Financial Sector Assessment Program United Kingdom Detailed Assessments of Standards and Codes

International Monetary Fund

doi:10.5089/9781451814200.002.A005

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Financial Sector Assessment Program United Kingdom Detailed Assessments of Standards and Codes

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International Monetary Fund

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Publication Date:: 14 Jul 2003

eISBN:: 9781451814200

Language:: English

Keywords:: ISCR; CR; market participant; U.K. financial system; FSA approach; FSA oversight; U.K. market; monetary policy; central bank; FSA rule; business plan; risk assessment; Financial stability assessment; Insurance companies; Insurance; Global

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This technical note reviews the Financial Sector Assessment Program of the United Kingdom. It examines the United Kingdom’s public debt management practices using the IMF-World Bank Guidelines for Public Debt Management as a framework. It analyzes the government’s Code for Fiscal Stability, transparency, accountability, debt strategy, and risk management framework. It also provides a detailed assessment of the antimoney laundering and combating the financing of terrorism regime and compliance of the Basel Core Principles of the United Kingdom.

Abstract

I. Basel Core Principles for Effective Banking Supervision

A. General

1. This assessment of U.K. compliance with the Basel Core Principles for Effective Banking Supervision was undertaken as part of the Financial Sector Assessment Program (FSAP) that the IMF has conducted at the request of the U.K. authorities over the period February–July 2002. The assessment was conducted by John Abbott (IMF-MAE), Laurie Edlund (Office of the Comptroller of the Currency), and Jan Rein Pruntel (Netherlands Bank).

B. Information and Methodology Used for the Assessment

2. The assessment has been based on the Core Principles Methodology that was published by the Basel Committee On Banking Supervision in October 1999.

3. In view of the highly developed nature of the U.K. banking sector, this assessment takes into account both the essential and the additional criteria that have been set out in the Core Principles Methodology.

4. The assessment takes into account a comprehensive self-assessment of compliance with the Basel Core Principles that was submitted by the U.K. authorities to the IMF prior to the May mission. Major further sources used for the assessment include numerous publications available from the FSA website, the Financial Services and Markets Act 2000 (FSMA), a CD-ROM provided by the FSA containing its Handbook of rules and guidance, presentation material and internal documents provided by FSA officers, and background material from various industry sources.

5. In addition extensive interviews were held with FSA officers, representatives of major U.K. incorporated banks and U.K. branches of overseas banks, senior representatives of the British Bankers Association, the Foreign Bankers and Securities Association, the Practitioners Panel on transparency established under the FSMA, and the Institute of Chartered Accountants in England and Wales. The assessment team gratefully acknowledges the cooperation received from all concerned which has added substantially to the effectiveness of the assessment.

C. Institutional and Macroprudential Setting—Overview

6. The FSA was established by the U.K. Government in May 1997, and commenced operation in an interim or transitional way in June 1998. The relevant law, the FSMA, was passed in 2000, and took full legal effect on December 1, 2001, a date usually referred to in this context as N2. The FSA initially absorbed the activities of a nine previous regulators or government departments, and in bank supervision specifically, the previous supervisory function of the Bank of England, and has since taken on even more responsibilities.

7. The U.K. banking industry has benefited from a remarkably stable macroeconomic environment and sustained growth over nearly a decade. The favorable environment owes much to sound macroeconomic policies as well as a strong policy framework, and to sustained structural reforms. Recently, however imbalances have emerged, particularly in the expansion of credit to consumers and businesses and burgeoning house prices. Although these imbalances are, on the whole, not large and likely to be resolved gradually, they do pose risks to the financial system that require monitoring and management.

D. General Preconditions for Effective Banking Supervision

8. The United Kingdom has a well developed judicial system with a reputation for probity and professionalism. Civil commercial matters are normally heard in one of the divisions of the High Court, with appeal processes available through the Court of Appeal and, if accepted, the House of Lords. The senior EU Court is the European Court of Justice and it has similar professional standing to the English upper courts. The legal system is based on case law as modified by equity considerations and domestic legislation. As the U.K. has no written constitution, Parliament is the supreme domestic law making body, but as a general principle EU law overrides domestic law under the Treaty of Rome. EU directives agreed by the Council of Ministers do not have the status of law but must be converted into national law by member states. From a regulatory point of view the legal and judicial precondition to effective banking supervision are very well satisfied.

9. The professions important to the financial sector are also well developed in the U.K. and are subject to full liability for breach of duty. The U.K. chartered accountants are expected to continuously maintain minimum levels of professional training. They have world class qualification and accreditation requirements and are seen as best practice resources by educators and professionals in many other countries. A new system of non-statutory independent regulation of the accountancy profession’s audit activities has recently been established under the auspices of the Accountancy Federation, which will raise the standards for oversight of the accountancy profession. The convergence toward fair value accounting (IAS 39) will introduce new issues for both firms and for regulators, issues that the U.K. profession is now beginning to address. Again, this precondition for effective regulation and supervision is well satisfied.

10. The auditing profession is also well established. External auditors need to be members of recognized supervisory organizations and to remain eligible to be a member under the rules of that organization (leading to a practicing certificate). Recognized organizations have to ensure that all their members are ‘fit and proper’ and that audit processes are carried out in a professional manner and with integrity. The main coordinating body for the six U.K. accounting bodies, the Counsultative Committee of Accounting Bodies, is a recognized supervisory body. The assessment team was not able to determine the level of performance of the internal audit function within the banking sector, but there appear to be varying degrees of competence and awareness of the risk based approach.

11. The United Kingdom is among the leading countries in the world in setting standards for corporate governance, including public disclosure practices. With regard to the regulated financial sector, market discipline is reinforced by the fact that the U.K. authorities have publicly stated their view that it is neither possible nor desirable to remove all risk of financial failure.

12. The United Kingdom has no special statutory insolvency procedures for banks. As limited liability companies, banks and other FSA-supervised financial institutions are generally subject to the same insolvency laws and procedures as those that apply for non-regulated companies. FSMA gives the FSA a limited role in statutory insolvency procedures for financial institutions, including the power to petition for an institution to be placed in administration or winding-up proceedings. Under the current system, bank depositors are treated like other creditors at the beginning of administration proceedings and delays in repayment of deposits can span several weeks. In terms of pre-statutory resolution of a troubled institution, however, the FSMA provides the FSA with a broad range of powers to resolve problems in banks, ranging from public censure to withdrawal of authorization, and the financial stability Memorandum of Understanding (between HMT, the FSA and the Bank) provides a broad framework within which official intervention of various sorts could be contemplated in more systemically important cases.

13. Overall the U.K. satisfies the Basel Core Principles preconditions for effective banking supervision.

Table 1.

Detailed Assessment of Compliance of the Basel Core Principles

Table 2.

Summary Compliance of the Basel Core Principles

^{^1/}C: Compliant.

^{^2/}LC: Largely compliant.

^{^3/}MNC: Materially non-compliant.

^{^4/}NC: Non-compliant.

^{^5/}NA: Not applicable.

Table 2.

Summary Compliance of the Basel Core Principles

Core Principle	C^1/	LC^2/
1. Objectives, Autonomy, Powers, and Resources	C
1.1 Objectives	C
1.2 Independence	C
1.3 Legal framework	C
1.4 Enforcement powers	C
1.5 Legal protection	C
1.6 Information sharing	C
2. Permissible Activities	C
3. Licensing Criteria	C
4. Ownership	C
5. Investment Criteria	C
6. Capital Adequacy	C
7. Credit Policies	C
8. Loan Evaluation and Loan-Loss Provisioning	C
9. Large Exposure Limits	C
10. Connected Lending	C
11. Country Risk	C
12. Market Risks	C
13. Other Risks	C
14. Internal Control and Audit	C
15. Money Laundering		LC
16. On-Site and Off-Site Supervision		LC
17. Bank Management Contact	C
18. Off-Site Supervision		LC
19. Validation of Supervisory Information		LC
20. Consolidated Supervision	C
21. Accounting Standards	C
22. Remedial Measures	C
23. Globally Consolidated Supervision	C
24. Host Country Supervision	C
25. Supervision Over Foreign Banks’ Establishments	C

^{^1/}C: Compliant.

^{^2/}LC: Largely compliant.

^{^3/}MNC: Materially non-compliant.

^{^4/}NC: Non-compliant.

^{^5/}NA: Not applicable.

Table 2.

Summary Compliance of the Basel Core Principles

Core Principle	C^1/	LC^2/
1. Objectives, Autonomy, Powers, and Resources	C
1.1 Objectives	C
1.2 Independence	C
1.3 Legal framework	C
1.4 Enforcement powers	C
1.5 Legal protection	C
1.6 Information sharing	C
2. Permissible Activities	C
3. Licensing Criteria	C
4. Ownership	C
5. Investment Criteria	C
6. Capital Adequacy	C
7. Credit Policies	C
8. Loan Evaluation and Loan-Loss Provisioning	C
9. Large Exposure Limits	C
10. Connected Lending	C
11. Country Risk	C
12. Market Risks	C
13. Other Risks	C
14. Internal Control and Audit	C
15. Money Laundering		LC
16. On-Site and Off-Site Supervision		LC
17. Bank Management Contact	C
18. Off-Site Supervision		LC
19. Validation of Supervisory Information		LC
20. Consolidated Supervision	C
21. Accounting Standards	C
22. Remedial Measures	C
23. Globally Consolidated Supervision	C
24. Host Country Supervision	C
25. Supervision Over Foreign Banks’ Establishments	C

^{^1/}C: Compliant.

^{^2/}LC: Largely compliant.

^{^3/}MNC: Materially non-compliant.

^{^4/}NC: Non-compliant.

^{^5/}NA: Not applicable.

E. Recommended Action Plan and Authorities’ Response to the Assessment

Recommended action plan

14. Table 3 sets out the actions recommended by the mission with respect to Bank supervision. Note that the recommendations related to principles 15, 16, 18, and 19 are to improve compliance with the Core Principles, while the other recommendations are more technical ones for Principles already complied with. The mission considers the latter desirable measures for further refining bank supervision given, in particular, the role of London as a major international financial center.

Table 3.

Recommended Action Plan with Respect to the Basel Core Principles

Table 3.

Recommended Action Plan with Respect to the Basel Core Principles

Reference Principle	Recommended Action
CP 8 Loan evaluation and provisioning	Introduce periodic reports on asset quality.
CP 12 Market risks	Consider expanding the supervisory staff responsible for testing banks’ market risks controls.
CP 13 Other risks	Develop a new approach to liquidity monitoring that will be more aligned to banks’ own techniques for liquidity management.
CP 15 Money laundering	FSA to monitor annually a sample of anti-money laundering reports from banks that have not been subject to on-site review.
CP 16 On-Site and Off-Site Supervision	See recommended actions under CPs 17, 18 and 19
CP 17 Bank management contact	Identify criteria for banks to notify the FSA of emerging problems at an early stage. Establish off-site monitoring triggers for the FSA to contact banks with emerging problems.
CP 18 Off-site supervision	Introduce regular reporting requirement for data on classified and non-performing loans.
CP 19 Validation of supervisory information	Introduce a requirement for key supervisory returns to be examined at least annually by external auditors. Extend listed banks’ disclosure requirements to non-listed banks.

Table 3.

Recommended Action Plan with Respect to the Basel Core Principles

Reference Principle	Recommended Action
CP 8 Loan evaluation and provisioning	Introduce periodic reports on asset quality.
CP 12 Market risks	Consider expanding the supervisory staff responsible for testing banks’ market risks controls.
CP 13 Other risks	Develop a new approach to liquidity monitoring that will be more aligned to banks’ own techniques for liquidity management.
CP 15 Money laundering	FSA to monitor annually a sample of anti-money laundering reports from banks that have not been subject to on-site review.
CP 16 On-Site and Off-Site Supervision	See recommended actions under CPs 17, 18 and 19
CP 17 Bank management contact	Identify criteria for banks to notify the FSA of emerging problems at an early stage. Establish off-site monitoring triggers for the FSA to contact banks with emerging problems.
CP 18 Off-site supervision	Introduce regular reporting requirement for data on classified and non-performing loans.
CP 19 Validation of supervisory information	Introduce a requirement for key supervisory returns to be examined at least annually by external auditors. Extend listed banks’ disclosure requirements to non-listed banks.

Authorities’ response to the assessment

15. The U.K. authorities consider that the FSAP assessment is valuable and clearly demonstrates the U.K.’s very high degree of compliance with the Basel Core Principles. They support the broad thrust of the FSAP mission’s findings and recommendations and find them helpful in taking forward some existing strands of work. In particular, they agree with the usefulness of developing a new approach to liquidity monitoring, and changes to their existing approach are in train. There are a small number of recommendations where they believe the current regime effectively fulfils the IMF’s requirements. There are also some recommendations where further consideration will be required to effectively account for the costs of implementing them relative to the benefit. Specific comments from the authorities on the recommendations in the table above, are as follows:

On CP 8, in line with their risk based approach to regulation, and the principle of proportionality, the FSA indicated that it currently operates a selective process to reporting asset quality, i.e., if they have concerns about an institution’s asset quality, or the possible deterioration of that asset quality, they may ask the bank to provide regular info on asset quality. Their approach to this issue is being considered under the currently ongoing data needs project, and would be considered in the same context as CP 18.
On CP 12, they noted that the FSAP team has rightly recognized their need to focus most of their resources, which are of course finite, on the institutions that have the largest combination of impact and risk.
On CP 13, the authorities agreed with the usefulness of developing a new approach to liquidity monitoring, and changes to their existing approach are in train. They have already consulted on systems and controls requirements and it is planned to introduce these in summer 2004. They will also consult on a framework of quantitative requirements for liquidity risk in summer 2003.
On CP 15, the authorities noted that they already monitor the reports of Money Laundering Reporting Officers and have undertaken a specific study of reports from 75 banks. This program of work will continue.
On CPs 16-19, in the context of a risk based approach, the authorities were of the view that, while valid, some of the recommendations about the supervisory process in relation to these Principles relating to on/off site supervision, management contact and validation of information, could be overly prescriptive and less relevant to low impact banks (which account for only 0.02 percent of deposit liabilities). They felt that, by and large their tools are adequate and it is doubtful whether the value of extra reports on asset quality would outweigh the cost. Nonetheless, they are reviewing their data needs requirements generally and exploring ways of strengthening baseline monitoring, including the quality of data they receive from firms and the timeliness of notifications. (See also comment on BCP 8). The recommendations will be considered in this context.

With respect to D firms [all low impact and low risk/medium low impact firms], in the authorities’ view, their new systems and processes deliver a robust, and appropriate supervisory regime for these firms, which have a low RTO and they do not wish to overburden this sector with unnecessary or disproportionate regulatory obligations.

Regarding CP 17, they noted that block one of the FSA handbook sets out senior management responsibilities and the Principles for Businesses. These have the status of rules and apply to all firms. One of these Principles requires firms to disclose appropriately anything that the FSA could reasonably expect to be notified of. The authorities felt that providing detailed criteria and triggers for when firms should contact or notify the FSA is unlikely to make firms more open. They already have a list of basic events that must be notified and moving beyond this minimum could perversely restrict the issues on which a firm feels it has to consider communicating, and also weaken senior management’s responsibility to make considered judgments.

On CP 19, the authorities noted that the FSA checks the plausibility of comparisons and trend analysis on financial returns from banks. Where there are concerns supervisors can request further information or appoint a skilled person (under S 166 of FSMA) to verify the accuracy of information. Auditors have a statutory duty to report to the FSA. Again, they are reviewing the recommended CP 19 requirement under the data needs project.

II. IAIS Insurance Core Principles

A. General

16. This is an assessment of the observance of the core principles of the International Association of Insurance Supervisors (IAIS) in the United Kingdom (U.K.). Insurance is supervised in the United Kingdom by the Financial Services Authority, an independent nongovernmental incorporated body limited by guarantee and operating under powers granted by the Financial Services and Markets Act 2000. The assessment was conducted by Carl Hiralal, Senior Director, Office of the Superintendent of Financial Institutions Canada, Conglomerates Group, and Rodney Lester, Lead Specialist and head of the Insurance and Contractual Savings practice in the Financial Sector Development Department of the World Bank. Frank Engels, U.K. desk officer for the IMF provided early commentary on the assessment and participated in the feedback sessions.

B. Information and Methodology Used for Assessment

17. This assessment has been based on the Insurance Core Principles Methodology (ICP) of the IAIS dated October 2000, as modified by the joint IMF/World Bank assessment template.

18. Given the highly developed nature of the U.K. insurance market, the current lack of stability in certain segments of the market and the large exposure to international financial activities, this assessment has been carried out on the basis of both the essential and supplementary criteria underpinning each Core Principle. In addition the assessors relied on the override provisions in the Methodology,¹ and applied standards appropriate to a leading industrial country.² The United Kingdom is the first insurance market of global significance to be assessed and provided special challenges. In particular it would have been possible to provide observed ratings on most of the CPs if just the law and FSA model (especially once rolled out) had been considered. The assessors view has been that this would not have added value given the current transition stage in the evolution in FSA, particularly with regard to supervision,³ and would not have done justice to the importance of the U.K. insurance sector, both domestically and internationally. Thus the assessment is based on the FSA as it was at the date of the assessment when supervisory practices were still being developed and resourced. In addition it needs to be explicitly stated that demanding benchmarks were applied and this will need to be acknowledged in any comparison with other industrial countries.

19. Major sources of information used for the assessment included the answers to the questionnaire submitted by the IMF prior to the mission, a comprehensive self assessment carried out by the Insurance Firms Division, information available from the FSA web site including numerous consultation papers, comprehensive CD-ROM databases provided by FSA, presentation material provided by FSA officers, statistical information provided by the Association of British Insurers (ABI) and S&P Thesys, and background information available from various professional firms and international industry intelligence services. In addition extensive interviews were conducted with numerous officers in FSA and the various governmental and regulatory bodies concerned with private pensions, senior management of ABI and the National Association of Pension Funds (NAPF), members of relevant boards of the Institute of Actuaries, senior chartered accountants and rating agency personnel, and a wide range of senior management from the insurance sector, including Lloyds. All concerned gave willingly of their time and were cooperative, and this added significantly to the effectiveness of the insurance assessment team.

C. Institutional and Macroprudential Setting—Overview

20. The British insurance industry is venerable and large. With net premium income in 2000 of £174 billion or approximately 10 percent of the world market, it is the third largest after the U.S. and Japan (although considerably smaller than either). See following table for premiums data. It includes the most important cross-border non-life insurance markets in Lloyds and the London Market, which together account for 65 percent of approximately US$20 billion of annual global cross border general insurance premium flows (Source-Sigma No. 6, 2001), and is a significant source of life insurance products for people resident in other EU countries. Insurance penetration⁴ at 15.8 percent is the highest in the world, South Africa excepted. This penetration is driven largely by a strong imperative to save for retirement in the U.K. given a relatively low (and declining) social security replacement ratio.

21. The insurance industry also makes a significant contribution to the economy. It employs in excess of 220,000 people directly and another 115,000 indirectly, accounting for 1.5 percent of total U.K. employment. It is an important contributor to the balance of payments, with overseas earnings in 2000 approaching £7 billion (£8.7 billion in 1999), of which the major element is insurance ‘exports’ (off shore insurance accepted or intermediated by a U.K.-based insurer or broker). U.K. insurers are also active in foreign markets; however this represents a relatively minor and reducing component of foreign earnings. Net assets of overseas operations have fallen for three years in a row with the main declines occurring in the U.S. and Europe, and only the few leading players continue to have global ambitions.

Table 4.

Gross Direct U.K. Sourced Premium Revenues

(in £ billions)

Source: ABI.

22. The U.K.-based insurers are, with self-administered pension funds, the most important repositories of individual financial sector wealth. Of total FY 2000 financial assets of households and related non-profits of £3 trillion, more than 50 percent is represented by insurance policyholder related liabilities (Source National Statistics, Financial Statistics, Table 12.1N). Total investment assets under management at the end of 1999 amounted to slightly over £1 trillion and the life and pensions sectors were easily the major providers of finance to government and private borrowers. When examined over time the long term insurance sector has also been the most consistent source of new investment funds in the economy, although given the stresses the industry is now experiencing (see below), this is not guaranteed to be the case in the future. While a figure for ‘other’ company securities on issue is not readily available, life insurers appear to account for a major part of the Sterling commercial paper on issue.

23. U.K. insurance companies and pension funds are under considerable stress given that their income has been eroded by market risk. While balance sheet concerns remain, the insurance sector is not likely to pose a systemic threat to the financial system. Owing to their investment profile, U.K. insurers, most notably life insurers and pension funds, have been specifically affected by the fall in stock prices and exceptionally low bond yields. Coupled with long-term non-life claims, substantial losses related to September 11, and in some cases mounting liabilities based on guaranteed annuities or defined-benefit schemes, the sector constitutes a potential source of market risk, as insurers hold around a fifth of total U.K.-quoted equities and could resort to asset sales to safeguard profitability and regulatory capital. Growing balance sheet concerns in the insurance industry have been reflected in increased supervisory activity, including suspensions and modifications to the FSA’s resilience tests and enhanced monitoring of the financial modeling of insurers.

Table 5.

Insurance Sector Asset Allocation, end-1999

Source: ABI ^1/

^{^1/}ABI is one good source of summary information on insurance industry developments but this is oriented to turnover and assets rather than detailed financial analysis. S&P Thesys is one good source of financial analysis. The U.K. regulatory returns tend to be liability oriented and insurers have traditionally been given considerable leeway in terms of submission time, although this has recently been tightened. Although most regulatory returns are still filed in paper form, firms now have the option to file electronically. Returns for individual companies are publicly available from Companies House.

Table 5.

Insurance Sector Asset Allocation, end-1999

	Cash & Equities	Gilts	U.K. Corporate Securities	Foreign Corporate Securities	Foreign Gilts	U.K. Loans	Unit Trusts	Other	Property	Total
Long Term (£bill)	50.1	123.6	467.3	81.3	21.8	9.3	83.7	28.5	51.0	916.6
%	5.5	13.5	51.1	8.9	2.3	1.0	9.1	3.1	5.5	100
General (£bill)	6.0	13.9	18.8	10.3	14.0	1.4	1.3	22.9	1.7	90.3
%	6.6	15.4	20.9	11.4	15.6	1.5	1.4	25.3	1.9	100

Source: ABI ^1/

Table 5.

Insurance Sector Asset Allocation, end-1999

	Cash & Equities	Gilts	U.K. Corporate Securities	Foreign Corporate Securities	Foreign Gilts	U.K. Loans	Unit Trusts	Other	Property	Total
Long Term (£bill)	50.1	123.6	467.3	81.3	21.8	9.3	83.7	28.5	51.0	916.6
%	5.5	13.5	51.1	8.9	2.3	1.0	9.1	3.1	5.5	100
General (£bill)	6.0	13.9	18.8	10.3	14.0	1.4	1.3	22.9	1.7	90.3
%	6.6	15.4	20.9	11.4	15.6	1.5	1.4	25.3	1.9	100

Source: ABI ^1/

Table 6.

Holdings of U.K. Securities 1998

(% of outstanding value)

Source: ONS

Table 6.

Holdings of U.K. Securities 1998

(% of outstanding value)

	Life Insurers	Non Life Insurers	Pension Funds
U.K. Gilts	43.0	5.5	30.6
U.K. company shares	20.3	0.9	22.3

Source: ONS

Table 6.

