complaints.

### Basel Core Principles (BCP) and Insurance Core Principles (ICP) Findings and Recommended Actions (selected)
- BCP assessment: confirms high standard of prudential regulation and supervision; issues from 2003 largely addressed.
- Selected recommended legal/regulatory actions for banking (CP references preserved):
  - CP1.2: Extend Chairman’s term of appointment to international norm.
  - CP4: Amend law to give GFSC power to review, object to, and reject transfers of significant ownership interests.
  - CP5: Provide power regarding major acquisitions.
  - CP9: Authorize GFSC to require banks to increase provisioning and overall financial strength.
  - CP10/CP11: Apply large exposure limits on a consolidated basis; require board approval and market terms for related-party transactions.
  - CP15: Limit outsourcing of essential functions; issue outsourcing guidance.
  - CP17: Require banks to have permanent internal audit and compliance functions.
  - CP21: Permit administrative fines; require top management certification of prudential reports.
- ICP assessment: GFSC largely observant with areas to enhance:
  - ICP 15: Consider broader enforcement powers (judicial managers, receivers).
  - ICP 16: Consider legal provision to give policyholders and claimants high priority in insolvency; policies on pledging/encumbrance of assets.
  - ICP 18–20: Refine risk matrix, provide guidance on captive insurers without reinsurance, consider explicit legal provision on technical provisions.
  - ICP 25–26: Enhance cooperation with foreign supervisors and implement IAIS public disclosure standards.
- Authorities’ implementation:
  - Banking Supervision (Bailiwick of Guernsey) Regulations, 2010 (in force April 30, 2010) and Financial Services Commission (Administrative Financial Penalties) Regulations, 2010 (in force September 1, 2010) cited as addressing many recommendations.
  - GFSC to consider and act on remaining insurance recommendations and disclosure rules coming into force in September 2010 (to be reviewed against revised IAIS ICPs in October 2011).

*IMF staff report excerpt as provided in the source content.*

### Executive Summary and Policy Agenda ....................................................................................

### Executive Summary and Policy Agenda

### Macroeconomic and Financial Setting
- Guernsey is one of the three British Crown Dependencies (the others being Jersey and the Isle of Man). It is not part of the UK or the EU, has its own parliament, legal and regulatory system, and tax regime, and uses the pound Sterling as its currency.
- Population: around 60,000.
- GDP: GBP 1.9 billion in 2009.
- Financial services account for nearly 40 percent of GDP and a quarter of total employment in 2009.
- Key financial activities: collective investment schemes (CIS), insurance (particularly captive insurers), trust and company services, and banking.
- Number of banks licensed: fell from 54 in 2002 to 43 at December 31, 2009.
- Recent macro outcomes:
  - Real GDP growth averaged 2 percent over the last decade but is volatile.
  - GDP growth: 5.2 percent in 2008; -2.2 percent in 2009.
  - Unemployment rate: 1.4 percent (noting unemployment doubled since mid-2007).
  - Retail price inflation: 2.2 percent for 2009.
- Guernsey has no central bank and no independent monetary policy; adjustments rely on price and wage flexibility, labor mobility, and fiscal measures.
- Guernsey is in a customs union with the EU and its physical exports enjoy access to member countries without tariff barriers.

### Stability Issues and Stress Tests
- The development of Guernsey’s economy depends on the performance of the financial sector.
- The financial sector is diverse and highly interrelated; CIS (rather than banking) make up the largest sector; banks primarily hold claims on parent group companies.
- Impact of the global financial crisis:
  - The crisis particularly affected banks through stresses at parent groups (notably a Guernsey subsidiary of an Icelandic bank placed in administration when it could not draw down funds within its group).
  - 2009 economic growth dropped to -2 percent in response to the global downturn.
- Stress-test conclusions:
  - Main vulnerabilities for banks:
    - Concentration risk and spillovers from parent banks.
    - Macro-financial risks through FX rate risk and asset price risk (to a lesser degree).
  - Life insurance sector:
    - Exhibits considerable resilience against shocks.
    - Losses observed in 2008 indicate the need for careful monitoring and timely, risk-sensitive solvency indicators.
- Structural challenges:
  - Corporate tax regimes across the three Crown Dependencies are under review, creating uncertainty for some businesses.
  - Changes in international regulations (particularly EU rules for banks and non-banks) could have important implications for Guernsey.

### Financial Sector Oversight and Regulatory Framework
- Overall assessment:
  - Financial sector regulation and supervision are of a high standard across sectors, reflecting enhancements to powers and resources in recent years.
  - Observance assessments were conducted for the Basel Committee Core Principles for Effective Banking Supervision (BCP) and the International Association of Insurance Supervisors Insurance Core Principles (IAIS ICP).
  - A separate mission assessed observance of FATF 40+9 Recommendations; AML/CFT assessment results will be in a separate report.
- Insurance sector:
  - Solvency regulation has been strengthened through the introduction of the Own Solvency Capital Assessment (OSCA).
- Investment sector:
  - Regulation enhanced by new conduct of business requirements.
  - Fund framework reformed to support reorientation to funds aimed at professional investors.
- Trust and company services:
  - Effective regulation, but recommendation to collect more economic data on the value of trust and company assets.
- GFSC (Guernsey Financial Services Commission):
  - Powers strengthened (including discretionary financial penalties).
  - Independence from government reinforced while preserving accountability.
  - Cooperates with home supervisors of institutions active on the island.
  - Appears adequately resourced overall, but needs more resources for cross-sector risk analysis using regulatory data and other information.
  - Effective enforcement for banks.
- Depositor Compensation Scheme (DCS):
  - Introduced and welcomed.
  - Limitations must be carefully communicated to depositors.
  - DCS design differs from many larger jurisdictions and international best practice:
    - Does not provide that depositors will always be fully compensated in a certain amount.
    - Target payout time is longer than elsewhere.
  - Recommendation to review the approach in the medium term in light of developing international standards.

### Policy Priorities and Recommendations (Key Findings and Agenda)
High priority (short-term, within 12 months)
- Monitor financial position of bank parent companies, using financial soundness indicators (FSIs) relating to solvency. Add and monitor data on large exposures (for borrower units).
- Add senior analyst level expertise to the staff of the GFSC to analyze risk across sectors using supervisory data and other information.
- Establish a forum devoted to monitoring financial stability and coordinating policy responses.
- Complete preparations on potential deposit compensation payouts (should the need arise in the future).

Medium priority (medium-term, 1–3 years) and short-term items identified
- Amend the Financial Services Commission (Bailiwick of Guernsey) Law (FSC Law) to provide for longer terms of office for the chairman of the GFSC. (Medium-term, 1–3 years)
- Broaden the range of enforcement powers for insurance regulation. (Medium-term, 1–3 years)
- Consider how best to implement the public disclosure standards established by the IAIS for insurance regulation. (Short-term, within 12 months)
- Collect and publish statistics on assets held by trusts and companies serviced by the Guernsey fiduciary sector. Make more comprehensive insurance sector data available. (Medium-term, 1–3 years)
- Further develop the assessments of economic capital requirements (OSCA) and stress tests for insurers. (Medium-term, 1–3 years)
- Create an ombudsman service for adjudicating complaints by individual retail consumers. (Medium-term, 1–3 years)
- Extend investor compensation arrangements beyond current limited scope. Review the DCS in light of international standards. (Medium-term, 1–3 years)

Additional supervisory and financial stability guidance highlighted
- GFSC should be prepared to progressively limit exposures of a bank (subsidiary) to its parent as strains become apparent.
- Improve corporate governance at financial institutions.
- Engage more extensively with supervisors of parent groups, recognizing practical limits on cooperation, especially in time of stress.
- Consider reviewing institutional arrangements for addressing financial stability issues, including establishing a forum devoted to monitoring financial stability and coordinating policy.
- Within the GFSC, dedicate resources to financial stability work covering the full scope of GFSC responsibilities.

