Responding to the financial crisis: challenging past assumptions

Speech by Adair Turner, Chairman, FSA
British Embassy, Paris
30 November 2009

The financial crisis of 2007/08 was the worst for at least 70 years. Economic catastrophe was only prevented by extreme policy responses: even with these responses, the world has faced huge economic cost. We must therefore identify the root causes as well as the symptoms.

To ensure that, we must recognise that what occurred was not just a crisis of specific institutions and regulations, but of an intellectual theory of rational and self-equilibrating markets.

We must be willing to consider a wide range of policy options to ensure greater alignment between private action and beneficial social effect.

And we must recognise that there are some key questions to which we do not yet have clear answers.

This afternoon I will therefore do three things:

First, review the causes of the crisis.
Second, highlight that this was not just a crisis of specific institutions or regulations, but of economic theory.
Third, explore two issues where we have more thinking to do.
There is now considerable consensus on what went wrong, described in, for instance my own Review and reports by Jacques de Larosiere for the European Commission, and by Paul Volcker for the G30. Five points are particularly important:

First, there was a macroeconomic context, large current account imbalances (Exhibit 1) which, combined with fixed exchange rate policies, drove huge accumulation of official holdings of low risk government securities (Exhibit 2), driving real risk-free interest rates down to historically low levels.
Second, these low interest rates in turn drove a frantic search for yield uplift among investors seeking apparently low-risk return. A demand which was met by financial innovation – the explosion of securitized credit, structured credits and credit derivatives, the alphabet soup of Credit Default Swaps (CDS) and Collateralized Debt Obligations (CDOs) and CDO squareds.
Third, financial innovation, combined with low interest rates, drove rapid credit growth in several countries, with lowering credit standards in many markets, particularly in residential and commercial real estate.
Fourth, leverage increased across the system, (Exhibit 3) both within institutions – banks and investment banks – and embedded within products.
Fifth, there were profound changes in the scale and nature of maturity transformation in the system – with increasing reliance on: the idea that, contractually, long assets could be considered liquid because they are saleable in liquid markets; potentially volatile wholesale funding; and increasing maturity transformation not on bank balance sheets, but in off-balance sheets (SIVs and conduits), on investment bank balance sheets and in mutual funds.
These factors greatly increased systemic risk and made the system highly susceptible to a surge of irrational exuberance and highly vulnerable when that exuberance turned to doubt and then despair.

We need to build a more stable system for the future. But to do that we must recognise that what failed last year was not just specific institutions or regulatory approaches, but the intellectual theory of automatically self-correcting and equilibrating markets, based on an efficient market hypothesis in which the rational behaviour of agents would lead necessarily to beneficial and stable results.

Three points illustrate that failure.

First, CDS spreads and equity prices for major banks from 2002 to 2008 (Exhibit 4). In efficient market theory, market prices are meant to capture thoughtful rational expectations of future events, provide information that leads to better decision-making and ensure market discipline. And even today, many market commentators quote CDS spreads for banks as providing useful information about the degree of risk in the financial system – ‘CDS spreads have reduced, therefore we infer that risk has reduced’.

But CDS spreads and equity prices for major banks provided us with no forewarning of the crisis: indeed, those who used CDS spreads to infer from the wisdom of markets the level and appropriate price of risk, would have concluded from these figures that the financial system had reached a point of historically low risk in spring 2007, the point we now recognise as that of maximum unrevealed fragility.

The idea that market prices are always in some efficient market sense ‘correct’ should have died and been buried in this crisis. And instead we need to recognise that market prices in liquid-traded markets can be subject to herd and momentum affects, to self-reinforcing cycles of exuberance and then despair.

A second illustration is a quote from the International Monetary Fund (IMF) Global Financial Stability Report in April 2006 (Exhibit 5), which mirrored the confidence which those low CDS spreads both reflected and reinforced.

‘There is growing recognition that the dispersion of credit risk by banks to a broader and more diverse group of investors, rather than warehousing such risk on their balance sheets, has helped make the banking and overall financial system more resilient.

The improved resilience may be seen in fewer bank failures and more consistent credit provision. Consequently the commercial banks may be less vulnerable today to credit or economic shocks.’

And the IMF was not alone. The assumption that financial innovation had made the world safer was a dominant conventional wisdom, an explanation for what looked to many economists like the ‘Great Moderation’. It reflected a confidence that, even if few people understood the intricacies of structured credit and credit derivatives trading, they must in some way be adding value and dispersing risk as any innovation that did not would not survive in a competitive marketplace. A confidence we might reasonably label the Greenspan doctrine.

And third (Exhibit 6), figures that chart rapidly increasing income leverage within the US and UK economies, increasing debt to GDP. But also the intriguing fact that while there was some increase in the leverage of household and commercial sectors, in their debt to GDP, the increase in the size of the financial systems balance sheets is far bigger than can be explained by this effect. Instead the most striking fact is the dramatic increase in intra-financial system claims, an explosion matched by huge increases in trading volumes relative to underlying real activities.

If we accept the Greenspan doctrine, then by definition all of this increased activity was economically useful, truly valuable. But if we do not, at least some of this increased financial activity may have reflected economic rent extraction rather than value added.

In the aftermath of the crisis, we must therefore be willing to challenge two assumptions:

first, that all markets are by definition self-correcting and in some sense rational;1and
second, that financial innovation resulting from market competition is by definition useful.
And we must ask whether the financial system is delivering its economic functions as efficiently as possible, or whether parts of it before the crisis had swollen beyond their economically efficient size.

In light of answers to these questions, we must design our regulatory response. Much of what is needed is clear:

capital and liquidity regulation reforms to make the banking system a shock absorber rather than shock amplifier in the economy: more capital and more liquidity, and countercyclical capital built up in the good times and able to be drawn down in bad;
reforms to deal with large systemically important, potentially too-big-to-fail banks, with possible capital surcharges for the largest and most interconnected, and/or resolution procedures that would enable controlled wind-down; and
action to reduce interconnectedness in Over- the-Counter (OTC) derivative markets, migrating as many contracts as possible to central counterparty clearing systems, and ensuring adequate capital and collateral against the remaining bilateral contracts.

Those elements of the agenda are already agreed and being pursued at both national and international levels. But I will concentrate today on two issues where appropriate policy is not yet clear, or where regulation alone might be insufficient:

first, the optimal level of capital in the banking system and of leverage across the economy; and
second, the optimal size of the wholesale financial services industry and in particular of trading activities.


Optimal capital requirements and leverage

On capital, there is very strong consensus that the global banking system should in future run with more capital and lower leverage than in the past – but how much more? Is the optimal capital ratio roughly 5%, or roughly 10%, or roughly 20%?

Two things are striking about that question.

The first is how absent it was from past regulatory debates, for example:

when the Basel 1 capital regime was introduced in the 1980s, there was a clear objective to level up capital ratios to best international practice level, but the latter was interpreted as being simply the level that existed in the countries with somewhat higher capital ratios – there was little debate about whether this level was optimal; and
while the design of Basel 2 involved immensely complex consideration of what relative risk weight to attach to different assets, when it came to the aggregate level of capital, the overt approach was to leave the overall level broadly unchanged.
The second striking fact is that comparisons across countries and periods show that banking systems can perform their economic functions with very different levels of capital. In both the UK and the US, there were past periods when banks had not just slightly but much higher capital ratios than today, and much lower leverage (Exhibit 7), but they still managed to perform credit intermediation functions in growing market economies.

So it is certainly possible to run banking systems with much higher levels of capital than today. And higher capital ratios should mean a more stable financial system.

But it also seems obvious that higher capital requirements would increase the cost of credit intermediation. Bank capital is more expensive than senior debt or deposits: bank equity capital is more expensive than debt capital. Therefore the more capital regulators demand, the higher the margin that banks need to charge between deposit rates and lending rates. And that might impose a cost on the economy, restraining lending through increasing its price.

But while that must be true to a degree, two caveats must be made:

The first reflects Modigliani and Miller’s famous insight on the impact of capital structure on a firm’s cost of capital, which notes that while lower leverage might seem to increase capital/funding costs by raising the proportion of more expensive equity capital, this effect is offset because as leverage falls, debts becomes safer and therefore less expensive and equity returns become less volatile and the cost of equity falls.2 The tax deductibility of interest payments, of course, means that these offsets are not complete, so that a private incentive to seek higher leverage still remains. But that raises the issue of whether our tax systems are sensibly designed.
The second is that an increased cost and decreased volume of lending is only harmful if we are confident the extra lending that would occur in a more lightly capitalised banking system would be beneficial. Constrained lending could be at the expense of useful investment projects, but decreased lending might also constrain wasteful projects and unaffordable borrowing commitments, particularly in an irrationally exuberant upswing. So we cannot decide the optimal leverage of the financial sector without considering the optimal leverage of the household and corporate sectors, and whether we can rely on those sectors to choose optimal debt levels.
So the reason why the world’s regulatory authorities have evaded the fundamental question of the optimal level of capital is simply that it’s very difficult to answer. And our decisions on how much to increase capital will therefore be inevitably judgmental.