Holdings of U.K. Securities 1998

(% of outstanding value)

	Life Insurers	Non Life Insurers	Pension Funds
U.K. Gilts	43.0	5.5	30.6
U.K. company shares	20.3	0.9	22.3

Source: ONS

D. General Preconditions for Effective Insurance Supervision

24. The United Kingdom has a well developed judicial system with a reputation for probity and professionalism. Civil commercial matters are normally heard in one of the divisions of the High Court, with appeal processes available through the Court of Appeal and, if accepted, the House of Lords. The senior EU Court is the European Court of Justice and it has similar professional standing to the English upper courts. The legal system is based on case law and domestic and EU legislation. As the United Kingdom has no written constitution, Parliament is the supreme domestic law making body, however as a general principle EU law overrides domestic law under the Treaty of Rome. EU directives agreed by the Council of Ministers and the European Parliament must usually be implemented into national law by member states. International Insurance Law can in many ways be said to be based on U.K. case law given the jurisdiction’s long history of insurance actions and settlements. Many insurance contracts around the world continue to be subject to English law and from a regulatory point of view the legal and judicial precondition could hardly be better satisfied.

25. The professions important to the financial sector are also well developed in the U.K. and are subject to full liability for breach of duty. There are in excess of 65,000 practicing chartered accountants in the U.K. many of which are insurance specialists. In addition there are approximately 3,000 actuaries active in the United Kingdom, all of which are expected to maintain minimum levels of continuing professional training. Both professions have world class qualification and accreditation requirements and are seen as best practice resources by educators and professionals in many other countries. Again it is hard to imagine a better level of satisfaction of a precondition for effective regulation and supervision.

26. One idiosyncratic feature of the U.K. environment is that there is no insurance accounting standard. Instead there is a Statement of Reporting Principles (SORP), largely worked out by the insurance sector on a modified regulatory reporting basis, but informed by general company reporting requirements, and with no objection from the Accounting Standards Board (which in the U.K. has the right to issue standards on its own authority, although under the guidance of the Financial Reporting Council). As a general rule the ASB has taken a limited interest in the financial sector allegedly because of the major scope for disagreement over reporting principles: the assessors were advised that the imposition of IAS in the EU in 2005 will to a large extent supplant the ASB role and that the U.K. will then be in a position to enforce an appropriate modern approach, which is still evolving. The IASB is still engaged in resolving the contentious issue of the valuation of liabilities arising from insurance contracts. In the interim there is ongoing scope for there to be up to three different sets of accounts struck within the United Kingdom for a long-term insurer (regulatory, modified regulatory, and assessed value).

27. The auditing profession is also well established. External auditors need to be members of recognized supervisory organizations and remain eligible to be a member under the rules of that organization (leading to a practicing certificate). Recognized organizations have to ensure that all their members are ‘fit and proper’ and that audit processes are carried out in a professional manner and with integrity. The role of the external auditor is increasingly taking on a prevention and detection role and the FSA’s regulatory model seeks to build on this. The main coordinating body for the six U.K. accounting bodies, the CCAB, is a recognized supervisory body. The assessment team was not able to determine the level of performance of the internal audit function within the insurance sector; however, anecdotal evidence pointed to considerable variation in levels of competence and awareness of the risk based approach. A number of large insurers now employ distinct full time compliance teams with high level reporting lines.

28. A relatively unique aspect of the FSA model is its rejection of the twin peaks model where market conduct and prudential supervision fall under different regulators and/or supervisors. Thus many officers in FSA have a joint responsibility to consider the financial strength of an institution at the same time as they are ensuring that its customers are being treated fairly. This integrated role can potentially place substantial demands on FSA supervisors if other parts of government also make decisions which affect this trade off.

29. The regulatory environment is in a process of rapid transition with the consolidation of at least nine former regulators into an independent FSA. While the reasons for this are well known and well founded there is a need to ensure that the circumstances which have made the U.K., and London in particular, the insurance center of the world, are not fundamentally altered. Prior to the formation of FSA the key formal insurance regulators was DTI and subsequently HMT, in both cases advised by the Government Actuary’s Department (GAD). These were seen to have a light regulatory touch (although the informal rules were well understood by the market) and in practice the role of rating agencies formed a third, market based form of regulation, providing an additional effective influence on governance in the general insurance segment.⁵ This has been supplemented by the central role of the appointed actuary in the long term sector. Overriding all of this has been the growing governance roles of directors and managers, supported by the internal and external audit functions.

30. The U.K. authorities are in the process of strengthening their approach to insurance regulation along the lines of their risk-based approach to supervision. The creation of the FSA as a single regulator revealed significant differences between the supervision of insurance and other financial sectors regarding similar types of risk. The so-called Tiner project has been initiated to implement and take forward a risked-based approach to insurance supervision where regulatory attention focuses on firms and activities likely to pose the greatest risk to the achievement of the regulator’s statutory objectives. This has already been reflected in the inclusion of major life and non-life offices in the Major Financial Groups Division (MFGD) of the FSA which conducts integrated regulation and supervision of the most important market participants. The Tiner project also aims at improving the prudential and conduct of business regimes for insurers, notably an increased focus on the firms’ strategies, quality of management and systems and controls; an improved disclosure and financial reporting regime; and a more proactive prudential regime with less reliance on desk-based analysis of financial returns.

31. The U.K. easily satisfies the preconditions for a full assessment.

E. Principle-by-Principle Assessment

32. As to the main findings of the mission regarding insurance supervision, the key issue is that FSA’s interim regime presently lacks a sufficient degree of experienced on site examination capacity. In addition greater precision in defining what is required of management and boards is desirable as many smaller institutions in particular will not be familiar with modern risk management concepts. Thus, while the assessors agree that the FSA’s objective of placing more governance and internal control responsibilities on insurance firms’ boards and management is highly desirable, they strongly feel that more independent assessment of the effectiveness of firms’ systems and controls is warranted.

33. At present there is no guarantee that a sufficiently comprehensive review of the appropriateness of firms’ risk management systems, asset allocation limits, internal controls, capital and reserves, and reinsurance programs will take place in light of the nature and amount of business underwritten: this is particularly the case where bank based large groups containing significant insurers are involved, or bank supervisors have been given very large insurance based groups to supervise and assimilate. This skills requirement will become even more evident when the envisaged risk-based approach to supervision (together with fair value accounting) is introduced, as this will inevitably require the ability to review complex simulations using model offices. As a consequence, the FSA should take steps to ensure that the risk review team, on which the large group supervisors draw, formally contains (either as establishment or through a solid line matrix) specialist insurance expertise in areas such as reinsurance, actuarial modeling and long-tail non-life claims, in addition to generalist insurance people. Some of these skills are scarce (for example non life actuarial skills) and long term consulting or staff exchange programs may be appropriate.

34. In terms of the current interim supervisory model, the present desk-based analysis of returns does not appear to adequately capture the risks of underlying exposures, again largely because of the availability and disposition of the requisite skills. Consequently, the assessors are of the view that the IAIS CPs 5, 6, 7, and 12 are broadly rather than fully observed. The mission also confirms the authorities’ self-assessment that CP 13, as formulated, is materially non-observed, given the limited reliance on onsite inspections under the current practice, while the core principles call for detailed onsite reviews of books, records, accounts and other documents. By contrast the assessors feel that the standards achieved in the U.K. under the governance and market conduct CPs constitute very good examples of international best practice.

35. It is the assessors’ understanding that the FSA is currently in the process of rolling out new risked-based modalities for prudential supervision (and related market conduct supervision in the case of with profits contracts) of insurance markets and building the available insurance skills base. These actions are based on the findings of the Tiner report and will operate within the overarching risk based philosophy and methodology which has been developed in the last three years. This program is expected to remedy most of the noted shortcomings on the prudential side. As a consequence, the recommendations which appear below are intended to work within this new framework, while emphasizing the unique (and in many cases highly indeterminate) nature of many insurance balance sheet risks.

Table 7.

Detailed Assessment of Observance of the IAIS Insurance Core Principles

Table 8.

Summary Observance of IAIS Insurance Core Principles

Table 8.

Summary Observance of IAIS Insurance Core Principles

Assessment Grade	Principles Grouped by Assessment Grade
Assessment Grade	Count	List
Observed	12	CP 1,2,3,4,8,9,10,11,14,15,16,17.
Broadly observed	4	5,6,7,12.
Materially non-observed	1	13
Non-observed	0
Not applicable	0

Table 8.

Summary Observance of IAIS Insurance Core Principles

Assessment Grade	Principles Grouped by Assessment Grade
Assessment Grade	Count	List
Observed	12	CP 1,2,3,4,8,9,10,11,14,15,16,17.
Broadly observed	4	5,6,7,12.
Materially non-observed	1	13
Non-observed	0
Not applicable	0

F. Recommended Action Plan and Authorities’ Response to the Assessment

Recommended action plan

36. Table 9 sets out the actions recommended by the mission with respect to insurance supervision. Note that the recommendations related to principles 5, 6, 7, 12, and 13 are to improve compliance with the Core Principles, while the other recommendations are more technical ones for Principles already complied with. The mission considers the latter desirable measures for further refining insurance supervision given, in particular, the role of London as a major international financial center.

Table 9.

Recommended Action Plan to Improve Observance of IAIS Insurance Core Principles

Table 9.

Recommended Action Plan to Improve Observance of IAIS Insurance Core Principles

Reference Principle	Recommended Action
Organization of an Insurance Supervisor
CP 1. The insurance supervisor of a jurisdiction must be organized so that it is able to accomplish its primary task, i.e., to maintain efficient, fair, safe, and stable insurance markets for the benefit and protection of policyholders. It should, at any time, be able to carry out this task efficiently in accordance with the Insurance Core Principles	The FSA should consider building its core insurance expertise to include individuals with significant experience in reinsurance, actuarial practice, and long tail, non life claims. These resources should be made available to all supervisors who are responsible for supervising insurance firms regardless of where they work within the FSA. Because the addition of these individuals would likely be organized in a matrix set up, the availability of their technical skills to all supervisors should be actively promoted within the FSA.
Corporate Governance and Internal Controls
CP 4 Corporate Governance
It is desirable that standards be established in the jurisdictions which deal with corporate governance. Where the insurance supervisor has responsibility for setting requirements for corporate governance, the insurance supervisor should set requirements with respect to: - the roles and responsibilities of the board of directors; - reliance on other supervisors for companies licensed in another jurisdiction; and the distinction between the standards to be met by companies incorporated in his jurisdiction and branch operations of companies incorporated in another jurisdiction	The FSA should consider making it mandatory for a Financial Condition Report (FCR) to be signed off by the Board and to be available to the FSA. The Board should take responsibility for the analysis of the FCR and ensure that the level of stress/scenario testing is appropriate to the complexity and size of the organization. The FSA may wish to work closely with the appropriate professional bodies to develop guidance for use by supervised firms when preparing the FCR. At the conclusion of every review of high impact firms, senior officials from the FSA should formally meet with the audit committees to review and present the management letter points. At each of these meetings it is also good practice to request an in camera meeting with only the non-executive members of the audit committees.
CP 5 Internal Controls The insurance supervisor should be able to: - review the internal controls that the board of directors and management approve and apply, and request strengthening of the controls where necessary; and - require the board of directors to provide suitable prudential oversight, such as setting standards for underwriting risks and setting qualitative and quantitative standards for investment and liquidity management require the board of directors to provide suitable prudential oversight, such as setting standards for underwriting risks and setting qualitative and quantitative standards for investment and liquidity management	The increasing pressures on insurance firms require management to pay to more attention to risk management practices. In the current environment, most firms, particularly those in MFGD, are increasingly strengthening their risk management practices; however, where this is not true, the FSA should consider encouraging those firms to do so. Possible actions that could be taken by firms include the establishment of a risk management function and a risk committee of the board. This would also largely deal with concerns expressed under CP 6 (Assets). Management letters from the regulator are important pieces of correspondence that usually deals with prudential issues which are also of interest to a firms’ auditors. Firms routinely provide copies of management letters to their auditors but this is not done consistently. The FSA may wish to standardize its procedures for processing management letters by including a requirement that firms provide a copy to their auditors on a timely basis.
Prudential Rules
CPs 6–10 Liabilities
CP 6	See comments under CP 5.
CP 7 Liabilities
Insurance supervisors should establish standards with respect to the liabilities of companies licensed to operate in their jurisdiction. In developing the standards, the insurance supervisor should consider: - what is to be included as a liability of the company, for example, claims incurred but not paid, claims incurred but not reported, amounts owed to others, amounts owed that are in dispute, premiums received in advance, as well as the provision for policy liabilities or technical provisions that may be set by an actuary; - the standards for establishing policy liabilities or technical provisions; and - the amount of credit allowed to reduce liabilities for amounts recoverable under reinsurance arrangements with a given reinsurer, making provision for the ultimate collectability	The determination of policy liabilities in life firms is a highly specialized task and involves the use of considerable judgment by the appointed actuary. Judgment is required even though the appointed actuary is required to calculate the policy reserves within the guidelines set out by the professional body. Judgment is particularly critical for some products as certain assumptions are highly sensitive and slight variations usually result in material differences in reserve balances. It would be good practice to require the implementation of a peer review process and the FSA may want to work with the institute of actuaries or other relevant professional bodies to implement such a review. Depending on the company-specific situation, a multi-discipline team may be required to do the review.
CP 10 Reinsurance
Insurance companies use reinsurance as a means of risk containment. The insurance supervisor must be able to review reinsurance arrangements, to assess the degree of reliance placed on these arrangements and to determine the appropriateness of such reliance. Insurance companies would be expected to assess the financial positions of their reinsurers in determining an appropriate level of exposure to them. The insurance supervisor should set requirements with respect to reinsurance contracts or reinsurance companies addressing: - the amount of the credit taken for reinsurance ceded. The amount of credit taken should reflect an assessment of the ultimate collectability of the reinsurance recoverable and may take into account the supervisory control over the reinsurer; and - the amount of reliance placed on the insurance supervisor of the reinsurance business of a company which is incorporated in another jurisdiction.	The FSA may wish to consider implementing a thematic review of reinsurance operations across the firms for purposes of ensuring that appropriate controls and systems are in place.
CP 12 Financial Reporting
It is important that insurance supervisors get the information they need to properly form an opinion on the financial strength of the operations of each insurance company in their jurisdiction. The information needed to carry out this review and analysis is obtained from the financial and statistical reports that are filed on a regular basis, supported by information obtained through special information requests, on-site inspections, and communication with actuaries and external auditors.	The risk profile of the insurance industry is increasing due to pressure points from several fronts including on-going underwriting losses (non-life); reduced returns on investment activities coupled with high expense pressures and uncertainty about long-tail liabilities.
	Currently, firms are required to file statutory returns annually. Given the rapidity with which an insurance firm’s risk profile can change, a move towards quarterly reporting, at least for higher priority firms, would significantly enhance a supervisor’s ability to closely monitor his or her assigned firm(s). Firms that fall under the purview of MFGD, particularly listed firms, should provide their MIS reports prior to public release.
	To accommodate this increased information flow, FSA may need to review its financial reporting data base and systems capability, and require electronic returns from insurers. Furthermore, it is necessary to carry out a review of the nature of the existing data being received as it may no longer be relevant. Consequently, changes to the statutory returns may be required.
	Public disclosure of relevant information on a timely basis is one element of the three-pillar approach proposed by the Basel Committee for banking supervision but is equally applicable to insurance firms. There is an increasing need for all firms to disclose more relevant information in their published financial reports. For example, there is need for firms to include more information on risk management practices, risk exposures and sources of gains and losses, etc. In this connection, the FSA has an important role to play in encouraging firms to adopt more appropriate disclosure practices.
CP 13 On-Site Inspection
The insurance supervisor should be able to: - carry out on-site inspections to review the business and affairs of the company, including the inspection of books, records, accounts, and other documents. This may be limited to the operation of the company in the jurisdiction or, subject to the agreement of the respective supervisors, include other jurisdictions in which the company operates; and - request and receive any information from companies licensed in its jurisdiction, whether this information be specific to a company or be requested of all companies.	In order to comply with this CP, the FSA will need to increase the resources and skill set of supervisors who are responsible for supervising the insurance industry. Core insurance expertise should be strengthened to include individuals with experience in reinsurance, risk management, actuarial science and long-tail, non-life claims.
CP 14 Sanctions
Insurance supervisors must have the power to take remedial action where problems involving licensed companies are identified. The insurance supervisor must have a range of actions available in order to apply appropriate sanctions to problems encountered	The FSA has powers under the FSMA to require firms to take remedial action when threats to the solvency of the institutions are noted. Although there are well developed processes within the FSA for dealing with firms when prudential concerns are noted, firms which are placed on a watch list are not formally notified when such action is taken. The FSA may way wish to consider notifying firms when, for prudential reasons, they are placed on a watch list.

Table 9.

Recommended Action Plan to Improve Observance of IAIS Insurance Core Principles

Reference Principle	Recommended Action
Organization of an Insurance Supervisor
CP 1. The insurance supervisor of a jurisdiction must be organized so that it is able to accomplish its primary task, i.e., to maintain efficient, fair, safe, and stable insurance markets for the benefit and protection of policyholders. It should, at any time, be able to carry out this task efficiently in accordance with the Insurance Core Principles	The FSA should consider building its core insurance expertise to include individuals with significant experience in reinsurance, actuarial practice, and long tail, non life claims. These resources should be made available to all supervisors who are responsible for supervising insurance firms regardless of where they work within the FSA. Because the addition of these individuals would likely be organized in a matrix set up, the availability of their technical skills to all supervisors should be actively promoted within the FSA.
Corporate Governance and Internal Controls
CP 4 Corporate Governance
It is desirable that standards be established in the jurisdictions which deal with corporate governance. Where the insurance supervisor has responsibility for setting requirements for corporate governance, the insurance supervisor should set requirements with respect to: - the roles and responsibilities of the board of directors; - reliance on other supervisors for companies licensed in another jurisdiction; and the distinction between the standards to be met by companies incorporated in his jurisdiction and branch operations of companies incorporated in another jurisdiction	The FSA should consider making it mandatory for a Financial Condition Report (FCR) to be signed off by the Board and to be available to the FSA. The Board should take responsibility for the analysis of the FCR and ensure that the level of stress/scenario testing is appropriate to the complexity and size of the organization. The FSA may wish to work closely with the appropriate professional bodies to develop guidance for use by supervised firms when preparing the FCR. At the conclusion of every review of high impact firms, senior officials from the FSA should formally meet with the audit committees to review and present the management letter points. At each of these meetings it is also good practice to request an in camera meeting with only the non-executive members of the audit committees.
CP 5 Internal Controls The insurance supervisor should be able to: - review the internal controls that the board of directors and management approve and apply, and request strengthening of the controls where necessary; and - require the board of directors to provide suitable prudential oversight, such as setting standards for underwriting risks and setting qualitative and quantitative standards for investment and liquidity management require the board of directors to provide suitable prudential oversight, such as setting standards for underwriting risks and setting qualitative and quantitative standards for investment and liquidity management	The increasing pressures on insurance firms require management to pay to more attention to risk management practices. In the current environment, most firms, particularly those in MFGD, are increasingly strengthening their risk management practices; however, where this is not true, the FSA should consider encouraging those firms to do so. Possible actions that could be taken by firms include the establishment of a risk management function and a risk committee of the board. This would also largely deal with concerns expressed under CP 6 (Assets). Management letters from the regulator are important pieces of correspondence that usually deals with prudential issues which are also of interest to a firms’ auditors. Firms routinely provide copies of management letters to their auditors but this is not done consistently. The FSA may wish to standardize its procedures for processing management letters by including a requirement that firms provide a copy to their auditors on a timely basis.
Prudential Rules
CPs 6–10 Liabilities
CP 6	See comments under CP 5.
CP 7 Liabilities
Insurance supervisors should establish standards with respect to the liabilities of companies licensed to operate in their jurisdiction. In developing the standards, the insurance supervisor should consider: - what is to be included as a liability of the company, for example, claims incurred but not paid, claims incurred but not reported, amounts owed to others, amounts owed that are in dispute, premiums received in advance, as well as the provision for policy liabilities or technical provisions that may be set by an actuary; - the standards for establishing policy liabilities or technical provisions; and - the amount of credit allowed to reduce liabilities for amounts recoverable under reinsurance arrangements with a given reinsurer, making provision for the ultimate collectability	The determination of policy liabilities in life firms is a highly specialized task and involves the use of considerable judgment by the appointed actuary. Judgment is required even though the appointed actuary is required to calculate the policy reserves within the guidelines set out by the professional body. Judgment is particularly critical for some products as certain assumptions are highly sensitive and slight variations usually result in material differences in reserve balances. It would be good practice to require the implementation of a peer review process and the FSA may want to work with the institute of actuaries or other relevant professional bodies to implement such a review. Depending on the company-specific situation, a multi-discipline team may be required to do the review.
CP 10 Reinsurance
Insurance companies use reinsurance as a means of risk containment. The insurance supervisor must be able to review reinsurance arrangements, to assess the degree of reliance placed on these arrangements and to determine the appropriateness of such reliance. Insurance companies would be expected to assess the financial positions of their reinsurers in determining an appropriate level of exposure to them. The insurance supervisor should set requirements with respect to reinsurance contracts or reinsurance companies addressing: - the amount of the credit taken for reinsurance ceded. The amount of credit taken should reflect an assessment of the ultimate collectability of the reinsurance recoverable and may take into account the supervisory control over the reinsurer; and - the amount of reliance placed on the insurance supervisor of the reinsurance business of a company which is incorporated in another jurisdiction.	The FSA may wish to consider implementing a thematic review of reinsurance operations across the firms for purposes of ensuring that appropriate controls and systems are in place.
CP 12 Financial Reporting
It is important that insurance supervisors get the information they need to properly form an opinion on the financial strength of the operations of each insurance company in their jurisdiction. The information needed to carry out this review and analysis is obtained from the financial and statistical reports that are filed on a regular basis, supported by information obtained through special information requests, on-site inspections, and communication with actuaries and external auditors.	The risk profile of the insurance industry is increasing due to pressure points from several fronts including on-going underwriting losses (non-life); reduced returns on investment activities coupled with high expense pressures and uncertainty about long-tail liabilities.
	Currently, firms are required to file statutory returns annually. Given the rapidity with which an insurance firm’s risk profile can change, a move towards quarterly reporting, at least for higher priority firms, would significantly enhance a supervisor’s ability to closely monitor his or her assigned firm(s). Firms that fall under the purview of MFGD, particularly listed firms, should provide their MIS reports prior to public release.
	To accommodate this increased information flow, FSA may need to review its financial reporting data base and systems capability, and require electronic returns from insurers. Furthermore, it is necessary to carry out a review of the nature of the existing data being received as it may no longer be relevant. Consequently, changes to the statutory returns may be required.
	Public disclosure of relevant information on a timely basis is one element of the three-pillar approach proposed by the Basel Committee for banking supervision but is equally applicable to insurance firms. There is an increasing need for all firms to disclose more relevant information in their published financial reports. For example, there is need for firms to include more information on risk management practices, risk exposures and sources of gains and losses, etc. In this connection, the FSA has an important role to play in encouraging firms to adopt more appropriate disclosure practices.
CP 13 On-Site Inspection
The insurance supervisor should be able to: - carry out on-site inspections to review the business and affairs of the company, including the inspection of books, records, accounts, and other documents. This may be limited to the operation of the company in the jurisdiction or, subject to the agreement of the respective supervisors, include other jurisdictions in which the company operates; and - request and receive any information from companies licensed in its jurisdiction, whether this information be specific to a company or be requested of all companies.	In order to comply with this CP, the FSA will need to increase the resources and skill set of supervisors who are responsible for supervising the insurance industry. Core insurance expertise should be strengthened to include individuals with experience in reinsurance, risk management, actuarial science and long-tail, non-life claims.
CP 14 Sanctions
Insurance supervisors must have the power to take remedial action where problems involving licensed companies are identified. The insurance supervisor must have a range of actions available in order to apply appropriate sanctions to problems encountered	The FSA has powers under the FSMA to require firms to take remedial action when threats to the solvency of the institutions are noted. Although there are well developed processes within the FSA for dealing with firms when prudential concerns are noted, firms which are placed on a watch list are not formally notified when such action is taken. The FSA may way wish to consider notifying firms when, for prudential reasons, they are placed on a watch list.