*Executive Summary and Policy Agenda — IMF FSAP Update (Guernsey)*

### 5.      Guernsey has a low taxation regime, which was comprehensively reviewed in

### 5.      Guernsey has a low taxation regime, which was comprehensively reviewed in 2007

### Taxation regime and international tax cooperation
- Individual income tax: a 20 percent rate for individual income tax was retained under the 2007 review.
- Corporate income tax:
  - Reduced from the start of 2008 to zero for most companies.
  - Exceptions: profits derived from traditional banking (i.e., lending) activities taxed at 10 percent, and utilities and property companies taxed at 20 percent.
- Other taxes and contributions:
  - There are no capital gains, wealth, inheritance, or general sales taxes.
  - Residents are subject to social security contributions.
- EU Savings Directive and exchange of information:
  - Guernsey participates in the EU Savings Directive framework and withheld tax on payments of savings income to EU residents under a transitional option.
  - On July 28, 2010, the Policy Council announced a movement to full automatic exchange of information from January 1, 2011 (to be completed by July 1, 2011).
- Tax-information exchange agreements and standards:
  - Guernsey has been deemed by the OECD to have implemented international standards on exchange of tax information.
  - It has signed 15 tax information exchange agreements (TIEAs) and is negotiating more—the minimum number asked for by the OECD is 12.

### Corporate tax regime review and pressures
- Following communication via the UK that certain member states considered the “zero/ten” corporate tax regime to be noncompliant with the spirit of the EU Code of Conduct, the corporate tax regime was again under review.
- A Guernsey consultation document was published on June 21, 2010 outlining several technical options for consideration within a framework of applying a general non-zero rate of corporate taxation.
- One alternative discussed at the time of the mission was a uniform 10 percent rate.

### Financial sector supervision and scope
- The GFSC (Guernsey Financial Services Commission) is responsible for the supervision of financial services.
- Most financial services, including trust and company services, are regulated; exceptions include consumer credit and pensions.
- The GFSC licenses companies in respect of the different services they provide to funds.

### Financial sector structure and composition
- Sectoral shares (by value of assets):
  - CIS sector: 50 percent of total financial sector assets.
  - Banking: 43 percent.
  - Insurance: 7 percent.
- Complementarity of services: Many regulated companies (including banks) provide administration, trustee, and custodial services to CIS; fund management, stock broking, and other investment services are more limited.
- Ownership and orientation:
  - Guernsey’s financial sector is internationally-oriented; major regulated financial companies are foreign-owned.
  - All the banks on the island and all the insurers undertaking international businesses are foreign-owned, generally branches or subsidiaries of the UK or major international groups.
- Advantages of Guernsey as a financial center: fiscal neutrality, legal and regulatory system, time zone, and skilled workforce.

### Banking sector details and crisis impact
- Trends and activities:
  - Accelerating trend away from retail business toward private banking and services to high net worth individuals and institutional fund and securities services.
  - Limited treasury, trading, or capital markets businesses on the island.
- Ownership and concentration:
  - Large U.K. banks and building societies have operations on the island; 40 percent of banks’ total assets are in the UK.
  - Many banks are from outside the EU (e.g., Bahrain, Bermuda, Canada, Switzerland, and the United States).
- Numbers and asset movements:
  - Total bank licenses fell from 54 to 45 from 2004 to 2009.
  - Total assets grew steadily from 2004 until 2009, when they fell 40 percent, reflecting falls in Swiss fiduciary deposits and exchange rate effects.
- Balance sheet (Banking system, End-2009):
  - Assets: GBP 135,803 (GBP millions).
  - Loans to Banks: GBP 75,605.
  - Loans to parent: GBP 56,464.
  - Marketable Assets: GBP 24,353.
  - Loans and Advances: GBP 25,710.
  - Deposits due to: GBP 114,751.
  - Deposits due to Parent/holding company or group: GBP 65,508.
  - Capital: GBP 2,273.
  - Percent of end 2008 GDP: Assets represent 7,893.9 percent of (end-2008) GDP as presented in the table.
- Crisis episodes and losses:
  - 2007: Northern Rock intervention created uncertainty over Guernsey depositors until a U.K. guarantee for the U.K. bank’s liabilities was extended to amounts owed to the Guernsey subsidiary.
  - Late 2008: Guernsey subsidiary of Landsbanki placed in administration; 1,600 depositors had £120 million on deposit. Payments to depositors from recoveries to date have amounted to 67.5 percent of deposits with the Joint Administrators projecting recoveries of up to 91 percent of deposits.

### Insurance sector and exposures
- Two segments:
  - Domestic segment: 21 insurers serving local risks.
  - International sector: 678 firms, including 323 cells in protected cell companies (PCC) and incorporated cell companies (ICC). Captives and commercial insurers write a wide range of business.
- Market composition and scale:
  - Captive insurers account for around 60 percent of the market.
  - Most captives are owned by U.K. parents (some 40 percent of U.K.’s FTSE 100 companies own captives in Guernsey) and employ fronting arrangements.
  - All but one captive insurer are managed by licensed insurance managers.
  - Total premiums in 2008 were GBP 3.3 billion and the sector held gross assets of GBP 21 billion.
- Risk profile:
  - The insurance industry is mainly exposed to external risks; a sustained worldwide economic downturn could affect captives and international life insurers.
  - Life insurers primarily offer unit-linked products where policyholders typically bear the investment risks.
  - A current challenge is Solvency II Equivalence, which appears to have implications for captive insurers; Guernsey is considering whether to seek recognition as an equivalent jurisdiction.
- Crisis effects:
  - Some captives had exposures to Icelandic banks or parents or placed reinsurance with a reinsurer in distress.
  - Several insurers writing mortgage indemnity lines ceased business.
  - Life insurers saw lower profitability mainly due to reduced management fees derived from reduced policy values.

### Investment funds, fiduciary services, and market developments
- Funds:
  - Nearly 900 funds with GBP 133 billion under management (net asset value), a reduction from nearly GBP 160 billion before the financial crisis.
  - Gross assets, taking into account leverage, total GBP 161 billion.
  - Non-domiciled open-ended schemes total a further GBP 49 billion.
  - Fund types shifting toward institutional, professional, and high net worth investors; growth in private equity funds, property funds, and funds of hedge funds.
- Investment business activities: administration and custody of open and closed-ended CIS are main focus; administration, trustee, and custodial services provided by Guernsey companies.
- Impact of crisis on investment businesses:
  - New fund launches fell sharply.
  - Valuations hampered by market illiquidity; some open-ended funds experienced liquidity pressures and invoked gating provisions.
  - Reduced income for fund administrators and exposures from inappropriate or improper portfolio selection.
- Fiduciary and professional services:
  - Numerous trust and company service providers operate on the island; most trusts are private discretionary trusts used by families and as investment vehicles for pension and employee benefit schemes.
  - A wide range of legal and accountancy services are available; all four major international accountancy firms are represented.
  - Accounting standards typically used: International Financial Accounting Standards (IFRS), U.S. General Agreed Accounting Principles (GAAP), and U.K. GAAP.

