Venture Capital and Private Equity Performance Survey of South Africa - 2009

The South African private equity and venture capital industry remained in a relatively healthy position in 2009. The latest report from KPMG in South Africa and SAVCA examines the South African PE market during this period.

Deloitte 2010 TMT Global Security study

Bounce Back

Following last year’s widespread cost-cutting initiatives due to the global economic downturn, technology, media and telecommunications (TMT) organization’s spending on security appears to be bouncing back―albeit modestly―in anticipation of renewed economic growth. The key question is whether these relatively small budget increases will make up for the ground lost during the recession.

Scope

The study is based on in-depth research and detailed interviews with nearly 150 TMT organizations around the world. This year’s research has been part of a global, cross industry program which has provided new and valuable insights about security in the TMT industry as compared with other industries.

Senior professionals in Deloitte’s Information & Technology Risk Services practice conducted focused discussions with information technology executives of leading global technology, media and telecommunications organizations.

Key findings of the survey:

At the time of the 2009 Global Security Study, the economy was in the deepest depths of a global recession and organizations were reviewing and cutting costs everywhere they could–including security.

The damage done by last year’s budget cuts is reflected this year in respondents’ responses: 57 percent of organizations polled believe they are falling behind or still catching up in dealing with security threats. Only one-third of the respondents believe they are “on plan”–compared with 60 percent in the 2009 study.

• Cloud computing could fundamentally change how IT services are delivered–but only if its security and privacy challenges can be resolved.
• Combating organized crime: Information security is now an issue of national security.
• Security in mergers and acquisitions: The right approach to information security can improve business agility.
• Maintaining trust online: Organizations need to protect their digital assets in a world where thieves and cheats are just a click away.
• Nature versus nurture: Internal security risks and human error can never be entirely eliminated. But with the right combination of training and data protection, they can be reduced to manageable levels.
• Weak links: To ensure a high level of security across the entire value chain, technology, media and telecommunications organizations must take an active role in identifying and verifying that their partners’ capabilities and controls are up to the challenge.
• More than IT: Information security is being recognized as a business issue, not just an IT issue.

2010 TMT Global Security study

Mauritius Leasing launches "Real Estate Leasing"

The Real Estate sector in Mauritius is about to experience a new wave of change. The Mauritius Leasing Company Limited announced today the launch of "Real Estate Leasing", yet another pioneering product in the portfolio of Mauritius Leasing. With this launch, the thriving property industry can now count on a new pillar to sustain its growth and make ownership more widely accessible to larger spheres of the community.

"Mauritius Leasing is proud to introduce such an innovative concept on the market which opens up further avenues for property investments in Mauritius", said Ashraf Esmael, General Manager of Mauritius Leasing.

"Up till now, Bank Loans were, by far, the main source of funding for acquiring property. With leasing facilities for property investments, businesses and households will now have more funding options to look at rather than the traditional methods. Real estate has been booming but its funding infrastructure has been lagging behind for decades." added Mr Esmael.

With Real Estate Leasing, the market is poised to experience new momentum with a new line of activity that can cater for tailor made solutions with regards to property investments.

The ML Real Estate Leasing is a powerful alternative to bank loans for property acquisition. It has been developed to appeal to potential home and land buyers, buyers of commercial spaces and other properties, property developers and real estate intermediaries.

At this moment, however, the real estate leasing facility excludes Integrated Resort Scheme [IRS] villas, building and other property development projects, which are in construction and marketing stage. This may come at a later stage.

UK : FRC issues new Governance Standards for Listed Companies

The Financial Reporting Council (FRC) has today introduced changes to the UK Corporate Governance Code (formerly known as the Combined Code) to help company boards become more effective and more accountable to their shareholders.

Changes include a clearer statement of the board’s responsibilities relating to risk, a greater emphasis on the importance of getting the right mix of skills and experience on the board, and a recommendation that all directors of FTSE 350 companies be put up for re-election every year.

Introducing the new Code Baroness Hogg, the FRC Chairman, said:

“Under my predecessor’s wise leadership, the FRC responded to the financial crisis by examining the questions it raised about corporate governance and thoroughly reviewing the Code. We have now reconfirmed its core principles and the flexibility provided by the ‘comply or explain’ approach.”

“The changes we have made are designed to reinforce board quality, focus on risk and accountability to shareholders. In return, we look to see a step up in responsible engagement by shareholders under the Stewardship Code, on which we have consulted and aim to publish by the end of June.”

Changes to the Code include:

• To improve risk management, the company‘s business model should be explained and the board should be responsible for determining the nature and extent of the significant risks it is willing to take.
• Performance-related pay should be aligned to the long-term interests of the company and its risk policy and systems.
• To increase accountability, all directors of FTSE 350 companies should be put forward for re-election every year.
• To promote proper debate in the boardroom, there are new principles on the leadership of the chairman, the responsibility of the non-executive directors to provide constructive challenge, and the time commitment expected of all directors.
• To encourage boards to be well balanced and avoid “group think” there are new principles on the composition and selection of the board, including the need to appoint members on merit, against objective criteria, and with due regard for the benefits of diversity, including gender diversity.
• To help enhance the board’s performance and awareness of its strengths and weaknesses, the chairman should hold regular development reviews with each director and FTSE 350 companies should have externally facilitated board effectiveness reviews at least every three years.

The UK Corporate Governance Code (formerly known as the Combined Code) sets out standards of governance for listed companies. Companies are required either to follow the Code or explain how else they are acting to promote good governance.

The new edition of the Code will apply to financial years beginning on or after 29 June 2010.

India - Easy Exit Scheme, 2010

In order to give an opportunity to the defunct companies, for getting their names struck off from the Register of Companies, the Ministry of Corporate Affairs has decided to introduce a Scheme namely, “Easy Exit Scheme, 2010” under Section 560 of the Companies Act, 1956.

2. The Scheme does not inter-alia cover the listed companies, section 25 companies, vanishing companies, companies under inspection/investigation, companies against which prosecution for a non-compoundable offence is pending in court, companies having outstanding public deposits or secured loan or dues towards banks and financial institutions or any other Government Departments etc. or having management dispute or company in respect of which filing of documents have been stayed by court or CLB or Central Government or any other competent authority.

3. Any defunct company desirous of getting its name struck off the Register under Section 560 of the Companies Act, 1956 shall make an application without fee in the Form EES, 2010 electronically on the Ministry of Corporate Affairs portal namely http://www.mca.gov.in/ along with affidavit, Indemnity Bond and a Statement of Account duly certified by the statutory auditor or a Chartered Accountant in whole time practice.

4. The scheme will be in operation from 30th May, 2010 to 31st Aug, 2010.

5. For details refer General Circular No: 2/2010 dated 26.05.2010 available here

6. Availing the benefit of the Scheme will prevent companies from prosecution and
other legal action.

India - Company Law Settlement Scheme, 2010.

It has been observed that a large number of companies are not filing their due documents timely with the Registrar of Companies. Due to this, the records available in the electronic registry are not updated and thereby are not available to the stakeholders for inspection. Further, due to non-filing of the documents on time, companies are burdened with additional fee and facing the prosecutions also

2. There are many companies, who have not increased their paid up capital up to the threshold limit provided in sub-section (3) and sub-section (4) of Section 3 of the Companies Act, 1956

3. In order to give an opportunity to the defaulting companies to enable them to make their default good by filing belated documents and to become a regular compliant in future, the Ministry of Corporate Affairs has introduced a Scheme namely, “Company Law Settlement Scheme, 2010,” for condoning the delay in filing documents with the Registrar, granting immunity from prosecution and charging additional fee of 25 percent of actual additional fee payable for filing belated documents under the Companies Act, 1956 and the rules made there under

4. After granting the immunity, the Registrar concerned shall withdraw the prosecution(s) pending if any before the concerned Court(s)

5. At the conclusion of the Scheme, the Registrar shall take necessary action under the Companies Act, 1956 against the companies who have not availed this Scheme and are in default in filing of documents in a timely manner

6. The scheme will be in operation from 30th May, 2010 to 31st Aug, 2010

7. For details refer General Circular No: 1/2010 dated 26.05.2010 available here

8. Availing the benefit of the Scheme will prevent companies from prosecution and other legal action

FSC : Suspension of six Global Business Licences

The Financial Services Commission (the “Commission”) having reasonable grounds to believe that the revocation of the Global Business Licences issued to the undermentioned companies is necessary to protect the good repute of Mauritius as a centre for financial services and to protect investors, has in accordance with Section 74 of the Financial Services Act decided to initiate proceedings with a view to revoking the said licences:-

1. AEcnFX (Mauritius) Ltd
2. BASEL FINANCIAL INC.
3. FXCOMPANY FINANCIAL GROUP LTD
4. FXMarkets Ltd
5. FXOpen Investments Inc.
6. WORLD DERIVATIVES TRADERS LTD

The Global Business Licences of the above companies are being suspended forthwith.