But one of the key insights on optimal capital structures may relate not to regulation but to tax. In Modiglaini and Miller’s analysis, the one factor that clearly makes it rational for either banks or corporates to increase their leverage is that in almost all corporate tax regimes across the world, returns to debt providers are tax deductible, but returns to equity providers not. Even, therefore, if we had sufficient confidence in free market rationality to assume that both corporate and banks in an unbiased world would chose capital structures that optimally balance equity and debt, tax regimes have introduced a huge bias towards sub-optimally high leverage. Changing those tax regimes now may be impossibly difficult. But we do at least need to understand that the bias exists and that our regulatory approach needs to lean against it.

Trading and market liquidity

My second open issue is the optimal scale of trading activities. Exhibit 6 highlighted the dramatic growth of financial sector assets and liabilities as percent of GDP, with the most rapid growth being claims between the financial institutions, rather than between the financial sector and the rest of the economy.

This growth of financial activity relative to real economic activity is also seen in measures of trading volume:

in the 1970s, world trade and long-term investment flows were supported by foreign exchange transactions that were roughly double the value of those real flows – today they are about 50 times more, with short-term capital flows being the dominant driver;
the value of interest rate derivatives has increased from $18 trillion in 1995 to $400 trillion today – a 20 times increase against a three times increase in nominal global GDP;
in 1990 credit derivatives did not exist – in 2007, about $60 trillion of gross nominal value was outstanding, a huge multiple of the value of the underlying credit instruments hedged through the derivatives markets; and
the value of daily oil trading on major exchanges in 1990 amounted to roughly the same as the value of underlying oil produced in the world – it is now ten times more.
A crucial question is whether this increased trading has made the economy more efficient or less. The dominant conventional wisdom of the last 20 years denied that this is even a legitimate question. If you trust the rationality of the efficient market and the wisdom of corporate treasurers only to buy financial products that make sense, then this expansion in trading volume must be axiomatically beneficial. But after this crisis that argument by axiom is no longer adequate. We have to ask fundamental questions about the real economic value of trading activity.

Some level of trading activity is clearly beneficial to the real economy. There is an economic value in market liquidity, in customers being able to buy and sell contracts in liquid efficient markets at fine bid-offer spreads. Economically beneficial trade is lubricated by forward foreign exchange markets, and you cannot have a liquid forward market without position takers, which means speculators. Speculators are not exactly the most favoured citizens today, but they do play a useful role in a market economy.

But the fact that market liquidity has an economic value does not mean that more market liquidity, supported by more speculation, is limitlessly beneficial in all markets. Liquidity provision, like most economic activities, is subject to diminishing marginal value. As Benjamin Friedman put it in an article in the Financial Times in August, it is difficult to discern the economic value of devoting high intelligence and large computing power to the task of anticipating market movements a few seconds before the rest of the market anticipates them.3 And as Professor John Eatwell has noted, global trade was actually growing faster in the 1970s, when FX volumes were only twice the volume of underlying trade and investment than today, when they are 50 times more.4

There may indeed be a point beyond which increased trading activities delivers not just diminishing marginal returns, but negative returns for the non-financial sector, inducing instability and extracting economic rents.

All liquid financial markets can be subject to herd effects, and the greater the volume of trading, the greater may be the potential for those herd effects. More trading can under some circumstances produce more volatility not less – volatility against which the non-financial sector then has to hedge, paying the financial sector for the service. The financial sector thus has a unique capability to create demand for its own services.
And the financial sector has a peculiar capability to charge high but hidden margins for some of its services. In its market-making activities, position-taking profits can be made by exploiting superior knowledge of underlying flows, which is a hidden form of margin.
And as Paul Woolley of the London School of Economics has shown that complex principal/agent relationships, combined with opaque products, create further large opportunities for rent extraction.5
Some categories of wholesale financial services, particularly but not exclusively those linked to the trading of complex instruments, such as structured credit and credit derivates, if left entirely to the free market, may have an inherent tendency not only to create instability but to grow beyond their economically optimal size.

And if they do that, they will tend to produce remuneration that some will see as excessive, and that while accepted in good economic times will become a focus of extreme resentment in recessions.

The question is then, what if any policy levers can be used to address the potential for trading activity to swell beyond its economically efficient size, for trading related profits to be supernormal, and for remuneration to appear excessive.

I will consider three:

the first is popular, indeed populist, but unlikely to be effective – direct regulation of bonuses;
the second is clearly appropriate and the essence of the regulatory response – higher capital requirements; and
the third may in practice be impossible to agree but should not be excluded from debate– financial transaction taxes.

Direct regulation of pay: The populist policy is to limit bankers’ bonuses. If we suggest that some banking activity is unnecessary, and if traders get paid enormous sums for trading these products, why not just limit the bonuses by setting a maximum percentage pay out rate of investment bank profits?

Such a policy would clearly be politically appealing in the current climate.

But in the long run this sector-specific incomes policy would be unenforceable. It would take investment banks no time at all to work out ways round such rules, such as shifting people from employee to self-employed status.

If super normal profits are being made, they will flow into the pocket of employees as well as shareholders. If you think that there is no problem of super normal profits, then you should accept bankers’ bonuses as earned for useful activity. If you think there is a problem, we have to address it at the level of pre-remuneration profit, not by asking regulators to do the impossible job of regulating pay levels.

Appropriate capital standards: A second policy option clearly required, and the core element in our policy response, is higher capital requirements on trading activity. The past capital regime for trading activity was not just a bit wrong, but radically wrong, based on simplistic faith in value-at-risk models simplistically applied, and on the unjustified assumption that presently liquid markets would always remain so. It allowed major trading banks to trade complex and risky instruments with clearly inadequate capital support.

Changes to the trading book capital regime already agreed for implementation by January 2011 will increase requirements over three times on some categories of trading activity, and among the Basel Committee’s most important agenda items is a fundamental review of the whole trading book capital regime. Higher capital against trading activity will greatly reduce the risks of financial instability; if it also reduces the volume of trading in some instruments and the aggregate remuneration of some traders that may be a perfectly acceptable side effect.

Financial transaction taxes: But even with higher capital requirements, financial trading activity may continue to grow both within the banking system and outside it, and those high levels of trading activity may continue to support unnecessary rent extraction by the financial sector, and may generate economic instability. If that is the case, and if society is worried about the consequences, either for financial instability or for the size and remuneration of the financial sector, then it should not exclude consideration of taxes on financial transactions. Anyone who thinks such taxes would prevent all or even most rent extraction in the financial sector, or that they could be designed to tune the liquidity of markets to precisely its optimal level – neither too liquid nor insufficiently liquid – is fooling themselves. But in the real world of imperfect instruments with which we seek results at least a bit better than those we see today, they should not be excluded from consideration.
But my objective today is not to propose specific policy measures – other than those related to capital and liquidity on which the global regulatory community is already actively engaged – but to stress the need, after this huge financial crisis to ask searching questions about the functions finance performs in our economy, about optimal levels of leverage in the whole economy as well as in the financial system itself, and about optimal levels of trading activity. These are questions we used to avoid, because a dominant ideology said that they were invalid or irrelevant, with the level of leverage and the scale of trading activity axiomatically optimal because chosen by free markets. In the face of this financial crisis, we can no longer avoid them.



1.The use of the word ‘irrational’ to describe herd and momentum effects can be challenged on the grounds that such effects can derive from actions that are rational at the level of individual agents. George Soros, for instance, making this case prefers to say that markets have no tendency to reach equilibrium, rather than that they are irrational.

2. Miller M and Modigliani F.: The cost of capital, corporation finance and the theory of investment, American Economics Review, 1958, 48:3, pp 261-297; Corporate income taxes and the cost of capital: a correction, American Economics Review, 53:3, 1963 pp 443-453

3. Benjamin Friedman’s article Overmighty Finance Levies a tithe of Growth, Financial Times, 26 August 2009

4.John Eatwell, Why Turner is Right, Prospect Magazine, Issue 164, 21 October 2009

5.Bruro Biais, Jean-Chartes Rochet and Paul Wooley, Rents, learning and risk in the financial sector and other innovative industries, September 2009

Conyers Dill & Pearman to advise on the laws of Cyprus

Multi-jurisdictional law firm Conyers Dill & Pearman has announced that it will be adding Cyprus legal advice to its already impressive roster of jurisdictions. The Cyprus practice will be launched out of Conyers’ Moscow office, and the firm will provide advice on all aspects of Cyprus corporate law.

Cypriot law firm Antis Triantafyllides & Sons LLC (ATS) has entered into an arrangement with Conyers Dill & Pearman for mutual co-operation on Cyprus, Bermuda, British Virgin Islands, Cayman Islands and Mauritius work. ATS will assign a lawyer from their Cyprus office to Conyers' Moscow office on completion of Russian employment formalities.