### Vulnerabilities, policy responses, and outlook
- Key vulnerabilities:
  - Heavy reliance on fund-, trust-, and company-originated business volumes.
  - Staff costs are high and recruitment of specialists can be difficult due to limited local skills pools and restrictions on immigration and housing availability.
  - Competition from other international centers and potential adverse impacts from regulatory changes in major markets, especially the EU.
  - Pressure from EU and wider developments in taxation reducing scope to maintain a distinct regulatory approach.
- Authorities’ responses to the crisis:
  - GFSC strengthened supervision focused on banks’ exposure to parents by introducing disclosure requirements to inform depositors on exposure to parents, exposure limits set individually by bank, and contingency planning for problems at the parent.
  - The authorities introduced a deposit compensation scheme (DCS) swiftly in late 2008, using enabling provisions introduced by secondary legislation years earlier.
- Outlook considerations:
  - Fiscal neutrality coupled with strong regulation remains essential to support business.
  - Regulatory changes such as Solvency II and possible non-equivalence decisions could affect key segments (notably captives and EU-oriented business).
  - Guernsey may choose to adopt equivalent measures and apply to the EU for recognition of equivalence, but such measures may not always suit Guernsey’s specific business characteristics.

*Source: Guernsey Financial Services Commission; IMF staff report excerpt.*

### 26.      Although the financial crisis has adversely affected banks and other financial

### _cr1101 - 26.      Although the financial crisis has adversely affected banks and other financial

### Stability overview and systemic context
- The financial crisis adversely affected banks and other financial institutions, but "the system has been shown to be relatively stable."
- The banking system "did not have major exposures to the asset classes most affected by the crisis (structured credit)," and the deposit-based business model supported stability and prevented shocks channeled through the interbank and securities markets.
- Two Guernsey banks experienced particularly severe stress in 2008; one was put in administration. In both cases difficulties resulted from the financial stress of their parent.
- The risks facing the system are characterized as "low probability–high impact," warranting careful monitoring and proactive action by the authorities.

### Key risks to the Guernsey banking system
- Intra-group contagion:
  - "42 percent of the banks’ assets constitute direct credit exposure within the groups (see Table 3)."
- Concentration of credit:
  - "Concentration of credit among the local economy (almost 6 percent of assets) and other financial sector counterparts (13.5 percent of assets) poses risks of contagion."
- High credit relative to the economy:
  - Lending to real sector borrowers is limited and conservative, but total credit is "about 400 percent of GDP."
- FX rate risk:
  - "The system is also exposed to FX rate risk, which is mainly hedged, but considerable movements in FX rates could potentially result in a decrease of the capital bases of a few financial institutions if not monitored and managed properly."
  - Note: "Two banks with significant capital bases had already addressed the issue some years ago and have denominated their capital in US Dollars."
- Parent-bank solvency/liquidity risk:
  - Parent bank solvency/liquidity deterioration could be triggered by a global double-dip scenario and/or idiosyncratic shocks; "Assessment: Low" likelihood but "Assessment: High" expected impact on financial stability if realized.
- Failure of one or more large exposures:
  - "Assessment: Low to Medium" likelihood but "Assessment: High" impact; identified as potentially the second most devastating risk after parent bank problems.
- Internal risks:
  - Reputation risk from a major fraud or mismanagement event could precipitate deposit withdrawals.
  - Operational/organizational risks from immigration restrictions that could lead to control weaknesses, inadequate hirings, and excessive outsourcing.

### Financial soundness and performance indicators (selected exact figures)
- Banking system recovery:
  - Capitalization dropped "by 4-5 percentage points compared with pre-crisis levels (to 14.9 percent by end 2008)."
  - By end-2009, "banks’ asset quality, profitability and capitalization were back at pre-crisis levels."
- Deposits:
  - Deposits peaked at "GBP 158 bn" during 2008 flight-to-quality flows; have since dropped back to the 2007 level "at around GBP 120 bn."
- Insurance sector solvency (statutory coverage ratio based on share capital):
  - Life companies: "more than 1200 percent."
  - Non-life firms: "more than 800 percent."
- Bank Financial Soundness Indicators (Table 5 excerpts, all values preserved exactly as in source):
  - Regulatory capital to risk-weighted assets: 19.8 (2003); 20.4 (2004); 18.8 (2005); 19.0 (2006); 17.6 (2007); 14.9 (2008); 19.3 (2009).
  - Regulatory Tier I capital to risk-weighted assets: 19.5 (2003); 20.1 (2004); 18.4 (2005); 18.3 (2006); 17.0 (2007); 13.8 (2008); 18.0 (2009).
  - Capital to assets: 2.0 (2003); 1.9 (2004); 1.5 (2005); 1.4 (2006); 1.2 (2007); 1.2 (2008); 1.7 (2009).
  - Domestic geographical distribution of loans to total loans: 7.5 (2003); 8.0 (2004); 5.6 (2005); 5.3 (2006); 5.0 (2007); 4.8 (2008); 9.7 (2009).
  - Cross-border distribution of loans to total loans: 92.5 (2003); 92.0 (2004); 94.4 (2005); 94.4 (2006); 95.0 (2007); 95.2 (2008); 90.3 (2009).
  - Of which: UK: 48.5 (2003); 47.2 (2004); 50.8 (2005); 43.8 (2006); 40.8 (2007); 43.0 (2008); 46.4 (2009).
  - Nonperforming loans (NPLs) to total gross loans /10: 0.0 (2003); 20.0 (2004); 20.0 (2005); 20.0 (2006); 40.0 (2007); 10.0 (2008); 30.0 (2009).
  - Loan-loss provisions to nonperforming loans: 21.7 (2003); 21.2 (2004); 55.4 (2005); 19.3 (2006); 20.0 (2007); 16.5 (2008); 7.5 (2009).
  - Total foreign currency-denominated loans to total loans: 49.4 (2003); 47.5 (2004); 59.2 (2005); 63.1 (2006); 68.0 (2007); 75.0 (2008); 73.4 (2009).
  - Sum of ten largest exposures to capital: 201.7 (2003); 198.6 (2004); 224.1 (2005); 304.4 (2006); 270.9 (2007); 233.2 (2008); 132.9 (2009).
  - Return on assets: 0.5 (2003); 0.6 (2004); 0.6 (2005); 0.5 (2006); 0.5 (2007); 0.6 (2008); 0.5 (2009).
  - Return on equity: 10.7 (2003); 11.3 (2004); 13.2 (2005); 12.2 (2006); 14.6 (2007); 10.8 (2008); 15.8 (2009).
  - Liquid assets to total assets: 62.2 (2003); 63.2 (2004); 70.6 (2005); 74.5 (2006); 77.2 (2007); 64.4 (2008); 61.3 (2009).
  - Deposits as a percentage of assets: 94.2 (2003); 92.5 (2004); 90.7 (2005); 90.7 (2006); 88.7 (2007); 87.7 (2008); 86.5 (2009).
  - Loans as a percentage of deposits: 63.9 (2003); 66.1 (2004); 82.9 (2005); 84.3 (2006); 89.4 (2007); 88.1 (2008); 88.3 (2009).
  - Off-balance sheet operations as a percentage of assets: 44.6 (2003); 48.6 (2004); 52.5 (2005); 42.2 (2006); 41.5 (2007); 28.3 (2008); 29.5 (2009).
  - Net open position in foreign exchange to capital: 1.4 (2003); 1.5 (2004); 1.9 (2005); 2.0 (2006); 0.6 (2007); 1.1 (2008); 1.5 (2009).
- Investment sector:
  - Accounts for "about 50 percent of the Guernsey financial sector."
  - Assets under management increased "by 300 percent during the last seven years."
  - Sector leverage appears limited; liquidity has not turned out to be an issue so far.