Authorities’ response to the assessment

37. The authorities noted that the FSA is carrying out a major program to reform insurance regulation (the Tiner project). This work was in train during the IMF’s mission and has now progressed further. The reforms are having a significant and far-reaching impact on the FSA’s approach to insurance regulation and on the industry. The program of reform was triggered by a number of factors. First, the insurance industry is operating in a significantly more challenging environment. This has underlined the importance of ensuring that insurance firms have sound management structures and adequate financial resources. Second, the creation of the FSA as a single regulator has highlighted significant differences between the regulation of insurance and of other sectors, not evidently justified by sectoral specifics. Third, an independent report commissioned by the FSA into the FSA’s regulation of Equitable Life made several recommendations about the regulation of the sector.

38. The reform program was established in September 2001 and the FSA set out the work that has been completed, or is underway, in a progress report published in October 2002. The reform program is focused on strengthening the prudential regime, including corporate governance, ensuring that insurance firms take proper account of the nature, diversity and scale of risks they face. It also aims at delivering a more proactive and challenging risk-based approach to regulating insurance, including significantly more on-site work.

39. As a result of the changes from the Tiner project insurance firms are facing a fundamental change in the way they are regulated, including a more proactive and challenging regulatory relationship. In line with the FSA’s risk-based approach, some firms will have started to notice the increased contact with supervisors at senior management and working levels. This reflects the explicit responsibility the FSA places on management for ensuring that systems and controls are adequate and that they are treating their customers fairly. The FSA uses a range of tools including on site work and reports by external auditors, actuaries and other professionals to test the controls that management have put in place.

40. The FSA has already begun to address the need for more insurance specialists. Over the last year the FSA has recruited in total 35 new insurance supervisors, the majority from insurance firms. These new recruits have brought with them a wide range of skills. In addition the Risk Review Department set up an insurance risk review team at the beginning of the year which includes secondees with strong technical skills and knowledge of the insurance market.

41. The FSA has already made good progress in addressing some of the points raised by the IMF. In particular, it has given guidance on improving risk management in insurance firms (see Consultation Paper 140 and feedback statement). This is also being addressed in the work to prepare an integrated prudential sourcebook. The FSA has developed proposals on the role of actuaries in life assurance companies on which it has already undertaken an initial consultation with the industry and other interested parties. More detailed proposals were published for consultation on January 24, 2003. The FSA has also published proposals to strengthen the regulation of insurance firms in the area of financial engineering, and has developed proposals on regulatory reporting, which specifically address the type of reporting required from insurance companies under risk-based supervision. These proposals also consider the issues about frequency of reporting by firms more generally.

42. The authorities welcomed the IMF’s recognition of the importance of the Tiner project in strengthening insurance regulation and in meeting much of the IMF’s proposed action plan. They had the following specific comments on the assessors’ recommendations:

On CP1, they agreed that having a range of expert skills in the FSA is important. The FSA’s risk review team includes insurance specialists, as well as specialists in credit risk, operational risk and traded risk. This is a valuable resource for the FSA, which it intends to maximize. The FSA’s actuarial and other specialist skills are already available to all those responsible for insurance firms.
On CP4, the authorities noted that the requirement for the Board of an insurance firm to receive and review financial information that provides a true reflection of the health of the business under a number of different scenarios, is clearly recognized. The FSA will place increasing emphasis on appropriate stress and scenario testing within insurance firms. The precise nature of any future requirements in this area, and any link to reporting by insurance firms to the FSA, are under consideration.

There is presently no clearly defined financial condition report for non-life insurers and the FSA would like the life one to be more clearly focused. Since the FCR includes an analysis of the financial impact of possible future scenarios, a report of this nature will be needed to support firms’ individual capital requirements, on which the FSA will be consulting shortly. At present the FCR does not give rise to a capital requirement as such. On that basis it would be premature to replace the existing resilience test.

It is not standard practice for FSA supervisors to see the Board or Audit Committee after a visit, but the FSA does write to the main Board to present the conclusions of its risk assessment. If there were significant issues arising that it was best to address through a meeting then the FSA would certainly pursue this option.

If the FSA wanted to see non-executive directors separately, it would probably involve them all rather than those represented in a particular committee. The FSA would only consider focusing on a select group of directors where it felt there were real problems that it was necessary to deal with through this route.
On CP 5, the FSA has made clear through the Tiner Reports on the future regulation of insurance (November 2001, progress report of October 2002) the importance it attaches to the need for firms to strengthen their risk management practices. This has been given further substance by the Guidance on Systems and controls published in a Policy statement issued in December 2002, which sets out for firms the FSA’s expectations that they will have proper risk management functions appropriate to the size and nature of their business. The FSA’s supervisors cover this area as an integral aspect of the FSA’s risk assessment framework. In addition the whole emphasis of the prudential source book is on the need for proper risk management practices. The Board should be responsible for the appropriate governance for risk management functions. Risk assessment letters and risk mitigation programmes are already copied to the auditors as standard practice.
On CP7, the authorities indicated that the FSA is proposing changes to the role of actuaries in the governance of life insurers. It published a consultation paper on these matters (CP167) in January 2003. The intention is that the policy reserves will be calculated by an actuary. The actuary will advise the board on the methods, bases and results of the calculations. The FSA will also require an independent review of the calculation of policy reserves by the auditor. The auditor will be required to take actuarial advice independent of the regulated firm’s actuary in forming the audit opinion. The FSA is working with the professional bodies to achieve appropriate guidance to professionals working in this area.

For non-life liabilities, the FSA will keep under review whether to introduce actuarial overview of the provisions as part of its review of insurance regulation. The FSA is preparing rules and guidance on stress and scenario testing and on individual capital adequacy standards as part of its work on the integrated prudential sourcebook. The FSA is also developing proposals for better regulatory reporting, which will take into consideration the appropriate format for reporting to the FSA risks to non-life insurers.
On CP 10, since the IMF visit the FSA has published a consultation paper with proposals to strengthen controls on financial engineering in insurance companies, which tackles reinsurance and other issues. The possibility of a wider thematic review of reinsurance arrangements will be considered alongside other priorities for such reviews.
On CP 12, the authorities fully recognized that insurance firms are operating in an increasingly challenging environment. Against this background, the FSA is examining how it can reform regulatory reporting to ensure that it receives the key information it requires for supervisory purposes while keeping the burden on industry to the minimum necessary. Issues such as public disclosure versus private reporting, quantity versus quality of information submitted, and capturing more forward-looking information are all being looked at.

Specifically in the insurance area, the FSA published a Discussion Paper on a new approach to regulatory reporting as part of the Tiner project. After analyzing the feedback on this, the FSA proposes to launch a consultation paper in mid-2003. Any proposals on the timeliness and frequency of information submitted by insurance firms will be dealt with then. The FSA recognizes that deciding on what, if any, information is required more frequently than annually, and what firms any additional reporting requirements should apply to, is a critical issue. Account will also have to be taken of international developments in planning changes in this area. The proposal that listed firms should provide any reports to the market to the FSA prior to public release will be considered.

The FSA is enhancing its IT capabilities to facilitate anticipated changes, and is in the early stages of developing electronic reporting. Initially it is looking at areas such as Authorization and Listing where there are potential efficiencies from the use of technology, but this will be expanded into new areas as appropriate.

The FSA is participating actively in international discussions within the IAIS and Joint Forum on the need for enhanced public disclosure of key financial information. The role of public disclosure of relevant information is integral to the approach the FSA intends to take in its own development work. In the forthcoming negotiations on a new EU insurance solvency regime the U.K. will press for the adoption of a three-pillar approach similar to that being proposed by the Basel Committee for the banking sector.
For CP 13, the authorities indicated that on-site inspection needs to be considered in the context of the FSA’s overall risk-based approach to insurance supervision. The FSA does not undertake on-site inspections of all insurance firms, but follows instead a risk-based approach. During 2002, the FSA began to assess insurance firms using the risk-based framework it has developed. The FSA intends to have a close and continuing relationship with high impact firms (judged by reference to the FSA’s statutory objectives). Prudential supervision in relation to these firms, and those judged medium impact, will be more pro-active and less reliant on desk-based analysis of financial returns. At the other end of the spectrum, low impact firms will not be subject to specific risk assessments, but supervised mainly through an analysis of the data routinely submitted to the FSA. On-site work in relation to these firms will (exceptionally) be undertaken in response to any risks identified from the data submitted, together with visits to a sample of firms as part of sector-wide reviews.

Over the last year the FSA has recruited in total 35 new insurance supervisors, the majority from insurance firms. These new recruits have brought with them a wide range of skills. In addition the Risk Review Department set up an insurance risk review team at the beginning of the year which includes secondees with strong technical skills and knowledge of the insurance market. This team is being used actively as part of the risk assessment process. The FSA has also begun to commission skilled persons reports from independent professional experts on specific aspects of a firm’s operation, systems or controls.
On CP14, the authorities did not believe the recommendation was appropriate. Where a firm is placed on the FSA watchlist the firm will already be well aware of the issues of concern to the FSA, on solvency or other matters, and remedial work will be underway. The FSA does not believe that telling firms that they are on the watchlist is appropriate, since it is essentially an internal tool.

III. IOSCO Objectives and Principles of Securities Regulation

A. General

43. The principal regulator of securities markets in the United Kingdom is the Financial Services Authority (FSA). There are other organizations involved in aspects of the regulation of securities markets and participants, as appears in the assessments below, but the FSA is the main subject of this assessment. This assessment was conducted as part of the Financial Sector Assessment Program of the International Monetary Fund (IMF) and the World Bank, between November 2001 and July 2002. The principal assessors with respect to securities were: Mr. Alan Cameron, A.M., lawyer and regulatory consultant, former chairman of the Australian Securities and Investments Commission, the Executive Committee of IOSCO, and the Joint Forum; and Mr. David Shillman, Counsel to the Director of the Division of Market Regulation at the U.S. Securities and Exchange Commission.

B. Information and Methodology used for Assessment

44. The assessment was conducted using the February 2002 version of the IOSCO Objectives and Principles of Effective Securities Regulation, and the guidance issued by the IMF and the World Bank prepared in conjunction with the Implementation Committee of IOSCO.

45. The main information sources in making the assessment were self-assessments prepared by the FSA using the Questionnaires developed by IOSCO, supplemented by: (a) documents furnished by the FSA, such as its Annual Reports, publications relating to its policies, and its handbook; (b) material obtained through the FSA’s website, such as press releases and speeches by senior FSA officials; (c) the Financial Services and Markets Act 2000 (FSMA); (d) interviews organized through the good offices of the FSA with market participants, industry groups, financial journalists, the FSA’s Consumer and Practitioner Panels, and others; and (e) lengthy discussions with senior staff of the FSA.

46. The team received full cooperation from the FSA in completing the assessment and expresses its appreciation for that assistance.

C. Institutional and Macroprudential Setting, Market Structure

47. The FSA was established by the U.K. Government in May 1997, and commenced operation in an interim or transitional way in June 1998. The relevant law, the FSMA, was passed in 2000, and took full legal effect on December 1, 2001, a date usually referred to in this context as N2. The FSA absorbed initially the activities of nine previous regulators or government departments, but has since taken on even more responsibilities. For present purposes, the relevant features were that the FSA is in legal terms the former Securities and Investments Board, and took on all of its roles, together with those of the Securities and Futures Authority and the Investment Management Regulatory Organization. Since then the FSA has also incorporated the U.K. Listing Authority (UKLA), formerly a division of the London Stock Exchange (LSE).

48. Trading of securities in the United Kingdom is conducted on securities exchanges, alternative trading systems, and in the over-the-counter (OTC) market. There are six securities exchanges in the United Kingdom: the LSE and Virt-X primarily trade equities; the London Metal Exchange for commodities; and the London International Financial Futures and Options Exchange (LIFFE), OM London, and the International Petroleum Exchange trade financial and commodity derivative products. Each of these exchanges is supervised by the FSA as a ‘Recognised Investment Exchange,’ and has certain self-regulatory responsibilities with respect to the conduct of business on its facilities. In addition, a number of firms, such as Instinet, E-Crossnet, ITG Europe (Posit) and BrokerTec, offer alternative trading systems to U.K. market participants. These ‘market infrastructure providers’ are supervised by the FSA in a manner similar to investment firms, with an emphasis on prudential and conduct of business rules. Finally, significant OTC markets exist in the U.K. for foreign exchange, bullion, money market and fixed income products, and interest rate derivatives. Participants in the OTC markets are supervised by the FSA as investment firms and, among other things, are required to comply with the FSA’s Code of Market Conduct and Inter-Professional Code.

49. The majority of the U.K. securities industry consists of subsidiaries of overseas financial institutions. For example, all of the parent companies of the top ten securities houses trading European shares in London are foreign, and together these institutions account for approximately 75 percent of the U.K. equity market. The LSE is the dominant U.K. stock exchange and, at the end of 2001, traded 2,975 equities. The LSE trades more foreign companies than any other exchange and daily trading volumes for international equities in London are almost double those for domestic companies. Annual turnover of domestic and foreign equities on the LSE was £5.5 trillion in 2001. In that year, domestic and foreign issues traded on the LSE had an aggregate market capitalization of £4.1 trillion, and funds raised totaled £149 billion. LIFFE dominates the U.K. market for exchange-traded financial derivatives. In 2001, annual turnover on LIFFE was more than 200 million contracts with a notional value in excess of £90 trillion. In the United Kingdom, the vast majority of fixed income trading takes place in the OTC markets. In the international bond market, London-based bookrunners (including both branches of overseas institutions and U.K.-based institutions) are estimated to account for 60 percent of eurobonds issued, with 70 percent of secondary market trading. London also accounts for almost a third of world foreign exchange activity, with an average daily turnover of $504 billion, and is the world’s most liquid spot market for gold and gold lending. Finally, London is the most active trading centre for OTC derivatives, with a market share of 36 percent.

D. General Preconditions for Effective Securities Regulation

50. London, of course, is one of the world’s major financial centres, and has the largest share of trading among many international financial markets, including foreign equity trading. Reasons for that prominence include the openness and efficiency of its markets, the concentration of skills and expertise in one place, and the liquidity which is already there. There appear to be no significant barriers to entry or exit from markets or products.

51. With respect to regulatory policy, London’s success in attracting overseas business can be attributed in part to the perception that the United Kingdom has a “proportionate” approach to regulation. IOSCO sets out three objectives that should form a basis for an effective system of securities regulation: (a) the protection of investors; (b) ensuring that markets are fair, efficient and transparent; and (c) the reduction of systemic risk. The U.K. regulatory system is broadly designed to address each of these objectives, albeit investor protection is to be delivered, at least in part, by requiring the provision of information to investors, and investor education, in addition to traditional means such as enforcement. Notably, the applicable objective under the FSMA charges the FSA with securing an “appropriate degree” of investor protection “while recognizing [investors’] own responsibilities.” As discussed more fully in the assessment, the FSA has issued comprehensive rules and guidance to implement its new statutory objectives under the FSMA. The effectiveness of this new regime, however, and in particular the FSA’s ‘risk-based’ approach to supervision, under which resources are allocated to those areas assessed as being of greater systemic importance, has yet to be tested in practice. Finally, the U.K. regulatory scheme will be affected, perhaps significantly, over the next several years by European Union legislation, as well as initiatives of the Committee of European Securities Regulators. It is already clear, for example, that the FSA’s powers need to be used and interpreted in light of the European Convention on Human Rights, but that should not prevent the FSA being effective.

52. The United Kingdom has a developed and robust legal system and its accounting standards are of a high and internationally acceptable quality. As to the tax framework, there has been long-standing criticism of the Stamp Duty, a 0.5 percent tax on the buy side of each share transaction in the United Kingdom, and concerns regarding it have become heightened as spreads have narrowed and the impact of the Stamp Duty becomes proportionately more significant. Demand for share substitutes that are free from the Stamp Duty, such as derivative products like contracts for difference and spread betting systems, has increased, thereby creating some distortions in the securities markets, but is not perceived at this stage as being likely to create vulnerabilities or cause systemic risks.

E. Principle-by-Principle Assessment

Table 10.

Detailed Assessment of Observance of the IOSCO Objectives and Principles of Securities Regulation

Table 11.

Summary Observance of the IOSCO Objectives and Principles of Securities Regulation

Table 11.

Summary Observance of the IOSCO Objectives and Principles of Securities Regulation

Assessment	Principles Grouped by Assessment Grade
Grade	Count	List
Implemented	30	CPs 1-30
Partially Implemented
Non-Implemented
Not applicable

Table 11.

Summary Observance of the IOSCO Objectives and Principles of Securities Regulation

Assessment	Principles Grouped by Assessment Grade
Grade	Count	List
Implemented	30	CPs 1-30
Partially Implemented
Non-Implemented
Not applicable

F. Recommended Actions and Authorities’ Response to the Assessment

53. Although the United Kingdom observes all of the IOSCO objectives and principles, some technical recommendations are outlined below to further improve the U.K.’s regulation of securities markets.

When policy in the area of co-operation in international enforcement is next under review, consideration might be given as to whether the requirement in the FSMA to take account of the U.K.’s own interest when assessing whether or not to provide assistance to foreign regulators, is consistent with the priority a major international financial centre like the United Kingdom ought to place on securing effective enforcement across national borders.
Consideration could be given as to whether it is economic or efficient for the law to require all prospectuses to be reviewed by the UKLA; the FSA’s ‘risk-based’ assessment methodology could also be appropriate in this context.

54. In the area of collective investments, matters which might be considered include:

Introducing a specific requirement for transactions with affiliated parties to be disclosed to investors and the FSA.
Introducing a requirement that delegates receiving delegations of functions such as portfolio management, investment advisory and other core functions be bound not only by contract with the operator, as at present, but also by law to comply with the same regulatory standards imposed on the operator itself.
Extending the regulatory framework applicable to delegates, to sub-delegates.
Requiring delegation arrangements for custody to also be notified in annual reports at least.
Introducing continuous disclosure requirements for CISs.
Finally, the FSA presently is conducting an internal review of transparency matters, and may wish to ensure that competitive pressures do not undermine the visibility of trading interest in the future.

G. Authorities’ Response

55. The authorities welcomed the positive assessment of the U.K.’s observance of the IOSCO principles and noted that the United Kingdom has fully implemented all 30 principles. They also noted that the FSAP team has been able to make some technical recommendations which they regard as helpful in providing constructive input to their thinking and they are considering how best to take them forward. They feel that the technical recommendations are constructive and provide useful support for ongoing FSA work to further strengthen the U.K. securities regime. Specific comments on the technical recommendations outlined above are as follows:

Co-operation in international enforcement. The authorities feel that in practice the recommendation concerning co-operation on international enforcement may be overstated, given both their record of effective co-operation and the requirements in FSMA to co-operate and to look beyond U.K. interests.
Review of all prospectuses by the UKLA. The authorities consider the recommendation to apply their risk-based approach to their approval of documents to be useful. They are seeking to develop a more risk-based approach to this work, although they would emphasize that they must still meet their obligations under European Directives that require approval of documents.
Collective investments - disclosure of transactions with affiliated parties and requirement of delegation arrangements The authorities noted that the U.K. has a very comprehensive and detailed regime for the regulation of Collective Investment Schemes (CIS) and in some areas they feel that their regime already provides sufficient protections equivalent to those suggested by the recommendations. On the recommendations on the use of delegates, and for continuous disclosure by CIS, they believe these measures are already undertaken within their regime. They are, however, reviewing their current requirements for continuing disclosure. On transactions with affiliated parties, the FSA is satisfied that the present requirements for information about such transactions to be passed to the FSA are consistent with their risk based approach to supervision and a proportionate regulatory regime. Nonetheless, they are also considering further refinements to their CIS regime through an ongoing current review and they noted that, in this respect, the FSAP recommendations more generally provide support for work already ongoing.
Encouraging RIEs to improve price transparency. The authorities recognize the importance of sustaining improvements in an increasingly competitive environment. To this end they have been working to underpin high levels of transparency in a more fragmented marketplace, while also paying due attention to the need not to damage liquidity.

IV. CPSS Core Principles for SIPS and Central Bank Responsibilities in Applying the CPs—NewCHAPS

A. General

56. This assessment was undertaken in the context of an IMF Financial Sector Assessment Program (FSAP) exercise for the United Kingdom over the period February–July 2002 which covered, inter alia, the Core Principles for Systemically Important Payment Systems.⁷ This assessment covers the NewCHAPS system, the basis for two schemes—CHAPS sterling and CHAPS euro, providing real-time gross settlement facilities for sterling and euro transactions, respectively.⁸

57. The Bank of England (the Bank) has conducted a formal self-assessment of the NewCHAPS system’s observance of the Core Principles. This assessment was made available to the mission. The Bank also provided detailed answers to an IMF questionnaire and a number of documents relevant for the assessment. Extensive meetings were held with officials from the Bank, supplemented by discussions with officials from the CHAPS Company as well as with the Association for Payment Clearing Services (APACS), six NewCHAPS members and two non-member institutions.

58. The G-10 Committee on Payment and Settlement Systems’ (CPSS) Report on Core Principles for Systemically Important Payment Systems Parts I and II and an IMF guidance note were used when assessing the NewCHAPS system. No obstacles were faced in the work. The authorities and others were fully cooperative.

The payment infrastructure in the United Kingdom

59. The majority of interbank transfers of funds in the United Kingdom are processed through four clearing systems, all of which operate under the umbrella of APACS:

As part of NewCHAPS, the CHAPS Sterling and CHAPS euro systems settle payments on an RTGS basis. They are primarily designed for high-value payments, although there is no lower (or upper) limit on the value of individual payments. The two NewCHAPS systems currently have 21 participants, of which 20 are members of CHAPS euro and 13 of CHAPS Sterling.
BACS⁹ is an Automated Clearing House (ACH), which processes large volumes of relatively low-value (retail) payments, including direct debits, direct credits, standing orders, and other non-urgent automated credit transfers.
Finally, paper debit and credit payment items are cleared through two parallel systems run by the Cheque & Credit Clearing Company (C&CCC).

60. The CHAPS Clearing Company Limited (CHAPSCo) is the governing body for the CHAPS Sterling and Euro systems. CHAPS Sterling started operations in 1984 as a nationwide, electronic interbank system for sending irrevocable, guaranteed and unconditional sterling credit transfers for same day value operating on an end-of-day multilateral net settlement basis. In April 1996, it was developed into an RTGS system. It now handles nearly all large-value same-day sterling payments between banks, other than those relating specifically to the settlement of securities transactions (handled through CREST).

61. In January 1999, a second CHAPS system—for euro-denominated payments—began operation. This system is connected to TARGET, the RTGS system for the euro. CHAPS euro is the U.K. national component of TARGET and is separate from the original CHAPS sterling system (although both are run by CHAPSCo). However, the technical differences between the two systems narrowed significantly in August 2001, when the NewCHAPS project moved the two systems onto the same (SWIFT-based) technical platform. The strategic decision to migrate to a common generic platform was motivated by the desire to achieve technological and cost efficiencies, to ensure a sufficiently flexible infrastructure to meet requirements for possible U.K. EMU entry, to prepare for implementation of ‘full DVP’ in the U.K. in November 2001 and to facilitate wider access to the CHAPS Sterling system.