John Collis, Chairman of Conyers, commented: “Triantafyllides is a well recognised and respected Cyprus firm and we are very pleased to be co-operating with them. The addition of a Cyprus practice enables us to further expand opportunities for clients doing business in major international financial centres. It is yet another differentiator for the firm as we continue to pioneer the field of multi-jurisdictional law. Conyers offers a range of market leading jurisdictions to our global client base and we continue to look at ways of augmenting our service offering.”

Caroline O’Hare, Managing Partner of Conyers’ Moscow office, added: “Cyprus is a leading treaty-based jurisdiction, and a preferred jurisdiction for Russian investment. Over the past year, we have seen considerable demand for advice on Cypriot law and are already receiving instructions from clients. As the only firm in Russia advising on offshore law, particularly British Virgin Islands and, going forward, Cyprus, Conyers will continue to provide clients with the highest quality responsive, timely and thorough legal advice on the major jurisdictions.”

The launch of Conyers’ Cyprus practice marks continued progression of the firm’s strategy to focus on the BRIC markets, following launches in São Paulo, Moscow and Mauritius over the past 2 years, in addition to its well established Hong Kong office.

Nearly half of all foreign direct investment into Russia flows through Cyprus and the British Virgin Islands, where Conyers is already well established. It is expected that economic cooperation between Cyprus and Russia will continue to increase, following the completion of Cyprus’ new double taxation avoidance treaty with Russia in April 2009, and Cyprus’ removal from Russia’s blacklist of states and territories which participated in exemption for dividends.

With the addition of Cyprus, Conyers will advise on the laws of Cyprus, Cayman Islands, British Virgin Islands, Bermuda and Mauritius.

OECD's Gurría to address Delhi symposium, present India investment study

OECD Secretary-General Angel Gurría will visit India on 3-4 December to meet senior government officials, to address a symposium on global economic prospects and the Indian economy and to present a new OECD review of India’s investment policies.

As the world economy struggles to pull out of recession, India is one of several major emerging economies that continues to show positive growth. In the short term, according to the OECD’s latest projections, poor monsoon rainfall will hamper the ongoing economic recovery in India only modestly. Growth is projected to rise above 7% in 2010 and 7.5% in 2011.

India participates in many areas of the OECD’s work as one of five major economies, along with Brazil, China, Indonesia and South Africa, with which the OECD launched an “enhanced engagement” partnership to develop joint responses to pressing global economic issues. During his visit, Mr. Gurría will meet with senior Indian government officials with a view to strengthening and broadening bilateral cooperation.

On Thursday 3 December, Mr. Gurría will address the India-OECD Symposium organised jointly with the Indian Council for Research on International Economic Relations (ICRIER). Other speakers will include Dr. C. Rangajaran, Chairman of the Economic Advisory Council to the Prime Minister of India, Ms. Usha Throat, Deputy Governor of the Reserve Bank of India and Dr. Rajiv Kumar, Director and Chief Executive of ICRIER.

On Friday 4 December, Mr. Gurría will join India’s Minister of Commerce and Industry, Mr. Anand Sharma, for the public launch of the OECD’s Investment Policy Review of India, at an event organised by Department of Industrial Policy and Promotion, Ministry of Commerce and Industry.

In parallel with these events, the OECD will organise a seminar on regulatory reform on 3 December. On 4 December, a seminar on e-government is being organised jointly with India’s Ministry of Communication.

New research from Chatham House indicates EU membership was helpful during crisis

The City of London Corporation today released a paper – Lessons from the Impact of the Economic and Financial Crisis on the EU and the European Neighbourhood – examining the deep and varied impact the global financial crisis has had on the European Union and its member states.

Commissioned by the City and produced by the International Economics Department at Chatham House, the report makes clear that, whilst the single market did not prevent a steep recession, some economies and sectors showed more resilience than others and that services industries generally played an important stabilising role. The European economic downturn now appears to have stabilised, leaving many EU member states in a far better position than non-members.

Echoing last week’s European Bank for Reconstruction and Development Transition Report 2009, this report also finds that international financial integration was generally a positive step for the newest Central and Eastern European members of the EU until the crisis disrupted trade and investment flows. Whilst Emerging Europe was the area worst affected by the crisis, some states coped fairly well with the crisis and parts of Central and Eastern Europe are beginning to see signs of renewed growth, which should accelerate in the coming years.

Stuart Fraser, Policy Chairman at the City of London Corporation, commented:

“At the heart of the European Union lies a pan-European desire to promote open markets and free trade between the 27 member states.

“The City has always been a vociferous defender of these principles. Our reputation as a leading centre for international finance has long been underpinned by a commitment to excellence, unbeholden to national self-interest.

“Whilst we must remain mindful of the differing economic traditions, circumstances and policy priorities that exist within the Union’s diverse membership, we must also recognise our shared common problems and concerns.

“Unparalleled levels of international cooperation helped dampen the impact of the financial crisis throughout the European Union and drive the European economy towards recovery.

“It is in all of our interests to continue to work together, so that we can guard against future economic crises and further enhance our international competitiveness in an increasingly globalised industry.

A retreat into protectionism is helpful to no-one.”

Download the Impact of the Crisis on the EU report

FSA statement re: Walker Review

The Financial Services Authority (FSA) welcomes the publication of Sir David Walker’s final review of corporate governance in UK banks and other financial institutions.

Many of the recommendations complement work the FSA is already carrying out, such as the increased focus on the quality of governance and risk management at FSA-regulated firms. The FSA has already strengthened its approach to the approval of individuals who manage and influence firms at a senior level and will publish a further consultation paper on governance and approved persons early next year.

The FSA introduced a remuneration code in August 2009. It comes into effect on 1 January 2010. Sir David Walker has expressed strong support for, and his recommendations are broadly consistent with, the FSA’s existing remuneration code.

The FSA reiterates its commitment to reviewing its remuneration code next year in order to take any international developments into account. This review will also consider whether, and how, to implement Sir David’s wider recommendations on remuneration.

In relation to shareholder engagement, on conclusion of the Financial Reporting Council’s consultation on the ‘Stewardship Code’ the FSA will consult upon a rule introducing a ‘comply or explain’ disclosure requirement for relevant investment management firms.

The FSA continues to participate actively in international fora to ensure that the UK continues to lead the way in setting high standards for governance and remuneration.

Government to implement Walker reforms on pay and governance

The Government will move quickly to implement the reforms of bank pay and governance proposed today by Sir David Walker.

Sir David’s review was commissioned by the Government earlier this year to explore failures of corporate governance and management of banks. His final report suggests a series of reforms to strengthen the role of shareholders, improve the quality of bank boards, and to increase transparency of pay and bonus policies.

Chancellor of the Exchequer Alistair Darling said:

“One of the fundamental causes of the financial crisis was bad management of some our major banks. Too many people around board tables did not ask the right questions; some chief executives did not fully understand the risks being taken by their traders; pay and bonuses encouraged reckless risk taking instead of responsible behaviour. Banks failed because some of the top people running banks failed to do their jobs.

“Tougher regulation, including stronger capital and liquidity requirements, reform of the mortgage market, greater competition, consumer protection, and living wills will help to make our system safer for the future. But the culture of the banks themselves must change.

“Sir David’s proposals are the blueprint for how banks must be run in the future. His interim report recommended changes to control bonuses that have already become part of a global standard agreed by the G20. The Government strongly supports his recommendations and will take steps to implement them as soon as possible.”

Sir David’s report recommends action to be taken by the Government, the Financial Services Authority, the Financial Reporting Council, bank owners, and the banks themselves. For its part, the Government accepts all the recommendations and will begin immediate work to implement them.

Specifically, the Government’s Financial Services Bill will allow the Treasury to issue regulations forcing banks to disclose in bands the number of staff earning more than £1million per annum. We will issue draft regulations for consultation in the New Year and bring them into force as soon as practicable after enactment of the Bill. This will force disclosure for the 2010 performance year.

In addition, the Financial Services Secretary Paul Myners will shortly meet with major institutional investors to discuss steps they can take to implement Walker’s recommendations as owners of UK banks.

A review of corporate governance in UK banks and other financial industry entities: Final recommendations (26 November 2009)

India : Setting up of a working group on foreign investment in India

Setting up of a working group on foreign investment in India (Dated 24th November, 2009)

Mauritius Research Council : A Study of the Implementation and Impact of Corporate Governance in Mauritius

A Study of the Implementation and Impact of Corporate Governance in Mauritius

UK : The FSA's agenda for fighting financial crime

Speech by Margaret Cole, Director, Enforcement and Financial Crime Division, FSA
British Bankers Association
19 November 2009

I am going to talk today about the FSA’s role in fighting financial crime. And I intend to say something about a current hot topic for debate in the criminal fraud arena: Who should be prosecuting what?