### Stress testing: methods, coverage, and principal outcomes
- Stress tests covered both top-down (TD) and bottom-up (BU) approaches; severity based on historical stress scenarios and expert assumptions reflecting the global financial crisis.
- Coverage: "About two thirds of the sector assets were covered, including 19 out of 21 subsidiaries and 5 out of 21 branches."
- Principal risk drivers identified by tests:
  - Credit risk (parental claims, large exposures other than intra-group exposure, and an increase in default rates).
  - Interest rate risk considered minor; FX rate risk, asset price risk, and operational risk relatively limited.
- High retained profits and 2009 re-established high bank capitalization were noted as solid buffers.
- Selected solvency stress test outcomes (Table 6 highlights; values preserved exactly as reported):
  - Pre-shock capital: CAR 18.1 (In GBP m 10.0; Max. 75.0; No. banks breaching min. CAR 0.0; Min. CAR 18.5; In percent 9.8; In GBP m 90.8; In percent of GDP 10.9; Recapitalization needs 0.1). [Note: table entries are presented verbatim in source; full tabular detail available in Table 6.]
  - Credit shock C3 (Default of the three largest exposures excluding the parent bank): CAR outcome shows severe stress with entries including "15.7 -106.3 75.0 3244.3 14.2 12.0 -21.6 59.9 6371.9 21.6" as reported in the table.
  - Credit shock C7 (10 percent of banks’ claims on their parent banks fail): CAR outcome includes "7.6 -109.1 69.6 9749.8 43.6 0.3 -15.0 73.9 131,294.1 75.2" as reported in the table.
  - Scenario analysis (I4 & F3 & A2 & C2 & O2) summary: "15.4 -64.5 73.1 366.3 3.9" as reported in the table.
- Conclusion from tests: Main vulnerabilities center on credit exposures (especially to parents and large concentrated exposures); some scenarios imply substantial recapitalization needs for affected banks.

### Policy recommendations and supervisory actions
- Monitoring and data improvements:
  - GFSC should "continue and extend their systematic monitoring of the evolution of aggregate credit risk in the system across sectors, in particular to related large counterparties."
  - GFSC should "improve its database in order to monitor exposure to borrower units on a timely basis (both the volume and default probability of the large exposures)."
  - Authorities should produce additional aggregate data regularly, including Financial Soundness Indicators (FSIs), peer group statistics, and risk-based solvency figures; cross-check data for robustness and quality.
  - Consider publishing aggregate balance sheets and the mean and distribution of FSIs to enhance transparency and peer comparisons.
- Supervisory and regulatory tools:
  - Closely monitor solvency of parent banks through market indicators, cooperation with home supervisors, and financial stability analysis.
  - Consider risk-mitigating strategies: selective licensing, restrictions on banks’ risk taking, limiting upstreaming of deposits, and ring-fencing measures where adequate.
  - Mitigate liquidity risks through strengthening of the DCS and increasing holdings of marketable liquid assets, noting the lack of a lender of last resort.
  - For insurers, develop economic capital assessments and separate stress tests to monitor sector risks; further develop assessments of economic capital requirements (e.g., OSCA) and stress tests.
- Stress testing and staffing:
  - GFSC should run top-down stress tests for the banking system to challenge banks’ own stress tests and ensure consistency; standardized bottom-up tests for the insurance sector.
  - GFSC needs to add senior analyst level expertise and cover all parts of the financial sector comprehensively (banks, insurance, and investment).
- Operational risk and cost cutting:
  - Pressures to cut costs should not come at the expense of excessive risk or weakening of risk management.
  - Diversification of income sources (for example into private banking) is recommended to complement cost-cutting without endangering stability.

*Source: IMF staff report excerpt as provided in the content unit*

### 41.      Banks are also relatively resilient to adverse scenarios related to the stress tests.

### _cr1101 - 41.      Banks are also relatively resilient to adverse scenarios related to the stress tests.

### Banking sector: resilience to stress tests
- "Banks are also relatively resilient to adverse scenarios related to the stress tests."
- Aggregated single shocks into a combined shock (scenario analysis) simulating a severe macroeconomic shock: three banks (of 19) have been found to be at risk.
- Recapitalization needs from the combined shock would be limited, except for one of the banks.
- Additional sensitivity analysis for credit risk did not reveal noteworthy additional risks beyond those highlighted by previous tests.
- Test A3 is identified as "probably the most conservative test among all of the tests" and was taken into account when assessing the overall impact of the tests (and led to classifying asset price risk among the "relatively limited" risks).

### Liquidity stress risks and results
- Liquidity risks could arise from a shock at a particular company or the island’s reputation, and could materialize through a run on deposits.
- Severe run scenario: daily withdrawal of 30 percent of deposits for five consecutive days.
- Under a highly severe run and limited willingness or ability of parent banks to support their Guernsey subsidiary or branch, some Guernsey banks could run out of liquidity within a week.
- The newly established DCS will help mitigate a name crisis, but a general run on deposits can only be precluded if parent banks are willing and capable to step in given the lack of a lender of last resort.
- Authorities need to assess whether their liquidity position is sufficient to meet upcoming Basel III standards and potential changes in intragroup funding practices.
- In case of deterioration of a parent bank’s solvency, Guernsey banks could increase holdings of marketable securities to mitigate a potential shock.

- Table 7. Guernsey: Liquidity Stress Test Results for the Banking Sector (numbers preserved as in source)
  - Columns implied: Sub-subsidiaries / Branches / Total / Sub-subsidiaries / Branches / Total
  - Test L1 (interbank funding remains available, no additional intragroup funding)
    - Day 1 0 1 1033
    - Day 2 0 1 1235
    - Day 3 1 2 37411
    - Day 4 3 2 510414
    - Day 5 7 2 913417
  - Test L2 (interbank funding essentially closed, no additional intragroup funding)
    - Day 1 0 1 1336
    - Day 2 1 2 36410
    - Day 3 2 9 12416
    - Day 4 1 1 21315419
    - Day 5 1 2 31516521
  - Sources: Staff estimates.
  - Notes attached in source:
    - (i) All Marketable Securities are Liquid (as is Cash)
    - (ii) Only Government Securities Remain Liquid (and Cash)
- Footnote: "The exercise included deposits available within a month."
- Footnote: "This analysis was not done during the time of the mission as the final rules were not yet decided on. The FSIs (Table 5) suggest that Guernsey banks do not face major challenges with respect to the Basel III liquidity ratios."