62. The main components of the NewCHAPS systems are: message exchange within two closed user groups comprising CHAPS (euro and Sterling respectively) members and the Bank, over the SWIFT FIN Copy Financial Application service (used in ‘Y-Copy’ mode);¹⁰ Computer Based Terminals (CBTs – SWIFT interfaces) located within members’ systems and at the Bank (the RTGS CBT); sterling and euro settlement accounts within the Bank’s real-time accounting system (the RTGS processor); and an Enquiry Link facility provided by the Bank, which enables system participants to interact with the RTGS processor to e.g., monitor payments progress, manage payments queues during the day and make certain funds transfers.

63. The Bank is responsible for the provision and maintenance of the central scheduling and settlement accounting environment for the settlement during the day of CHAPS payments and other transactions between members outside the CHAPS operating day, as well as intraday payment flow monitoring. It is also responsible for the provision and maintenance of the Enquiry Link network (based on SWIFTNet and subject to bilateral contractual arrangements between the bank and SWIFT) and for the provision of intraday liquidity to CHAPS members through an intraday repo facility (subject to bilateral contractual arrangements between the Bank and members). CHAPSCo is responsible for the provision and maintenance of the messaging network conveying CHAPS payment information between CHAPS members and to and from the Bank over the SWIFT network (subject to contractual arrangements between CHAPSCo and SWIFT).

B. The Functioning of the NewCHAPS System

64. In NewCHAPS, payments are processed as follows: a payment message (MT100, MT103 or MT202) is submitted to the SWIFT network. This message is held in the FIN Copy service and a settlement request (MT096) containing a subset of the original message is forwarded to the RTGS Processor, via the RTGS CBT. On reaching the RTGS Processor, all payment messages pass through a validation process, for example to check for duplicate messages.

65. All valid payment requests submitted to the Bank are then routed via a Central Scheduler to the RTGS processor. It is expected that the vast majority of payments will pass straight through the Central Scheduler for settlement. However, payments will be forwarded for settlement only after they meet the conditions contained in certain ‘filters’ in the central scheduler. These filters are set by individual banks and are not compulsory. There are three filters and any combination of one, two or three filters may be set by banks:

Value ‘threshold:’ Payments that are equal to or greater than this value are held in the central scheduler with a status of ‘blocked by value.’
Individual payment ‘filter’: a bank may submit payments with a status of ‘held.’ Such payments are held within the central scheduler until the status is removed by that bank.
Individual domestic counterparty ‘switch:’ individual banks can temporarily hold in the central scheduler all payments to another CHAPS member. Such payments will be held within the central scheduler with a status of ‘held for counterparty’.

66. Items which pass through the Central Scheduler are held in the sending bank’s Funds Queue (one for each currency). Payments on the Funds Queue are processed first by priority, then by value (with the lowest value settlement request queued ahead of higher value settlement requests), then by time input to the funds queue, then by time of input to the RTGS Processor.

67. Settlement requests can be allocated a ‘Priority’ number within the range of 1-99 with Priority 1 being the highest. Settlement requests within the range of 1 to 19 are able to use ‘headroom’ (see below). The Priority levels 1-9 and 90-99 are reserved for use by the Bank, while individual banks can allocate other priority levels to individual payment messages. If no Priority is allocated, the system default Priority of 50 is allocated. The Priority of a settlement request may be changed at any time provided it has not settled. Changing a Priority has the effect of moving the item in the funds queue.

68. The RTGS Processor settles payments by simultaneously debiting the sending member’s Settlement Account while crediting that of the receiving member. Any payment from a sending member may not be revoked by it after the Bank has debited its Settlement Account. Once these entries have been made on the Settlement Accounts of the sending member and the receiving member, settlement is final. After settlement, a Settlement Confirmation (MT097) is sent from the RTGS Processor to the SWIFT FIN Copy service. The initial payment message is then automatically released, with full details plus a settlement confirmation, from FIN Copy to the receiving member, who is required to validate the payment and to accept it.¹¹

69. The sending member may request that FIN Copy produces a Sender Notification message (MT012) to inform the member that a Settlement Confirmation has been received by FIN Copy from the RTGS Processor. The sending member may also request that FIN Copy produces a Delivery Notification (MT011) once the settled payment message has been successfully delivered to the receiving member.

70. According to the Memorandum of Understanding between the Bank and CHAPSCo (“the MoU”), the transmission time between one member’s internal system and another’s should be no longer than 60 seconds (30 seconds for network processing and 30 seconds for processing by the RTGS processor excluding any delays caused by queuing in the Central Scheduler or lack of liquidity).

71. To enable Members to make time-critical payments such as settlement of net obligations in ancillary payment systems, each bank can reserve part of its total available liquidity within the RTGS settlement process for those payments—so-called ‘headroom.’ A member-parameterized default setting allows individual banks to reserve a set amount at the start of each business day; members can change the amount reserved intraday. As noted above, ‘priorities’ are used to indicate payments which may use this reserved balance.

72. To improve the efficiency of liquidity usage in the CHAPS sterling system, by preventing any one institution from hoarding liquidity, members are required to comply with the following guidelines, measured over a calendar month.

73. At an aggregate level, the experience suggests that CHAPS Sterling appears to be meeting the throughput guidelines quite easily (some 30–40 minutes in advance of the deadlines).

74. The Enquiry Link, which is an interactive link between Members and the RTGS processor based on SWIFTNet Interact service, can be used to adjust Central Scheduler settings, to select payments on which the Member wishes to override thresholds, to cancel any payments queued in the Central Scheduler and in the Funds Queue or to alter the priority of payments. It can also be used by CHAPS members intraday to fund and defund their separate CREST RTGS account for DvP (there is automatic functionality available to do this too, the Automatic Liquidity Transfer (ALT) Mechanism).

75. Cross-border TARGET payments initially follow a similar path to domestic euro payments. However, when the sender’s account is debited, an RT TARGET account is credited and a settlement confirmation is returned to FIN Copy. This releases the full payment message in SWIFT, which is sent back to the Interlinking component in the RTGS processor. The RT TARGET account is then debited and the recipient national central bank’s (NCB) account is credited. A TARGET message is then sent through SWIFT to the destination NCB. The destination NCB credits the recipient’s settlement account and relays the message in the domestic format.

Statistical information regarding volumes and values of transactions

NewCHAPS average daily volumes (000’s) and values (£ millions):

		1999		2000		2001
		Vol	Val	Vol	Val	Vol	Val
Sterling		78.5	177,396	86.1	195,023	91.7	202,857
Euro		9.7	85,367	12.9	99,277	14.5	118,368
	Domestic	2.5	11,926	3.0	12,143	3.4	15,534
	Cross-border	7.2	73,441	9.9	87,134	11.1	102,834

NewCHAPS average daily volumes (000’s) and values (£ millions):

		1999		2000		2001
		Vol	Val	Vol	Val	Vol	Val
Sterling		78.5	177,396	86.1	195,023	91.7	202,857
Euro		9.7	85,367	12.9	99,277	14.5	118,368
	Domestic	2.5	11,926	3.0	12,143	3.4	15,534
	Cross-border	7.2	73,441	9.9	87,134	11.1	102,834

Average transaction values (£):

		1999	2000	2001
Sterling		2,259,420	2,264,212	2,211,854
Euro
	Domestic	4,810,022	4,136,902	4,628,028
	Cross-border	10,415,628	8,881,953	9,253,968

Average transaction values (£):

		1999	2000	2001
Sterling		2,259,420	2,264,212	2,211,854
Euro
	Domestic	4,810,022	4,136,902	4,628,028
	Cross-border	10,415,628	8,881,953	9,253,968

76. The intraday pattern of payment flows differs slightly between sterling and euro:

Sterling: The CHAPS Sterling day is characterized by three peaks: two morning peaks around 07:30 (volume) and 10:00 (value) and an afternoon peak between 14:30 and 15:30. A trough is generally observed between 08:30 and 09:30, probably reflecting a pause between payments input ahead of settlement date and payments generated during the day.
Euro: The profile for CHAPS euro exhibits peaks from 07:30 to 08:00 and again from 15:00 to 15:30. In between, the number of payments drops steadily until 12:00 and stays low until 14:00. Generally, euro payments are processed earlier in the day than sterling payments with 20 percent of euro payments processed by 08:00 compared to 13 percent for sterling. The late peak largely reflects cross-border TARGET payments, with banks placing surplus liquidity in the euro area.

77. For CHAPS Sterling, financial transactions account for 76 percent by value transmitted and 38 percent by volume. Although financial transactions still dominate the value transmitted, their market share by volume is down from 45 percent in 2000. The rest is accounted for by commercial and consumer transactions. 21 percent of CHAPS Sterling payments are below £1,000 and 47 percent below £10,000.

Purpose of CHAPS payments:

Source: CHAPS Traffic Survey 2001. Figures provided are indicative only, and may not add up to 100 percent.

Purpose of CHAPS payments:

Purpose of payment	% by volume	% by value	Average value of transaction
			(£000s)
FX	5-7	16	4,900
Total financial	38	76	4,600
Inter-account transfer	10	22	4,700
Housing & legal	16	1	300
Business	29	-	9

Source: CHAPS Traffic Survey 2001. Figures provided are indicative only, and may not add up to 100 percent.

Purpose of CHAPS payments:

Purpose of payment	% by volume	% by value	Average value of transaction
			(£000s)
FX	5-7	16	4,900
Total financial	38	76	4,600
Inter-account transfer	10	22	4,700
Housing & legal	16	1	300
Business	29	-	9

Source: CHAPS Traffic Survey 2001. Figures provided are indicative only, and may not add up to 100 percent.

78. Less detail is available for CHAPS euro. However, payments related to foreign exchange activity account for approximately 50 percent of euro values.

79. The three peak volume and value days for sterling and euro respectively are set out in the table below.

Three peak days within last year, volumes (000’s) and values (£/€ billions):

	Volume	Value
Sterling	29/06/01: 188.806	28/09/01: £318.95
	28/09/01: 186.535	29/06/01: £311.30
	30/03/01: 178.086	29/09/00: £296.82
Euro	20/02/01: 23.982	29/06/01: €302.99
	16/01/01: 22.687	16/01/01: €253.95
	30/05/01: 21.767	29/09/00: €232.93

Three peak days within last year, volumes (000’s) and values (£/€ billions):

	Volume	Value
Sterling	29/06/01: 188.806	28/09/01: £318.95
	28/09/01: 186.535	29/06/01: £311.30
	30/03/01: 178.086	29/09/00: £296.82
Euro	20/02/01: 23.982	29/06/01: €302.99
	16/01/01: 22.687	16/01/01: €253.95
	30/05/01: 21.767	29/09/00: €232.93

80. With regard to payments originated within CHAPS Sterling, payment flows are concentrated, with the 5 biggest banks accounting for over 80 percent of both value and volume. In CHAPS euro/TARGET, payment flows are less concentrated than for CHAPS Sterling, with the 5 biggest banks accounting for just over 67 percent of volumes.

General preconditions for effective payment systems

81. The United Kingdom has a stable macroeconomic environment and a well-developed public infrastructure, which support the financial market. Several key EU directives (including the Settlement Finality Directive), which all Member States have incorporated in their respective laws, cover the payment system.

82. The Association for Payment Clearing Services (APACS) was set up in 1985 as a non-statutory association of major banks and building societies. It has become the umbrella body providing a mechanism for consultation and acting as a representative for the U.K. payments industry with 31 members. APACS is an unincorporated association of members, one of whose tasks is to promote the operational efficiency and financial integrity of the U.K.’s payments infrastructure, including CHAPS. Until recently, all members of CHAPS also had to be members of APACS (but not vice-versa). There is no legal relationship between the two organizations.

83. The CHAPS Clearing Company (CHAPSCo) is responsible for setting the operational rules for the CHAPS Sterling and euro systems and for developing the system to meet Members’ changing needs. The settlement members of CHAPS are involved in this process through their membership of the Board of the CHAPS Clearing Company and its committees.

84. The CHAPS Board usually meets on a bimonthly basis. Each member is entitled to appoint one Director, regardless of whether they belong to either one or both of the clearings. Members of the same corporate group are entitled to only a single seat on the Board between them. However, a Director appointed by a Member whose clearing volume exceeds 10 percent of the Company’s total clearing volume is eligible for an extra vote at Board meetings. Directors have a fiduciary responsibility towards all shareholders of the company and not just the member they represent. Directors must be familiar with their own legal responsibilities and the legal requirements of the company. Finally, they must be able to commit their institution where company decisions require member agreement and ensure their institutions’ compliance with decisions taken by the Company. The Board appoints the Company Manager to be responsible for the day-to-day management of the Company and for implementing Board policies.

85. Any settlement member, or the Company Manager, may propose rule changes by submitting their request to the CHAPS Operational Committee which, after consulting all settlement members (and obtaining the views of the CHAPS Technical and Security Committees as appropriate), will forward the proposal and its recommendation to the Board. Under the Settlement Finality Directive, all changes to the Rules must be formally advised to the Bank in its capacity as designating authority under that Directive.

86. As all Members are represented at CHAPS Board they are thus consulted on all Board decisions. Indirect members and end-users are not consulted directly.

87. The Bank is a Member of CHAPS, and is represented as of right at APACS Council and the CHAPS Board. There is, in addition, close liaison between CHAPS’ senior management and the Bank’s Oversight Team. The Bank of England has clearly defined its oversight role vis-à-vis U.K. payment systems in a publication readily available on its web site.

Changes and reforms in process

88. Through its committee structure and the Strategic Planning Working Group, CHAPSCo, its members and the Bank review current functionality and the possible further development of NewCHAPS’ functionality. This work is undertaken in parallel with discussions (in which the Bank is also participating) within the ESCB regarding the development of the TARGET 2 system. Whilst discussions are only at a very early stage, it remains unclear what features this development might add. Any significant development will clearly take some time to implement.

89. Over the years since its creation, APACS had come to adopt an influential role in the strategic direction of the schemes under its umbrella. Some concern existed that APACS’ role had the potential to reduce the effectiveness of scheme governance. During the period of this assessment, these issues contributed to the development of proposals to reform APACS’ role and to clarify that responsibility for the operation and development of each clearing lie with the relevant Clearing Company. At the same time, there was also a concern not to inhibit APACS from continuing to contribute to industry-wide initiatives. In September 2002, reforms to APACS role were introduced, and each of the clearing companies under APACS, including CHAPSCo, now has full and explicit responsibility for its own governance, while the previous requirement for CHAPS members to be members of APACS has been removed.

C. Main Findings—Summary

90. The mission has found that NewCHAPS observes the applicable Core Principles, following the recent reforms to arrangements involving APACS. In the initial phase of this assessment, NewCHAPS fully observed seven Core Principles, and two Core Principles were broadly observed. One Core Principle was (and remains) not applicable, while the four responsibilities of the central bank were (and are) observed. The mission’s initial assessment therefore pointed to opportunities for further improvements with respect to fair and open access and governance to ensure full adherence to the Core Principles. The subsequent implementation of the reforms noted above, however, allows the recognition of the NewCHAPS service as fully compliant with the applicable core principles. Those aspects aside, there remain some other, more technical refinements at the margin in a few areas that the mission recommends be pursued.

Table 12.

Detailed Assessment of Observance of CPSS Core Principles for SIPS and Central Bank Responsibilities in Applying the CPs—NewCHAPS

Table 13.

Summary Observance of CPSS Core Principles and Central Bank Responsibilities in Applying the CPs—NewCHAPS

Table 13.

Summary Observance of CPSS Core Principles and Central Bank Responsibilities in Applying the CPs—NewCHAPS

Assessment grade	Count	List
Assessment grade		Principles grouped by assessment grade
Observed	9 + 4	CP I, II, III, IV, VI, VII, VIII, IX and IX; Responsibilities A – D
Broadly observed	-
Partly observed	-
Non-observed	-
Not applicable	1	CP V

Table 13.

Summary Observance of CPSS Core Principles and Central Bank Responsibilities in Applying the CPs—NewCHAPS

Assessment grade	Count	List
Assessment grade		Principles grouped by assessment grade
Observed	9 + 4	CP I, II, III, IV, VI, VII, VIII, IX and IX; Responsibilities A – D
Broadly observed	-
Partly observed	-
Non-observed	-
Not applicable	1	CP V

D. Recommended Actions and Authorities’ Response to the Assessment

Recommended actions

91. The mission conducted an assessment of the NewCHAPS system relative to the Core Principles for Sytemically Important Payments Systems and confirmed observance of these principles. While the mission’s initial assessment pointed to opportunities for further improvements in fair and open access and governance to ensure full adherence to the Core Principles, changes which subsequently became effective addressed these issues.

92. While the mission’s assessment is that the applicable Core Principles and central bank Responsibilities are already observed, there are nevertheless a few other, more technical, refinements that the mission believes would desirably still be pursued, to further improve existing arrangements:

The RTGS documentation identifies as a contingency measure the move of the payments processing to a so-called RTGS “by-pass” mode. Currently, this materially implies a move to an unprotected end-of-day (bilateral) net settlement procedure where no centralised risk management rules apply. There is currently no requirement that banks apply risk management rules of their own—it is also unclear whether and/or how they may do so. Since the initial FSAP assessment, however, the CHAPS Board has agreed procedures, to be implemented during 2003, to limit the financial exposures which could build up in by-pass mode. The fact that the documentation specifies a contingency arrangement (required to allow the handling of all payments due on that date) is itself positive (many systems do not do so); and since it is specified, it would be highly desirable to elaborate more fully, in the RTGS documentation, the means by which financial risks will be controlled and by which end-of-day net settlement will be achieved in all circumstances.
While NewCHAPS overall is a very well functioning and robust system, it has nevertheless suffered from a few longer outages during the last year. There were specific problems behind some of these episodes that have since been rectified but, in any event, and in view of the increase in time critical intraday payments (due to DVP settlement of securities and the forthcoming payment-versus-payment settlement of foreign exchange transactions), due attention should be paid to the assurance of continued high availability of the system.
Within the sterling service, cut-off extensions have been quite frequent. While participants feel the existing disciplinary mechanisms, which in large part rely on peer pressure, work well, this should be monitored closely with a view to implementing more stringent criteria to enforce discipline if problems persist.
Account management and transaction fees for the two RTGS services are set in a way that raises the question of whether the current tariff would enable the euro service to recover costs fully, were some facilities not shared with the sterling service. The Bank could usefully check the consistency of fees charged for the two RTGS services with its pricing objectives.
It would be useful for the CHAPS Clearing Company to take measures to increase external transparency in the governance and activities of NewCHAPS.
In its paper on “Oversight of Payment Systems”, published in November 2000, the Bank undertook to report on its payment systems oversight activities annually. The box on payments oversight in the June 2002 FSR is a useful step in this direction, and we would encourage the Bank to further develop this (or a similar vehicle) into a regular (annual) account of developments in this area. Inter alia, in such an account, the Bank could usefully elaborate more fully on (e.g.) the evolving relationship between its oversight role and its operational role as a member in its own right of both NewCHAPs and BACS.
The Bank has begun the process of assessing the key U.K. systems, with the main focus initially on CHAPS and BACS, for which self-assessments against the Core Principles have been produced. To increase the public awareness of the Banks’ oversight activities and the implementation of its oversight policies, it is recommended that the main thrust of the assessment against the Core Principles of different U.K. payment schemes be made public.
When an appropriate opportunity arises, it would be desirable to lay out more fully and formally in statute the Bank’s critical payments and settlement systems oversight responsibility, arising from its central banking functions which inherently underpin monetary policy and financial system stability. Since the Bank has few formal legal powers in relation to payment and settlement systems, it can only use moral suasion in its endeavors to achieve its oversight objectives. While the achievement of progress on the basis of mutual understanding and agreement is desirable, the existence of formal authority may in some circumstances be a precondition for the effective enforcement, where necessary, of the oversight policy.

E. Authorities’ Response

93. The FSAP visit was a valuable opportunity to have the management of risk within the U.K.’s main payment systems reviewed by external experts, and the authorities welcomed the constructive approach taken by the IMF team throughout the mission. The thorough review process illustrated the strengths of the U.K. system, but also provided useful insights into a number of areas where work was needed if CHAPS is to remain at the forefront internationally.

94. Much of that work has already been completed since the initial review by the IMF team, and a number of concerns expressed at that time have been addressed. The authorities welcome the fact that CHAPS was subsequently found to comply fully with the relevant Core Principles and that its oversight of U.K. payment systems meets international standards. CHAPS’ continued observance of the Core Principles is a high priority for the U.K. authorities and for CHAPS members. The authorities take note of the recommendation to increase the transparency of the Bank’s oversight work; the Bank has taken steps in this direction.

V. IMF’s MFP Transparency Code-Transparency of Monetary Policy

A. General

95. This report assesses the consistency of monetary policy in the United Kingdom with the monetary policy portion of the Code of Good Practices on Transparency in Monetary and Financial Policies. The assessment was made in the context of a Financial Sector Assessment Program (FSAP) mission to the United Kingdom from February 6–20, 2002.¹²

B. Information and Methodology Used for Assessment

96. The assessment was based on an updated self-assessment prepared by the Bank of England in January 2002; a review of documents maintained on the Bank’s website, such as the Annual Report, the quarterly Inflation Report, the Quarterly Bulletin, minutes of Monetary Policy Committee (MPC) meetings, the 1998 Bank of England Act, and various operational notices that guide the Bank’s dealings with the private sector; discussions with Bank and HM Treasury staff, and members of the MPC; and discussions with a wide range of informed external observers of U.K. monetary policy, including financial market participants, private-sector economists, journalists, and a member of the academic community.

97. The U.K. authorities fully cooperated with the assessment, and all required information and documents were provided.

C. Institutional and Market Structure—Overview

98. In October 1992, the U.K. adopted inflation targeting as its framework for monetary policy following its exit from the European Exchange Rate Mechanism one month earlier. Between October 1992 and June 1995, monetary policy operated with a target range of 1 to 4 percent. From June 1995 to May 1997, the target was 2½ percent or less. In both of those periods monetary policy decisions were taken by the Chancellor of the Exchequer in consultation with the Bank of England.¹³ In May 1997, the Chancellor delegated operational responsibility for the conduct of monetary policy to the Bank of England’s MPC, while retaining the right for the government to set the inflation target. This new regime was formalized in the Bank of England Act 1998 (Act). The MPC’s task is to set the Bank’s official lending rate (two-week repo rate), on the basis of a majority vote, to achieve the inflation target it has been given—currently 2½ percent for RPIX inflation. The MPC consists of the Governor and two Deputy Governors of the Bank, two other internal members appointed by the Bank after consulting with the Chancellor, and four external members appointed by the Chancellor for renewable three-year terms. In addition, a representative of HM Treasury is allowed to attend and speak at MPC meetings, but this individual has no vote. The MPC is required to meet at least once a month. The Act requires the MPC to publish minutes of its meetings within six weeks (they are released in practice within two weeks) and a quarterly inflation report that spells out how inflation has performed relative to target and sets out the MPC’s outlook for inflation going forward.

99. The inflation target is symmetric in that deviations below target are treated in the same way as those above target. Mortgage interest costs are excluded from the target in order to avoid the perverse short-term effects of higher interest rates feeding into higher mortgage rates, and ultimately higher inflation in the short run. Inflation has consistently been within one percentage point of target since the introduction of the current framework in 1997.