Notice is given that where the above companies also hold an Investment Dealer Licence or Investment Adviser Licence, these licences are being suspended with immediate effect in accordance with Section 27(3) of the Financial Services Act.

Pursuant to Section 27(5) of the Financial Services Act, where a licence is suspended, the licensee shall cease to carry out the activity authorised by the licence.

Furthermore, the Chief Executive of the Commission having reason to believe that the above companies are carrying or are likely to carry out activities that may cause serious prejudice to the reputation of Mauritius has, in accordance with Section 75(2) of the Financial Services Act, ordered an inquiry into the activities of the above companies.

In addition, the Chief Executive of the Commission has, in accordance with Section 44(1) of the Financial Services Act, ordered that an investigation be conducted into the business of the above companies.

Mauritius Reiterates its Support to African Union’s Values

Mauritius reaffirms its commitment to the values of the African Union and its relentless efforts to bring unity, peace and prosperity in Africa, said the Minister of Foreign Affairs, Regional Integration and International Trade, Dr. Arvin Boolell, in his message to the nation on the occasion of Africa Day.

The 47th Anniversary of the Founding of the Organisation of the African Unity (OAU), now known as the African Union was celebrated yesterday all over Africa. The theme for Africa Day this year is “Building and Maintaining Peace through Sports in Africa”.

Minister Boolell commended the choice of the theme which he considered as apt as the continent will be hosting for the first time in history, the Soccer World Cup. The organisation of such a prestigious event in South Africa is a source of pride to the whole continent, said the Minister, noting that it is a golden opportunity for all Africans, particularly the African teams, to demonstrate to the world a sense of hospitality, fair play and openness. These are important facets of our African culture, he added.

The Minister observed that, since its creation, the Organisation of the African Unity has come a long way in promoting the values and principles enshrined in its Constitutive Act, particularly in the field of Peace and Security. The declaration of the Year 2010 by the African Union as the Year of Peace and Security bears testimony of the unflinching efforts it is pursuing in that direction, he stated.

Dr. Boolell also stressed the importance that Mauritius attaches to the work being carried out by the African Union, adding that the country is committed to lend its full support to assist the Organisation in moving forward its agenda.

It is recalled that immediately after its independence, Mauritius joined the Organisation of the African Unity, which on 11 July 2000 became the African Union.

Workshop addresses cyber security challenges

A two-day training workshop for Computer Emergency Response Team (CERT-MU)and Computer Incident Response Team (CIRT) is being held under the patronage of the National Cybercrime Prevention Committee at the Swami Vivekananda International Conference Centre, Pailles since yesterday.

The Committee is organising the training workshop to provide participants who are involved in cyber security activities with a better insight into the establishment and the functioning of the Computer Emergency/ Incident Response Team to enable the proactive and reactive handling and managing of computer incidents.

The National Cybercrime Prevention Committee is a working group established by government under the aegis of the Information and Communication Technology Authority with the mandate of addressing cyber crime issues. Its members comprise officials from the Ministry of Information and Communication Technology, the Attorney General's Office, the Ministry of Education and Human Resources, the Data Protection Office and the Police IT Unit. Its responsibilities include reviewing the state of play in fighting cyber crime and issuing implementable recommendations.

In his opening address yesterday morning, the Minister of Information and Communication Technology, Mr T. Pillay Chedumbrum, announced that a Controller of Certification Authority would be operationalised soon to enable the carrying out of secured electronic transactions at government and businesses level. This initiative is a step further in government’s efforts to support the development of a trustworthy and competitive information economy in Mauritius.

The Minister recalled measures already introduced to combat cyber crime and transform Mauritius into an information-secure society so that it drives its way towards earning recognition at international level as a secure regional Information and Communication Technology hub. They include the introduction of appropriate legislations relating to cyber security, and the setting up of instances such as the national Computer Emergency Response Team (CERT-mu), a police unit dedicated to fight cyber crimes, a unit to address security of Government Information Systems as well as a Data Protection Office to protect privacy of data. Mr Pillay Chedumbrum stated that other legislations such as regulations regarding Child Online Safety and Spam Control are in the pipeline to further strengthen the legal arsenal.

The ICT minister also stressed the importance of protecting the rights of the vast majority of people who use ICT for legitimate purposes. He affirmed government’s commitment to strike the right balance between the need for efficient enforcement and the need to protect the privacy and freedom of expression of citizens while ensuring that great care is taken to ensure fairness and prevent abusive restrictions. He added that the fight against cyber crime needs not only to harness efforts of the public and private sectors in Mauritius but also seek bilateral collaboration between countries and with relevant international bodies.

IOSCO Publishes Principles on Cross Border Supervisory Cooperation

The International Organization of Securities Commissions (IOSCO) has today published a set of Principles Regarding Cross-Border Supervisory Cooperation developed by its Technical Committee’s Task Force on Supervisory Cooperation.

These Principles, accompanied by a report and sample Memorandum of Understanding (Sample MOU), set out how securities regulators can better build and maintain cross-border cooperative relationships that will allow them to more effectively oversee financial services providers such as, investment advisers, asset managers, hedge funds, credit rating agencies, exchanges and clearing houses, that operate in multiple jurisdictions.

The objective of these Principles is to assist regulators in determining the form of cooperation best suited to the regulatory task at hand, and outline the critical issues that experience has shown regulators should agree upon when building a supervisory cooperation arrangement.

The Task Force co-chairs, Kathleen Casey, Chairman of the Technical Committee, and Jean-Pierre Jouyet, Chairman of the Autorité des marchés financiers of France, said:

“Supervisory cooperation involves the exchange of day-to-day oversight information outside of an enforcement context. Where financial firms or other market participants operate across borders, financial regulators can benefit from sharing information they have collected with their overseas counterparts, as this can assist each regulator in recognizing potentially troublesome trends, help identify common concerns and improve the abilities of regulators to assess the risk profile that a globally-active regulated entity may present.

“IOSCO has been at the fore in promoting better cooperation standards for securities enforcement, through its MMoU. Today’s report sets out the framework for better supervisory cooperation outside of enforcement matters, improving information sharing arrangements and conducting joint inspections, which is in keeping with G20 recommendations.

“We expect this to be useful for members in their drive to improve their oversight of entities which operate across borders, such as investment advisers, credit rating agencies, hedge funds, exchange operators and clearing houses.”

The Principles for Supervisory Cooperation

The IOSCO Principles for Supervisory Cooperation focus on three elements of successful supervisory cooperation:

1. General principles – which describe the usefulness of cooperation and the types of information and consultation that regulators should share and engage in;
2. Principles on the mechanisms for cooperation - which describe the functioning of memoranda of understanding, supervisory colleges and regulatory networks; and
3. Principles relating to the mechanics of cooperation, such as the basic principles of constructing a supervisory cooperation MOU.

The Report on Fostering Supervisory Cooperation among Securities Regulators

The Report analyzes the different types of regulated entities and the globalization of their operations, and offers suggestions on enhancing cross-border cooperation among regulators in order to improve the supervision of globally-active entities.

The Report, in particular, describes two instances where enhanced supervisory cooperation may be necessary:

• The first involves regulated entities that operate in one jurisdiction but also have affiliates in other jurisdictions. A regulator may need assistance from a foreign counterpart, because a domestic entity may be significantly impacted by the activities of its foreign affiliate; and
• The second involves regulated entities that provide services in multiple jurisdictions and thus are subject to regulation by multiple regulators. In this situation, cooperation is necessary to avoid conflicting regulation and to limit duplicate efforts by regulators.

The Report also describes different types of mechanisms that securities regulators may use to foster greater supervisory cooperation, including ad hoc discussions, MOUs, supervisory colleges and networks of regulators. In addition, the Report suggests that regulators expand the notion of supervisory cooperation to establish networks to consider and evaluate risks to domestic and global markets. Instead of focusing narrowly on entity-specific oversight, the Report suggests that regulators should explore opportunities to further collaborate on identifying, assessing and mitigating emerging risks and seek to address and evaluate them on a global basis.

Before supervisory cooperation can be effectively implemented, obstacles that hinder these efforts must be considered and if possible removed. The Report highlights several existing obstacles to cooperation that regulators should be aware of and, depending on the circumstances, may wish to address in order to make supervisory cooperation more effective.

These obstacles include legal and organizational impediments to sharing information. By identifying such impediments, regulators can design cooperative arrangements that avoid some of these hazards while seeking any necessary legal or regulatory changes to requirements that limit such cooperation.

Sample Annotated MOU

Accompanying the Report is an annotated Sample MOU. Task Force members believe a Sample MOU may assist IOSCO members when designing bilateral supervisory arrangements by demonstrating ways that the Principles (and particularly those principles relating to the mechanics, process, terms and conditions of cooperation) can be implemented in practice. The Sample MOU describes the issues and possible terms that may prove effective for supervisory cooperation arrangements, and illustrates some of the ways different jurisdictions might approach regulatory and legal issues that might arise when constructing such arrangements in practice. Fundamentally, the terms of any arrangement will have to be determined by the partners to such an arrangement and will necessarily reflect their own legal and regulatory circumstances and needs.