### Insurance sector: stress-testing findings
- Stress test for 22 Guernsey insurers confirms the Guernsey insurance sector exhibits resilience against shocks.
  - Rationale: relatively low exposure to risk (unit-linked business with a low element of pure life insurance risk) and sound levels of capitalization for the vast majority of firms and the system on average.
- Under a scenario test, three firms would run short of capital; given the severity of the shock, this confirms the system overall appears to be well capitalized.
- Some institutions could face vulnerabilities in a highly adverse scenario, with potential second-round effects such as contagion; there were some losses in the life insurance sector in 2008.
- Risk-based stress tests (OSCA exercise) show companies most vulnerable in BU stress tests are also those with lowest capitalization in economic OSCA terms.
  - Economic capital requirements (OSCA figures) by far exceed statutory minimum capital requirement levels (for the 2009 stress test sample by 200 percent).
  - High capitalization under current statutory rules should not create a false sense of security; nevertheless, capitalization remains good overall.

### Recommendations on stress-testing and solvency regime
- Authorities should further pursue efforts aimed at risk-based stress testing:
  - Objective: standardize the tests (common solvency measure(s), comparable methods used to run the tests, and the scenario definition) to monitor the system in economic terms in a TD manner.
  - Move toward collection of pertinent data including FSIs to support risk-based testing.
  - These efforts would form a basis to move to a risk based solvency regime (Solvency II or an equivalent framework).

### Financial stability policy: institutional arrangements and the GFSC role
- In the absence of a central bank, financial stability issues fall to the GFSC, supported by the government.
- No established framework for macro-prudential analysis and decision-taking at the time of the report.
- Post-crisis cooperation included rapid establishment of the DCS; GFSC is central to maintaining stability given banks’ importance and vulnerability to parent problems.
- GFSC strategy for addressing bank risks includes:
  - More cautious and restrictive approach to granting new banking licenses.
  - Preference for subsidiaries over branches for supervisory monitoring and control, while still licensing branches where parents are among the strongest international groups and/or from jurisdictions able to provide effective support.
  - Introduction of an upstreaming policy, limits on some subsidiaries’ exposures to their parents, and GFSC notification requirements improving depositor information about ultimate exposure to parent companies.
- Implementation will take time; GFSC expects supervisory strategy plus global consolidation trends to push business models toward wealth-management/ private banking and away from retail deposit-taking and upstreaming.

### Essential policy measures (three areas)
- (i) GFSC must be ready to limit additional upstreaming by individual banks and, if necessary, to ring fence deposits thoroughly when serious concerns arise over parental exposure or possibility of stress. GFSC must ensure it has necessary powers, supervisory tools, and resources.
- (ii) GFSC must invest supervisory effort in improving corporate governance at banks and hold boards/managers responsible for contributions to financial stability, including monitoring and managing concentration of risk from parental exposures. Additional measures (e.g., ring fencing) might be implemented.
- (iii) GFSC needs to engage more extensively with supervisors of parent groups, recognizing limits on practical cooperation in stress times; create expectations in home supervisors to explain resolution frameworks and inform/consult with Guernsey ahead of problems. Applying to become members of colleges for the most important banks could be a way forward.

### Monitoring parent institutions and longer-run strategy
- GFSC should intensify analysis of how changing legal frameworks and policy priorities affect Guernsey banks and influence development of policy on cross-border bank resolution to reduce repeat of Landsbanki Guernsey subsidiary events.
- Monitor solvency of parent banks directly using FSIs related to solvency (ratings, CDS spreads, KMV EDFs) and liquidity positions where feasible.
- Guernsey should keep long-run strategy under review; be alert to possibility that a business model based on upstreaming might involve too much exposure to parent jurisdictions and be open to setting limits on all banks’ exposures.
- Even without upstreaming, significant vulnerabilities to parents may remain due to common management, shared infrastructure, and reputation.

### Deposit Compensation Scheme (DCS) — design and actions
- DCS covers deposits of individual depositors, wherever located, up to a maximum of £50,000 per person.
- The scheme is not funded, though it has government-guaranteed liquidity back-up, and aims to pay compensation within three months of a bank failure.
- Maximum total amount of compensation is capped at £100 million in any five-year period.
  - Payouts would be scaled back if a number of banks, or one of the largest banks (by covered deposits), fail in this period.
- Some 180,000 depositors had deposits covered by the scheme as at September 2008.
- Analysis of deposit distribution as at that time suggests near 100 percent coverage in case of a single bank failing for subsidiaries, and 62 percent coverage for bank branches.
- The scheme will be paid for by banks through annual charges and special charges in the event of a bank failure.
- Recommendations regarding the DCS:
  - Make limitations clear to depositors and complete practical preparations to make actual payouts.
  - Ensure banks have IT systems to facilitate early and complete identification of covered deposits to support timely payouts.
  - Board of the DCS has powers to take action to ensure lowest cost resolution, including providing financial support to prevent failure; policies need to be developed on use of these powers and coordination with GFSC powers (CP 23).
  - Medium-term wider review of the DCS is recommended, to consider reducing the payout period, reviewing cap on total payouts, ex ante funding of the scheme, and a risk-based assessment of banks; authorities are already considering ex ante funding and risk-based assessment, but implementation will take time.

### Institutional arrangements for financial stability
- GFSC leads monitoring financial stability issues, informed by supervisory information; States of Guernsey Policy Council (through its Fiscal and Economic Policy Group) maintains close interest.
- Consideration could be given to establishing a forum devoted to monitoring financial stability and coordinating policy responses (GFSC remains responsible for regulatory policy and handling supervisory cases).
- Within GFSC, financial stability could be supported by dedicated resources covering full scope of GFSC responsibilities.

### Financial sector oversight and GFSC developments
- GFSC mandate in the FSC Law: effective supervision of financial services, maintaining confidence in financial services sector, safety, soundness, and integrity of regulated sector, and combatting financial crime and financing of terrorism.
- Governance: currently six commissioners elected by the States of Deliberation on nomination of the Policy Council; GFSC funded by industry fees and had 96 staff at the time of the report.
- 2003 OFC assessment found high quality regulatory system with areas to strengthen:
  - Enhance functions and independence of GFSC; amend law to establish safety, soundness, and integrity objectives and eliminate "development" as a function.
  - Address resource deficit in GFSC’s Banking Division.
  - Enhance GFSC powers and procedures in banking and securities.
- Since 2003, authorities have enhanced regulatory framework and responded to crisis lessons:
  - Legislative changes to strengthen GFSC independence.
  - Implementation of Basel II for banks in January 2008.
  - Various official reviews and strategic actions to re-orientate banking sector away from retail deposit-taking and upstreaming toward private banking and wealth management.

### Banking supervision: assessment and further actions
- BCP assessment confirms high standard of prudential regulation and supervision; issues from 2003 largely addressed.
- GFSC has considerable independence, suitable accountability, and is broadly adequately resourced.
- GFSC cooperates with home supervisors via numerous MOUs and information exchange, including regular visits and on-site supervision; asymmetry in some relationships limits benefit.
- Recent failures transmitted rapidly from problems elsewhere; subsequent reviews of GFSC performance under stress were favorable.
- Several broad areas for further action (CP references preserved as in source):
  - (i) CP 4 "Transfer of significant ownership": GFSC should have power to review and, if necessary, rescind transfers of significant shareholdings in licensed banks.
  - (ii) CP 5 "Major acquisitions": a similar power is required.
  - (iii) CP 9: GFSC should have explicit power to require that a bank increase provisioning and, if necessary, overall financial strength.
  - (iv) CP 10 and CP 11: large exposure limits should be applied on a consolidated basis given related party lending; all transactions with banks’ related parties should receive prior board approval and be on market terms.
  - (v) CP 21: supervisory reporting would benefit from a requirement for senior level certification and capacity for GFSC to impose administrative penalties for tardy reporting.
  - (vi) CP 1(2): GFSC should consider amending its governing statute to increase chairman term of office from current one year to a term consistent with international practice.
  - (vii) The Banking Supervision (Bailiwick of Guernsey) Regulations 2010 (came into operation on April 30, 2010) together with contemplated amendments to GFSC’s Codes of Practice have been designed to address items (i) through (v) above.