100. The Bank implements monetary policy by lending to its counterparties in the sterling money market at interest rates tied to the official repo rate chosen by the MPC. Liquidity forecasts are published and market operations are conducted by the Bank several times each business day. There are no statutory reserve requirements in the U.K.—settlement banks are required to maintain positive balances in their accounts at the Bank at the end of each business day. However, all banks and building societies with average eligible liabilities in excess of £400 million are required to hold noninterest bearing ‘cash ratio deposits’ at the Bank set at 0.15 percent of their domestic deposit base. These deposits are meant to provide the Bank with revenue to finance the unrecovered costs associated with monetary policy and financial stability activities. Settlement banks are also able to obtain intraday credit from the Bank on a collateralized basis to facilitate the smooth functioning of the real-time gross settlement (RTGS) payment system.

D. Practice-by-Practice Assessment

General comments

101. U.K. monetary policy is grounded in an inflation targeting framework that is one of the most transparent in the world—a view that is widely shared by market participants and other observers. The framework was significantly improved in 1997 when the government: granted the Bank operational independence in the conduct of monetary policy; introduced a point-target for inflation and clarified that the target is to be pursued over time in a symmetric fashion; created the MPC with external participants, which facilitated the consideration of different perspectives in monetary policy decisions; and introduced individual accountability for monetary policy votes. External observers generally praised the changes to the framework and the Bank for its efforts to highlight the uncertainty in monetary policy through the use of probabilistic fan-charts in its quarterly Inflation Report and its discussion of its economic outlook in a probabilistic sense. Moreover, the strong performance of the current framework is illustrated by the fact that inflation expectations seem to be well anchored by the inflation target, the degree of uncertainty in markets regarding future policy actions has declined over time, and the Bank scores well in public opinion polls (although the latter may reflect the current low level of interest rates and the overall strong performance of the U.K. economy). Indeed, the Bank of England observes most of the elements of the monetary policy portion of the Transparency Code.

Section 1: Clarity of Roles, Responsibilities, and Objectives

102. The Bank of England observes all of the elements of this principle. External observers applauded the U.K. authorities for introducing major improvements to the clarity of monetary policy objectives and the governance structure surrounding monetary policy in the Bank of England Act 1998. In particular, they welcomed the introduction of a point-target for inflation, and the delegation by the Chancellor of the Exchequer of interest rate settings to the MPC. Nonetheless, a couple of observers questioned whether the recently-observed tendency of inflation to run just below the target (both in practice and in the Bank’s projections) introduced an element of uncertainty to the objectives of monetary policy. The MPC spoke to this issue directly in the minutes of its February 2002 meeting, which were published on the Bank’s website on February 20, 2002.

Section 2: Open Process for Formulating and Reporting Monetary Policy Decisions

103. The Bank of England observes all of the elements of this principle. The framework for monetary policy and the modalities used to conduct monetary policy are outlined and discussed in the Bank’s publications and on its website. Similarly, the details surrounding the composition, structure and functions of the MPC are clearly documented and publicly disclosed through various channels. Changes in interest rate settings are announced immediately after the MPC meetings, which normally take place monthly. The schedule for these meetings is publicized prior to the start of the year. The minutes of the MPC meetings, which contain the votes of individual members and a nonattributed summary of the discussion, are released within 13 days of the meeting, even though by law they need only be released within six weeks of the meeting. In addition, the Bank issues a quarterly Inflation Report that discusses monetary policy objectives, and the prospects for achieving them. It also works collaboratively with financial market participants to champion measures to promote well-functioning markets and solicit their views on changes to monetary operating procedures. And data reporting forms and regulations are available on the Bank’s web site together with accompanying definitions.

104. External observers generally praised the Bank for its efforts to highlight the uncertainty in monetary policy through the use of probabilistic fan-charts and its attempts to discuss its economic outlook in a probabilistic sense without focusing on point-estimates. That said, there appears to be some uncertainty outside the Bank as to what the fan-charts represent: the uncertainty inherent in the consensus forecast of the MPC versus an illustration of the range of views of MPC members. The Bank has sought to clarify this issue in boxes contained in several Inflation Reports, and by providing a table in the Report that summarizes MPC members’ different assumptions. In addition, the Bank was criticized for not pre-announcing the extraordinary meeting of the MPC in September 2001. However, given the prevailing circumstances, the decision of whether to preannounce such a meeting is a difficult judgment call. The Bank’s decision to not announce the meeting ahead of time on this occasion was consistent with those of other central banks, such as the European Central Bank and the Federal Reserve.

Section 3: Public Availability of Information on Monetary Policy

105. The Bank observes all of the elements of this principle except the one dealing with timeliness of data that are published in accordance with the IMF’s data dissemination standards, and the one dealing with the disclosure of aggregate information on emergency financial support provided by the central bank; these are broadly observed. In the former case, the SDDS’ prescribed timeliness for data publication is 14 days, while the Bank publishes the data after 21 working days. The requirements of the SDDS are met by making use of a ‘flexibility’ option with respect to the timeliness of publication of data for the Analytical Accounts of the Central Bank. This is because the data disseminated are an integral part of the balance sheet of all monetary financial institutions that forms the basis of the U.K. monetary statistics, and these data are published as a complete package at the earliest opportunity. In the case of information on emergency financial support operations, the Bank does not provide enough information to enable outsiders to fully discern the effects of the operations on the Bank’s revenues and expenses for the year(s) in question.

106. The Bank has an extensive public relations program to build public awareness of monetary policy and the MPC’s mandate. In addition, members of the MPC make a large number of public presentations over the course of a year, and are frequently interviewed by members of the media, both in London and around the U.K.

Section 4: Accountability and Assurances of Integrity by the Central Bank

107. The Bank observes all of the elements of this principle, except those dealing with the disclosure of information on expenses and profit in operating the central bank and the publication of conflict of interest guidelines, which are broadly observed. In the case of the former, since the Bank does not publish detailed profit and loss accounts, external observers are not able to fully discern the effects of lender-of-last-resort operations on the Bank’s revenues and expenses for the year(s) in question. In the case of the latter, the Bank has very stringent conflict of interest guidelines, which are not formally published. However, as a matter of policy the Bank will provide oral briefings of the rules in response to external requests.

Table 14.

Detailed Assessment of Observance of IMF’s MFP Transparency Code—Monetary Policy

Table 15.

Summary Observance of IMF’s MFP Transparency Code-Monetary Policy

Table 15.

Summary Observance of IMF’s MFP Transparency Code-Monetary Policy

Assessment Grade	Practices Grouped by Assessment Grade
Assessment Grade	Count	List
Observed	42
Broadly observed	4	Principles 3.1, 3.2.3, 4.2.1, 4.4
Partly observed
Not observed
Not applicable

Table 15.

Summary Observance of IMF’s MFP Transparency Code-Monetary Policy

Assessment Grade	Practices Grouped by Assessment Grade
Assessment Grade	Count	List
Observed	42
Broadly observed	4	Principles 3.1, 3.2.3, 4.2.1, 4.4
Partly observed
Not observed
Not applicable

E. Recommended Action Plan and Authorities’ Response to the Assessment

Recommended action plan

108. Section 3.1: When feasible, shorten the publication period of the U.K. monetary statistics from 21 days to 14 days.

109. Sections 3.2.3 and 4.2.1: When disclosing lender-of-last-resort support provided to distressed financial institutions, consider providing enough information to enable external observers to fully discern the effects of these operations on the Bank’s revenues and expenses for the year(s) in question.

110. Section 4.4: Although the conflict of interest guidelines are contained in a number of documents and the Bank has a policy of orally explaining them upon request, it should consider publishing a summary of them, and make it clear how members of the public can obtain further information (or the underlying documents) if they so wish.

Table 16.

Recommended Action Plan to Improve Observance of IMF’s MFP Transparency Code Practices—Monetary Policy

Table 16.

Recommended Action Plan to Improve Observance of IMF’s MFP Transparency Code Practices—Monetary Policy

Reference Practice	Recommended Action
III. Public Availability of Information on Monetary Policy
3.1	When feasible, shorten the publication period of the U.K. monetary statistics form 21 days to 14 days.
3.2.3	When disclosing lender-of-last-resort support provided to distressed financial institutions, consider providing enough information to enable external observers to fully discern the effects of these operations on the Bank’s revenues and expenses for the year(s) in question.
IV. Accountability and Assurances of Integrity by the Central Bank
4.2.1	Same as 3.2.3
4.4	Although the conflict of interest guidelines are contained in a number of documents, the Bank should consider publishing a summary of them, and make it clear how members of the public can obtain further information (or the underlying documents) if they so wish.

Table 16.

Recommended Action Plan to Improve Observance of IMF’s MFP Transparency Code Practices—Monetary Policy

Reference Practice	Recommended Action
III. Public Availability of Information on Monetary Policy
3.1	When feasible, shorten the publication period of the U.K. monetary statistics form 21 days to 14 days.
3.2.3	When disclosing lender-of-last-resort support provided to distressed financial institutions, consider providing enough information to enable external observers to fully discern the effects of these operations on the Bank’s revenues and expenses for the year(s) in question.
IV. Accountability and Assurances of Integrity by the Central Bank
4.2.1	Same as 3.2.3
4.4	Although the conflict of interest guidelines are contained in a number of documents, the Bank should consider publishing a summary of them, and make it clear how members of the public can obtain further information (or the underlying documents) if they so wish.

Authorities’ response

111. Because of the interrelationships between some of the issues in the monetary policy transparency assessment and some of those in the transparency assessment covering the Bank of England’s financial policy functions (See Part F below), the authorities’ response here covers both Bank of England assessments.

112. The authorities welcomed the recognition that the Bank of England’s monetary and financial policy frameworks are some of the most transparent in the world. Their specific responses on the main recommendations above are as follows.

On Principle 3.1, the authorities indicated that shortening the publication period of U.K. monetary statistics could only be achieved by imposing significant additional costs on some of the contributors to the data. They noted that, with the exception of the Analytical Accounts of the Central Bank, the U.K. monetary statistics fully meet the requirements of the SDDS in respect of timeliness of publication. Narrow money data are published on the third working day after the final Wednesday of the reference month and Broad money and credit data are published after 14 working days. It is the sectoral breakdowns of broad money and credit, and the consolidated balance sheet of monetary financial institutions, that are not published until after 21 working days. Publication of the sectoral breakdowns takes place 4 working days after the last data become available, and could only be accelerated by imposing unjustifiably high costs on contributors. The requirements of the SDDS are met by the use of a ‘flexibility’ option in respect of the timeliness of publication of the Analytical Accounts of the Central Bank.
In relation to Principles 3.2.3, 4.3, 7.3.1 and 8.3, the authorities noted that in exceptional circumstances, as part of its central banking functions, the Bank may act as “lender of last resort” to financial institutions in difficulty so as to prevent a loss of confidence spreading through the financial system as a whole. All lender of last resort support operations are disclosed and that disclosure happens in a timely manner. There will be a presumption in favor of disclosing support in the Bank of England’s first annual report following the support operation. If disclosure at that time would be damaging to financial stability or the support operation itself, then disclosure would be postponed and the issue re-considered after a further year and, if necessary, in subsequent years until disclosure took place. In disclosing information, those factors which meant that an earlier disclosure would have been unsafe will be explained. Note 1 of the Bank’s Annual Accounts explains the Bank’s policy in this area in more detail.
On Principles 4.4 and 8.4, the authorities noted that the Court of the Bank has set rules on personal financial dealing which are designed to address the issue of possible financial conflict of interest or misuse of confidential information. MPC members and executive directors are required to disclose the stock of their financial assets, and some liabilities, to the Personnel Director (or in the case of the Governors to the Chairman of the Committee of Non-Executive Directors). MPC members are strongly advised wherever practicable to place their investments at arms length under fully discretionary management. Where this is not practicable they must seek prior agreement before every transaction. Briefings on these rules have been provided in response to external requests up to now. In November 2002, the Bank sent a detailed summary of the rules as they apply to MPC members to the Treasury Committee of the House of Commons, on the assumption that the Treasury Committee will in due course publish them as evidence. Once that happens, the Bank will place a copy of the summary on its web site.

VI. IMF’s MFP Transparency Code—Transparency of Payment Systems Oversight and Other Financial Stability functions of the Bank of England

A. General

113. This assessment of the transparency of payment systems oversight and other financial stability functions of the Bank of England was undertaken in conjunction with the evaluation of U.K.’s financial system made in February-July 2002 by the IMF as part of its Financial Sector Assessment Program. The assessment was made by Mr. Martin Andersson (Sveriges Riksbank) and Mr. Tom Kokkola (European Central Bank). The assessment was conducted within the framework of the IMF’s Code on Good Practices in Transparency of Monetary and Financial Policies.

B. Information and Methodology Used for the Assessment

114. The assessment was undertaken on the basis of a self-assessment made by the Bank of England, together with a review of various relevant documents including especially the Annual Report, successive editions of the Financial Stability Review and the Quarterly Bulletin and the 1998 Bank of England Act and key documents on its website relating to payments system oversight in particular. In addition, the mission held a variety of discussions with the Bank of England, the Financial Services Authority (FSA), HM Treasury (HMT), market participants and representatives of the media and academia. The U.K. authorities fully cooperated with the assessment, and all required information and documents were provided. Compared to the self-assessment, differences reflected in the mission’s assessment have been largely in the nature of elaboration and extension rather than revision.

C. Institutional and Market Structure—Overview

115. There is currently no direct specification, in law or regulation, of payment and settlement systems oversight or a broader financial stability responsibility as key roles of the Bank, with the exception that the Bank is the designator of payment systems under the Financial Markets and Insolvency (Settlement Finality) Regulations 1999.¹⁴ However, there are a number of less direct references that quite clearly imply or presume these responsibilities for the Bank.¹⁵

116. Instead, the framework for the Bank’s role with regard to payment systems oversight is given in the Memorandum of Understanding (MoU) between the Bank of England, the FSA and HMT, while for the Bank’s financial stability work more generally, the broad framework is laid down in the MoU and its Annual Report. The latter sets out the Bank’s Core Purposes, and Objectives and Strategy, as determined by the Court of Directors acting under Section 2 of the Bank of England Act 1998.

117. The MoU sets out the Bank’s responsibilities within a broader structure for coordination between the three organizations, under the aegis of the tripartite Financial Stability Standing Committee (FSSC). It specifies that the Bank is responsible for the overall stability of the financial system as a whole, and identifies five financial stability roles which stem from this:

Stability of the monetary system.
Financial system infrastructure, in particular payments systems at home and abroad.
Broad overview of the system as a whole.
Being able in exceptional circumstances to undertake official support operations having informed HMT (under MoU arrangements).
The efficiency and effectiveness of the financial sector, with particular regard to international competitiveness.

D. Practice-by-Practice Assessment

General comments

118. The transparency of the financial stability function of the Bank of England is, to a large extent, at the forefront, internationally. For example, the Bank was among the first central banks to regularly publish financial stability assessments, which is done biannually in the Financial Stability Review (FSR)

119. Much progress has been made in recent years and the Bank complies with all the elements of the IMF’s Financial Policy Transparency Code, except those dealing with the disclosure of information on expenses and profit in operating the central bank and the publication of conflict of interest guidelines. These are rated as broadly observed. (The details are covered in the assessment of Transparency in Monetary Policies and are therefore only noted briefly here.) There are some other issues where there is still some room for further refinement of already strong transparency practices, but these are issues at the margin.

Section 5: Clarity of Roles, Responsibilities, and Objectives

120. Overall, the Bank’s payments oversight and other financial policy responsibilities are publicly disclosed and discussed in a way that compares very well with good practice internationally. This is done mainly through regular Bank publications—specifically:

The Annual Report
The Financial Stability Review (FSR), which is produced biannually and is widely regarded as a leading example of central bank publications on financial stability developments and analysis.

121. In addition, the Bank has also published separately its framework for payment systems oversight (Oversight of Payment Systems, November 2000) and its policy with regards to settlement accounts (Bank of England Settlement Accounts: consultative document, January 2002). There is also a separate Financial Stability section on the Bank’s website.

122. Discussions with market participants and other observers have confirmed the view that the Bank is clear and transparent with respect to its payment systems oversight and financial stability functions. In the Annual Report 2001, it was noted that there had been some 65,000 hits on the website for the stability assessment in the week following its publication.

123. To supplement the above mechanisms, the IMF mission believes that it would be helpful, at a convenient time in the legislative schedule, to lay out more fully and formally in statute the Bank’s financial stability and payments and settlement systems oversight responsibility.

124. It is stated in the MoU that the three institutions concerned have to work together and coordinate amongst each other in financial crisis situations. In practice, such co-operation is organized within the framework of the FSSC. Due to the central role played by the Bank in the financial markets, it has market-based experience and capabilities that are of utmost importance in dealing with such crisis situations. The possibility of the Bank acting in support operations in order to resolve a financial crisis situation is explicitly recognized in both the MoU and the Annual Report. What that means in practice—both as to the Bank’s role as provider of emergency liquidity assistance and to any role it may have under the tripartite structure, in working out market solutions to systemically important financial sector problems—has not, however, been elaborated further in any recent, readily available documentation. The most recent elaboration is contained in a 1993 Governor’s speech, which outlines the general framework and principles for the Bank’s role as a provider of emergency liquidity assistance. While the structure and procedures for effective and coordinated crisis management seem to be in place, public awareness thus may remain somewhat limited. The possibility of providing further clarification on the division of roles, and the guiding principles and procedures used in crisis management, could usefully be explored.¹⁶

Section 6: Open process for Formulating and Reporting of Financial Policies

125. The Bank formulates its financial policy objectives in the Annual Report. This includes the overall objectives, the priorities for the coming year and a description of what progress has been made. In addition, the Court’s evaluation¹⁷ of how well this has been done is presented.

126. Internally, there is a Financial Stability Committee (FSC), which meets on a monthly basis. The FSC reviews major current policy issues and the staff’s assessment of actual and potential risks to stability. The discussions in the FSC also help to establish the Bank’s position on questions which are under consideration in U.K. (e.g., at the level of the FSSC) or internationally. The FSC discussions are open to a wide range of staff, which is acknowledged as a positive way of involving staff in the policy process. However, more sensitive issues may be discussed outside the FSC, in a narrower group.

127. The Bank of England’s reporting requirements for statistical returns, and copies of the returns, are available from the Bank’s website. Changes to reporting requirements are communicated via statistical notices, which are sent to each reporting institution and posted on the website. These requirements, and more comprehensive information about the Bank’s approach to collection and dissemination, are embodied in the “Code of practice for Bank of England statistics”; available in hard copy and on the website. Links to all the references above, along with other information about Monetary and Financial Statistics, are available on the website.

Section 7: Public Availability of Information on Financial Policies

128. The Bank’s principal action, given its macro-prudential surveillance role, is the article in the biannual Financial Stability Review (FSR) on the Financial Stability Conjuncture and Outlook, which surveys incipient risks to the financial system, and its capacity to absorb any such shocks. This surveillance work is also reflected in regular articles in the Quarterly Bulletin.

129. The Bank also publishes material on structural developments relevant to financial stability, for example on new financial instruments or patterns of exposures, on payments system developments, and on regulatory changes—domestically or internationally—likely to affect the system as a whole.

130. This publication program is supported by an active and extensive speaking program by senior officials of the Bank.

131. In the paper on Oversight of Payment Systems it is said that the Bank will publish yearly reports of its oversight activities. Until quite recently, there was only a very brief summary in the Annual Report to meet this commitment. However, the June 2002 FSR contained a useful box on payments system oversight. This box also rightly notes that the Bank has a broader oversight and financial stability interest in securities settlement systems and clearing houses (including central counterparties), in addition to their interest stemming from the “embedded payments systems” aspect of the securities settlement systems. (Previously, this broader dimension was somewhat submerged in the Bank’s publications, with the emphasis on the narrower payments system perspective.) Finally, the box also briefly notes the Bank’s operational role in U.K. payments systems, which is an important point to communicate given that the Bank is a member in its own right of both NewCHAPS and BACS. This box, or some other similar vehicle, could be suitable for evolving into a form of brief annual review of this area.

132. The Bank reports aggregate financial data using a variety of media and delivery channels: a monthly publication of key data series “Monetary and Financial Statistics” and an annual “Statistical Abstract” are available in hard copy and also on the Bank website. Press releases are issued in paper form and posted on the website, as new data become available. Most series are available via Datastream; in addition, Bloomberg, Knight Ridder and Reuters carry selected series.

133. The Bank publishes the results of its money market operations each day on wire services; an aggregate monthly summary in Bankstats (tables D2.1/2.2); and a quarterly summary in the Quarterly Bulletin. A highly aggregated balance sheet, the ‘Bank Return’, is published weekly.

Section 8: Accountability and Assurances of Integrity

134. Senior officials of the Bank appear in public before the House of Commons Treasury Committee and the House of Lords Economic Affairs Committee. The Bank is obliged to submit to the Chancellor of the Exchequer an Annual Report on its activities in that year. The Bank’s Annual Report is laid before Parliament by the Chancellor of the Exchequer.

135. Data on the Bank’s balance sheet and income/expenditure are publicly disclosed on a regular basis. The Bank’s accounts are audited by an external auditor. Audit is conducted in accordance with Companies Act requirements and auditing standards issued by the U.K. Auditing Practices Board, except where this would be inconsistent with the Bank’s functions.

136. Internal governance procedures are described in the Bank’s Annual Report. The Court is responsible for managing the Bank’s affairs, other than the formulation of monetary policy, which is the function of the Monetary Policy Committee. Under the Court, the Bank’s senior policy-making body is the Governor’s Committee, comprising the Governors and Executive Directors. The internal management of the Bank is the responsibility of the Management Committee.

137. The Bank has internal rules on personal financial dealings set by the Court, which are designed to address the issue of possible, actual or perceived financial conflict of interest or misuse of confidential information. Bank staff have statutory immunity in respect of banking supervisory acts or omissions before June 1998 when supervision was transferred to the Financial Services Authority. Bank staff also enjoy statutory immunity under the Settlement Finality Regulations 1999. The Bank has indemnified members of its Court of Directors against personal civil liability arising from the carrying out of their functions. These immunities are publicly disclosed.

Detailed assessment

138. The assessment was undertaken on a qualitative basis based on a five-fold assessment categorization: observed, broadly observed, partly observed, non-observed, and not applicable. A practice is considered observed whenever all assessment criteria are generally met without any significant deficiencies. A practice is considered broadly observed whenever only minor shortcomings are found, which do not raise major concerns and when corrective actions to achieve full observance with the practice are scheduled and realistically achievable within a prescribed period of time. A practice is considered partly observed whenever the shortcomings are sufficient to raise doubts about the ability to achieve observance within a reasonable time frame. A practice is considered non-observed whenever major shortcomings are found in adhering with the assessment criteria. Whenever a practice is assessed to be broadly, partly or non-observed, suggestions are proposed for achieving full observance. (Even when a practice is considered observed, recommendations may also be given for further refinement of the arrangements.) A practice is considered not applicable whenever it does not apply given the structural, legal and institutional conditions.

Table 17.

Detailed Assessment of Observance of MFP Transparency Code—Financial Stability and Payment Systems Oversight.

139. Based on the detailed assessment, a summary table of observance is presented in Table 18.

Table 18.

Summary Observance of IMF’s MFP Transparency Code—Financial Policy

Table 18.

Summary Observance of IMF’s MFP Transparency Code—Financial Policy

Assessment Grade		Practices Grouped by Assessment Grade
Assessment Grade	Count	List
Observed	29
Broadly observed	3	Principles 7.3.1, 8.3, 8.4
Partly observed
Not observed
Not applicable	3	Principles 6.1.4, 7.6, 7.7

Table 18.