IoM : Amendments to the Anti-Money Laundering and Countering the Financing of Terrorism Handbook

Amendments to the Anti-Money Laundering and Countering the Financing of Terrorism Handbook ("AML/CFT Handbook") include the removal from Appendix G(a) (formerly Appendix G) of the reference to the FATF statement of 18 February 2010 entitled "Improving Global AML/CFT Compliance: On-Going Process" and countries referred to within that statement.

A new Appendix G(b) has been added entitled "Countries and territories covered by other statements from international bodies" drawing the statement issued by the FATF on 18 February 2010 entitled "Improving Global AML/CFT Compliance: On-Going Process" to the attention of licenceholders in order that it can be taken into account when conducting risk assessments and in respect of AML/CFT systems and controls. Business relationships and one-off transactions with persons or legal arrangements resident or located in jurisdictions listed in Appendix G(b) do not need to be treated automatically as higher risk.

Section 4.5.1 of the AML/CFT Handbook has also been amended to allow, on an exceptional basis where the certifier is unable to provide the full certification wording for identity documents, the flexibility to accept the wording "certified as a true copy of the original".

Full details of the changes made to the AML/CFT Handbook

Amended AML/CFT Handbook

OECD : Why sound institutions and smart regulation matter

Remarks by Angel Gurría, OECD Secretary-General, delivered at the Berlin conference on “Financial Market Regulation after Pittsburgh – Achievements and Challenges”

Berlin, 20 May 2010

Chancellor Merkel, Minister Schäuble, Commissioner, Excellencies, Ladies and Gentlemen:

The Swiss writer Max Frisch said:
“A crisis is a productive state; you simply have to get rid of its aftertaste of catastrophe.”

The strong and effective reactions of governments and central banks, the strengthened cooperation of advanced and emerging economies in the G20, the endorsement of Financial Market Reform at the G20 Leaders’ Summits and, more recently, the reaction of European Leaders in support of the Euro are all different and important pillars of this “productive state”.

But the crucial questions remain: Have we been “productive and effective” enough? Are the institutions sound? Do our rules and regulations provide the right incentives? And is our institutional architecture well-equipped to promote productivity and growth in the long term?

Global consistency is the key principle that should be respected in the reform process - we must further strengthen the links between macro management, fiscal consolidation, structural reforms, and prudential regulation and surveillance.


1. Credible exit strategies and sound fiscal consolidation are needed more than ever

Both stages of the crisis, the one which started in August 2007 and the current sovereign debt one are about too much leverage: in the private sector first and in the government sector now. The first leg of the crisis saw private debt insolvency being transferred onto the public balance sheet in various ways. With public solvency now being questioned by the market, the room to keep putting things onto the “pay later” bill has significantly diminished.

Securing fiscal sustainability is of the utmost urgency. Public Deficits are too large in many OECD countries and debt levels are exceeding 100% of GDP on average. For many countries there is a risk that unfavourable dynamics are sparked off as increasing debt levels raise risk premia, adding to the debt burden while holding growth back, with further adverse consequences on debt sustainability.

We welcome the strong reaction by the European Council in combination with the impressive fiscal consolidation and structural reform package in Greece, as well as the bold adjustment measures recently announced in Spain and Portugal. We will continue to work with those countries to support their reform efforts in areas such as taxation and tax compliance, labour market, innovation and public sector reform.

When restructuring is forced upon a country by a crisis, the costs and the pain are much worse than when reforms are addressed under controlled conditions and with medium-term recovery in mind. This is why countries should think, plan and communicate clear exit strategies now and to combine them with structural reforms to harness new sources of growth, like innovation and green growth.

In this context, international coordination and cooperation is a sine-qua-non in this agenda. This is why the G20 Framework for Strong, Sustainable and Balanced Growth is such an important policy approach to deal with the current crisis.

An additional risk to the global environment is the situation in Asia, where overheating due to large capital inflows is leading to rising inflationary pressures. There are two features about the institutional architecture that are important to keep in mind when thinking about the situation in Asia. First, exchange rate flexibility could alleviate some of the pressure on monetary policy in emerging economies, allowing more scope to address domestic inflation.

Second, the risk of this region backing away from open markets, for example with new capital controls or other measures that impede cross border flows needs to be avoided.


2. Sound institutions and smart financial regulation will be crucial

Improved macro management and structural reform has to be accompanied by consistent and reinforcing prudential rules for the financial system. There are four features of the financial crisis that are particularly important to address:

First, too-big-to-fail institutions took on too much risk driven by innovations and regulatory arbitrage with no effective constraints on leverage.

Second, capital rules proved to be pro-cyclical in the way they operated in practice.

Third, we saw insolvency resulting from contagion and counterparty risk driven mainly by the capital market activities of banks (as opposed to traditional credit market).

Finally, the lack of efficient resolution regimes fostered a culture of growing profits for short-term private gain, while socializing any losses that might arise. This issue, of course, is not independent of too big to fail considerations.

Regulatory reform is proceeding at several places and levels. In the United States, the proposal includes the possible separation of certain proprietary trading, hedge fund and private equity activities from “banking”. The Basel Banking Committee is revising the Basel II capital rules and proposing new liquidity ratio rules. Last year that Committee also proposed new trading book reforms. The Financial Stability Board (FSB) is seeking to insure an internationally coherent framework for financial reform. The European Union is drafting its own related directives. Finally, the European Central Bank also has sets of rules for its operations with banks, and these too have had to be adjusted in recent weeks.

So what sort of financial system are we creating? At this stage we simply do not know what costs might arise from overlaps and inconsistencies in this multi-level reform process; nor how they might interact in a future crisis. Nor do we fully understand how the grey lines between banks, insurance companies, reinsurers, investors, hedge funds and other shadow banking entities will be redrawn as a result of new incentives for arbitrage that might arise. All these financial firms operate in different jurisdictions with different regulators and supervisors responsible for them. Often supervisors at the national level are setting rules for banks and other financial institutions that operate in markets that go well beyond national borders, and which interact with other institutions outside of their jurisdiction.

The new quantitative impact study of the Basel Banking Committee will only take into account its own proposals, and cannot be expected to include all the other institutional changes and interactions going on at the same time.


3. The institutional architecture – how can we make it strong and sustainable for the future?

The institutional architecture for financial regulation is a concern for us at the OECD. The financial system, in essence, is a system of “promises”. Each promise should be treated in exactly the same way from a regulatory perspective. But the present structure does not necessarily foster this: It provides incentives for banks and other institutions to introduce innovations to allocate capital and risk so as to minimize capital requirements and to maximize short-term private gains, rather than acting in the most efficient way from the perspective of long-term growth. These efforts lead to shifts in the dividing line between banking and shadow banks that are very difficult to anticipate in advance.

It is for this reason that we at the OECD favour the simple understandable ex-ante rules. Among all those on offer, we place most emphasis on the following:

First: a leverage ratio on all bank assets. Why? Because the biggest problem is the shortage of capital. A leverage ratio can be set in a way that avoids the shifting of promises, and ensures that minimum requirements are met. Once accounting standards are brought into line, it will greatly facilitate international coordination. It will be important to meet the deadline to decide and announce what the new capital rules will be by the end of this year. This will remove an element of uncertainty which is currently holding back lending. Subsequently it will be important for countries to move together to achieve such rules over a reasonably short period to avoid creating new arbitrage opportunities.

Second, we favour the idea of a capital buffer over the minimum requirement, so that through restrained dividends, buybacks and bonuses in the good times capital can be built above the minimum and, subsequently, can be run down to the minimum in a crisis. This is consistent with counter-cyclical capital rules and other dynamic provisioning proposals that we fully support.

Third, we favour separation of certain investment banking activities from commercial banking to minimise contagion and counterparty losses within and between banks due to losses that arise from capital market activities in a crisis. The whole point of commercial banks having capital is that it should be there in a crisis to absorb losses, and to reduce the damaging economic effects of deleveraging. While separation will help to reduce the “too big to fail” problem it does not eliminate it. Capital market banks may still be too large and systemically important. They should be supervised, subject to capital rules where trading book requirements are appropriate to the risk they take, and they should be accompanied by resolution regimes including living wills.

Chancellor Merkel, Minister, Ladies and Gentleman: we have to work in the next months on a new institutional architecture for financial reform at both the macro and the micro level. We have to do much better in reducing the role of perceived national self interest in the financial reform process, and focus on improved coordination and consistency and to encourage banks to go back to their most important function which is to lend

We need such new architecture of financial reform to be combined with sustainable fiscal consolidation strategies, structural reforms and efforts to explore new sources of growth to build a stronger, cleaner and fairer world economy after the crisis. The three C’s: Cooperation, Coordination and Consistency are key to overcome the current and avoid another C – another crisis. Toronto in June and Seoul in November can be milestones in this respect – as can Berlin today!