*Italic: IMF country report content as provided in the supplied source unit.*

### 64.      Guernsey updates its regulatory regime continually and has implemented all the

### _cr1101 - 64.      Guernsey updates its regulatory regime continually and has implemented all the

### Insurance supervision: framework, crisis response, and Solvency II considerations
- The GFSC adopts a risk-based and proportionate approach in supervising its large population of insurers, promoting efficient allocation of regulatory resources.
- Licencing and prudential regime:
  - Licenses are given to captive insurers individually.
  - Consistent prudential regulation applies to both captive and commercial insurers.
  - Ongoing supervision of captives is exercised through insurance managers.
  - The GFSC has adequate powers and well-documented policies, procedures, and customized checklists to ensure consistency in supervisory decisions.
- Industry reception and regulatory frameworks:
  - The introduction of the OSCA by insurers has been well received by the industry.
  - Regulatory frameworks for corporate governance, risk management, and AML/CFT are described as comprehensive and robust.
- Response to the global financial crisis:
  - The GFSC worked with insurance managers to resolve crisis-related issues and assessed financial condition of parents of some captives.
  - Relevant insurers affected by the crisis were closely monitored.
  - Insurers relying on loans to parent companies to meet solvency requirements were required to reapply for such loans to qualify as approved assets; restrictions were imposed in some cases.
  - As at March 3, 2010, insurers’ loans to parents totaled £5.8 billion of which £5.2 billion was approved for solvency purposes, representing 33 percent of net assets.
    - Footnote detail: These figures are skewed by two large captive insurers. If the loans by these two captives are excluded, loans to parents amount to £1.1 billion of which £392 million (or 2.2 percent of net assets) was approved for solvency purpose.
- Solvency II and risk-based solvency regime work:
  - The GFSC is assessing the impact on the Guernsey insurance sector in the event Guernsey decides to implement a risk-based solvency regime.
  - An independent review of the implications of Guernsey seeking recognition of Solvency II equivalence has been commissioned by the commerce and employment department (CED); the GFSC is fully involved and working with the CED.
- Suggested enhancements and supervisory cooperation:
  - Need to establish effective cooperation arrangements with relevant home/host supervisors for recognized insurers without physical presence and to protect foreign policyholders of international life insurers.
  - Consider expanding the range of enforcement powers and implementing IAIS public disclosure standards.
  - Continually assess practical implementation of OSCA, including establishing criteria on the use of internal models.

### Investment business and funds regulation
- IOSCO implementation:
  - The GFSC has substantially implemented recommendations of the 2003 OFC assessment of IOSCO Objectives and Principles of Securities Regulation.
  - Legislative reform aligns GFSC objectives with IOSCO and equips GFSC with onsite powers.
  - New conduct of business rules introduced; a proposed GFSC code of corporate governance will apply to funds and fund services providers.
  - The GFSC continues risk-based regulation and close supervision of licensees.
- Fund framework reforms and fast-track approvals:
  - Legislative changes aligned requirements for closed-ended funds with open-ended funds.
  - Funds aimed at broadly professional investors or offered only to investors outside Guernsey qualify for fast track approval (within three days) by the GFSC.
  - Funds may be established in companies, trusts, partnerships, and as PCCs or ICCs.
  - Fast track procedures rely on warranties by the fund administrator that due diligence established regulatory requirements are met; the GFSC also assesses the quality of the fund sponsor.
- Sector reorientation and supervisory focus:
  - The funds sector is reorienting away from retail to professional and international investors; specialist funds are increasing.
  - GFSC is assessing whether administrators have expertise to manage more complex funds (e.g., funds of hedge funds) that may be illiquid or hard to value.
- Unregulated funds and data collection:
  - Guernsey has not introduced unregulated funds; GFSC retains regulatory control over all funds and facilitates data collection.
  - Full quarterly statistics are published on Guernsey funds.
- Investor compensation arrangements:
  - Currently, compensation is available only for retail funds eligible for marketing in the UK, providing maximum compensation of GBP 60,000 for losses arising from defaults by a fund administrator or trustee/custodian; no payment has ever been made.
  - A review is under way to consider possible extension of cover to other investors; any extension would exclude professional investors and requires careful cost-benefit analysis and consideration of whether the system should be pre-funded (currently not funded, but has government guaranteed liquidity back-up).
- EU regulatory developments:
  - The draft directive on alternative investment fund managers (AIFM) would allow only EU-based AIFMs to manage and distribute relevant funds to EU investors.
  - Much of Guernsey business is directed to the EU, so Guernsey faces choices on whether and how to change requirements to meet conditions likely to be placed on third country AIFMs; GFSC, industry, and government are monitoring developments.

### Trust and company service providers
- Licensing and statistics:
  - The GFSC licenses service providers, not trusts or companies themselves.
  - Nearly 200 licensed trust and company service providers exist, including trust companies owned by banks and independent private trust companies.
  - Around 1,500 new companies are registered on average each year by the Guernsey Companies Registry (not part of the GFSC).
  - No data are collected on the value of trusts and companies’ assets; estimated at hundreds of billions of pounds.
  - Recommendation: GFSC should consider reinstating regular collection of data on asset values that was discontinued some years ago.
- Regulatory regime for service providers:
  - Full regulation since 2001; AML requirements applied since 2000.
  - Supervisory focus includes fitness and propriety and adequacy of financial resources: capital equal to three months expenditure and professional indemnity insurance must be held.
  - Regular reports to the GFSC and onsite supervision are undertaken on a risk-based cycle.

### AML/CFT provisions and implementation
- Legal framework and offences:
  - Guernsey’s AML/CFT legal framework is comprehensive and criminalizes money laundering (ML) and terrorism financing (TF) fully in line with the international standard.
  - No shortcomings identified in the legal framework; concerns remain on implementation of ML provisions.
- Financial Intelligence Service and preventive measures:
  - The Financial Intelligence Service (FIS) is adequately performing its role as the financial intelligence unit.
  - Preventive measures for financial institutions and DNFBPs are largely in line with FATF Recommendations.
  - Competent authorities have adequate supervisory powers; financial institutions and DNFBPs receive adequate AML/CFT supervision.
- Sanctions and transparency:
  - The sanctioning regime for discretionary financial penalties for non-compliance is not considered dissuasive and proportionate.
  - Legal entities and arrangements: measures ensure transparency and availability of accurate, adequate, and current beneficial ownership and control information to law enforcement and competent authorities.
  - Effective mechanisms exist for coordination and cooperation among domestic AML/CFT stakeholders, including an active policy coordination committee.
  - MLA and extradition frameworks are sound; the majority of requests are processed timely and constructively.
  - Note: A separate Fund mission was conducted in May 2010 to assess Guernsey’s compliance with the FATF AML/CFT standard; a detailed assessment report is nearing completion and an AML/CFT ROSC will be circulated to the Executive Board for information.