It’s important to be clear that our work in relation to financial crime is not just about enforcement and criminal prosecutions. Much of what we do is less glamorous and doesn’t always grab the headlines, but it is of vital importance for our Financial Crime objective, which mandates us to work to reduce the extent to which it is possible for regulated businesses – or those which should be regulated but aren’t – to be used for purposes connected with financial crime. The objective is focused on crime prevention and I am going to start today by saying something about the frontline work we do to achieve this in our roles, first as gatekeeper and second as supervisor.

Gatekeeper

We are the gatekeeper of the UK financial system. Firms or individuals wishing to operate in the UK must meet our 'fit and proper' standard. Those who don't, stand to be rejected during our authorisation, approval or change of control processes. There are numerous aspects to fitness and properness – competence, integrity and the ability to establish the right culture and tone at the top are important features.

A murky past, a reputation for unscrupulous business methods or sailing close to the wind will also call fitness and properness into question. Applications from countries where personal histories are obscure or controverted, or corruption is endemic in business life, add to the challenge.

We address these challenges by building stronger links with overseas law enforcement and regulatory agencies, by devoting more people and resources to the cases that call for heightened due diligence and, above all, as you would expect from an intrusive regulator, by a sceptical, questioning approach that does not shy away from making decisions that will be contested. In this we are aided by the fact that the burden of proof is on the applicant to satisfy us of their integrity. That puts us in a strong legal position to take robust decisions, and we have been doing so.

People seeking to bypass the FSA as gatekeeper can expect little sympathy. In September this year we brought our first prosecution against an individual for acquiring a controlling interest in a regulated firm without giving the FSA prior notice and for making false and misleading statements – and we obtained a conviction. A second prosecution is under way.

But we don’t or shouldn’t perform the gatekeeper function in isolation – we do expect authorised firms to work with us in the fight against financial crime and to assist us in keeping undesirable companies and individuals away from UK authorised firms and their customers.

Supervision

The second strand of our financial crime work to mention today is in the FSA core activity of supervision. As you know, the FSA has strengthened its supervisory philosophy and operating model. We are committed to intensive, intrusive, outcomes-focused supervision. Under this model our supervisors focus on what really matters. Not tick-box compliance with individual rules – but on what firms and individuals do and the real world impact of those outcomes. This means we will focus on risks inherent in firms’ business models and we will be proactive in making sure those risks are managed. So that where we find issues of concern, we will act to bring about mitigation of risks.

To strengthen these changes further, last month we reorganised our core activities: we integrated our retail and wholesale firm supervision into one Supervision Business Unit. These supervisors are supported by subject matter specialists in a new Risk Business Unit, as well as by financial crime specialists in my area – the merged Enforcement and Financial Crime Division.

The Financial Crime and Intelligence Department provides specialist support to supervisors on the financial crime risks faced by firms. We have dedicated staff who work alongside supervisors during visits or ARROW risk assessments. They also investigate what has gone wrong in cases of crystallised financial crime risk. And we also have policy experts who make sure that our supervisors are fully appraised on relevant issues relating to financial crime.

So that brings me to the outcomes we expect to see from firms. First of all, senior management should take clear responsibility for managing financial crime risks, whether they arise from launderers and fraudsters, or corrupt intermediaries. These risks should be treated like any other risk faced by the business – they should be understood, assessed and monitored, and judgements should be made about how best to mitigate them.

We expect to see senior management demonstrating leadership on financial crime issues. We look for evidence that senior management understand and are shaping their firm’s approach to financial crime risks. And we want to see suitably senior and independently-minded staff with sufficient resources taking responsibility for mitigating financial crime risks.

If a supervisor decides to probe on financial crime issues, where might this attention turn?

One real-life example is money laundering. The 2007 anti-money laundering regime has now bedded down to the point where the Treasury have launched a review of how well it is functioning. We believe the regime is more sensitive to risks than was once the case. But the risks posed by money launderers have not gone away. And where we see weaknesses in anti-money laundering systems and controls we will act.

In the case of our action against Sindicatum Holdings Ltd last year, we fined the Money Laundering Reporting Officer personally – that’s the first time this has happened.

One important element of firms’ anti-money laundering defences is the identification of customers who are ‘politically exposed persons’. These are senior public officials who may abuse their position for their own personal gain and that of their close associates. Clearly, only a minority of such customers will be corrupt, but firms must subject these customers to more thorough monitoring. This legal duty stems from the great damage that corruption does to political systems and economies throughout the world.

So it is no surprise that we will treat very seriously the discovery that a regulated firm is itself involved in financial crime. Our action against Aon earlier this year showed our resolve on this point. This insurance intermediary made payments to third parties when, in the words of our Final Notice, it ‘ought to have been reasonably obvious [to Aon Ltd] that there was a significant risk that the Overseas Third Party might bribe the insured, the insurer, or a public official’.

Our penalty of £5.25m for failing to maintain adequate systems to counter the risk of bribery and corruption is the highest corruption-related penalty in the UK to date.

In light of this case, we envisage that supervisors may in the future be asking whether a firm’s geographical reach, customer base, product lines, or sales channels make it vulnerable to the risk that staff pay or receive bribes. Firms that use go-betweens to generate new business in jurisdictions associated with systemic levels of corruption may receive particular attention. I would expect firms in this position to be actively implementing measures to mitigate the threat.

To conclude on the subject of corruption, and to be absolutely clear, the FSA is not a criminal prosecutor for bribery and corruption. Where we find evidence of criminal matters we refer them to the Serious Fraud Office (SFO) who are the UK lead agency for criminal prosecutions for corruption. So far as financial services firms and individuals are concerned, our role is focused on prevention.

The law in the UK places other obligations on financial firms. For example, the asset-freezing regime and directions issued under the new Counter Terrorism Act restrict firms’ ability to do business with certain customers. An FSA supervisor’s role is to oversee the systems and controls firms must put in place in order to comply with these requirements. Our recent thematic work on firms’ efforts to comply with UK financial sanctions was not reassuring – we are concerned it remains possible for sanctioned individuals to slip through the net. We published our findings in April. Firms should be in no doubt that, where we continue to identify systems and control weaknesses, we will use our enforcement tool.

And data security is another area where we can, and will, use enforcement action to support the work of our supervisors. We expect firms to consider how their actions or failures leave others open to the threat of fraud. We continue to learn of data security lapses that put customers’ personal information at risk. This summer’s enforcement action against three units of HSBC saw substantial fines paid for weak controls over the security of customer data. And we will follow up with further enforcement cases to demonstrate the importance of this subject.

Enforcement and criminal prosecutions

So that brings me to the subject of enforcement activity – and an important subset of that activity – criminal prosecutions.

The Enforcement and Financial Crime Division takes the lead for the FSA in pursuing the strategy of credible deterrence. And I have already mentioned some of our regulatory enforcement outcomes this year in support of our financial crime objective.

But the FSA is not just a regulator – there are some types of financial misconduct we can prosecute criminally. I started by saying this is something of a hot topic at the moment. We were accused recently of having transformed ourselves into an assertive criminal prosecutor – something I took as a compliment until I saw it was qualified by the statement that this had happened in the absence of public debate. Our credentials for prosecuting have also been questioned, although I am not sure how seriously, on the basis that we are not superintended by the Attorney General, lack the powers some other prosecutors have, and are not funded by the public purse.

It is not clear what the basis for these propositions is, since the original statutory provisions which underpin the prosecution powers (and their funding) were debated in parliament in 2000, the FSA is accountable to parliament through the Treasury, judicial approval has recently been given to the FSA’s prosecutorial actions and I have been articulating the FSA’s prosecution policy over the last three years, in response to which there have been no discernible dissenting voices.

The FSA is, of course, a prosecutor with a limited remit, a remit we are very clear about. But there is no reason why this should be seen as a bad thing. There are a number of other specialist prosecutors reflecting the view that it is important to have specialist fraud authorities rather than one jack of all trades. Almost every prosecutor other than the CPS prosecutes a limited range of offences.

At the FSA we decided three or so years ago that we should take stronger action in relation to markets offences – in particular insider dealing, a crime we have specific statutory remit to investigate and prosecute. We recognised that the history of insider-dealing prosecutions in the UK has not been a distinguished one, and that it continues to be difficult to root out and prove insider dealing. But despite the risks, we have taken steps to become a heavyweight criminal prosecutor.

Our successes in this area are the result of a joint venture approach in which Markets, Financial Crime and Intelligence, and Enforcement work intensively together to deliver throughput of cases and public outcomes.

Two essential elements in the investigation process for insider dealing and other markets offences are: access to good intelligence; and the ability to analyse it. This is a highly specialised area, in which the FSA can claim to have massive experience, not least from conducting numerous market abuse enquiries since 2000. Our Markets Division maintains close liaison with all the major exchanges, and can follow up suspicious trading activity quickly and expertly.