Summary Observance of IMF’s MFP Transparency Code—Financial Policy

Assessment Grade		Practices Grouped by Assessment Grade
Assessment Grade	Count	List
Observed	29
Broadly observed	3	Principles 7.3.1, 8.3, 8.4
Partly observed
Not observed
Not applicable	3	Principles 6.1.4, 7.6, 7.7

E. Recommended Action Plan and Authorities’ Response to the Assessment

Recommended action plan

140. This section contains recommended steps for achieving observance. This is presented in the table 3 below in order to facilitate the monitoring of progress in relation to each practice where shortcomings were assessed. Only those practices with respect to which specific recommendations are being made are listed.

Table 19.

Recommended Action Plan to Improve Observance of IMF’s MFP Transparency Code Practices-Financial Policy

Table 19.

Recommended Action Plan to Improve Observance of IMF’s MFP Transparency Code Practices-Financial Policy

Reference Practice	Recommended Action
VII. Public Availability of Information on Financial Policies
7.3.1	When disclosing lender-of-last-resort support provided to distressed financial institutions, consider providing enough information to enable external observers to fully discern the effects of these operations on the Bank’s revenues and expenses for the year(s) in question.
VIII. Accountability and Assurances of Integrity by Financial Agencies
8.3, 8.4	The conflict of interest guidelines are contained in a number of documents, which have not been published. However, the Bank has a policy of providing oral briefings on the rules in response to external requests, even though it does not formally published them. The rules were tightened further in 2002, when MPC members and some staff will be required to disclose information on asset holdings as well as the flows associated with financial transactions.

Table 19.

Recommended Action Plan to Improve Observance of IMF’s MFP Transparency Code Practices-Financial Policy

Reference Practice	Recommended Action
VII. Public Availability of Information on Financial Policies
7.3.1	When disclosing lender-of-last-resort support provided to distressed financial institutions, consider providing enough information to enable external observers to fully discern the effects of these operations on the Bank’s revenues and expenses for the year(s) in question.
VIII. Accountability and Assurances of Integrity by Financial Agencies
8.3, 8.4	The conflict of interest guidelines are contained in a number of documents, which have not been published. However, the Bank has a policy of providing oral briefings on the rules in response to external requests, even though it does not formally published them. The rules were tightened further in 2002, when MPC members and some staff will be required to disclose information on asset holdings as well as the flows associated with financial transactions.

141. In addition to the above, further refinements are recommended in a few areas where the MFP Transparency Code Practices are already considered to be observed. In the mission’s view, such refinements would further bolster (albeit at the margin) the Bank of England’s already strong commitment to financial policy transparency. Specifically:

(5.1) When an appropriate opportunity arises, it would be desirable to lay out more directly and formally in statute the Bank’s financial stability and payments/settlement system responsibilities.
(5.2 and 6.1) Some further, readily accessible, elaboration would be desirable on the general principles for emergency liquidity assistance, and on the Bank’s role more generally in financial crisis situations.
(5.3.1 and 5.4) The recently published FSR box on payments system oversight (June 2002), or some other similar vehicle, should evolve into a regular (annual) account of the Bank’s activities in payments system oversight. From time to time, such an account could usefully include some more elaboration on particular oversight issues or arrangements. For example, while the June 2002 box reiterated the Bank’s operational role as a member in its own right of some systems, future boxes could elaborate further on the Bank’s oversight role with regard to securities clearing and settlement issues, and on the relationship between its oversight and operational roles.

Authorities’ response

142. The authorities response to this assessment of transparency in respect of the Bank of England’s financial policy responsibilities is incorporated into that for the monetary policy transparency assessment (see Part E above).

VII. MFP Transparency Code—Transparency of Financial Policies (Financial Services Authority)

A. General

143. This report assesses the consistency of the U.K.’s Financial Services Authority’s practices with the financial policies portion of the Code of Good Practices on Transparency in Monetary and Financial Policies. The assessment was made in the context of a Financial Sector Assessment Program (FSAP) mission to the United Kingdom from May 8-24, 2002.¹⁸

B. Information and Methodology Used for Assessment

144. The assessment was mainly based on a self-assessment prepared by the Financial Services Authority (FSA) in April 2002 plus a review of relevant documents maintained on FSA’s website, including: the Financial Services and Markets Act 2000 (FSMA); the 2002 Handbook of Rules and Guidance; the 2000/01 Annual Report; the 2002/03 Plan & Budget; the 2002 Financial Risk Outlook; the 1997 Memorandum of Understanding between HM Treasury, the Bank of England and the FSA; public speeches by senior FSA officials; and various operational notices that guide the FSA’s dealings with the private sector. In addition, discussions were held with FSA staff and informed external observers of U.K. financial policies. The latter included: financial institution officials, members of the FSA’s consumer and practitioner panels; trade association representatives; and journalists. Input was also provided by colleagues who conducted the assessment of U.K. banking, insurance, and securities market supervisory practices against various international standards and codes.

145. The U.K. authorities fully cooperated with the assessment, and all required information and documents were provided.

C. Institutional and Market Structure—Overview

146. On December 1, 2001 the FSA became the single statutory regulator for the majority of financial services in the United Kingdom, replacing the previous sectoral regulators, such as the Securities and Futures Authority, the Personal Investment Authority, and the Investment Management Regulatory Organization. Responsibility for banking supervision under the Banking Act 1987 had passed from the Bank of England to the FSA in June 1998. From January 1999 the FSA had also undertaken prudential insurance supervision on behalf of HM Treasury, and now does so as its own responsibility. Thus, it now supervises, inter alia, banks, insurance companies, securities firms, financial exchanges and other financial markets, and investment advisors. The FSA’s responsibilities are both wider and deeper than those of the predecessor bodies. Wider, in that they embrace additional firms, including those previously regulated by their professional bodies (for example, solicitors and accountants); and deeper, in that they extend the powers of the FSA in relation to regulated firms—for example, to promote standards of market conduct through a Code and to enforce firms’ compliance with requirements to have anti-money laundering controls.

147. The FSA exercises statutory powers under the Financial Services and Markets Act 2000 (FSMA). This provides a broad legal framework for financial regulation in the U.K. and equips the FSA with a single set of powers and responsibilities, supported by a range of accountability mechanisms. The FSA is an independent non-governmental body in that it has been structured as a limited company and financed by direct levies on the financial services industry. It is accountable to Treasury Ministers, and through them, to Parliament. The FSA’s governing body is the Board, currently consisting of a Chairman, three executive directors, and eleven non-executive directors, all appointed by HM Treasury.

148. The FSMA requires the FSA to pursue four objectives:

To maintain confidence in the U.K. financial system;
To promote public understanding of the financial system;
To secure an appropriate degree of protection for consumers while recognizing their own responsibilities; and
To reduce the potential for regulated business to be used for a purpose connected with financial crime.

149. The legislation applies these objectives directly to specific FSA activities—making rules, preparing and issuing codes, giving advice and guidance, and determining the general policy by which it acts. In carrying out these activities the legislation requires the FSA to take into account a number of factors. They are:

Using its resources in the most economic and efficient way;
Recognizing the responsibilities of regulated firms’ own management;
Being proportionate in imposing burdens or restrictions on the industry;
Taking into account the international character of financial services and the U.K.’s competitive position;
Facilitating competition among regulated firms;
The need to minimize the adverse effects of regulation on competition; and
Facilitating innovation in connection with regulated activities.

150. The FSA takes a different approach to regulation from that of its predecessors. The current regime focuses on the risks to the FSA’s various statutory objectives, and applies a risk-based approach to the regulation of financial institutions. In pursuing its objectives, the FSA regularly monitors the risks to its objectives and adjusts its resources and supervisory focus as needed to address the changing nature of these risks over time. The degree of supervision applied to each regulated institution depends on the impact of the institution on the realization of the FSA’s statutory objectives if risk crystallizes and the probability or likelihood of risk crystallizing. In addition, the FSA regularly undertakes a thematic review of issues that cut across more than one industry sector and have wide-ranging implications for consumers. These reviews are usually conducted by investigating the practices of a sample of regulated firms operating in different industry sectors.

D. Practice-by-Practice Assessment

General comments

151. The FSA observes all of the elements of the financial policies section of the Code. External observers praised the current framework, and the FSA in particular, for making the regulatory process more transparent and accountable than the previous regime. That observation was evident across all of the major financial sectors. The FSA’s roles, responsibilities, and objectives are clearly defined in the FSMA, and explained through various channels, including public speeches, conferences, and publications available on the FSA’s website. The policy formulation and reporting process is transparent and involves regular consultation with consumers and industry. Extensive information on the relevant policies is available in FSA publications, the level of accountability is high, and the degree of assurance of integrity is appropriate.

Section 5: Clarity of Roles, Responsibilities, and Objectives

152. The Financial Services Authority observes all of the elements of this principle. The FSA’s roles, responsibilities, and objectives are clearly defined in the FSMA and explained through various media, including publications, its website, and public speeches. The relationship between the FSA, HM Treasury, and the Bank of England is outlined in a Memorandum of Understanding (MoU) between these institutions.

153. There continues to be significant uncertainty in the financial community about the process used by the FSA to manage the various objectives assigned to it. To some extent this reflects the limited experience with the new regulatory approach, and to its credit, the FSA has endeavored through various publications, meetings with stakeholders, seminars, and workshops to explain its risk-based approach to supervision, and how its risk assessments drive the priorities assigned to its work on each of these objectives. Nonetheless, the continuing uncertainty suggests the need for further efforts to help regulated institutions and the general public improve their understanding of the new regulatory framework.

Section 6: Open Process for Formulating and Reporting of Financial Policies

154. The Financial Services Authority observes all of the elements of this principle. The framework for regulatory and supervisory policies and the risk-based approach used to conduct FSA’s practices are outlined and discussed in FSA’s publications and on its website. Similarly, the details surrounding the composition, structure and functions of the FSA are clearly documented and publicly disclosed through various channels. The policy formulation and reporting process is transparent and involves regular consultations with consumers and practitioners. In addition, The FSA reports publicly in a number of other ways on how it is pursuing its overall policy objectives – for example, in the publication A New Regulator for the New Millennium, in policy statements on individual issues, in its annual Plan & Budget, in evidence to parliamentary committees, and in speeches, conferences and press releases.

155. While a transparent regulatory and supervisory framework has been introduced with appropriate accountability mechanisms, there is still significant uncertainty in the financial community about how the FSA’s policies will be implemented in practice. The FSA has sought to deal with this matter in a number of publications and conferences that outlined its risk-based approach to regulation. Both the FSA and the financial services industry recognize the challenge of setting up a single regulator with the new framework. However, the FSA should bear in mind that regulated firms will be closely scrutinizing its actions for examples of how its policies will be implemented in practice. In particular, they are eager to see the extent to which the FSA applies judgment and tailors supervision to individual circumstances, rather than adopting a mechanical rules-based approach to supervision.

156. In addition, while financial institutions generally praised the FSA’s efforts to closely consult stakeholders when formulating policies for regulating institutions, a couple noted that the consultation process can be rather onerous and costly for the institutions involved. To some extent this is unavoidable, since many consultations are to be expected when one is introducing a new approach to regulation. Moreover, FSA officials noted that they continue to obtain good feedback from stakeholders despite the large number of consultations in recent years. The FSA is encouraged to continuously look for ways to streamline the consultation process, so that stakeholders’ views can be collected and incorporated in a cost-effective and efficient fashion. To their credit, it should be noted that FSA officials are sensitive to this issue, and are awaiting feedback from the Practitioner Panel’s annual survey, which includes questions that address this issue.

Section 7: Public Availability of Information on Financial Policies

157. The Financial Services Authority observes all of the elements of this principle. Information on the relevant policies is extensively available in FSA’s publications. For instance, the FSA’s Annual Report contains an overview of the main developments in the financial services sector in the U.K. during the year under review. Similarly, the FSA’s annual Plan & Budget includes an overview of the external environment within which the FSA will operate over the coming period. The FSA also publishes a range of other publications that report on major developments, such as reports detailing the outcome of work on various regulatory themes, and a new publication called Financial Risk Outlook, which summarizes significant developments in the broader environment within which the FSA operates.

158. The FSA has an extensive consumer education program to promote public understanding of the financial system and secure the appropriate degree of protection for consumers. In addition, FSA senior officials make a large number of public presentations over the course of a year, and are frequently interviewed by members of the media. However, there are some operational issues in which the FSA could further improve the transparency of its practices. For instance, consumers’ awareness of their rights under the Financial Services Compensation Scheme (FSCS), which acts as a financial safety net for consumers that have claims against failed financial institutions, is limited. To its credit, the FSA recognizes this issue and issued a consultation paper in May 2002, which included proposed changes to business rules that would require firms to disclose relevant information about the compensation scheme, its coverage, and limits. Moreover, the FSCS is working with the FSA, stakeholders, and journalists to make its presence better known. Its website has recently been enhanced, and in recent months it has produced a range of booklets and other information for consumers that have been reviewed by the Plain Language Commission.

Section 8: Accountability and Assurances of Integrity by Financial Agencies

159. The FSA observes all of the elements of this principle. The level of accountability is high, and the degree of assurance of integrity appropriate. The FSA regularly provides evidence to parliamentary committees on the conduct of financial policies, policy objectives, and performance in pursuing FSA’s objectives. The FSA appears twice a year before the Treasury Committee of the House of Commons, once to discuss its Annual Report and once to answer questions on its plans for the coming year. From time to time the FSA also gives evidence to the Committee on specific regulatory issues. The Committee publishes the FSA’s evidence as part of its proceedings.

Table 20.

Detailed Assessment of Observance of IMF’s MFP Transparency Code—Financial Policies (FSA)

Table 20.

Detailed Assessment of Observance of IMF’s MFP Transparency Code—Financial Policies (FSA)