OECD : Regulatory reform in the financial system

Article by Angel Gurria, Secretary General of the OECD, ditributed to the participants of the International conference on financial market regulation in Berlin

The Berlin Conference “Effective Financial Market Regulation after Pittsburgh: Achievements and Challenges” is taking place at a very timely moment. Proposals for reform abound at the national, regional and global levels. The aim of all these efforts is to help ensure that the chances of another global financial crisis like the one we have just endured are greatly reduced. The recent instability in sovereign debt markets reinforces the need to make progress in regulatory reform and better link it to macroeconomic stabilisation.

We must further strengthen the links between micro and macro prudential regulation and surveillance as well as with sound macroeconomic management and fiscal consolidation. The global financial crisis was sparked off in the mortgage market and soon became a generalized event with broad macroeconomic implications. The current sovereign debt crisis in Europe is the result of poor macroeconomic performance and management that, if not addressed, could impact severely the private banking and financial system and spread well beyond the shores of Europe. Since macroeconomic instability can be exacerbated by flaws in the regulatory and surveillance mechanisms, policies at the macro and regulatory levels must proceed in mutually reinforcing ways.

I welcome the recent resolve by Europe’s leaders to deal with the current Euro crisis. They rightly point to the need to strengthen the interaction between macro and micro financial stability. Such interaction will need to be accompanied by decisive steps towards global consistency so as to insure, among other things, that financial arbitrage is not the source of new risks to the economic and financial system.

First, I would like to touch on some of the macro issues in the current situation. Second, I will summarise key aspects of the reform process. The question of whether we have the right overall balance and sequencing in the proposed reforms will be touched on in the third section of this paper. I will finally address issues about the timetable for getting there also taking into account the current economic outlook. This is linked to the very important question of whether all countries must implement the reforms at the same pace, or whether some allowance should be made for the particular circumstances of individual countries with very different starting points, or even for individual financial firms with quite different business models.

Credible fiscal consolidation strategies and sustainable exchange rate policies are needed more than ever

The recent crisis in the Euro Zone is simply another manifestation of the global financial crisis. In very broad terms both crises are about too much leverage: in the private sector first and now in the government sector. The first leg of the crisis saw private debt insolvency dealt with by transferring much of it onto the public balance sheet. With public solvency now being questioned by the markets, the room to keep putting things onto the “pay later” bill has diminished.

Public Deficits are too large in many countries, but the rolling wave of the financial crisis has descended on the European public sector first. There is an institutional aspect as to why this is so. Currency unions work well when there is a single fiscal authority and all regions are flexible and competitive within it. Fiscal regulations like the Stability Pact won’t work if cost structures are allowed to get out of line through lack of regional competitive flexibility. The temptation is to put off painful labour market and pension adjustments and let fiscal responsibility slip; but this very combination makes fiscal adjustment difficult as longer-run growth prospects decline. At this point catalysts for crises become things like credit rating downgrades to a rating below which rules forbid central banks to purchase debt and the market reacts violently -sometimes irrationally - to force policy adjustment.

If things are allowed to get to this point, then the only way to get back in front of the markets is to surprise them with a package of measures that will be judged to be more than actually required. If the policy package proves not to be enough - because initial judgements are wrong or because governments don’t follow through - then the loss of credibility that comes with debt restructuring becomes even more painful. The experience in Latin America teaches that restructuring forced upon a country by a crisis is much worse that the pain of getting the necessary albeit tough policies right from the beginning.

Still another macro aspect of the crisis is the very different situation in Asia. This region did not experience a financial crisis, and yet with its managed exchange rate regime it essentially imports accommodative monetary policy from other parts of the world. This has resulted in loose credit flows and booming asset prices in China, Hong Kong, Singapore, Korea and Taiwan. The risk of some dislocation arising from inflation pressure building up in this region would not be helpful to the adjustment processes in other parts of the world—for at least as far as net exports are concerned, Asia has been one of the really bright spots of global trade.

The risk of this region backing away from open markets and imposing capital controls, or taxes that impede cross border flows would be an unhelpful evolution of the institutional architecture. At the OECD we have always been of the view that a key aspect of the adjustment process is how to tap the resources of these high-saving surplus countries to help with the debt - including public debt - and equity needs of the countries trying to deal with the financial crisis. There is also the risk that the use of blunt instruments like reserve requirements and other administrative measures to contain inflationary pressures would not represent the best way to advance institutional structures compatible with sustainable longer-term growth. Indeed, the risk of a larger than intended negative shock to demand in China would have strong ramifications for the region—and through trade to other parts of the world. The OECD therefore favours policies to deepen capital markets in the Asian region, the fostering of cross-border flows and, of course, working towards more flexible exchange rates. Such an approach would also be consistent with resolving macroeconomic goals and providing more efficient price signals for the allocation of global capital.

The Regulatory Reform Process

At the micro/regulatory level there is a need for reforms that do not cut across the goals for low- inflation sustainable growth. The Pittsburgh Summit foreshadowed a long list of reforms:

More and better quality capital, with a leverage ratio and perhaps countercyclical buffers (the current timetable is for these rules to be decided by the end of 2010 and implemented by the end of 2012).

• Better liquidity and risk measurement.
• Disclosure will be enhanced (e.g. off-balance sheet exposures).
• Oversight of credit rating agencies (CRA’s) has increased and accounting standards should be unified between the US and Europe.
• Better regulation of market practices and underwriting standards.
• The use of centralised clearing and exchanges for more over the counter (OTC) derivatives is envisaged.
• Better alignment of compensation with long-term value creation.
• The use of supervisory colleges, legal frameworks and contingency planning for coordination of cross-border issues in a crisis.
• Improved resolution tools and frameworks (the FSB is due to deliver something by October 2010).

The Basel Banking Committee is working on the first two of these reforms - the capital and liquidity rules and has released its proposals for comment - with quantitative impact studies to follow this year. Its proposals aim to improve the quality, consistency & transparency of the capital base; to enhance risk coverage (including off balance sheet) and, very importantly, they suggest 3 new features of the capital rules: a leverage ratio, measures to deal with pro-cyclicality and the introduction of a capital “buffer”. The liquidity measures include new ratios to ensure banks have at least 30 days liquidity cover and that the stability of their funding is improved by rules about the structure of their liabilities and assets.

In addition, in the US the Dodd Bill is working its way through the law making process. The main elements of the US reforms here are:

• A Financial Stability Oversight Council.
• A Consumer Financial Protection Bureau (in the Fed).
• A Resolution Mechanism.
• Regulation of OTC derivatives by SEC & Commodity Futures Trading Commission.
• Restriction on risk taking by banks using depositors’ funds.
• SEC to regulate rating agencies.
• Restructure US bank regulators.
• Creation of an Office of National Insurance in Treasury; to propose regulation of insurance.

Within Europe new directives are being prepared to adapt many of the Basel proposals for Europe, and the issue of how and whether to streamline the vast national supervisory structures and align them with the single market remains alive.

As EU leaders have stated just a few days ago, the sovereign debt crisis is putting further pressure to make progress in financial market regulation and supervision.

Many of the proposed reforms have strong merit. But what interests me at this point in time is whether or not the overall balance and sequencing of the reforms is ‘right’. For if the easier financial reforms are carried out - the low hanging fruit - and the harder but potentially more important things are left to one side there is a risk of partial solutions that lead to second best outcomes. This will also arise if countries go through with their own reforms - influenced by regulatory capture or popular pressure in their own country - without moving in a coordinated way between jurisdictions in a truly global approach. The experience of the past few years suggests we cannot again afford to drift towards a second-best regulatory system for financial markets.

Have We Got the Overall Balance Right?

The recent instability in sovereign markets reinforces the need to make progress in regulatory reform and to link it with macro stabilisation. The financial system should be efficient in allocating capital and risk, without amplifying macroeconomic fluctuations or interfering with the setting and transmission of monetary policy.

In a previous publication the OECD argued that there were 7 priorities for reform:

1. Strengthen the regulatory framework by streamlining regulatory institutions, and clarifying responsibilities and business conduct rules.

2. Focus on the integrity and transparency of financial markets.

3. Ensure more capital and less leverage, address the pro-cyclicality issue and avoid regulatory subsidies to the cost of capital.

4. Strengthen our understanding of how tax regimes affect the soundness of financial markets.

5. Ensure better accountability to owners whose capital is at risk through the reform of corporate governance.

6. Ensure the capital of commercial banks is not put at risk by capital market banking, by ensuring a separation of certain activities that put the banks own capital at high risk in periods of financial volatility.

7. Strengthen financial education and consumer protection.
With respect to the reforms foreshadowed at Pittsburgh, I would say that by far the most emphasis has been placed on the second and third of the above priorities - though the Dodd Bill does leave the door open for some more progress on the issue of separation of certain high-risk activities from commercial banking (priority number 6 above).