The Financial Crime and Intelligence Department (FCID), which joined the Enforcement Division on 1 October, has access to intelligence across a broad spectrum. Both Markets and FCID have extensive analytical skills. Lawyers and investigators in the Wholesale Department of Enforcement have long experience of dealing with these cases, and they have wide-ranging investigatory powers under the Financial Services and Markets Act 2000 (FSMA). There are several ongoing large enquiries, two cases have successfully been brought to trial and convictions achieved, and there are three more going through the court process this year. This work has been done at no cost to public funds. And it is work which the police and other prosecutors do not have spare resources to tackle – and lacking current experience in a complex field, it makes no sense for them to take it on. They have many other important areas of fraudulent activity to tackle, including, for example, the current emphasis on international corruption.

The FSA has the tools it needs to prosecute markets cases. Importantly, we also have the option to take cases down the regulatory market abuse route (an option which we have used frequently since 2000), and can apply civil recovery and fines to these cases. Where the offenders are authorised by the FSA, that authorisation can be removed.

If the decision is taken to prosecute – and I should say we strictly follow the guidance laid down in the Code for Crown Prosecutors and the FSA Enforcement Guide, charges of money laundering can be added to charges of insider dealing where appropriate, and recovery of the proceeds of crime can be achieved through the confiscation process, backed up by restraint orders. And, with Royal Assent being given last week to the Coroners and Justice Act, we will soon be able to make use of the immunity from prosecution and assisting offender powers in Part 2 of the Serious Organised Crime and Police Act 2005.

We have also received significant judicial approval for our prosecution policies. The Court of Appeal, in R v Rollins and R v McInerney, has confirmed that the FSA has the power to prosecute money-laundering offences and conspiracies which relate to FSMA and insider dealing activity. And our policy of credible deterrence has received clear backing from the Lord Chief Justice, who has clearly stated that insider dealing is a serious offence demanding a custodial sentence (R v McQuoid).

The FSA’s role in the market abuse area is a vital part of the widespread assault being conducted by various authorities on fraudulent activity and financial crime. And that is why we will continue to pursue our prosecution strategy for insider dealing and markets offences resolutely and assertively. And, as I have said before, it is a long-term plan.

So it is clear that we can and should prosecute insider dealing. But what about other species of fraud?

Our interest is always primarily to make sure that criminal offences are prosecuted by the right authority – and by that I mean the prosecutor with clear remit and mandate, skills, specialisation and resource. That way a prosecution is more likely to be conducted skilfully and effectively and has better prospects of succeeding and thereby sending the deterrence message that criminal prosecutions are intended to deliver.

We are not, and do not aspire to be, a general fraud prosecutor. Very often frauds that we discover, for example, investment frauds, are more suitable for another prosecutor, usually the SFO or the Fraud Prosecution Unit of the Crown Prosecution Service (CPS). And we regularly refer cases to them and assist them in the preparation of their cases. But we do, of course, recognise that our financial crime statutory objective also requires us to focus on reducing the extent to which unauthorised businesses can be used for a purpose connected with financial crime.

Our strategy in respect of unauthorised business is known as the 3D strategy.

The three Ds are:

• disruption – where we use our powers to disrupt ongoing activity;
• deterrence – where we seek to deter those planning to engage in such activity by seeking the toughest and most effective penalties in our cases); and
• discouragement – where we focus on discouraging the public from dealing with unauthorised businesses.

We have recognised this year an increase in the unauthorised business frauds coming to our attention and we have responded by creating a new Unauthorised Business Department, focusing on share frauds such as boiler rooms and deposit-taking scams.

So to conclude, I hope I have given you a clear understanding this morning of the scope of our financial crime mandate, the breadth of work we do in this area and our visible commitment to this important area of the FSA’s work.

Our aim is to be considered and proportionate, and to make good use of all the tools available to us. And as I have made clear, that does where appropriate include the Enforcement tool in all its forms, both regulatory and criminal.

Mauritius Private Foundation

To nurture the dynamism of the financial services industry, Government will pass an innovative and competitive law on Private Foundation. This will allow the setting up of foundations in the Global Business Sector to further promote Mauritius as a platform for wealth management, services, succession and estate planning as well as pension funds.

The Financial Services Commission (FSC) will seek recognition as an equivalent jurisdiction with other financial centres. This will expand the scope for the Mauritian financial industry to market its products internationally.

Government is also undertaking a study on the appropriate fiscal regime to improve the competitiveness of Mauritius as a business centre for Funds whilst staying in line with responsible international norms.

ACCA calls for improved dialogue between regulators and businesses in 2010

ACCA has published a new paper in which it urges regulators and businesses to engage in a common sense business dialogue to ensure that global financial regulation heads in the right direction in 2010.

In the policy paper, entitled The Future of Financial Regulation - An Update, ACCA calls for changes, including better ethics training for all directors including non-executive directors, the implementation of a US-style Consumer Financial Protection Agency in Europe and the urgent need for company boards to upgrade their risk functions.

'We need to see specific proposals to turn the G20's stated pledge to see integrity in financial institutions turn into reality,' said Ian Welch, ACCA's head of policy and co-author of the report. 'The way to do this is for both businesses and regulators to agree on ways to instil and implement ethical business codes in our financial and corporate sectors.

'Buy-in from both sides is the key to achieving successful regulation. The risk is that if this is not achieved, governments could lose patience and impose a framework of strict and detailed regulations rather aiming for than a balanced and common sense business environment.'

The paper argues that much remains to be done to ensure non-executive directors exercise meaningful and effective oversight of actions of executives in large complex banks. They particularly need help in obtaining assurance that agreed board policies have actually been implemented by management.

The discussion paper also discusses the principles needed for solid financial regulation in the future. It examines:

• the purpose and structure of regulation


• competition


• standards of conduct and competence


• governance


• accountability and incentives


• risk management and capital funding.

'It is still too early to give a definitive view of the regulatory landscape as proposals are still being consulted on at national and global levels,' said John Davies, ACCA's head of business law and co-author of the report. 'The debate will go on way into 2010. But some of the key points made by ACCA have been followed, notably on the welcome maintenance of national supervision as the bedrock of regulation.

'Speculation during the past year about the introduction of some sort of "super-regulator" has remained, mercifully, just that. The connection between regulator and regulated must be maintained, which is why we also have concerns about the proposed pan-EU regulatory architecture - co-ordination and best practice sharing is good, but remoteness is not.'

Welch added: 'We are concerned at a continued lack of action on the so-called "too big to fail" institutions - the existence of which is an anathema to good regulation. Extra capital requirements and more intensive supervision will go so far, but it is disappointing that the re-introduction of a Glass-Steagall type division of investment and retail banking activities are not being taken a bit more seriously.

'Competition is the key to effective regulation and governments must put the promotion of competition at the heart of their approach.'

STEP : Confidence in global recovery builds in Trust & Estate Business

The Society of Trust and Estate Practitioners (STEP) have released figures from their latest global quarterly confidence survey showing member confidence in the recovery continues to grow around the world.

The STEP Near Term Confidence Index, which looks at the outlook over the next three months, has risen from 11 to 20. This index was -13 at the start of the year. The STEP Longer Term Confidence Index, which looks at the outlook over the next 12 months, has similarly risen strongly, from 28 to 37, having begun the year at -2. The survey looks at members’ views across a wide range of jurisdictions and trust and estate businesses

The Confidence Indices are constructed by taking the balance of survey respondents replying that they expect business to “improve” or “significantly improve” relative to those expecting business to “decline” or “decline significantly”.

STEP Chief Executive David Harvey said: “The steady increase in confidence among STEP members is a strong indicator that the trust and estate industry is looking forward to a bright future. It is especially encouraging that this comes during a period of rapid change in the industry worldwide. STEP is committed to being at the forefront of these changes and will continue to help its members in over 60 countries around the world to adapt to business challenges during a period of rapid change in the global economy.”

STEP members can access the findings of the 3rd quarter STEP business confidence monitor here

Deutsche Bank named "Best Administrator for Small and Start up Hedge Funds" by HFM Week

Deutsche Bank's Alternative Fund Services, part of the bank's Trust & Securities Services business in its Global Transaction Banking (GTB) division, recently won the "Best Administrator for Small and Start up Hedge Funds" award from HFM Week.

HFM Week's US Service Provider Awards are designed to recognize companies that have outperformed their peer group over the course of 2008/2009. The awards are judged both quantitatively and qualitatively producing a final short-list of candidates that have demonstrated financial progress, growth and genuine innovation. Deutsche Bank was one of seven finalists and in HFM Week's words "Deutsche Bank's Alternative Fund Services has continued to grow, demonstrating a sustained commitment to clients and quality product offering."

"Winning Best Administrator for Small and Start up Hedge Funds is industry recognition for the high quality service we aim to provide and to our entire team which works diligently to serve the needs of our clients," said Chris Nero, Co-Head of Alternative Fund Services.

In addition, the Bank's Global Prime Finance business, within its Global Markets division, received the Prime Broking Innovation award.