### Other supervisory and market conduct issues
- Audit oversight:
  - No official oversight of the quality of audits by Guernsey companies currently exists; auditors are subject to reviews by their professional bodies (e.g., ICAEW practice assurance review scheme).
  - Companies’ law amendments due to take effect in April 2010 will require Guernsey audit firms, for companies whose shares are admitted to trading on an EU regulated market, to register with the Guernsey Company Registry.
  - Audit regulations based on UK standards and regular inspection of audit quality for listed entities will be carried out by either the U.K.’s Audit Inspection Unit or the ICAEW.
- Ombudsman scheme:
  - Establishment of an ombudsman scheme is recommended to support market conduct, investigate and adjudicate unresolved customer complaints, and reinforce high standards—helping confidence for customers remote from providers.

### Annex—Basel Core Principles for Effective Banking Supervision: main findings and recommendations
- Assessment context:
  - Assessment undertaken as part of an IMF FSAP Update in 2010, prepared during an IMF mission in March 2010; updates the 2002/2003 BCP assessment.
  - Assessors: Peter Kruschel (BaFin) and Keith Bell (banking supervision consultant).
- Main findings:
  - The BCP assessment confirms a high standard of prudential regulation and supervision; issues from 2003 have largely been addressed.
  - GFSC conducts an on-site supervision program supported by off-site analysis; on-site emphasis on AML/CFT and credit risk management and other themed inspections.
  - On-site visits are followed up with recommendations and close tracking of corrective action.
  - A framework of minimum prudential standards is provided by the Financial Services Commission (Bailiwick of Guernsey) Law 1987 (FSC(G) L, as amended), the Banking Supervision (Bailiwick of Guernsey) Law 1994, as amended, the Banking Supervision (Bailiwick of Guernsey) Regulations 1994, Codes of Practice for Banks, and GFSC Guidelines and Guidance Notes.
- GFSC mandate, independence, and resourcing:
  - GFSC responsibilities include reducing public risk from financial unsoundness or mismanagement, protecting the island’s reputation, promoting Guernsey’s economic interests, and countering financial crime.
  - GFSC enjoys considerable independence with suitable accountability; the FSC(G) L was amended in 2009 to remove “development of the financial services industry” as a GFSC function and to clarify circumstances in which the PC may instruct the GFSC.
  - GFSC’s chairman is appointed for a one-year term (noted as an anachronism).
  - GFSC is broadly adequately resourced; funded by industry fees adjusted to marginal costs plus a markup for fixed costs; the GFSC currently has over 100 staff and is seen as rigorous and expert by private-sector representatives.
- Supervisory powers and crisis experience:
  - GFSC has disciplinary powers (request information, issue directions, impose license conditions, appoint inspectors, revoke licenses, request court administration of a bank); fines cannot yet be imposed for administrative matters but enabling powers exist in law.
  - Past failures of two banks showed rapid transmission of external problems to Guernsey; subsequent reviews of GFSC performance under stress were favorable.
- Cooperation with home supervisors:
  - Numerous MOUs signed; information exchange and regular supervisory visits occur.
  - Asymmetry with some home regulators limits benefits GFSC can draw from cooperation.
- Areas identified for further action (require primary or secondary legislative changes):
  - (i) CP 4 “Transfer of significant ownership”: GFSC should have power to review and, if necessary, rescind transfers of significant shareholdings in licensed banks.
  - (ii) CP 5 “Major acquisitions”: similar power required for GFSC.
  - (iii) CP 9: explicit power for GFSC to require a bank increase provisioning and, if necessary, overall financial strength.
  - (iv) CP 10/11: apply large exposure limits on a consolidated basis given related party lending; require prior board approval and market terms for related-party transactions.
  - (v) CP 21: supervisory reporting should include senior level certification and capacity for GFSC to impose administrative penalties for tardy reporting.
  - (vi) CP 1.2: consider amending GFSC’s statute to increase the chairman’s term from one year to a term consistent with international practice.
- Implementation steps taken:
  - The Banking Supervision (Bailiwick of Guernsey) Regulations 2010, which came into operation on April 30, 2010, together with contemplated amendments to the GFSC’s Codes of Practice, have been designed to address items (i) through (v) above.

*IMF staff report text (excerpts) provided in the source content.*

### 1. Objectives, independence, powers,

### 1. Objectives, independence, powers, transparency, and cooperation

### Independence, accountability and transparency
- The GFSC Chairman is appointed annually by the States.

### Banking sector supervisory deficiencies and findings
- Law does not provide the GFSC power to review, object to and reject any proposal to transfer a “significant ownership” interest.
- The law requires the GFSC to be consulted prior to a major change in business focus; regulations to define types and amounts (absolute and/or in relation to capital base) of acquisitions and investments needing prior supervisory approval (or ex post notification) and to provide criteria to assess proposals have yet to be tested.
- There is no power to require banks to increase their levels of provisions.
- Banks have large discretion in applying exemption from large credit limit of 25 percent on large exposures to parents.
- There are no legal requirements that:
  - (a) transactions with related parties be subject to prior approval by the bank's board; and
  - (b) that exposures to related parties explicitly may not be granted on more favourable terms.
- The extent of outsourcing regarding the administered banks should be reduced and not cover essential functions as risk management.
- No guidance on the requirements of outsourcing and legal risk is in place.
- Banks are not required to have internal audit function in place; the GFSC relies on the group audit systems.
- Banking legislation does not explicitly require banks to have a permanent compliance function.
- Main relevant rules on abuse of financial services are covered in the Handbook. A separate mission on AML/CFT issues found that the pertinent legal framework is robust to deter and prevent the abuse of financial services.
- Regulations permitting the imposition of administrative fines have not been issued.
- Prudential reports do not require “top management” certification.

### Recommended action plan to improve compliance with the Basel Core Principles (selected CPs)
- CP1.2: Extend Chairman’s term of appointment to international norm.
- CP4: Amend law so GFSC has power to review, object to, and reject any proposal to transfer a “significant ownership” interest.
- CP9: Commission should get authorisation to require banks to increase their levels of provisions.
- CP10: The Commission should continue to restrict large limits of banks to their parents in relation to their own capital approaching the 25 percent limits to all banking exposures.
- CP11: Establish regulations that require transactions with related parties to be subject to prior approval by the bank's board; legislation should be introduced that exposures to related parties explicitly may not be granted on more favourable terms.
- CP15: The extent of outsourcing regarding the administered banks should not cover essential functions as risk management. The GFSC should stipulate detailed guidance on the requirements of outsourcing and continue its work on Guidance on legal risks.
- CP17: The banking legislation should require banks to have a permanent internal audit and compliance function in place.
- CP21: Issue regulations to permit administrative fines. Require “top management” certification of prudential reports.