As far as regulatory reform is concerned, it is important to get the balance right in 4 areas: Capital arbitrage, transparency of financial markets, separation in the banking sector and macro-prudential regulation.

1. Capital Arbitrage: Promises of the Financial System
The financial system in essence is a system of promises. In the traditional credit culture of banking, a bank takes deposits and promises safety and an interest return to its depositors. It keeps a little capital aside in the form of common equity, promising shareholders that they will be paid a regular dividend and capital growth through sound and prudent corporate governance. The bank lends to households and to businesses, which are usually too small to raise money in the capital markets. The borrowers promise to repay loans and to pay interest for being able to bring their spending plans into fruition. Over the years, through financial innovation, this set of promises has become increasingly complex. Banks raise money in wholesale markets, and securitization and the use of complex OTC derivatives has permitted the promises to be shifted around. These innovations and changes in business models have meant that the credit culture of commercial banking has become increasingly mixed up with capital market banking: both within large complex conglomerates, or in the inter-connectedness when dealing with each other in the buying and selling of new products.

Contagion and counterparty risks related to these new products were a key hallmark of the crisis, at least in its first phase - with losses on capital market products destroying capital and leading to systemic problems. The incentives in the system were not appropriate, and when the crisis arose there simply wasn’t enough capital to absorb the losses. The ability of banks to shift promises around - capital arbitrage - played a significant role in the lead up to this outcome. Banks have a great incentive to shift promises around if different capital rules and tax regimes make it beneficial to do so.

We at the OECD believe that one of the most fundamental principles of financial regulation should be that all of the promises in the financial system should be treated in exactly the same way, regardless of where they might sit. If this basic principle is not achieved, then the incentives for capital arbitrage will remain in place. Un-productive financial innovation not focused upon longer-run economic goals will be the inevitable result. Leverage will be expanded in new ways that regulators and supervisors will not be able to anticipate, and unacceptable risk taking - and dare I say “bubbles” - may return.

It is not easy for regulators to deal with this shifting around of the promises of the financial system when there are so many opportunities for arbitrage: different capital rules and the shopping around for the easiest regulatory regime; lack of global coordination of regulations; the different tax treatment of financial products; and the existence of offshore lower-tax jurisdictions.

With respect to the capital rules, the Basel proposal for a leverage ratio is a very good first step for reducing capital arbitrage - the OECD has also championed this proposal and we fully endorse it. A leverage ratio can ensure that banks are sure to have enough capital as the requirement relates to the banks’ whole portfolio, rather than to specific assets with different weights that can be arbitraged. Therefore management decisions about allocating capital to risky activities would take account of the full market cost of capital, and the potential risks and rewards of investing in the asset, but would not be influenced by regulatory rules specific to the asset.

The capital required under a leverage ratio needs to be set at a level that ensures enough capital exists to be able to always absorb losses in a crisis.

How well does the leverage ratio proposal sit with the risk-weighted asset approach? This is hard to say - but our feeling is that if the leverage ratio requirement is set too low, with the hope that risk-weighted capital would be higher, then the capital arbitrage process would again come into play, shifting promises around in new ways until excess capital above the minimum required by the leverage ratio was eliminated. In this sense the risk would be that the leverage ratio would become a maximum (rather than a minimum) capital requirement at a too-low level.

At the OECD we also have a preference for transparent simple rules, rather than an over-reliance on models with subjective inputs - or approaches that rely on too much external rating. While acknowledging the progress made to bring about greater consistency and to use inputs with a less cyclical bias - the pro-cyclical issue -we think the prominent role of the leverage ratio and the use of the Basel Committee’s excellent proposal for a capital “buffer” will in practice be most important for avoiding future crises. This capital buffer idea is very important - and it goes some way towards provisioning in a countercyclical way. An excess capital buffer should be built above the minimum requirement in the good times, in a sufficient amount so that it doesn’t fall below in the minimum in bad times. That banks would build up the buffer by avoiding special dividends, share buy backs and bonuses until the required buffer was met seems very sensible indeed.

While the prominence of a leverage ratio is a key tool for reducing regulatory arbitrage, its ability to do so will be compromised if it is not adopted consistently in the global financial system across all jurisdictions - that is to say its introduction will need to be coordinated in a consistent way. There seems to be some agreement about this, and we will see what happens in practice.

A closely related issue concerns the number and structure of regulators and supervisory agencies. Here there appears to have been much less progress with the idea that regulatory regimes should be streamlined. If promises can be passed out of the banking system into the insurance sector, for example, or into the shadow banking system more generally, then the enforcement of capital rules for banks will be less effective. Regulatory regime shopping would then remain a feature of the system working against the ultimate aim of reducing arbitrage, leverage and ensuring that there is enough capital to absorb losses in future crises. Worse still, it will stimulate new innovations to avoid holding capital - hardly a productive activity for a financial system that is supposed to be improving the allocation of resources to attain long-term growth.

I don’t have the answers as to how to bring about a more unified structure of regulation - and perhaps it is asking too much of our political systems to deliver it - but at least improved coordination among regulators should be sought.

2. Integrity and Transparency of Financial Markets
I will now come back to the issue or the complexity of capital market products - for even if we have good regulatory rules - these will mean very little if we do not have transparency and integrity in financial markets. In particular I want to touch on some issues with respect to the credit default swap (CDS) that have been so prominent in the shifting of promises in recent years.

Prior to the CDS innovation and its widespread use in financial markets, the market for “credit” was incomplete - for example, unlike other many other assets, it was not possible to go short bank loans. Regulators did not have to think as much about the shifting of promises: but this all changed with the CDS innovation. It has played a key role in securitization and the shifting of promises between banks, insurance companies and investors - with the line between the banking and the shadow banking systems also moving backwards and forwards depending on how regulations and innovations interact with each other in terms of the incentives they create for short-term profits. There is at least some doubt as to whether this type of activity is very productive in terms of long-run economic goals.

The saga unfolding at Goldman Sachs is one very good example of derivatives being used in this way. The use of Repo 105 in Lehman Brothers to disguise leverage is another. But these are only recent things in the news. Phase 1 of the global crisis was arguably driven by this sort of structuring of products simply to make short-term gains. Politicians and policy makers sometimes ask me whether this means that CDS and related structured products should simply be banned outright in banking. There is no clear cut answer. This is because the CDS can play a productive role in genuinely meeting investor demands and diversification with longer-run benefits for the economy although we are aware of the downside risks.

We feel that the Basel proposals to build incentives into the capital rules that encourage more trading of CDS and related products on centralized exchanges is a very useful step in the right direction - it adds transparency and allows for exchanges to play a greater role in guaranteeing the delivery of promises. Of course many genuine demands between banks and their customers for tailored products with specific requirements will not lend themselves to generalized trading on exchanges - liquidity will always be a problem - and it will have to be dealt with in contracts between banks and (hopefully sophisticated) investors.

Progress can also be made on harmonizing standards and practices, and establishing central counterparty clearing arrangements to reduce the gross size of outstanding contracts by netting mechanisms. With respect to the inputs for valuing OTC capital market products there has also been progress with audit oversight and rating agency reform.

While progress has been made in improving the transparency or markets and products, the issue of how they are reported through accounting standards deserves to be touched upon. Loans with reasonably predictable cash flows lend themselves to amortised cost accounting, whereas capital market products should in principle be marked to market, and fair value through profit or loss accounting principles should apply. While this may seem harsh for supervisors trying to deal with a crisis situation - where the pressure is for forbearance and less disclosure of the true divestment value of assets on balance sheets, longer-run reform should make no exceptions to the need for integrity and transparency.

For example, many commentators highlight the fact that not all banks erred in their approach to risk management and governance, while others were very poor performers in this respect. This argues for strengthening the governance of financial firms ensuring their full accountability to the owners whose capital is at risk. Shareholders must exert more discipline on management to pursue strategies with appropriate longer term-risk and reward payoffs. But this sort of discipline is impossible if shareholders and their agents do not know what is truly happening on bank income and balance sheet statements. It is very important that US GAAP and IFRS convergence occurs as quickly possible - in line with all the other regulatory reforms - and that it does so in a manner that does not compromise on transparency issues.

3. Separation
Contagion and counterparty risk played a big role in the crisis. The OECD believes that separating from commercial banking some of the capital market activities that were associated with large losses during the crisis remains one of the most important areas to address if we are serious about reducing the chances of a repeat crisis in the future, with all of the negative impacts on the real economy. Yet to date we have seen very little progress in this area. Commercial banks play a key role in lending to consumers and businesses - and small and medium-sized businesses (SME’s) are particularly dependent on banks to fund their activities and provide jobs. Quite often these banks have large retail funding of their activities and benefit from guarantees that their unsophisticated investors’ money will be safe.