IOSCO consults on point of sale disclosure for Collective Investment Schemes

The International Organisation of Securities Commissions (IOSCO) Technical Committee has published a consultation report on Principles on Point of Sale Disclosure. The Report proposes a set of principles, for the disclosure of key information relating to collective investment schemes, designed to assist markets and market authorities when considering point of sale disclosure requirements in their respective jurisdictions.

The Technical Committee is seeking input from financial services practitioners, industry participants and other relevant stakeholders.

The closing date for responses is 16 February 2010.

Summary

The Report analyzes issues relating to requiring key information disclosures to retail investors relating to collective investment schemes (CIS) and their distribution prior to the point of sale (POS). It also sets out principles to guide possible regulatory responses. The report does not examine issues relating to the suitability of CIS or similar products and does not purport to describe or address all disclosure obligations of the intermediary (e.g., relating to general information on the intermediary’s range of services, the safeguarding of client assets, client categorization or information that needs to be disclosed in the client agreement).

Transparency in the market place, particularly disclosure of information to investors, has always been a high priority for regulators in seeking to ensure that markets run efficiently and with integrity. Enhancing POS disclosure, by helping to ensure that investors are able to consider key information about CIS products before they invest, can contribute to this goal. The recent crisis in the financial markets has highlighted the critical role that accurate, understandable and meaningful disclosure can play. This, and other IOSCO projects, can assist regulators in developing a path towards renewed investor trust in both the producers of financial products and the intermediaries that sell them.

The Report analyzes in detail the key issues raised by POS disclosure, including:

• whether regulatory disclosures are in fact effective in addressing information asymmetries that exist between investors, producers and sellers;
• what constitutes key information;
• how information should be delivered and whether a layered approach should be used;
• what exactly should be understood as delivery;
• at what point in time the information should be delivered;
• use of plain language rather than technical jargon; and
• the format of disclosures.

The Proposed Principles For Disclosure of Key Information in regard to CIS Prior to the Point Of Sale are as follows:

Principle 1
Key information should include disclosures that inform the investor of the fundamental benefits, risks, terms and costs of the product and the remuneration and conflicts associated with the intermediary through which the product is sold.

Principle 2
Key information should be delivered, or made available, for free, to an investor before the point of sale, so that the investor has the opportunity to consider the information and make an informed decision about whether to invest.

Principle 3
Key information should be delivered or made available in a manner that is appropriate for the target investor.

Principle 4
Disclosure of key information should be in plain language and in a simple, accessible and comparable format to facilitate a meaningful comparison of information disclosed for competing products.

Principle 5
Key information disclosures should be clear, accurate and not misleading to the target investor. Disclosures should be updated on a regular basis.

Principle 6
In deciding what key information disclosure to impose on intermediaries and product producers, regulators should consider who has control over the information that is to be disclosed.

In addition, the Report’s examination of possible disclosure of key information has highlighted the following important points:

• No matter what disclosures are mandated, they will not have the intended effect if the investor either does not read and/or understand the information provided. Regulators should therefore consider measures to help improve retail investor education in order to enhance their financial literacy and ability to read investment documentation and make informed investment decisions;
• In general, new POS disclosure requirements should not be imposed without the benefit of consumer testing or assessment to help determine the likely effectiveness of new disclosure requirements; and
• The principles set forth in this report may also be applicable to non-retail investors.

IASB completes first phase of financial instruments accounting reform

The International Accounting Standards Board (IASB) issued today a new International Financial Reporting Standard (IFRS) on the classification and measurement of financial assets. Publication of the IFRS represents the completion of the first part of a three-part project to replace IAS 39 Financial Instruments: Recognition and Measurement with a new standard - IFRS 9 Financial Instruments. Proposals addressing the second part, the impairment methodology for financial assets were published for public comment at the beginning of November, while proposals on the third part, on hedge accounting, continue to be developed.

The new standard enhances the ability of investors and other users of financial information to understand the accounting of financial assets and reduces complexity – an objective endorsed by the Group of 20 leaders (G20) and other stakeholders internationally. IFRS 9 uses a single approach to determine whether a financial asset is measured at amortised cost or fair value, replacing the many different rules in IAS 39. The approach in IFRS 9 is based on how an entity manages its financial instruments (its business model) and the contractual cash flow characteristics of the financial assets. The new standard also requires a single impairment method to be used, replacing the many different impairment methods in IAS 39. Thus IFRS 9 improves comparability and makes financial statements easier to understand for investors and other users.

The IASB has received broad support for its approach. This became evident during the unprecedented global scale of consultation and outreach activity it undertook in order to refine proposals contained within the exposure draft published in July 2009. Round table discussions were held in Asia, Europe and the United States. Interactive webcasts, each attracting thousands of registered participants, have been held, often on a weekly basis. In addition, more than a hundred meetings have been held with interested parties around the world during the past four months.

The views expressed to the IASB during its consultations resulted in the proposals being modified to address concerns raised and to improve the standard. For example, IFRS 9 requires the business model of an entity to be assessed first to avoid the need to consider the contractual cash flow characteristics of every individual asset. It requires reclassification of assets if the business model of an entity changes. The IASB changed the accounting that was proposed for structured credit-linked investments and for purchases of distressed debt. The IASB also addressed concerns expressed about the problems created by the mismatch in timings between the mandatory effective date of IFRS 9 and the likely effective date of a new standard on insurance contracts.

Furthermore, in response to suggestions made by some respondents, the IASB decided not to finalise requirements for financial liabilities in IFRS 9. The IASB has begun the process of giving further consideration to the classification and measurement of financial liabilities and it expects to issue final requirements during 2010.

A feedback statement providing comprehensive details of how the IASB has responded to comments received through the consultation process is available for download by clicking here.

The effective date for mandatory adoption of IFRS 9 Financial Instruments is 1 January 2013. Consistent with requests by the G20 leaders and others, early adoption is permitted for 2009 year-end financial statements.

Commenting on IFRS 9, Sir David Tweedie, Chairman of the IASB, said:

We have delivered on our commitment to the G20 and stakeholders internationally to provide an improved financial instrument standard for the classification and measurement of financial assets for use in 2009. Benefiting from unprecedented levels of consultation with stakeholders around the world, the IASB has made significant changes in its initial proposals to improve the standard, provide enhanced transparency and respond to stakeholder concerns.

The IASB staff presented a webcast on IFRS 9 Financial Instruments. To listen to a recording of that webcast please click here

BKCG White Paper - Brand Identity for Hedge Funds : Build It and They Will Come

"Brand Identity for Hedge Funds: Build It and They Will Come"

UK Financial Markets see gradual pick up in activity in the last 6 months

• 6 out of 11 indicators of financial services activity up in Q3 over Q2
• London holds leading share of international trading in many markets
• Global investment banking fee revenue down 4 per cent in first nine months of 2009 on same period in previous year

UK financial markets: A number of sectors and markets have seen gradual gains in the second and third quarters of 2009, although activity remains low compared to levels of activity in the previous years, according to the six-monthly International Financial Markets in the UK and quarterly City Indicator Bulletin reports both released today by International Financial Services London (IFSL), the independent organisation promoting UK financial services worldwide.

6 out of 11 financial market indicators were up in Q3 2009, a continuation of the trend seen in the second quarter of this year. These included the number of City job vacancies, which reached 11,529 in Q3 2009, from 9,720 in Q2 2009. CEBR are also more optimistic on the employment outlook having recently cut their estimate of expected losses in City type jobs in 2009 from 29,000 to 19,000. The office market is showing signs of stabilising with take up rising and the vacancy rate declining for the first time in two years. UK wide indicators were also encouraging. The CBI’s quarterly survey found that the volume of business in UK financial services rose for the first time in two years in the third quarter of this year. The overall UK picture remains mixed with 8 out of 11 indicators - including new job vacancies, prime rents and UK equity turnover – reporting lower levels of activity compared to the same period last year.

UK’s share of international financial markets: Global investment banking fee revenue totalled $44bn in the first nine months of 2009, down 4 per cent compared to the same period in the previous year. The US was the primary source of income with around 50 per cent of the global total. Although the UK’s $3.7bn in fee revenue accounted for around a quarter of the European total, around 50 per cent of European investment banking activity was conducted in London.

London has maintained a considerable share of international trading in many markets. Most recent figures show that London had a 36 per cent share of global foreign exchange trading, 19 per cent of international bank lending, 18 per cent of hedge fund assets and 19 per cent of foreign equities turnover.

Duncan McKenzie, IFSL’s Director of Economics, said: “While recovery in financial markets remains tentative, the UK has a broad and deep financial services market on which to build. The structural strengths - diversity of markets, strong skills base, global orientation and legal system - that underpin London’s status as a global financial centre remain in place.”

Click here to view PDF of International Financial Markets in the UK report
Click here to view PDF of City Indicators Bulletin

Appleby Tops First PLC Which Lawyer? Offshore Law Firm Super League

Leading offshore law firm Appleby has been named winner of the inaugural Practical Law Company (PLC) Which Lawyer? Offshore Law Firm Super League 2009. The award recognises the firm’s ability to help global companies solve the complex problems that arise from doing business across borders with different regulatory, legal and commercial frameworks.