### Authorities’ response to the banking assessment (selected responses with dates and regulations)
- CP1.2: The GFSC will request an amendment to the Financial Services Commission (Bailiwick of Guernsey) Law, 1987 to be amended in order to address the IMF’s recommendation.
- CP4: The Banking Supervision (Bailiwick of Guernsey) Regulations, 2010 came into force on 30 April 2010 and satisfy the IMF’s recommendation.
- CP9: The Banking Supervision (Bailiwick of Guernsey) Regulations, 2010 came into force on 30 April 2010 and satisfy the IMF’s recommendation.
- CP10: The GFSC revised the Principle and Guidance to be followed by locally incorporated banks regarding large exposures in order to satisfy the IMF’s recommendation.
- CP11: The Banking Supervision (Bailiwick of Guernsey) Regulations, 2010 came into force on 30 April 2010 and satisfy the IMF’s recommendation.
- CP15: The Banking Supervision (Bailiwick of Guernsey) Regulations, 2010 came into force on 30 April 2010 and satisfy the IMF’s recommendation on the employment of sufficient individuals to cover essential functions. The GFSC has also issued an outsourcing guidance paper, which satisfies the IMF’s recommendation on outsourcing. With reference to the IMF’s recommendation on legal risk, the GFSC is, as recommended, continuing its work on legal risk.
- CP17: The Banking Supervision (Bailiwick of Guernsey) Regulations, 2010 came into force on April 30, 2010 and satisfies the IMF’s recommendation.
- CP21: The Financial Services Commission (Administrative Financial Penalties) (Bailiwick of Guernsey) Regulations, 2010 came into force on 1 September and satisfy the IMF’s recommendation in relation to the imposition of administrative fines. The Banking Supervision (Bailiwick of Guernsey) Regulations, 2010 came into force on 30 April 2010 and satisfy the IMF’s recommendation in relation to the prudential reports of banks being required to have “top management” certification.

### Insurance sector assessment: main findings and statistics
- Assessment benchmarks Guernsey’s regulatory regime against the ICPs issued by the IAIS in October 2003; assessment conducted from March 1-10, 2010 under the Fund’s FSAP.
- Guernsey’s insurance industry structure:
  - The international sector represents more than 90 percent of the market.
  - Captive insurers represent 60 percent of the sector.
  - About 50 percent of international business originates from the UK.
- As at March 3, 2010:
  - Insurers’ loans to parents totaled £5.8 billion of which £5.2 billion was approved for solvency purposes, representing 33 percent of net assets.
  - Note: If two large captives are excluded, loans to parents amount to £1.1 billion of which £392 million (or 2.2 percent of net assets) was approved for solvency purpose.
- The GFSC adopts a risk-based and proportionate approach; GFSC gives licenses to captive insurers individually and adopts consistent prudential regulation for both captive and commercial insurers.
- The GFSC has adequate powers and well-documented policies, procedures, and customized checklists to ensure consistency in supervisory decisions.
- The GFSC responded proactively to the global financial crisis by working with insurance managers, assessing parents of captives, monitoring affected insurers, and requiring reapplication for loans to parents used as approved assets; restrictions were imposed in some cases.
- The GFSC is assessing implications of implementing a risk-based solvency regime and has commissioned an independent review regarding Solvency II equivalence.

### Insurance Core Principles: summary of observance (selected ICP findings)
- ICP 1: Guernsey has well-established policy, legal, and institutional frameworks; GFSC recognizes accounting, auditing and actuarial standards and professional bodies from reputable jurisdictions.
- ICP 2: GFSC’s objectives and functions are clear and appropriate; it does not have any objective related to the promotion of the insurance industry. Recognized insurers permitted to write domestic risks without any physical presence in Guernsey may have implications to protection of domestic policyholders.
- ICP 3: GFSC has adequate powers, legal protection, and resources; operationally and financially independent and accountable.
- ICP 4: Supervisory approach and processes are defined and transparent; scope for providing more comprehensive information about financial condition of industry.
- ICP 5: GFSC regularly exchanges information and has signed eight MoUs with foreign supervisors; has applied to become a signatory to the IAIS Multilateral MoU.
- ICP 6: Licensing framework is clear and transparent; clarified recognition criteria to reflect practice (only from UK and IOM where domestic policyholders are protected under compensation schemes).
- ICP 7: GFSC performs due diligence on proposed owners, controllers, and directors; empowered to issue disqualification orders against auditors and actuaries.
- ICP 8: Any person wishing to acquire 15 percent or more of an insurer requires the prior approval of the GFSC.
- ICP 9: CGC applies to all insurers; insurers must certify adherence annually.
- ICP 10: Internal controls incorporated into CGC and monitored during on-site visits; most captives rely on insurance managers’ internal procedures.
- ICP 11–14: GFSC proactively monitors market developments, has consistent processes for reviewing annual returns, clear inspection policies, and a three-year rolling program.
- ICP 15: GFSC empowered to take a range of proportionate measures; main tool is imposition of licensing conditions; scope to widen enforcement powers.
- ICP 16: Legal framework provides for orderly winding up and exits; policyholders and beneficiaries are not given legal priority in insolvency.
- ICP 17: GFSC currently has no group/home supervisor responsibilities but is committed to establish a framework when such responsibilities arise.
- ICP 18–23: GFSC provides guidance on risk assessment and management, requires strategic underwriting and pricing policies, checks technical provisions methodology, and has established requirements for investments, derivatives, and capital adequacy with ongoing work on OSCA and internal models.
- ICP 24–28: GFSC has comprehensive frameworks for intermediaries, consumer protection for domestic policyholders, limited statutory disclosure requirements under IBL, guidance on fraud, and robust AML/CFT requirements supervised through on-site inspections.

### Recommended action plan for insurance sector (selected ICPs)
- ICP 1: Consider providing clear guidance to accountants, auditors, and actuaries on their respective roles, including professional independence.
- ICP 2: Articulate regulatory and supervisory scope and objectives in protecting domestic policyholders in respect of recognized insurers.
- ICP 15: Review reliance on licensing conditions and consider establishing a wider range of enforcement powers, e.g., appointment of judicial managers and receivers.
- ICP 16: Consider establishing (a) an explicit legal provision to ensure policyholders and claimants are given high priority in the event of insolvency; and (b) regulatory policies on pledging or encumbrance of assets by insurers.
- ICP 18: Refine the risk matrix to incorporate explicit factors addressing corporate governance and risk management.
- ICP 19: Provide guidance on how it assesses insurance risks of captive insurers seeking approval to have no reinsurance protection.
- ICP 20: Consider including an explicit legal provision in the IBL requiring insurers to maintain adequate technical provisions at all times.
- ICP 25: Consider effective regulatory cooperation with relevant regulatory authorities to enhance protection of policyholders located outside of Guernsey.
- ICP 26: Consider how best to implement the public disclosure standards established by the IAIS.

### Authorities’ response to the insurance assessment (selected responses)
- ICP 1: The GFSC will consider how best to address the IMF’s recommendations.
- ICP 2: Work is under way to provide improved transparency in relation to the protection of domestic policyholders in respect of recognized insurers.
- ICP 15: The GFSC will consider how best to address the IMF’s recommendations.
- ICP 16: The GFSC will be working with the relevant parties to improve the legislation with respect to policyholders and claimants in the event of insolvency.
- ICP 18: The GFSC’s risk matrix is being reviewed to incorporate the additional risk factors.
- ICP 19: The GFSC will consider how best to address the IMF’s recommendations.
- ICP 20: The position on technical provisions will be addressed when the insurance legislation is reviewed following the revision of the IAIS ICPs in October 2011.
- ICP 25: The GFSC will consider how best to address the IMF’s recommendations.
- ICP 26: Disclosure rules, which have already been made, come into force in September 2010 and will be reviewed against the revised IAIS ICPs when they are issued in October 2011 to ensure they are both adequate and appropriate.

*Source: IMF staff report excerpt on Guernsey supervisory assessment and recommended action plans.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr1101.pdf_