It seems to us that commercial banking should be separated from capital market banking in some way. Why do we insist so much on this? The answer comes from asking why banks are asked to hold any capital at all. Banks hold capital so that it will be there to absorb losses when they occur in a crisis. The capital has to be there to do this. If it is not, banks will be forced into deleveraging or, worse, into bankruptcy. If you allow banks with retail and commercial banking functions to bet their capital in proprietary operations, then it is precisely going to be the case that such capital will not be there in a crisis. Prices of capital market products can fall sharply in crisis periods, resulting in the contagion and counterparty risks that I have referred to as the main hallmarks of the crisis.

Some policy makers recommend that prop trading desks and bank-sponsored hedge funds and private equity affiliates should be separated. We agree that these functions should certainly be separated from commercial banking. But at the OECD we are a little more extreme. Other investment banking activities are capable of losing more money than these few functions. OTC derivatives are a very clear example of an activity that needs to be separate from commercial banking and carried out in a securities firm with separate capitalization and not subject to regulatory subsidy and implicit or explicit guarantees. But if this is so what about origination? It was at the very heart of the crisis. Bank capital is at risk because it involves warehousing loans and securities before they are sold to clients. But if we include origination, then why not market making? Big capital market banks that have hedge funds as clients need inventory for rapid execution, and this too means that bank capital is at risk.

In very broad terms, the issue here is that higher risk investment banking should not be mixed up with commercial banking. If it is, the cost of capital for the investment bank will tend to be subsidized with the stamp of approval provided by explicit or implicit guarantees, and from the commercial banks point of view their capital may be at risk in ways that are hard to anticipate. If the capital is not there when loan losses mount, commercial banks move into a de-leveraging phase with negative impacts on the economy. The separation issue is concerned with reducing this risk.

There are many ways to go about separation in practice. At the OECD we favour a non-operating holding company structure where the capital of each affiliate is strongly silo’d. That is to say, counterparties of the securities/derivatives businesses have no call on the capital of the group as a whole—only on the entity with which they trade—and certainly not that of the commercial bank. For these separated activities margin requirements and the cost of capital will be higher, and there can be no implicit subsidy from deposit insurance in the retail banking affiliate to the cost of funding in the capital markets activities of the group.

4. Macro prudential regulation
The Basel Banking Committee has also called for better macro prudential management, whereby policy makers can take into account asset price and credit cycles in order to deal with pro-cyclicality at a broader level. At the OECD we see this macro prudential recommendation as an admirable objective. However, the difficulties of undertaking it should not be under-estimated. The reason for this is leads and lags in modeling credit, and the problem of structural change caused by financial innovation—often in response to the very sort of regulatory changes proposed by the Basel Committee. Credit lags the cycle, and the identification of a ‘bubble’, leading to provisioning to offset it, could easily occur at a time when the economy is beginning to turn down—exacerbating the cycle. Similarly, just as securitization dampened balance sheet credit growth in the past—leading to a false signal that there was no leverage problem—so too might future developments in the shadow banking system lead to similar distortions that would be difficult for supervisors and other policy makers to identify.

The current outlook and the timetable for reform

In the response to the sovereign debt turmoil European leaders have called for “the need to make rapid progress on financial markets regulation and supervision; increasing transparency and supervision in derivatives markets and dealing with the role of rating agencies”. They also called for an “intensification of the work on crisis management and resolution in the financial sector and on a fair and substantial contribution of the financial sector to the costs of crises”.

The current economic outlook in Europe, but with obvious ramifications in global financial markets, introduces new elements in shaping the implementation and timing of the phasing in of new capital rules. This is also a very difficult issue because all countries are not in the same position, and there are substantial differences between individual firms. On the one hand, there is a very good argument for allowing some flexibility in the timetable. Some European banks have less capital and more leverage than their US counterparts for example, and the crisis in Europe seems to have lagged behind that in the US (in both the writing off of losses and in the speed of raising more capital).



Right now the economic outlook in Europe reflected in our latest projections is weaker than in the United States, and a sovereign debt crisis has caused new dislocations that have to be dealt with. From this perspective it could seem very poor timing to impose new capital raising burdens on European banks struggling to adjust their balance sheets not only for loan losses related to the crisis and the slowdown in activity currently under way, but also because of new pressures related to their exposures to sovereign debt. Countries that need to adjust their fiscal policy more strongly than others risk a prolonged period of weak economic activity. Very clearly, it would be helpful if the economies of other EU countries did not weaken excessively at the same time. This might have the effect of making the adjustment process more difficult. Indeed, the weaker is economic growth the more difficult becomes the task of fiscal adjustment—weaker growth leads to weaker revenues, and the adjustment process ends up “chasing deficits down”. This might prevent credit from supporting the recovery to an even greater extent thereby making the adjustment process all the more difficult.

However, it has also to be born in mind that right now credit demand is in any case very weak, as private sector deleveraging continues - supply constraints related to capital are not binding right now.

Making undue allowance for particular regions because of the current set of macroeconomic difficulties does not make for sound financial reform and a level playing field in global financial markets. If capital rules were more lenient in some regions for a number of years, then capital arbitrage would continue, as the incentive to take advantage of jurisdictions where the regulatory burden is less would be compelling. Banks that performed well and are very well capitalised would find themselves competing with banks carrying a lower capital, essentially rewarding poorer performers at the expense of strong performers. This would weaken rather than strengthen overall financial stability. It is very important that the sequencing of the reform process should see all jurisdictions moving together and respecting the principles of a competitive level playing field and with new opportunities for regulatory arbitrage kept at a minimum. The OECD therefore supports the idea that capital rules should be announced at the end of the year - consistent with the timetable set at Pittsburgh. Supervisors should cajole the banks under their jurisdiction to raise common equity capital as quickly as possible.

Conclusions

I draw three lessons from the above considerations:

First, financial sector reform and macro stability go together and therefore require coordination between the different policy domains and agencies. This is also true from the point of view of the timing of actual phasing in of reforms which has to take into account the need to move quickly towards fiscal sustainability and therefore avoid pro-cyclical effects.

Second, global consistency is the key principle that should be respected in the financial reform process - speed is less important than balanced progress towards first best longer-run reform. The new capital rules suitable for the long run should be announced at the end of this year, and implementation should be encouraged by supervisors from now until prospective completion of requirements by the end of 2012. This should also help to speed other convergence issues that need to be settled - accounting standards, derivative rules, and the separation issue for example. If these and other reforms are carried out in a piecemeal way there will be inevitable overlaps with possibly unforeseen and negative consequences for the financial sector and the economy more generally.

Third, while international coordination is essential it will not produce results if individual countries do not put in place the right policies to achieve fiscal sustainability and to phase in new regulatory measures once they are agreed so as to avoid opportunistic behaviour.

Avoiding Corruption Risks in the City : The Bribery Act 2010

The Bribery Act is expected to reinforce the UK’s international reputation for setting high standards in the regulation of economic activity and as a country that takes corruption seriously. This report provides an overview of corruption risk for City businesses, focusing on the issues raised by the Bribery Act. It describes the Act and seeks to minimise uncertainty for City businesses about how it will be interpreted and enforced once it comes into effect. It also highlights the types of business activity which put City businesses at greatest risk in relation to bribery and prosecution.

Download Avoiding Corruption Risks in the City : The Bribery Act 2010

Three Caribbean jurisdictions move up on OECD progress report

Dominica, Grenada and Saint Lucia have been moved into the category of jurisdictions considered to have substantially implemented the standard on transparency and exchange of information, having now all signed at least 12 exchange of information agreements conforming to the standard.

This brings to 28 the number of jurisdictions that have moved into this category since April 2009. The move affecting Dominica, Grenada and Saint Lucia follows the signature of a series of agreements involving these three jurisdictions plus Antigua and Barbuda, which had already reached 12 agreements on 7 December 2009, and the Nordic countries (Denmark, Faroe Islands, Finland, Greenland, Iceland, Norway and Sweden).

Following these signatures, Antigua and Barbuda has now signed a total of 20 agreements meeting the international standard. Dominica and Grenada have now signed 13 agreements each, and Saint Lucia has signed 15 agreements.

As members of the Global Forum on Transparency and Exchange of Information for Tax Purposes, each of these jurisdictions agreed to participate in a peer review of their laws and practices in this area. According to a schedule published by the Global Forum, Antigua and Barbuda, Grenada and Saint Lucia will undergo reviews of their legal and regulatory framework for exchange of information in 2011 and reviews of their information exchange practices in 2013. Dominica’s peer reviews will take place in 2012 and 2014.

Commenting on the latest signings, Jeffrey Owens, Director of the OECD’s Centre for Tax Policy and Administration, said: “We continue to see a great deal of progress in the Caribbean as jurisdictions move to sign agreements. With Dominica, Grenada and Saint Lucia now reaching this benchmark, most of the Caribbean jurisdictions have implemented their commitment to signing exchange of information agreements.

“We will be working with the remaining Caribbean jurisdictions – Belize, Costa Rica, Guatemala, Montserrat and Panama – to encourage them to follow this trend, providing them with whatever assistance is needed. The real test will come with the peer review process, when the Global Forum can evaluate the quality of these agreements and the extent of the implementation of the standards in practice.”