The winning citation stressed, “Appleby has transformed itself into one of the largest offshore players through a series of mergers and new office openings over the last few years. Its most recent merger, with leading Manx firm Dickinson Cruickshank, has been a significant factor in it securing first place in the super league.”

The PLC Which Lawyer? Offshore Super League is comprised of nine elite law firms which qualified for inclusion based on their existing endorsements by PLC Which Lawyer? in two or more offshore jurisdictions plus extensive research of PLC’s general counsel network, client feedback and lawyer peer reviews.

Appleby led the field with 42 individual lawyer recommendations and jurisdictional recommendations in Bermuda, BVI, Cayman Islands, Isle of Man and Jersey - more than any other firm in both categories.

Following the Isle of Man merger, Appleby has 74 partners globally - the largest number of any offshore firm. In 2009 Appleby also opened offices in the Seychelles and added a representative office in Bahrain to its extensive global network.

Peter Bubenzer, Appleby’s Global Managing Partner added: “We are delighted to have achieved this accolade. Our goal has been to become the leading provider of legal, fiduciary and administration services across the offshore world and it is particularly important that our market leading position has been recognised by practitioners and clients through PLC Which Lawyer’s extensive research.”

STEP : New report confirms importance of offshore centres to world economy

The positive role that offshore financial centres play in supporting growth around the world is highlighted in a new report, International Finance Centers and the World Economy, published today. The report was commissioned by the Society of Trust and Estate Practitioners (STEP) from prominent US economist Professor James R Hines Jr of the University of Michigan and NBER.

Ahead of this weekend’s G20 Finance Ministers’ meeting the report gives a strong indication of the key role well regulated offshore centres now play in the global economy by providing capital to support business activity in neighbouring economies.

The report finds strong evidence from a range of sources that offshore centres play a vital role in the international financial system, improving the availability of credit and encouraging competition in domestic banking systems. The result is a boost in investment in the major economies which ultimately supports job creation and growth.

Professor Hines commented that: “The evidence indicates that offshore centres contribute to financial development and stability in neighbouring countries, encouraging investment, employment, and other aspects of business development. They have salutary effects on tax competition, promote good government, and enhance economic growth elsewhere in the world.”

Chief Executive of STEP Worldwide David Harvey welcomed the report saying: “This report provides further robust evidence of the positive role offshore centres play in the world economy. Last week the Foot Review of British offshore financial centres found that they provided net financing to the British banking system of $332.5 billion in the second quarter of 2009. Professor Hines’ report demonstrates that IFCs play a similar role around the world, lowering the cost of capital to developed and developing economies alike.”

InternationalFinanceCentresThe Hines Report.pdf

STEP Mauritius Cocktail Reception and Gala Dinner - 28 November 2009

The Board of Directors of the Society of Trusts and Estate Practitioners (Mauritius) Ltd, kindly requests the pleasure of your company at a Cocktail Reception followed by Gala Dinner to celebrate seven years of STEP’s presence in Mauritius.

STEP along to Balaclava, the finest feast awaits you all. And there beside the frangipani, we TRUST you all will have a ball. In this ESTATE amidst the cane fields, on a floating lake of blue, we have made a ‘Sugar Island’, a setting fit for all of you. So, every member, book a table, we’ll fit you in if we are able.

The menu's chosen, such a feast, with dishes giving rich variety. So come along and celebrate the seven years of your SOCIETY.

Nick Jacob, Deputy Chairman of STEP Worldwide, will be present as a special guest and will also make a short presentation at the event.

To view the full invitation for this event, click here

IOSCO consults on principles to mitigate private equity conflicts of interest

The International Organization of Securities Commissions’ (IOSCO) Technical Committee has published a Consultation Report on Private Equity Conflicts of Interest. The Report proposes a number of Principles for the effective mitigation of the potential conflicts of interest encountered in private equity firms, and the risks these conflicts pose to fund investors or the efficient functioning of the market.

The report examines the material conflict of interest risks encountered at each stage of the life cycle of a typical private equity fund, managed by a multi-fund, multi-strategy firm, and sets out the potential and common methods for mitigating these potential conflicts of interest alongside each risk. Mitigation typically takes the form of appropriate alignment of interest through incentive structures, disclosure and legal agreements. This issue was originally identified as an emerging risk from the private equity industry in a report published by IOSCO in June 2008.

Kathleen Casey, Chairman of the Technical Committee, said:

“IOSCO, as part of its mission, focuses its work on addressing risks to investor protection and the fair and efficient functioning of financial markets. Like other segments of the financial services industry, the manner in which private equity firms are structured has the potential to create conflicts of interest for their fund managers which, if not adequately addressed, have the potential to disadvantage investors.

“These principles provide industry and regulators with principles by which to assess the quality of controls aimed at managing these potential conflicts, and are intended to be readily applicable to all private equity firms regardless of where they are organised or operating, their chosen investment strategy, fund structure or other investment business activities.

“The development of these principles demonstrates our commitment to ensuring that investors of all types receive adequate protection and markets remain fair, efficient and transparent.”

Proposed Principles for the mitigation of Conflicts of Interests

These principles were developed using a multi-fund, multi-strategy private equity firm as a reference point. They are designed to be applied to all types of private equity firms allowing for firms different size, structure and operations.

The management of each private equity firm, and their investors, should take into consideration the nature of the firm in question when seeking to apply the principles.

1. A private equity firm should seek to manage conflicts of interest in a way that is in the best interests of its fund(s), and therefore the overall best interests of fund investors.
2. A private equity firm should establish and implement written policies and procedures to identify, monitor and appropriately mitigate conflicts of interest throughout the scope of business that the firm conducts.
3. A private equity firm should make the policies and procedures available to all fund investors both at inception of their relationship with the firm, and on an ongoing basis.
4. A private equity firm should review the policies and procedures, and their application, on a regular basis, or as a result of business developments, to ensure their continued appropriateness.
5. A private equity firm should favour mitigation techniques which provide the most effective mitigation and greatest level of clarity to investors.
6. A private equity firm should establish and implement a clearly documented and defined process which facilitates investor consultation regarding matters relating to conflicts of interest.
7. A private equity firm should disclose the substance of opinion given through the investor consultation process and any related actions taken to all affected fund investors in a timely manner (save where to do so would breach any other legal or regulatory requirement or duties of confidentiality).
8. A private equity firm should ensure that all disclosure provided to investors is clear, complete, fair and not misleading.

The report was produced by a working group, chaired by Dan Waters of the UK Financial Services Authority, established by the Technical Committee Standing Committee on Investment Management and composed of representatives of the global supervisory community and private equity industry experts.

The consultation period closes on 1 February 2010.

IMF : Statement at the Conclusion of an Article IV Mission to Mauritius

An International Monetary Fund (IMF) mission headed by Atish Ghosh visited Mauritius during October 19-31, 2009 to conduct Article IV consultation with the authorities. The mission’s work focused on the impact of the global financial crisis on the Mauritian economy and the associated policy response. The mission met with Prime Minister Dr. The Honorable Navinchandra Ramgoolam, Dr. The Honorable Vice Prime Minister and Minister of Finance an Empowerment Rama Sithanen, Governor of the Bank of Mauritius Rundheersing Bheenick, other senior government officials, as well as representatives of the private sector and civil society.

At the end of the mission, Mr. Atish Ghosh, Mission Chief for Mauritius, issued the following statement today in Port Louis:

“Since the last Article IV consultation a year ago, Mauritius, like other emerging market countries, has been suffering from the fallout of the global financial crisis. The mission welcomes the prompt and comprehensive policy response, which included fiscal stimulus, monetary loosening, and direct measures, developed in cooperation with the private sector, to help preserve jobs (such as the Mauritius Approach, Work and Training Scheme, and targeted/time bound tax relief). This has not only helped cushion the economy from the impact of the crisis, it has also better positioned Mauritius to benefit from an upturn in the world economy.

“The economic outlook for Mauritius, as for the global economy, is subject to an unusually high degree of uncertainty. Still, there are some initial positive indications, including in the tourism and other export sectors; growth next year is expected to be considerably stronger than in 2009. The challenge now is to determine when to resume fiscal consolidation without jeopardizing the recovery by prematurely withdrawing stimulus. This calls for some stimulus measures to be held contingently in reserve and deployed only if the recovery seems to be faltering; the announced stimulus package has in part this contingent feature. As the effects of the global crisis pass, resuming efforts at fiscal consolidation and an effective debt management strategy should help place public debt back on a downward path.

“The Monetary Policy Committee (MPC), whose establishment in 2006 was a major step in enhancing the monetary policy framework, appropriately lowered the key policy interest rate last year and earlier this year in the face of weakening activity. Pending further indications on economic prospects, the interest rate should be maintained at its current level, remaining vigilant should inflationary pressures arise as the world economy recovers.