V. Clarity of Roles, Responsibilities, and Objectives of Financial Agencies Responsible for Financial Policies
5.1	The broad objective(s) and institutional framework of financial agencies should be clearly defined, preferably in relevant legislation or regulation.
Description	The broad objectives and constitution of the FSA are set out in the Financial Services and Markets Act 2000 (FSMA), which also provides for the establishment of a number of related bodies. In particular, the FSA is required to establish a body corporate to manage a compensation scheme (the Financial Services Compensation Scheme) (see s 212 FSMA), and to establish a body to operate a financial ombudsman scheme (Schedule 17). The FSMA sets out certain requirements and powers in relation to the management of these schemes. The compensation scheme broadly pays compensation to claimants in respect of claims made in connection with regulated activities carried on by authorized persons, and the financial ombudsman scheme broadly operates to resolve disputes between authorized firms and their customers. The FSMA requires the FSA to pursue four objectives: Market confidence, i.e., maintaining confidence in the financial system; Public awareness, i.e., promoting public understanding of the financial system; The protection of consumers, i.e., securing the appropriate degree of protection for consumers (which broadly covers consumers of regulated activities); and The reduction of financial crime, i.e., reducing the extent to which it is possible for a business carried on - (a) by a regulated person, or (b) in contravention of the general prohibition - to be used for a purpose connected with financial crime. The legislation applies these objectives directly to specific FSA activities – making rules, preparing and issuing codes, giving advice and guidance, and determining the general policy by which it acts. In carrying out these activities the legislation requires the FSA to take into account a number of factors. They are: Using its resources in the most economic and efficient way; Recognizing the responsibilities of regulated firms’ own management; Being proportionate in imposing burdens or restrictions on the industry; Taking into account the international character of financial services and the U.K.’s competitive position; Facilitating competition among regulated firms; The need to minimize the adverse effects of regulation on competition; and Facilitating innovation in connection with regulated activities. The FSA refers to these as “the principles of good regulation” and has set out how it expects to apply them in its work in a document called A New Regulator for the New Millennium (January 2000). This can be found on the FSA website (www.fsa.gov.uk/pubs/policy/index-2000.html). The constitutional requirements applying to the FSA are set out in Schedule 1 of the FSMA.
Assessment	Observed
Comments	The FSMA represents a significant improvement in the transparency of the regime over the previous arrangements in which financial sector supervision was dispersed among a number of regulatory bodies.
5.1.1	The broad objective(s) of financial agencies should be publicly disclosed and explained.
Description	The broad objectives of the FSA are set out in the FSMA (see 5.1 above). The FSA publicizes the existence of the objectives and its interpretation of them through various media, including publications (e.g., Annual Report and Plan & Budget), its website, and public speeches.
Assessment	Observed
Comments	External observers suggested that there continues to be significant uncertainty in the financial community about the process used by the FSA to manage the various objectives assigned to it. To some extent this reflects the limited experience with the new regulatory approach, and to its credit, the FSA has endeavored through various publications, open public meetings, regular meetings with trade associations, media relations, seminars, and workshops to explain its risk-based approach to supervision, and how its risk assessments drive the priorities assigned to its work on each of these objectives. It believes that time will help generate practical experience and knowledge. Nonetheless, the continuing uncertainty suggests the need for further efforts to help regulated institutions and the general public improve their understanding of the new regulatory framework.
5.1.2	The responsibilities of the financial agencies and the authority to conduct financial policies should be publicly disclosed.
Description	The FSA’s responsibilities and powers are set out in the FSMA (and related secondary legislation). The FSA is required to consult on its proposals to make rules and publish general guidance. In addition the FSA publicizes its responsibilities through various media, including publications, its website, and public speeches.
Assessment	Observed
Comments	An unusual feature of the FSA’s governing legislation is that the U.K. Listing Authority (UKLA) has a separate legal relationship with HM Treasury even though it is now part of the FSA for administrative and operational purposes. FSA and Treasury officials explained that this reflects the fact that separate objectives needed to be set for the UKLA because the general ones applicable to the FSA do not adequately address the unique nature of the UKLA’s mandate. The UKLA’s objectives and accountability features are set out in Schedule 7 of the FSMA. However, it is not clear whether the FSA is operating in its own right or as agent of the Treasury in the case of UKLA activities. The independence of the FSA is reinforced by the accountability mechanisms listed below, including the published exchange of correspondence between the Chancellor and the Chairman of the FSA (December 2001). Although it is clear from the published exchange of correspondence that the Government supports the risk-based approach to financial regulation, some external observers suggested that the Government could defend the framework more openly in public, rather than leaving it to FSA officials to argue the case for both the framework and the FSA’s performance within it.
5.1.3	Where applicable, the broad modalities of accountability for financial agencies should be publicly disclosed.
Description	There are a number of provisions in the FSMA covering accountability. These are: The requirement (in Schedule 1 para 10) that the FSA must at least once a year make a report to HM Treasury (HMT) on, inter alia, the discharge of its functions. The government can direct the FSA on topics to be covered in the report. The report is laid before Parliament and published on the FSA’s website. In addition, the FSA is required (in Schedule 1 para 11) to hold an annual public meeting to discuss its report; The responsibilities of the non executive directors committee of the FSA Board in keeping under review, e.g., the FSA’s internal financial controls, and its use of resources and to report on these matters to HMT (see para 4 Schedule 1); The requirement (in s.8 & 9) for the FSA to publicly consult practitioners and consumers “on the extent to which its general policies and practices are consistent with its general duties” under s. 2 of the FSMA. The FSMA also establishes mechanisms for direct input into the regulatory process by practitioners and consumers – including through the Practitioner and Consumer Panels which the FSA is required to maintain; The requirement (in Schedule 1 para 7) that the FSA must make arrangements for the investigation of complaints (“the complaints scheme”) arising in connection with the exercise of its functions; The power for HMT (in s.12) to appoint an independent person to conduct a review of the economy, efficiency and effectiveness with which the FSA has used its resources in discharging its functions; The power for HMT (in s.14) to arrange for an inquiry to be held in certain cases where there has been a serious failure in the system of regulation established by the FSMA; and The powers of the Director General of Fair Trading (Chapter III of Part X) to keep the FSA’s regulatory provisions and practices under review. The Competition Commission also has a related role (s 162). The FSMA also establishes an independent Financial Services and Markets Tribunal, established and run by the Lord Chancellor’s Department (part of Government). The Tribunal will consider afresh case-related decisions by the FSA if the firm or individual involved chooses to refer the case to it. Subject to these accountability mechanisms and checks and balances, the FSA operates independently of Government. This was confirmed in December 2001 in a published exchange of correspondence between the Chancellor and the Chairman of the FSA. Among other things this confirmed that the FSA would notify the Chancellor in writing as soon as circumstances or issues arise which the FSA judges serious enough to be likely to prompt the Government to consider launching a statutory inquiry. The correspondence is to be found on the web at www.hm-treasury.gov.uk/Newsroom_and_Speeches/Press/2001/press_144_01.cfm?
Assessment	Observed
Comments	As required by the FSMA, the FSA regularly consults the financial services industry and consumer groups when it is considering adopting or changing regulations and supervisory practices. Discussions with external observers confirmed that the FSA has a good working relationship with the Consumer and Practitioner Panels that oversee its activities. The Consumer Panel, for instance, has supported the FSA in its efforts to improve protection and consumer awareness, pushing the FSA to do more for consumers as the regulatory system advances and new challenges are developed. The FSA also values the feedback provided by the Practitioner Panel from its survey of financial firms.
5.1.4	Where applicable, the procedures for appointment, terms of office, and any general criteria for removal of the heads and members of the governing bodies of financial agencies should be publicly disclosed.
Description	The FSA is required to comply with the requirements as to its constitution set out in Schedule 1 of the FSMA. This includes a requirement (Schedule 1 para 2) that the chairman and other members of the FSA’s governing body must be appointed, and be liable to removal from office, by HMT. Appointments are made on principles of good corporate governance known as the Nolan Principles (www.ocpa.gov.uk/leaflets/code.htm). The composition of the FSA Board, and their period of office, is publicized on the FSA’s website and in the FSA’s Annual Report.
Assessment	Observed
Comments	Formal safeguards governing the removal of senior officials from office are limited. Although, officials are appointed for specific terms, their contracts indicate that they can be removed at any time. If dismissed, an official removed could pursue a judicial review in certain circumstances. However, an important safeguard in the U.K. context is the close public scrutiny provided by an independent media over the activities of public officials. In these circumstances, it is unlikely that a senior official could be removed from office without the government having to publicly disclose and defend the reasons behind its decision.
5.2	The relationship between financial agencies should be publicly disclosed.
Description	The terms of the 1997 Memorandum of Understanding (MoU) agreed between HM Treasury, the Bank of England and the FSA explain how the three authorities will work together towards their common objective of financial stability and sets out how their responsibilities will be discharged. The MoU is published on the FSA’s website.
Assessment	Observed
Comments
5.3	The role of oversight agencies with regard to payment systems should be publicly disclosed.
Description
Assessment	Not applicable
Comments
5.3.1	The agencies overseeing payment systems should promote the timely public disclosure of general policy principles (including risk management policies) that affect the robustness of systemically important payment systems.
Description
Assessment	Not applicable
Comments
5.4	Where financial agencies have oversight responsibilities for self-regulatory organizations (e.g., payment systems), the relationship between them should be publicly disclosed.
Description	One of the key elements of the Government’s restructuring of U.K. financial regulation has been the replacement of the previous hybrid structure involving a multiplicity of regulatory bodies – some statutory and some self-regulating – with a single, statutory financial regulator. As a result, there are only limited areas within the financial sector in which the new framework provides for any significant elements of self-regulation. The FSMA gives the FSA responsibility for supervising recognized investment exchanges (RIEs) and recognized clearing houses (RCHs). RIEs and RCHs are, to a degree, self-regulatory organizations, but the legislative framework in the U.K. has been structured in such a way that RIEs and RCHs are not fully autonomous organizations. The responsibilities of these organizations in relation to the markets in which they operate, and the responsibilities and powers of the FSA vis-à-vis those organizations are set out in the FSMA, the Financial Services and Markets Act (Recognition Requirements for Investment Exchanges and Clearing Houses) Regulations 2001, and the Recognized Investment Exchanges and Recognized Clearing Houses Sourcebook (REC). The position of RIEs and RCHs is covered in greater detail in the IOSCO assessment.
Assessment	Observed
Comments	Another self-regulatory organization that operates in the financial sector is the Takeover Panel, whose activities are not subject to formal oversight by the FSA. The Panel regulates takeovers and mergers in order to protect the interests of minority shareholders, and is widely respected by the financial community despite not having formal enforcement powers. If the Panel finds that there has been a violation, its options range from issuing private reprimands and public censure, to reporting the offender’s conduct to another regulatory authority, such as the FSA. The FSA has made it clear that it will not exercise its enforcement powers in a takeover situation except in exceptional circumstances (e.g., at the request of the Panel).
5.5	Where self-regulatory organizations are authorized to perform part of the regulatory and supervisory process, they should be guided by the same good transparency practices specified for financial agencies.
Description	RIEs and RCHs are required to provide the FSA with notifications on a broad range of subjects - from changes in their internal organization, constitution and governance to financial information, complaints against the them, hours of operation etc. The FSA does not require the publication of such information but RIEs and RCHs are free to publish this information if they so choose, and we understand that some of them do so, either in their annual reports or on their websites. The regulatory and supervisory objectives of RIEs and RCHs are spelled out in the Recognition Requirements. The FSA Handbook provides additional guidance as to how the FSA interprets these regulatory and supervisory objectives. RIEs and RCHs do make texts of regulations and guidelines readily available to the public. The Recognition Requirements require RIEs and RCHs to have appropriate procedures for making and amending their rules. Such procedures must include procedures for consulting users of the facilities in appropriate cases. The FSA will thus have regard to the extent to which the RIE/RCHs’ procedures include informal discussions at an early stage with users of its facilities or appropriate representative bodies; publication to users of its facilities of a formal consultation paper which includes clearly expressed reasons for the proposed changes and an appropriately detailed assessment of the likely costs and benefits; adequate time for users of its facilities to respond to the consultation paper and for the U.K. recognized body to take their responses properly into account; adequate arrangements for making responses to the consultation available for inspection by users of its facilities, unless the respondent requests otherwise; adequate arrangements for ensuring that the U.K. recognized body has proper regard to the representations received; and publication, no later than the publication of the amended rules, of a reasoned account of the U.K. recognized body’s decision to amend its rules (REC 2.14.6). However, FSA allows RIEs and RCHs to restrict consultation where it is essential to make a change to their rules without delay in order to ensure continued compliance with the Recognition Requirements or other obligation under the FSMA. RIEs and RCHs must provide a copy of their annual reports and accounts to the FSA under the Notification rules. The annual report and accounts will include audited financial statements, operating expenses and revenues. If the RIE/RCH is publicly listed, then under the Listing Rules, it is required to disclose publicly its annual report and accounts on a pre-announced schedule. If the RIE/RCH is a mutual, the annual report and accounts will be disseminated to members. Most RIEs and RCHs publish statistics on trading volumes and other market data. The Recognition Requirements require RIEs/RCHs to have in place certain safeguards for investors – not only in terms of ensuring that business conducted on the RIE/RCH affords proper protection to investors, but also ensuring that there are adequate complaints procedures and disciplinary procedures. Typically, RIEs and RCHs will make details of complaints procedures and disciplinary procedures public. At the very least, these procedures will be disclosed to their members. Officials from RIEs and RCHs do appear before parliamentary committees to give evidence on a range of issues. The RIE/RCH Sourcebook says that in determining whether a RIE/RCH meets the Recognition Requirements, the FSA will have regard to the arrangements and systems and controls the RIE/RCH has in order to manage conflicts of interest. It is a matter for the individual RIE/RCH as to whether they choose to publicly disseminate the details of such arrangements.
Assessment	Observed
Comments
VI. Open Process for Formulating and Reporting of Financial Policies
6.1	The conduct of policies by financial agencies should be transparent, compatible with confidentiality considerations and the need to preserve the effectiveness of actions by regulatory and oversight agencies.
Description	The FSA is generally required to consult practitioners and consumers ‘on the extent to which its general policies and practices are consistent with its general duties’ (s 8). The FSA’s policies are for example reflected through its use of its rule making powers (e.g., in Chapter 2 of Part X), its power to issue guidance (Chapter II of Part X) and statements of principle and codes in relation to approved persons (s 64). The FSA is required to consult publicly on its proposals to make rules (s.155), to give general guidance (s.157 (3)) and to issue a statement of principle or code in relation to approved persons (s.65). The FSA makes extensive use of its website to issue consultative papers, statements of policy etc and has published a statement of its open approach to regulation (“The Open Approach to Regulation” (1998)). The FSA’s proposals to make rules must also be accompanied by a cost benefit analysis, an explanation of the purpose of the proposed rules, and an explanation of the FSA’s reasons for believing that making the proposed rules is compatible with its general duties. The FSA has the power (s.148) to modify or waive various specified types of rules in relation to an authorized person. Unless it is satisfied that it is ‘inappropriate or unnecessary to do so’, the modification or waiver must be published by the Authority. In doing so the FSA must inter alia consider whether the publication would prejudice, to an unreasonable degree, the commercial interests of the authorized person concerned or any other member of his immediate group (s.148 (7)).
Assessment	Observed
Comments
6.1.1	The regulatory framework and operating procedures governing the conduct of financial policies should be publicly disclosed and explained.
Description	The FSA consults in a range of ways in order to: obtain information and views to help the FSA take well-informed decisions, bearing in mind in particular the costs, benefits, and practical implications of proposed changes to regulatory requirements; receive alternative suggestions for achieving particular regulatory objectives; promote understanding of the FSA’s overall objectives and the reasons for the policies and procedures it adopts; obtain feedback on the FSA’s existing policies, practices and performance. Consultation is public and involves the full range of interested parties, including consumers, and their representative bodies; individuals, firms or groups with relevant expertise; trade associations; advisory groups established by the FSA; voluntary organizations; academics and professional training bodies; and the media. The FSA publishes its policies through various media, including publications and electronic media (CD ROMs, website) and publicizes and explains its policies through the press etc.
Assessment	Observed
Comments	Although the policy formulation process and reporting process is transparent and involves regular consultations with consumers and industry, external observers commented that there is still significant uncertainty in the financial community about how the FSA’s policies will be implemented in practice. To some extent this reflects the limited experience with the new framework. The FSA has sought to deal with this matter in a number of publications and conferences that explain its risk-based approach to supervision and how it plans to enforce its policies. Nonetheless, the FSA should bear in mind that regulated institutions will be closely scrutinizing its actions for examples of how its policies will be implemented in practice. In particular, they are eager to see the extent to which the FSA applies judgment and tailors supervision to individual circumstances, rather than adopt a mechanical rules-based approach to supervision.
6.1.2	The regulations for financial reporting by financial institutions to financial agencies should be publicly disclosed.
Description	The rules setting out authorized firms’ reporting requirements, and related guidance, are published in the FSA’s Handbook of rules and guidance.
Assessment	Observed
Comments
6.1.3	The regulations for the operation of organized financial markets (including those for issuers of traded financial instruments) should be publicly disclosed.
Description	The regulations applying to the participants in financial markets covered by the FSMA are published in the form of rules (in particular the rules in the Interim Prudential Sourcebook for Investment Business and the Conduct of Business Sourcebook which apply to authorized investment firms, and the rules applying more generally to market participants in the Market Conduct Sourcebook, which includes the Code of Market Conduct and Price Stabilizing rules). Investment exchanges and clearing houses recognized under the FSMA (Part XVIII) are required to have rules covering certain areas in order to be recognized (see The Financial Services and Markets Act 2000 (Recognition Requirements for Investment Exchanges and Clearing Houses) Regulations (SI 2001 No. 995), and The Recognized Investment and Recognized Clearing Houses Sourcebooks in the FSA Handbook). The FSA is the competent authority for the Official List covering the listing of securities and has the power to make listing rules (e.g., s 76 FSMA). The listing rules are published on the FSA’s website and are available (like all FSA publications) in hard copy.
Assessment	Observed
Comments
6.1.4	Where financial agencies charge fees to financial institutions, the structure of such fees should be publicly disclosed.
Description	The FSA’s power to charge fees is set out in the FSMA (the principal power is in Schedule 1 para 17). In making such rules the FSA is required to follow the public consultation procedures in the FSMA (see s.155). See also FSA Consultative Paper 111 on its proposed fees. The FSA also publishes its Budget and related operating plans which determine its financing requirement.
Assessment	Observed
Comments
6.1.5	Where applicable, formal procedures for information sharing and consultation between financial agencies (including central banks), domestic and international, should be publicly disclosed.
Description	The provisions of the FSMA (Part XXIII) restrict the FSA’s ability to disclose restricted information under the Act to others. The FSA has negotiated MoUs with various overseas supervisors/regulators covering the exchange of information. The FSA has also negotiated an MoU with the Bank of England and HM Treasury which inter alia covers the exchange of information (see 5.2 above). This has been published.
Assessment	Observed
Comments
6.2	Significant changes in financial policies should be publicly announced and explained in a timely manner.
Description	The FSA is required under the FSMA to consult publicly on proposals to make rules, amend rules, and give general guidance and to publish cost-benefit analyses of such proposals. The procedures are set out in the FSMA (see 6.1 above).
Assessment	Observed
Comments	While financial institutions generally praised the FSA’s efforts to closely consult stakeholders when formulating policies for regulating institutions, a couple of observers noted that the consultation process can be rather onerous and costly for the institutions involved. To some extent this is unavoidable, since many consultations are to be expected when one is introducing a new approach to regulation. Indeed, there were 41 consultations in 2001 and 22 in the first five months of 2002. Moreover, FSA officials noted that they continue to obtain good feedback from stakeholders despite the large number of consultations in recent years. The FSA is encouraged to continuously look for ways to streamline the consultation process, so that stakeholders’ views can be collected and incorporated in a cost-effective and efficient fashion. To their credit, it should be noted that FSA officials are sensitive to the issue of consultation burden, and are awaiting feedback from the Practitioner Panel’s annual survey, which includes questions that address this issue.
6.3	Financial agencies should issue periodic public reports on how their overall policy objectives are being pursued.
Description	The FSMA requires the FSA to report annually to Government on the extent to which, in its view, its regulatory objectives have been met during the year under review. The Government lays that report before Parliament and the FSA publishes it and places it on its website. The Report gives a wide-ranging account of the FSA’s work. The FSMA provides that Government may direct the FSA to cover particular matters in such reports. The FSA’s Annual Report describes publicly in a number of other ways on how it is pursuing its overall policy objectives – for example, in the publication A new regulator for the new millennium, in policy statements on individual issues (for instance, its approach to promoting consumer understanding of the financial system), in its annual Plan & Budget, and in evidence to parliamentary committees (which they publish as part of their proceedings), in speeches and press releases.
Assessment	Observed
Comments
6.4	For proposed substantive technical changes to the structure of financial regulations, there should be a presumption in favor of public consultations, within an appropriate period.
Description	See answer at 6.1 and 6.2 above. In addition, consistent with HM Government practice, all significant changes to regulations made by HM Treasury under the FSMA are subject to public consultation.
Assessment	Observed
Comments
VII. Public Availability of Information on Financial Policies
7.1	Financial agencies should issue a periodic public report on the major developments of the sector(s) of the financial system for which they carry designated responsibility.
Description	The FSA’s Annual Report, referred to in 6.3 above, contains a brief overview of the main developments in the financial services sector in the United Kingdom during the year under review. The FSA’s annual Plan & Budget includes an overview of the external environment within which the FSA will operate over the coming period. The FSA also publishes a range of other publications that report on major developments, such as reports detailing the outcome of work on various regulatory themes (e.g., the impact of e-commerce) and a new publication called Financial Risk Outlook which summarizes significant developments in the broader environment within which the FSA works.
Assessment	Observed
Comments	The Financial Risk Outlook discusses a broad set of risks and opportunities to the FSA’s objectives. The publication was only introduced in 2002, and as such has yet to develop a strong public following. Although the analysis contained in the document was developed in consultation with the Bank of England, it is somewhat surprising to discover that it refers to IMF economic projections for the U.K. economy rather than those underpinning the Bank’s Inflation Report. The FSA offered two main reasons for this: (i) the timing of IMF forecasts neatly corresponds to its needs; and (ii) the IMF forecasts cover the global environment, providing a consistent set of forecasts and a good degree of international detail.
7.2	Financial agencies should seek to ensure that, consistent with confidentiality requirements, there is public reporting of aggregate data related to their jurisdictional responsibilities on a timely and regular basis.
Description	The FSA publishes data, in its Annual Report and elsewhere, on levels of regulatory activity – for example, number of firms authorized and individuals approved, number of disciplinary proceedings against firms and individuals. Aggregate data on volumes of business conducted by the firms or undertaken in the markets appears in ad hoc reports, speeches etc that are placed on the FSA’s website. The FSA has also introduced a new regular publication, Financial Risk Outlook, that carries a range of financial data. Many RIEs and RCHs publish statistics on trading volumes and other market data. See the Bank of England’s response for further details on data regularly published by the U.K. authorities.
Assessment	Observed
Comments	See the assessment of the Bank of England against the financial policies section of the IMF Code of Good Practices on Transparency in Monetary and Financial Policies. The FSA indicated that it will bear in mind the desirability of being able to publish aggregate data in its work on data requirements.
7.3	Where applicable, financial agencies should publicly disclose their balance sheets on a preannounced schedule and, after a predetermined interval, publicly disclose information on aggregate market transactions.
Description	The FSA’s balance sheet is published in its Annual Report, referred to in 6.3 above. See also 7.2 above.
Assessment	Observed
Comments
7.3.1	Consistent with confidentiality and privacy of information on individual firms, aggregate information on emergency financial support by financial agencies should be publicly disclosed through an appropriate statement when such disclosure will not be disruptive to financial stability.
Description
Assessment	Not applicable
Comments
7.4	Financial agencies should establish and maintain public information services.
Description	The FSA maintains an extensive public information service. It issues a wide range of publications on its activities and policies in addition to its Annual Report, referred to above. All these publications are available on its website, as well as in hard copy. The FSA publishes a range of consumer guides, fact sheets, information packs, CD-ROM, and, when necessary, issues consumer alerts that warn the public about scams or developments to watch out for. In addition, the FSA maintains a dedicated website and telephone help line for consumers which offer a variety of information and advice. Members of the public can use the FSA’s website to check if a firm is authorized to do certain business and also use the FSA’s Comparative Tables to compare similar financial products from various providers (e.g., charges and other basic information). The FSA also provides a range of educational resources for schools and colleges, covering the full age range, and arranges conferences and seminars for educational specialists. The FSA’s website has been vetted by the Plain Language Commission and awarded the ‘Clear English Standard’ for its clarity and ease of use. The FSA also has an active program to explain its policies and activities to the media.
Assessment	Observed
Comments
7.4.1	Financial agencies should have a publications program, including a periodic public report on their principal activities issued at least annually.
Description	The FSA issues a wide range of publications on its activities and policies – Discussion Papers, Consultation Papers, Feedback and Policy Statements, Occasional Papers – in addition to its Annual Report and annual Plan & Budget referred to above. All these publications are available on its website, as well as in hard copy.
Assessment	Observed
Comments
7.4.2	Senior financial agency officials should be ready to explain their institution’s objective(s) and performance to the public, and have a presumption in favor of releasing the text of their statements to the public.
Description	FSA senior staff appear frequently on public platforms to give an account of the Authority’s work (including an annual public meeting to discuss its Annual Report); speeches given on such occasions are often the subject of a press release and are sometimes made available in full, on its website. The FSA also has an active program to explain its policies and activities to the media.
Assessment	Observed
Comments	There were 16 published speeches on financial regulation policies and related regulatory issues by the Chairman and other FSA senior officials in 2001, and 11 in the first five months of 2002. Senior FSA officials members gave more than 170 on the record interviews to the media on regulatory and supervisory issues in 2001 and 50 in the first five months of 2002.
7.5	Texts of regulations and any other generally applicable directives and guidelines issued by financial agencies should be readily available to the public.
Description	The FSA’s rules and guidance are publicly available in a number of media – on its website, on CD ROM and in hard copy.
Assessment	Observed
Comments
7.6	Where there are deposit insurance guarantees, policyholder guarantees, and any other client asset protection schemes, information on the nature and form of such protections, the operating procedures, how the guarantee is financed, and the performance of the arrangement should be publicly disclosed.
Description	The Financial Services Compensation Scheme (FSCS) pays compensation, in appropriate cases, where a regulated firm is unable to meet its liabilities. The FSA is responsible for making the FSCS rules and for approving its annual budget. Those rules are available publicly in the same way as other FSA rules – see 7.5 above. Both the FSA and the FSCS publish information for consumers on the coverage of the FSCS and on the protection it provides – in booklets and on both organizations’ websites (www.fsa.gov.uk and www.fscs.org.uk). The FSCS makes detailed information available to consumers on how to make a claim under the Scheme. The FSMA requires the FSA to approve the FSCS annual budget and to make the rules, following consultation, governing the funding of the Scheme. The FSCS budget is disclosed. The rules on funding the Scheme are publicly available through the usual channels – see 7.5 above. The FSCS publishes an annual report on its discharge of its responsibilities. It is largely in the usual format for a company report, including information on finances (with auditor sign off), directors, committees, and highlights and summaries of the activities through the year, including on claims decisions and compensation payments.
Assessment	Observed
Comments	External observers noted, and FSCS officials conceded, that consumers’ awareness of their rights and privileges under the FSCS is limited. The FSA is aware of this issue, and issued a consultation paper in May 2002 that included proposed changes to conduct of business rules that would require firms to disclose relevant information about the compensation scheme, its coverage, and limits. Moreover, the FSCS is working with the FSA, trade associations, consumer advice organizations, and journalists to make its presence better known. Its website has recently been enhanced, an in recent months it has produced a range of booklets and other information for consumers that have been reviewed by the Plain Language Commission.
7.7	Where financial agencies oversee consumer protection arrangements (such as dispute settlement processes), information on such arrangements should be publicly disclosed.
Description	The FSMA requires the FSA to establish a scheme for resolving complaints between consumers and firms. Under this requirement, the FSA has set up the Financial Ombudsman Service (FOS), as the dispute resolution mechanism. The FSA is responsible for making rules governing complaints handling by firms, and for approving the rules which the FOS makes under the FSMA regarding its operation. These rules are publicly available in the usual ways – see 7.5 above. Both the FSA and FOS provide information to consumers – over the web, in brochures and by telephone – on how the arrangements work and on how to make a complaint. Under the FSA rules, firms are required to display in branches and sales offices a notice explaining that they are covered by the FOS. In addition, the rules oblige firms to provide a written copy of their complaints procedure to consumers on request, or when a complaint is made. The FOS annual budget is approved by the FSA and publicly consulted on yearly, before being published together with the FOS’s business plan for that year. In addition, the FOS reports publicly each year on how it has fulfilled its statutory functions. FOS publishes monthly newsletters which outline interesting cases and judgments it has made and discuss their implications. FOS also issues occasional discussion papers where it thinks an adjudication may have wider ramifications for a product type which it thinks the industry should be aware of.
Assessment	Observed
Comments
VIII. Accountability and Assurances of Integrity by Financial Agencies
8.1	Officials of financial agencies should be available to appear before a designated public authority to report on the conduct of financial policies, explain the policy objective(s) of their institution, describe their performance in pursuing their objective(s), and, as appropriate, exchange views on the state of the financial system.
Description	The FSA regularly gives evidence to parliamentary committees on all these issues. It is now an accepted convention that the FSA appears twice a year before the Treasury Committee of the House of Commons, once to discuss its Annual Report and once to answer questions on its plans for the coming year. From time to time the FSA also gives evidence to the Committee on specific regulatory issues. The Committee publishes the FSA’s evidence as part of its proceedings. In addition, the FSA from time to time gives evidence to other parliamentary committees in the context of individual inquiries – for example, on globalization, fighting financial crime, and e-commerce.
Assessment	Observed
Comments	See 7.4.2 for data and comments on public appearances.
8.2	Where applicable, financial agencies should publicly disclose audited financial statements of their operations on a preannounced schedule.
Description	As part of its Annual Report, referred to in 6.3 above, the FSA publishes, within 3 months of the financial year end, audited financial statements and information on its accounting practices. The Annual Report also includes information on internal governance and control procedures necessary to ensure the integrity of operations, including on the role of the Audit and other Committees. The FSA reports against those standards of good corporate governance which are applied in the U.K. to all listed companies and complies with those which are appropriate.
Assessment	Observed
Comments
8.2.1	Financial statements, if any, should be audited by an independent auditor. Information on accounting policies and any qualification to the statements should be an integral part of the publicly disclosed financial statements.
Description	Financial statements are audited by an independent auditor and information on accounting policies is publicly disclosed in the Annual Report, referred to in 6.3 above.
Assessment	Observed
Comments	The FSA’s financial statements are fully consistent with U.K. private sector accounting practices.
8.2.2	Internal governance procedures necessary to ensure the integrity of operations, including internal audit arrangements, should be publicly disclosed.
Description	As required by the FSMA (Schedule 1), the Annual Report includes information on internal governance and control procedures necessary to ensure the integrity of operations, including on the role of the Audit and other Committees. The FSA reports against those standards of good corporate governance which are applied in the U.K. to all listed companies and complies with those which are appropriate.
Assessment	Observed
Comments
8.3	Where applicable, information on the operating expenses and revenues of financial agencies should be publicly disclosed annually.
Description	This information is included in the FSA’s Annual Report, referred to in 6.3 above.
Assessment	Observed
Comments
8.4	Standards for the conduct of personal financial affairs of officials and staff of financial agencies and rules to prevent exploitation of conflicts of interest, including any general fiduciary obligation, should be publicly disclosed.
Description	The terms and conditions in the employment contracts of FSA officials and staff include such standards. All staff are required to comply with a code of conduct designed to address the issue of possible, actual or perceived financial conflict of interest or misuse of confidential information. This code is published on the FSA’s website.
Assessment	Observed
Comments	The FSA’s Code of Conduct for staff is clear and comprehensive with stringent disclosure requirements for all staff.
8.4.1	Information about legal protections for officials and staff of financial agencies in the conduct of their official duties should be publicly disclosed.
Description	The FSMA (Schedule 1 paragraph 19) provides that the FSA and any person who is, or is acting as, a member, officer or member of staff of the FSA is not to be liable in damages for anything done or omitted in the discharge, or purported discharge, of the FSA’s function. However this protection does not apply if the act or omission is shown to have been in bad faith, or unlawful as the result of section 6(1) of the Human Rights Act 1998.
Assessment	Observed
Comments

Table 20.