Mauritius hosts 6th Collaborative Africa Budget Reform Initiative Seminar

The 6th annual seminar of the Collaborative Africa Budget Reform Initiative (CABRI) on the theme "Good Financial Governance: Towards Modern Budgeting", opened yesterday at La Plantation Hotel in Balaclava. Some 70 delegates, namely senior government officials from 28 countries across the African continent, are participating along with their Mauritian counterparts.

The seminar which is being held from 18 to 20 May is organised in collaboration with the Ministry of Finance and Economic Development under the aegis of the Regional Multidisciplinary Centre of Excellence (RMCE). It aims at providing an opportunity for the participants to debate and discuss on modern budgeting practices and systems that will impact on the future direction of public financial management in Africa. In addition to sharing and learning from each other's experiences in the field of budgetary reforms, the delegates will also take stock of the achievements of these reforms in each particular country.

Several topics are being discussed during the three-day forum. They are namely; understanding the opportunities for and complexities in good financial governance in Africa, examining the results of the recent joint country case study on programme-based budgeting in Mauritius, launching of the CABRI-OECD exercise to assist Ghana in using country systems for the delivery of development assistance and exploring the role and management of private sector involvement in public infrastructure development.

In his opening address at the seminar, the Director at the Ministry of Finance and Economic Development, Mr K.N.Bunjun, who was speaking on behalf of the Vice-Prime Minister and Minister of Finance and Economic Development, highlighted that Mauritius has come a long way since the programme-based budgeting approach was adopted in the fiscal year 2008-2009 and he stressed that the PBB which is Government's tool to enhance service delivery to the population, should be further re-modelled to render it more realistic and suitable to the local environment.

He added that the Ministry of Finance and Economic Development also intends to set up a Delivery Unit under the Vice-Prime Minister's leadership to secure delivery of about 10-15 major domestic policy priorities selected by the Prime Minister. The major priorities will be selected from across the areas of health, education, policing, criminal justice and transport. The Delivery Unit will lead in building the overall capacity of Government to speed up the reform process by establishing a pragmatic, evidence-informed approach to policy making and implementation.

It will be recalled that CABRI is a network of about 38 countries and has now become a legal and independent membership-based organisation which has as objectives to promote efficient and effective management of public finances to fulfill governance requirements as well as foster economic growth and enhance service delivery for the improvement of living standards of African people. CABRI has already held five successful Budget Reform seminars and the fifth seminar was held in Senegal in April 2009 on the theme: "Strengthening Budget Practices in Africa".

UK : FSA's approach to intensive supervision

Speech by Jon Pain, Managing Director, Supervision, FSA
City and Financial Intensive Supervision Conference

Good morning, I am pleased to be here to talk to you today on intensive supervision. As we emerge from the embers of the worst financial crisis in over 70 years, firms and regulators alike need to ensure that lessons are learnt and that behaviours and the way we operate changes, so that the same mistakes are not repeated.

The changes we have made in our approach to supervision are designed to make regulation more effective and reduce the likelihood of a future crisis – however, effective supervision and regulation will only get us so far. The life support given to the financial sector over the last two years should be a sobering enough effect for firms to recognise that significant changes are needed. As profits return to the sector with increasing frequency, firms must not be lulled into a false sense of security. To restore trust in financial services we need ensure we are not blind to the challenges that remain. I would like to cover three key questions:

• What does the FSA’s intensive approach to supervision mean in practice?
• What outcomes are we seeking to achieve?
• What are the outstanding challenges we face?

What is intensive supervision?

However, before I go on to talk about what this means in practice, I want to briefly recap on what we mean by intensive supervision.

Previously the FSA rarely intervened until it was clearly evident that something had gone wrong. Intervention needed to be based on evidence that risks had crystalised. This approach was described as ‘light touch’. The old approach was never going to stop firms making mistakes, as that was not its intention. This approach was of course the mandate for the FSA set by the city and society at that time.

The new approach we have moved to is ‘outcomes-based’ and this is delivered through intensive supervision. This approach is centered on intervening in a proactive way. To do this we needed to operate entirely differently, changing both our philosophy of ‘what supervision means’ and our approach to and the use of resources. We now:

• undertake more extensive business model analysis, to understand the key drivers of risk and sustainability of your business;
• make judgements, on the judgements of senior management;
• act quickly and decisively;
• proactively look to influence outcomes, not merely react to events;
• apply a greater depth of analytical rigour – for example, through embedding severe stress tests into our assessment, of how much capital a firm should hold; and
• we back up our intensive supervision with credible deterrence when standards are not met – as evidenced by fines of over £33m for last year.

This intensive approach is not just a battle hungry FSA looking for confrontation for its own sake. Our message to firms is clear – where necessary we will intervene and we will not be pressurised to back off. Firms will be well advised to engage with us in a proactive and open-minded manner rather than believe they can bulldoze the regulator at the last minute. To successfully deliver better outcomes we will of course need to deliver intensive supervision through more effective engagement and understanding of firms business.

What does this mean in practice?

So, how have we made this change and what does it mean in practice? We regulate over 20,000 firms, which spans from an independent financial advisor to the largest global banks. There are two important myths about our approach to intensive supervision.

The first is that intensive supervision only applies to our largest firms. We in fact require our supervision across the total spectrum of firms to adopt this intensive philosophy – to make any interaction with firms count. But of course, the second myth is that our supervisors approach and resources are the same for all firms. It simply isn’t feasible to deploy that level of resources for all supervision of firms – so our approach has to be risk-based.

The largest firms are subject to a close and continuous approach, where dedicated relationship teams are assigned to one firm with a structured programme of work in addition to regular risk assessments. For medium-sized firms, a dedicated relationship manager is assigned to a firm who will be subject to a periodic risk assessment – the frequency of which will vary depending on our view on the level of risk the firm or sector poses. Both large and medium-sized firms will also be subject to thematic sector-wide reviews.

Small firms are not subject to an individual specific risk assessment. These firms are monitored by a combination of baseline monitoring, risk alerts and thematic sector-wide reviews.

Enhanced supervision capability

For the largest, most systemically important firms, we have already more than doubled the resources allocated to their supervision, we now have teams of 15-20 supervisors plus specialist prudential and conduct risk resource – creating an FSA-wide integrated team of 60-80 for certain portfolio or deep dive reviews.

We are also continuing to develop a more rigorous analytical approach to how we regulate the largest institutions. This will be rolled out to large banks and insurers later this year and will involve regular deep-dive reviews throughout the regulatory period.

For prudential issues we will be undertaking more intensive reviews – for example, on capital, liquidity, risk management, governance and business models – through which we will increase the depth of our analysis, undertake a broader range of stress scenarios and include more peer group and sectoral analysis in our assessments.

For conduct issues we will be assessing the key drivers of potential conduct issues by better understanding the risks posed by the firm’s business model. Intervening much higher up the product chain and undertaking detailed outcomes testing work across the sales process and post-sale handling. This will be supported by an increased use of mystery shopping and consumer research.

Through this enhanced approach to both prudential and conduct issues, we will be supervising these firms in a more indepth and structured way than ever before, to build a rolling programme of assurance that will reduce the likelihood of risks crystallizing. And, over time, we will be applying the learning’s from this approach in a proportionate way to our medium-sized firms.

However, as I mentioned, not all firms will have dedicated supervisory resource. For the thousands of smaller firms we continue to deliver supervision through our assessment programme, which includes regional roadshows, firm visits and follow-up workshops, and feedback from the firms involved has generally been positive. In addition, as a result of risk alerts and thematic work, we will make more intensive individual firm interventions. The recent banning of 80 mortgage advisers for fraud with fines of over £1m was one such intervention.

To deliver our intensive approach to supervision we have significantly increased our capability by:

• recruiting over 350 staff in the last year across supervision, specialist areas and enforcement – my team of direct supervisors is now 1,200 people;
• increasing our capability to undertake in depth financial and business model analysis; and
• creating a specialist Conduct Risk division to focus on ensuring firms are delivering fair outcomes for consumers.

But this is not just about quantum of resource – we are also building our supervision capabilities and quality of supervision by:

• implementing a new comprehensive, eight week induction programme for all relationship-managed supervisors;
• introducing mandatory assessments of competence, in core areas for our lead supervisors; and
• enhancing our T&C regime that requires all supervisors to demonstrate adequate levels of technical skill, behavioral competence and sector specific knowledge.

Delivering intensive supervision

Now we recognise that intensive supervision will be felt by firms but will not always be visible to the external world. By definition our interventions are designed to deliver better outcomes, but preventative action is not always apparent. But we have fundamentally changed our approach – let me bring it alive with some examples:

• For a number of mergers or acquisitions over the last 18 months, we have been at the heart of the analysis and judgements being made by senior management, ensuring that customers’ interests are protected, that there are financially viable plans in place, that integration does not bring undue regulatory risk and that management and governance are capable and able to deliver. In the past our role would have been more passive in assessing the change of control of the firm much later in the process.
• Our ‘finger prints’ have been increasingly felt where we have actively encouraged a change in management or board members. Where we have identified weak or ineffective management or governance. To do this we have increasingly used our section 166 powers, to appoint independent skilled person reviews, to bring issues to the table.
  