“The mission welcomes the structural reforms in recent years, which have contributed to raising Mauritius’s competitiveness. Maintaining reform momentum, as well as enhancing the quality, coverage, and timeliness of macroeconomic statistics to meet the IMF’s Special Data Dissemination Standard (SDDS), will further strengthen Mauritius’s ability to compete with other emerging market and advanced economies, including as an important international financial center.

“The IMF stands ready to continue to assist the authorities in the implementation of their economic program, including through the provision of technical assistance, and looks forward to continued fruitful policy dialogue in the period ahead.”

New Zealand Department of Internal Affairs: Spammers penalised

Two more New Zealanders have admitted their part in a major international spamming operation and must pay substantial financial penalties.

Justice French (in a judgment dated 27 October 2009) in the High Court in Christchurch ordered Shane Atkinson of Christchurch to pay $100,000 and courier, Roland Smits, $50,000 for their roles in a Christchurch business that over four months in 2007 sent over two million unsolicited emails to New Zealand addresses marketing pharmaceutical products. In December 2008 Shane’s brother, Lance Atkinson, of Pelican Waters, Queensland, paid $100,000 plus costs of $7666 after admitting his involvement. Lance is also facing court action in the United States brought against him by the Federal Trade Commission.

The latest settlements mark the final stage of Operation Herbal King, an investigation conducted by the Department of Internal Affairs’ Anti-spam Compliance Unit. Within three months of the passing of the Unsolicited Electronic Messages Act in 2007, the Department had shut down the New Zealand component of what was ranked as the largest pharmaceutical spamming operation in the history of the Internet.

The operation organised and paid affiliates around the world to send spam emails marketing Herbal King, Elite Herbal and Express Herbal branded pharmaceutical products. These were manufactured and shipped by Tulip Lab of India, through a business known as the Genbucks Affiliate Programme. This business was operated by Genbucks Ltd, a company incorporated in the Republic of Mauritius.

Internal Affairs Deputy Secretary Keith Manch said the Department worked with overseas agencies, particularly the USA’s Federal Trade Commission, to conclude the investigation.

“Operation Herbal King is a major success for the Department and its small Anti-Spam Compliance Unit,” Keith Manch said. “Following the passing of the UEM Act, we entered into international agreements to share information about spamming and pursue cross-border complaints.

“The FTC was able to provide technical information making it possible for our investigators to identify the defendants and obtain evidence of the offending.

“The Act stops New Zealand from becoming a spammer’s haven. Current estimates suggest that around 120 billion spam messages are sent every day. These emails clog up the Internet, disrupt email delivery, reduce business productivity, raise internet access fees, irritate recipients and erode people’s confidence in using email.”

New League Table of World’s Most Secretive Tax Havens

A league table of the world’s most secretive tax havens has been compiled by campaigners seeking greater transparency about the operation of ‘offshore’ finance centres.

The Financial Secrecy Index (FSI) analyses the level of secrecy each haven offers, and the extent of their reluctance to co-operate with other countries tax authorities.

These factors give each haven an ‘Opacity Score’ which is then combined with a weighting that reflects the scale of the cross-border financial activity the haven hosts, to determine its ‘financial secrecy’ ranking.

According to the index, the most secretive havens are: (1) USA (Delaware)i; (2) Luxembourg; (3) Switzerland; (4) Cayman Islands; (5) United Kingdom (London).

Full list here

The index has been drawn up by the Tax Justice Network, an international, non­aligned coalition of researchers and activists with a shared concern about the harmful impacts of tax avoidance, tax competition and tax havens, and Christian Aid, a leading UK development NGO.

John Christensen, director of the Tax Justice Network’s International Secretariat, said: ‘Secrecy is a core feature of the global financial system. Jurisdictions compete with each other to provide it in order to attract financial flows.

‘But this comes at a price. Financial secrecy provides cover for all manner of crimes and abusive practices: money laundering, tax evasion and avoidance, insider trading, terrorist financing, embezzlement, Ponzi schemes, illicit financial flows, fraud and much more.

‘The Financial Secrecy Index shows just how entrenched the problem of financial secrecy is. The index is an important tool that highlights the desperate need for new rules in international finance that would make the disclosure of information between different tax jurisdictions automatic.’

Mr Christensen added that Swiss-style bank secrecy is just one of many facilities that jurisdictions offer to provide confidentiality in international finance. In Anglo-Saxon countries, trusts and certain kinds of companies are often used to provide deeper, more devious forms of secrecy than can be achieved with bank privacy alone.

‘Many other barriers to the flow of information exist, ‘he said. ‘None of this would be possible without the legal framework the havens provide.’

In popular imagination, tax havens are palm fringed island idylls with luxury yachts, shady law firms and expensive offices festooned with the brass name plates of anonymous shell companies.

The FSI reveals a much broader picture. The main global suppliers of financial secrecy are in fact rich nations operating specialised enclaves like Delaware, often with links to smaller ‘satellite’ jurisdictions that are conduits for illicit financial flows into the mainstream capital markets.

The research identified one country in particular – the United Kingdom – with political and other links to a huge global network of tax havens. With half the world’s secrecy jurisdictions located in Commonwealth Countries, Crown Dependencies or British Overseas Territories, the UK’s historic support for financial secrecy globally has been substantial. Read more here…

Mr Christensen said Delaware in the US was particularly poor at disclosing information, although it was a hub of corporate activity. Luxembourg and Switzerland specialised in ‘traditional bank secrecy’, while the Caymans are now the fifth largest financial centre in the world because of the huge amount of corporate activity they attract from the Americas, as well as the large number of personal investment corporations based there.

Meanwhile London sits at the centre of a web of satellite jurisdictions. It is the most transparent of the jurisdictions in the index, but its importance in global offshore finance means that the secrecy it does provide has the potential to do more damage than, for example, small island havens which are less transparent but play a smaller role in global offshore finance.

The FSI uses twelve key financial secrecy indicators, identified in the Tax Justice Network’s Mapping the Faultlines project, in order to identify the provision of secrecy in each jurisdiction.

The indicators produced some striking statistics. For example, only one of the 60 jurisdictions reviewed - Monaco - requires all types of companies to disclose their beneficial ownership.

In other words, in 59 of the 60 havens, it is impossible to find out who owns the companies located within each. Not a single one has a central register of trusts and foundations that is publicly accessible via the internet. Read more here…

One of the routine uses of tax havens is to facilitate illicit financial flows. The World Bank has endorsed estimates by Raymond Baker, director of Washington-based Global Financial Integrity (GFI) in 2005 that illicit financial flows across borders ranged between $1trillion and $1.6 trillion per year, with half the money coming from developing and transitional economies.

In a 2009 update, GFI estimated annual illicit cross-border flows out of developing countries alone at about $850 billion -$1 trillion. In testimony before the U.S. House of Representatives, Raymond Baker compared these figures to the size of foreign aid flows, which have ranged up to just $100 billion annually.

He noted: ‘For every dollar Western governments have been handing out across the top of the table, crooked Western banks, businesses and middlemen of various descriptions have been taking back up to ten dollars of illicit proceeds under the table’.

The FSI’s authors consider the main global initiative against tax havens -efforts being led by the Organisation for Economic Co-Operation and Development (OECD) to achieve greater transparency -woefully inadequate.

In April 2009, following the London G20 summit, the OECD announced a list would be established of financial centres which fail to co-operate with other jurisdictions on tax and transparency issues.

‘Unfortunately, the OECD system is based on extremely weak standards of transparency and information exchange,’ said Alex Cobham, policy manager at Christian Aid.

‘All a haven has to do to get its name removed from the list is to sign bilateral disclosure agreements with 12 other countries. Even if that number is increased, the problems will remain insurmountable -these agreements are riven with loopholes which make them virtually impossible to implement.

‘Such flaws are perhaps unsurprising because, as the FSI shows, the biggest secrecy providers are in fact OECD members. The global body mandated to lead the fight against secrecy is therefore deeply compromised and conflicted in its aims.

‘Nonetheless, the meeting of G20 Finance Ministers in St Andrews on 7 November has the chance to impose a level playing field among all jurisdictions, by mandating the creation of a multilateral agreement for the exchange of tax information, with effective sanctions against those jurisdictions providing offshore financial services which do not sign up – whether they are OECD members or not.

‘Tackling secrecy in international finance requires a range of strategies, and a long-term approach. Crucially, we need to effect significant cultural change, so that the world becomes less tolerant of secrecy.

‘In addition, international accounting standards need to be changed to force companies trading internationally to disclose the profits made, and taxes paid, in every country where they operate. That way abuses could be quickly spotted.’

Clear international standards are needed, Mr Cobham added, for collecting and providing information on beneficial and legal ownership related to corporations, trusts, foundations, and a range of other facilities that secrecy jurisdictions provide.

And the economics profession should start researching how secrecy shapes and distorts international financial flows, and how secrecy in one jurisdiction can have an impact on other jurisdictions.