• We have intensified our interventions on firms, with weak business models, where we have shaped and facilitated market solutions by encouraging boards and management to seek realistic strategies, to face up to current realities, look at alternatives and engage with possible suitors.
  
• We have stepped in to ensure that even when margins are under pressure, firms continue to act in the interest of customers, do not impose unfair contract terms and treat their customers fairly. Where consumers interests have not been met we have taken decisive action – this includes:
  
• the action we took against GMAC for unfair treatment of customers in arrears, which resulted in a fine of £2.8m and redress of £7.7m; and
• on MPPI, where we had concerns over how contract terms were varied and we agreed with industry that £60m of redress would be paid and contract terms realigned.
  
• And at the onset of the crisis our analysis and stress testing of capital and liquidity were integral to the government’s re-capitalisation of the banks. And for Lloyds and RBS, we played a pivotal role in assessing if they needed to participate in the Asset Protection Scheme, or sought alternative market-based solutions.
  
• As well as increasing the intensity of the firms and individuals already regulated, we have also toughened our supervision of the gateway for new applications or changes in control. Banking applications are now subject to intensive scrutiny, whether they are new start-up banks or existing authorised firms applying for deposit-taking permission.
  
• We are challenging firms to ensure their application includes a detailed, well thought through business model that is believable not just aspirational and has already been stress-tested and challenged as to its viability, that they have robust liquidity and capital financial resources, and that management are capable with relevant experience.

Outcomes

So, as you can see, we are already delivering our more intensive supervisory approach, but what outcomes are we seeking to achieve through this approach? I think these can be summarised into three broad categories:

• that firms are well-managed and have good governance;
• that firms are prudentially sound on a forward looking basis; and
• that consumers achieve a fair deal and are treated fairly.

Taking the first of these, it is clear to us that the financial crisis exposed significant shortcomings in governance and management across numerous firms.

And although poor governance was only one of many factors that contributed to the financial crisis, it was an important one. We are therefore looking closer at behaviour and culture in firms, particularly ensuring two key things:

• one – that good culture and behaviours in firms is being driven by senior management; and
• two – that good culture and behaviours are being reinforced by effective corporate governance and the role of the boards.

Through the crisis we have also seen examples where boards did not sufficiently challenge the executive or understand their firms’ business models and their inherent risks, and where boards did not simply receive the relevant management information to be able to carry out their important oversight role. Boards need to make sure they have the right people, asking the right questions, informed by the right information. As I said earlier, where this is not the case we will take action.

We also now place much greater emphasis on the role of senior management at firms. In October 2008 we implemented significant changes to our assessment of candidates who wish to perform functions of significant influence within firms. This included considerably increasing the number of candidates we interview. While it remains the duty for firms and shareholders to ensure the right people are in key functions, we will also make sure that these key roles are performed by people who are up to the job.

Since we adopted this more intrusive approach, we have completed over 400 interviews, of which more than 30 individuals have subsequently been withdrawn by the firm. Firms therefore need to take note that this is not just a box-ticking exercise.

Where we find issues with how individuals have performed their roles we will continue to take action, as demonstrated in our successful enforcement action against two former Northern Rock Directors for failing in carrying out their responsibilities.

Of course, part of changing behaviour and culture is about looking at the incentives on offer. We know that another contributing factor, albeit not a key one to the financial crisis, was remuneration practices, notably in the banking sector. Individual incentives can either reinforce or undermine a firm’s strategy and risk profile, so we have created a remuneration code of practice to ensure firms’ remuneration policies promote effective risk management. Earlier this year we undertook extensive supervisory reviews to ensure compliance with the code. We plan to publish a review of our code later this year.

Moving onto the second outcome that firms are adequately capitalised, it’s clear senior management need to ensure they have plans in place to remain resilient throughout economic cycles. We also expect firms to develop a robust and effective stress testing programme, which assesses their ability to meet capital and liquidity requirements in stressed conditions.

To ensure firms are financially sound, we have significantly strengthened both our prudential policy framework and our supervisory interventions in this area:

• We have implemented a new liquidity regime, which requires firms to hold adequate liquidity on a self-sufficient basis, has a narrower definition of what constitutes liquid assets, requires enhanced liquidity risk management and has more granular and frequent reporting requirements.
  
• We also continue to work internationally on ensuring we have a more robust capital framework that improves firm’s quality of capital and strengthens areas which were underweight pre-crisis, such as trading book capital, eligibility of hybrid capital and management of large exposures. Indeed, in the interim, we have increased the required levels of capital that banks and building societies need to hold to better cover their risks and protect their depositors’ capital sufficient to maintain their core Tier 1 ratio above 4% of their risk-weighted assets over a three to five year horizon.
  
• We have undertaken detailed, indepth stress tests on a number of firms across different sectors to ensure their capital and liquidity is sufficient to absorb any future shocks.
  
• And we have begun work on recovery and resolution plans – sometimes called ‘living wills’ to tackle the risk that certain banks are ‘too big to fail’.

However, we should be under no illusion that, on its own, regulatory and supervisory reform will be enough to prevent future crises. We are still working with the Tripartite to develop a more effective macro-prudential framework and the relevant tool to use when appropriate.

The third and equally important outcome is that firms treat their customers fairly and ensure they achieve a fair deal. The financial crisis has shaken the public’s trust in financial services to its roots.

And, as many consumers have found their financial situation less secure, the need to ensure consumer protection has never been greater. Continued failures in this regard (such as PPI, MPPI, complaints handling and treatment of with-profits policy holders) points to a lack of focus by firms on consumer needs. Indeed, product innovation has led to more complexity and a focus on profitability, rather than a clear unambiguous focus on consumer needs. Firms need to prove by their actions rather than their words that the consumer is genuinely at the heart of their business.

To increase consumer protection we have recently announced our new, more proactive approach to conduct regulation, where we will intervene earlier in the product chain to spot potential risks to consumers and prevent consumer detriment.

As for prudential risks we will do this through increased business model analysis to understand the key drivers of profitability and the risks this poses to consumers. We will increasingly test outcomes through mystery shopping and on site visits.

We are also seeking to improve the long-term efficiency and fairness of markets. Our initiatives in both the Mortgage Market Review and the Retail Distribution Review are two examples of how we have undertaken whole of market reforms to fundamentally reshape markets to deliver better outcomes for consumers.

And where we do spot failure, we will continue to secure the appropriate level of redress and compensation for consumers and ensure we provide credible deterrence by taking tough action against firms and individuals. Only last month we announced the results of our review of banks complaints handling where the results were less than impressive –.as a result two banks have been referred to Enforcement for further investigation of their complaint handling and we will conduct follow-up work later this year to test whether the changes being made in the banks we reviewed have been effective in raising standards. Where firms continue to deliver poor outcomes, we will take tough action to drive an improvement in standards.

We will continue to ensure consumers receive good outcomes through our proactive approach to conduct risks and our intensive supervision. However, rebuilding confidence will not be a simple task and it’s essential for the benefit of society at large that the industry collectively heeds the call and takes decisive action to treat its customers fairly.

Challenges we face

I wanted to end by briefly touching on three key challenges that we face.

The first is that we need to secure international consensus and maintain the required momentum to deliver an enhanced prudential framework that delivers a more resilient and robust banking sector. Within this we are fully aware of the need to ensure that the total package of measures that we agree and the glide path to improved standards must not cause the instability we are seeking to avoid.

However, industry also needs to recognise that the world has changed. That the life-support governments and central banks have and continue to provide around the globe are a stark reminder of the need for a more resilient financial sector. The financial sector must be capable of standing on its own two feet and not have the expectation that the taxpayer will always be the provider of the last resort.

The second, evidenced by the events that have unfolded across the Eurozone, is that the worldwide economic recovery remains fragile. These secondary sovereign shocks pose risks to the UK recovery that we at the FSA, alongside our Tripartite colleagues, remain very alive to. And while the exact path of the UK recovery remains uncertain, firms, regulators and governments alike need to be alert to these risks.

Finally, the FSA faces a number of internal risks and challenges for our people. To continue to deliver and fully embed our intensive approach, we need to continue to increase our overall resource and ensure that the training provided enables supervision to deliver our agenda. But we also need to continue to deliver a cultural shift, where supervisors have a much tougher role, which demands supervision have a well-balanced analytic capability, good industry understanding and are prepared to take tough decisions.

In conclusion, I firmly believe that our more intensive supervisory approach is already achieving results. We have significantly improved our capability to deliver the outcomes that society demands of us, but we still have more to do.

Thank you.