Detailed Assessment of Observance of IMF’s MFP Transparency Code—Financial Policies (FSA)

V. Clarity of Roles, Responsibilities, and Objectives of Financial Agencies Responsible for Financial Policies
5.1	The broad objective(s) and institutional framework of financial agencies should be clearly defined, preferably in relevant legislation or regulation.
Description	The broad objectives and constitution of the FSA are set out in the Financial Services and Markets Act 2000 (FSMA), which also provides for the establishment of a number of related bodies. In particular, the FSA is required to establish a body corporate to manage a compensation scheme (the Financial Services Compensation Scheme) (see s 212 FSMA), and to establish a body to operate a financial ombudsman scheme (Schedule 17). The FSMA sets out certain requirements and powers in relation to the management of these schemes. The compensation scheme broadly pays compensation to claimants in respect of claims made in connection with regulated activities carried on by authorized persons, and the financial ombudsman scheme broadly operates to resolve disputes between authorized firms and their customers. The FSMA requires the FSA to pursue four objectives: Market confidence, i.e., maintaining confidence in the financial system; Public awareness, i.e., promoting public understanding of the financial system; The protection of consumers, i.e., securing the appropriate degree of protection for consumers (which broadly covers consumers of regulated activities); and The reduction of financial crime, i.e., reducing the extent to which it is possible for a business carried on - (a) by a regulated person, or (b) in contravention of the general prohibition - to be used for a purpose connected with financial crime. The legislation applies these objectives directly to specific FSA activities – making rules, preparing and issuing codes, giving advice and guidance, and determining the general policy by which it acts. In carrying out these activities the legislation requires the FSA to take into account a number of factors. They are: Using its resources in the most economic and efficient way; Recognizing the responsibilities of regulated firms’ own management; Being proportionate in imposing burdens or restrictions on the industry; Taking into account the international character of financial services and the U.K.’s competitive position; Facilitating competition among regulated firms; The need to minimize the adverse effects of regulation on competition; and Facilitating innovation in connection with regulated activities. The FSA refers to these as “the principles of good regulation” and has set out how it expects to apply them in its work in a document called A New Regulator for the New Millennium (January 2000). This can be found on the FSA website (www.fsa.gov.uk/pubs/policy/index-2000.html). The constitutional requirements applying to the FSA are set out in Schedule 1 of the FSMA.
Assessment	Observed
Comments	The FSMA represents a significant improvement in the transparency of the regime over the previous arrangements in which financial sector supervision was dispersed among a number of regulatory bodies.
5.1.1	The broad objective(s) of financial agencies should be publicly disclosed and explained.
Description	The broad objectives of the FSA are set out in the FSMA (see 5.1 above). The FSA publicizes the existence of the objectives and its interpretation of them through various media, including publications (e.g., Annual Report and Plan & Budget), its website, and public speeches.
Assessment	Observed
Comments	External observers suggested that there continues to be significant uncertainty in the financial community about the process used by the FSA to manage the various objectives assigned to it. To some extent this reflects the limited experience with the new regulatory approach, and to its credit, the FSA has endeavored through various publications, open public meetings, regular meetings with trade associations, media relations, seminars, and workshops to explain its risk-based approach to supervision, and how its risk assessments drive the priorities assigned to its work on each of these objectives. It believes that time will help generate practical experience and knowledge. Nonetheless, the continuing uncertainty suggests the need for further efforts to help regulated institutions and the general public improve their understanding of the new regulatory framework.
5.1.2	The responsibilities of the financial agencies and the authority to conduct financial policies should be publicly disclosed.
Description	The FSA’s responsibilities and powers are set out in the FSMA (and related secondary legislation). The FSA is required to consult on its proposals to make rules and publish general guidance. In addition the FSA publicizes its responsibilities through various media, including publications, its website, and public speeches.
Assessment	Observed
Comments	An unusual feature of the FSA’s governing legislation is that the U.K. Listing Authority (UKLA) has a separate legal relationship with HM Treasury even though it is now part of the FSA for administrative and operational purposes. FSA and Treasury officials explained that this reflects the fact that separate objectives needed to be set for the UKLA because the general ones applicable to the FSA do not adequately address the unique nature of the UKLA’s mandate. The UKLA’s objectives and accountability features are set out in Schedule 7 of the FSMA. However, it is not clear whether the FSA is operating in its own right or as agent of the Treasury in the case of UKLA activities. The independence of the FSA is reinforced by the accountability mechanisms listed below, including the published exchange of correspondence between the Chancellor and the Chairman of the FSA (December 2001). Although it is clear from the published exchange of correspondence that the Government supports the risk-based approach to financial regulation, some external observers suggested that the Government could defend the framework more openly in public, rather than leaving it to FSA officials to argue the case for both the framework and the FSA’s performance within it.
5.1.3	Where applicable, the broad modalities of accountability for financial agencies should be publicly disclosed.
Description	There are a number of provisions in the FSMA covering accountability. These are: The requirement (in Schedule 1 para 10) that the FSA must at least once a year make a report to HM Treasury (HMT) on, inter alia, the discharge of its functions. The government can direct the FSA on topics to be covered in the report. The report is laid before Parliament and published on the FSA’s website. In addition, the FSA is required (in Schedule 1 para 11) to hold an annual public meeting to discuss its report; The responsibilities of the non executive directors committee of the FSA Board in keeping under review, e.g., the FSA’s internal financial controls, and its use of resources and to report on these matters to HMT (see para 4 Schedule 1); The requirement (in s.8 & 9) for the FSA to publicly consult practitioners and consumers “on the extent to which its general policies and practices are consistent with its general duties” under s. 2 of the FSMA. The FSMA also establishes mechanisms for direct input into the regulatory process by practitioners and consumers – including through the Practitioner and Consumer Panels which the FSA is required to maintain; The requirement (in Schedule 1 para 7) that the FSA must make arrangements for the investigation of complaints (“the complaints scheme”) arising in connection with the exercise of its functions; The power for HMT (in s.12) to appoint an independent person to conduct a review of the economy, efficiency and effectiveness with which the FSA has used its resources in discharging its functions; The power for HMT (in s.14) to arrange for an inquiry to be held in certain cases where there has been a serious failure in the system of regulation established by the FSMA; and The powers of the Director General of Fair Trading (Chapter III of Part X) to keep the FSA’s regulatory provisions and practices under review. The Competition Commission also has a related role (s 162). The FSMA also establishes an independent Financial Services and Markets Tribunal, established and run by the Lord Chancellor’s Department (part of Government). The Tribunal will consider afresh case-related decisions by the FSA if the firm or individual involved chooses to refer the case to it. Subject to these accountability mechanisms and checks and balances, the FSA operates independently of Government. This was confirmed in December 2001 in a published exchange of correspondence between the Chancellor and the Chairman of the FSA. Among other things this confirmed that the FSA would notify the Chancellor in writing as soon as circumstances or issues arise which the FSA judges serious enough to be likely to prompt the Government to consider launching a statutory inquiry. The correspondence is to be found on the web at www.hm-treasury.gov.uk/Newsroom_and_Speeches/Press/2001/press_144_01.cfm?
Assessment	Observed
Comments	As required by the FSMA, the FSA regularly consults the financial services industry and consumer groups when it is considering adopting or changing regulations and supervisory practices. Discussions with external observers confirmed that the FSA has a good working relationship with the Consumer and Practitioner Panels that oversee its activities. The Consumer Panel, for instance, has supported the FSA in its efforts to improve protection and consumer awareness, pushing the FSA to do more for consumers as the regulatory system advances and new challenges are developed. The FSA also values the feedback provided by the Practitioner Panel from its survey of financial firms.
5.1.4	Where applicable, the procedures for appointment, terms of office, and any general criteria for removal of the heads and members of the governing bodies of financial agencies should be publicly disclosed.
Description	The FSA is required to comply with the requirements as to its constitution set out in Schedule 1 of the FSMA. This includes a requirement (Schedule 1 para 2) that the chairman and other members of the FSA’s governing body must be appointed, and be liable to removal from office, by HMT. Appointments are made on principles of good corporate governance known as the Nolan Principles (www.ocpa.gov.uk/leaflets/code.htm). The composition of the FSA Board, and their period of office, is publicized on the FSA’s website and in the FSA’s Annual Report.
Assessment	Observed
Comments	Formal safeguards governing the removal of senior officials from office are limited. Although, officials are appointed for specific terms, their contracts indicate that they can be removed at any time. If dismissed, an official removed could pursue a judicial review in certain circumstances. However, an important safeguard in the U.K. context is the close public scrutiny provided by an independent media over the activities of public officials. In these circumstances, it is unlikely that a senior official could be removed from office without the government having to publicly disclose and defend the reasons behind its decision.
5.2	The relationship between financial agencies should be publicly disclosed.
Description	The terms of the 1997 Memorandum of Understanding (MoU) agreed between HM Treasury, the Bank of England and the FSA explain how the three authorities will work together towards their common objective of financial stability and sets out how their responsibilities will be discharged. The MoU is published on the FSA’s website.
Assessment	Observed
Comments
5.3	The role of oversight agencies with regard to payment systems should be publicly disclosed.
Description
Assessment	Not applicable
Comments
5.3.1	The agencies overseeing payment systems should promote the timely public disclosure of general policy principles (including risk management policies) that affect the robustness of systemically important payment systems.
Description
Assessment	Not applicable
Comments
5.4	Where financial agencies have oversight responsibilities for self-regulatory organizations (e.g., payment systems), the relationship between them should be publicly disclosed.
Description	One of the key elements of the Government’s restructuring of U.K. financial regulation has been the replacement of the previous hybrid structure involving a multiplicity of regulatory bodies – some statutory and some self-regulating – with a single, statutory financial regulator. As a result, there are only limited areas within the financial sector in which the new framework provides for any significant elements of self-regulation. The FSMA gives the FSA responsibility for supervising recognized investment exchanges (RIEs) and recognized clearing houses (RCHs). RIEs and RCHs are, to a degree, self-regulatory organizations, but the legislative framework in the U.K. has been structured in such a way that RIEs and RCHs are not fully autonomous organizations. The responsibilities of these organizations in relation to the markets in which they operate, and the responsibilities and powers of the FSA vis-à-vis those organizations are set out in the FSMA, the Financial Services and Markets Act (Recognition Requirements for Investment Exchanges and Clearing Houses) Regulations 2001, and the Recognized Investment Exchanges and Recognized Clearing Houses Sourcebook (REC). The position of RIEs and RCHs is covered in greater detail in the IOSCO assessment.
Assessment	Observed
Comments	Another self-regulatory organization that operates in the financial sector is the Takeover Panel, whose activities are not subject to formal oversight by the FSA. The Panel regulates takeovers and mergers in order to protect the interests of minority shareholders, and is widely respected by the financial community despite not having formal enforcement powers. If the Panel finds that there has been a violation, its options range from issuing private reprimands and public censure, to reporting the offender’s conduct to another regulatory authority, such as the FSA. The FSA has made it clear that it will not exercise its enforcement powers in a takeover situation except in exceptional circumstances (e.g., at the request of the Panel).
5.5	Where self-regulatory organizations are authorized to perform part of the regulatory and supervisory process, they should be guided by the same good transparency practices specified for financial agencies.
Description	RIEs and RCHs are required to provide the FSA with notifications on a broad range of subjects - from changes in their internal organization, constitution and governance to financial information, complaints against the them, hours of operation etc. The FSA does not require the publication of such information but RIEs and RCHs are free to publish this information if they so choose, and we understand that some of them do so, either in their annual reports or on their websites. The regulatory and supervisory objectives of RIEs and RCHs are spelled out in the Recognition Requirements. The FSA Handbook provides additional guidance as to how the FSA interprets these regulatory and supervisory objectives. RIEs and RCHs do make texts of regulations and guidelines readily available to the public. The Recognition Requirements require RIEs and RCHs to have appropriate procedures for making and amending their rules. Such procedures must include procedures for consulting users of the facilities in appropriate cases. The FSA will thus have regard to the extent to which the RIE/RCHs’ procedures include informal discussions at an early stage with users of its facilities or appropriate representative bodies; publication to users of its facilities of a formal consultation paper which includes clearly expressed reasons for the proposed changes and an appropriately detailed assessment of the likely costs and benefits; adequate time for users of its facilities to respond to the consultation paper and for the U.K. recognized body to take their responses properly into account; adequate arrangements for making responses to the consultation available for inspection by users of its facilities, unless the respondent requests otherwise; adequate arrangements for ensuring that the U.K. recognized body has proper regard to the representations received; and publication, no later than the publication of the amended rules, of a reasoned account of the U.K. recognized body’s decision to amend its rules (REC 2.14.6). However, FSA allows RIEs and RCHs to restrict consultation where it is essential to make a change to their rules without delay in order to ensure continued compliance with the Recognition Requirements or other obligation under the FSMA. RIEs and RCHs must provide a copy of their annual reports and accounts to the FSA under the Notification rules. The annual report and accounts will include audited financial statements, operating expenses and revenues. If the RIE/RCH is publicly listed, then under the Listing Rules, it is required to disclose publicly its annual report and accounts on a pre-announced schedule. If the RIE/RCH is a mutual, the annual report and accounts will be disseminated to members. Most RIEs and RCHs publish statistics on trading volumes and other market data. The Recognition Requirements require RIEs/RCHs to have in place certain safeguards for investors – not only in terms of ensuring that business conducted on the RIE/RCH affords proper protection to investors, but also ensuring that there are adequate complaints procedures and disciplinary procedures. Typically, RIEs and RCHs will make details of complaints procedures and disciplinary procedures public. At the very least, these procedures will be disclosed to their members. Officials from RIEs and RCHs do appear before parliamentary committees to give evidence on a range of issues. The RIE/RCH Sourcebook says that in determining whether a RIE/RCH meets the Recognition Requirements, the FSA will have regard to the arrangements and systems and controls the RIE/RCH has in order to manage conflicts of interest. It is a matter for the individual RIE/RCH as to whether they choose to publicly disseminate the details of such arrangements.
Assessment	Observed
Comments
VI. Open Process for Formulating and Reporting of Financial Policies
6.1	The conduct of policies by financial agencies should be transparent, compatible with confidentiality considerations and the need to preserve the effectiveness of actions by regulatory and oversight agencies.
Description	The FSA is generally required to consult practitioners and consumers ‘on the extent to which its general policies and practices are consistent with its general duties’ (s 8). The FSA’s policies are for example reflected through its use of its rule making powers (e.g., in Chapter 2 of Part X), its power to issue guidance (Chapter II of Part X) and statements of principle and codes in relation to approved persons (s 64). The FSA is required to consult publicly on its proposals to make rules (s.155), to give general guidance (s.157 (3)) and to issue a statement of principle or code in relation to approved persons (s.65). The FSA makes extensive use of its website to issue consultative papers, statements of policy etc and has published a statement of its open approach to regulation (“The Open Approach to Regulation” (1998)). The FSA’s proposals to make rules must also be accompanied by a cost benefit analysis, an explanation of the purpose of the proposed rules, and an explanation of the FSA’s reasons for believing that making the proposed rules is compatible with its general duties. The FSA has the power (s.148) to modify or waive various specified types of rules in relation to an authorized person. Unless it is satisfied that it is ‘inappropriate or unnecessary to do so’, the modification or waiver must be published by the Authority. In doing so the FSA must inter alia consider whether the publication would prejudice, to an unreasonable degree, the commercial interests of the authorized person concerned or any other member of his immediate group (s.148 (7)).
Assessment	Observed
Comments
6.1.1	The regulatory framework and operating procedures governing the conduct of financial policies should be publicly disclosed and explained.
Description	The FSA consults in a range of ways in order to: obtain information and views to help the FSA take well-informed decisions, bearing in mind in particular the costs, benefits, and practical implications of proposed changes to regulatory requirements; receive alternative suggestions for achieving particular regulatory objectives; promote understanding of the FSA’s overall objectives and the reasons for the policies and procedures it adopts; obtain feedback on the FSA’s existing policies, practices and performance. Consultation is public and involves the full range of interested parties, including consumers, and their representative bodies; individuals, firms or groups with relevant expertise; trade associations; advisory groups established by the FSA; voluntary organizations; academics and professional training bodies; and the media. The FSA publishes its policies through various media, including publications and electronic media (CD ROMs, website) and publicizes and explains its policies through the press etc.
Assessment	Observed
Comments	Although the policy formulation process and reporting process is transparent and involves regular consultations with consumers and industry, external observers commented that there is still significant uncertainty in the financial community about how the FSA’s policies will be implemented in practice. To some extent this reflects the limited experience with the new framework. The FSA has sought to deal with this matter in a number of publications and conferences that explain its risk-based approach to supervision and how it plans to enforce its policies. Nonetheless, the FSA should bear in mind that regulated institutions will be closely scrutinizing its actions for examples of how its policies will be implemented in practice. In particular, they are eager to see the extent to which the FSA applies judgment and tailors supervision to individual circumstances, rather than adopt a mechanical rules-based approach to supervision.
6.1.2	The regulations for financial reporting by financial institutions to financial agencies should be publicly disclosed.
Description	The rules setting out authorized firms’ reporting requirements, and related guidance, are published in the FSA’s Handbook of rules and guidance.
Assessment	Observed
Comments
6.1.3	The regulations for the operation of organized financial markets (including those for issuers of traded financial instruments) should be publicly disclosed.
Description	The regulations applying to the participants in financial markets covered by the FSMA are published in the form of rules (in particular the rules in the Interim Prudential Sourcebook for Investment Business and the Conduct of Business Sourcebook which apply to authorized investment firms, and the rules applying more generally to market participants in the Market Conduct Sourcebook, which includes the Code of Market Conduct and Price Stabilizing rules). Investment exchanges and clearing houses recognized under the FSMA (Part XVIII) are required to have rules covering certain areas in order to be recognized (see The Financial Services and Markets Act 2000 (Recognition Requirements for Investment Exchanges and Clearing Houses) Regulations (SI 2001 No. 995), and The Recognized Investment and Recognized Clearing Houses Sourcebooks in the FSA Handbook). The FSA is the competent authority for the Official List covering the listing of securities and has the power to make listing rules (e.g., s 76 FSMA). The listing rules are published on the FSA’s website and are available (like all FSA publications) in hard copy.
Assessment	Observed
Comments
6.1.4	Where financial agencies charge fees to financial institutions, the structure of such fees should be publicly disclosed.
Description	The FSA’s power to charge fees is set out in the FSMA (the principal power is in Schedule 1 para 17). In making such rules the FSA is required to follow the public consultation procedures in the FSMA (see s.155). See also FSA Consultative Paper 111 on its proposed fees. The FSA also publishes its Budget and related operating plans which determine its financing requirement.
Assessment	Observed
Comments
6.1.5	Where applicable, formal procedures for information sharing and consultation between financial agencies (including central banks), domestic and international, should be publicly disclosed.
Description	The provisions of the FSMA (Part XXIII) restrict the FSA’s ability to disclose restricted information under the Act to others. The FSA has negotiated MoUs with various overseas supervisors/regulators covering the exchange of information. The FSA has also negotiated an MoU with the Bank of England and HM Treasury which inter alia covers the exchange of information (see 5.2 above). This has been published.
Assessment	Observed
Comments
6.2	Significant changes in financial policies should be publicly announced and explained in a timely manner.
Description	The FSA is required under the FSMA to consult publicly on proposals to make rules, amend rules, and give general guidance and to publish cost-benefit analyses of such proposals. The procedures are set out in the FSMA (see 6.1 above).
Assessment	Observed
Comments	While financial institutions generally praised the FSA’s efforts to closely consult stakeholders when formulating policies for regulating institutions, a couple of observers noted that the consultation process can be rather onerous and costly for the institutions involved. To some extent this is unavoidable, since many consultations are to be expected when one is introducing a new approach to regulation. Indeed, there were 41 consultations in 2001 and 22 in the first five months of 2002. Moreover, FSA officials noted that they continue to obtain good feedback from stakeholders despite the large number of consultations in recent years. The FSA is encouraged to continuously look for ways to streamline the consultation process, so that stakeholders’ views can be collected and incorporated in a cost-effective and efficient fashion. To their credit, it should be noted that FSA officials are sensitive to the issue of consultation burden, and are awaiting feedback from the Practitioner Panel’s annual survey, which includes questions that address this issue.
6.3	Financial agencies should issue periodic public reports on how their overall policy objectives are being pursued.
Description	The FSMA requires the FSA to report annually to Government on the extent to which, in its view, its regulatory objectives have been met during the year under review. The Government lays that report before Parliament and the FSA publishes it and places it on its website. The Report gives a wide-ranging account of the FSA’s work. The FSMA provides that Government may direct the FSA to cover particular matters in such reports. The FSA’s Annual Report describes publicly in a number of other ways on how it is pursuing its overall policy objectives – for example, in the publication A new regulator for the new millennium, in policy statements on individual issues (for instance, its approach to promoting consumer understanding of the financial system), in its annual Plan & Budget, and in evidence to parliamentary committees (which they publish as part of their proceedings), in speeches and press releases.
Assessment	Observed
Comments
6.4	For proposed substantive technical changes to the structure of financial regulations, there should be a presumption in favor of public consultations, within an appropriate period.
Description	See answer at 6.1 and 6.2 above. In addition, consistent with HM Government practice, all significant changes to regulations made by HM Treasury under the FSMA are subject to public consultation.
Assessment	Observed
Comments
VII. Public Availability of Information on Financial Policies
7.1	Financial agencies should issue a periodic public report on the major developments of the sector(s) of the financial system for which they carry designated responsibility.
Description	The FSA’s Annual Report, referred to in 6.3 above, contains a brief overview of the main developments in the financial services sector in the United Kingdom during the year under review. The FSA’s annual Plan & Budget includes an overview of the external environment within which the FSA will operate over the coming period. The FSA also publishes a range of other publications that report on major developments, such as reports detailing the outcome of work on various regulatory themes (e.g., the impact of e-commerce) and a new publication called Financial Risk Outlook which summarizes significant developments in the broader environment within which the FSA works.
Assessment	Observed
Comments	The Financial Risk Outlook discusses a broad set of risks and opportunities to the FSA’s objectives. The publication was only introduced in 2002, and as such has yet to develop a strong public following. Although the analysis contained in the document was developed in consultation with the Bank of England, it is somewhat surprising to discover that it refers to IMF economic projections for the U.K. economy rather than those underpinning the Bank’s Inflation Report. The FSA offered two main reasons for this: (i) the timing of IMF forecasts neatly corresponds to its needs; and (ii) the IMF forecasts cover the global environment, providing a consistent set of forecasts and a good degree of international detail.
7.2	Financial agencies should seek to ensure that, consistent with confidentiality requirements, there is public reporting of aggregate data related to their jurisdictional responsibilities on a timely and regular basis.
Description	The FSA publishes data, in its Annual Report and elsewhere, on levels of regulatory activity – for example, number of firms authorized and individuals approved, number of disciplinary proceedings against firms and individuals. Aggregate data on volumes of business conducted by the firms or undertaken in the markets appears in ad hoc reports, speeches etc that are placed on the FSA’s website. The FSA has also introduced a new regular publication, Financial Risk Outlook, that carries a range of financial data. Many RIEs and RCHs publish statistics on trading volumes and other market data. See the Bank of England’s response for further details on data regularly published by the U.K. authorities.
Assessment	Observed
Comments	See the assessment of the Bank of England against the financial policies section of the IMF Code of Good Practices on Transparency in Monetary and Financial Policies. The FSA indicated that it will bear in mind the desirability of being able to publish aggregate data in its work on data requirements.
7.3	Where applicable, financial agencies should publicly disclose their balance sheets on a preannounced schedule and, after a predetermined interval, publicly disclose information on aggregate market transactions.
Description	The FSA’s balance sheet is published in its Annual Report, referred to in 6.3 above. See also 7.2 above.
Assessment	Observed
Comments
7.3.1	Consistent with confidentiality and privacy of information on individual firms, aggregate information on emergency financial support by financial agencies should be publicly disclosed through an appropriate statement when such disclosure will not be disruptive to financial stability.
Description
Assessment	Not applicable
Comments
7.4	Financial agencies should establish and maintain public information services.
Description	The FSA maintains an extensive public information service. It issues a wide range of publications on its activities and policies in addition to its Annual Report, referred to above. All these publications are available on its website, as well as in hard copy. The FSA publishes a range of consumer guides, fact sheets, information packs, CD-ROM, and, when necessary, issues consumer alerts that warn the public about scams or developments to watch out for. In addition, the FSA maintains a dedicated website and telephone help line for consumers which offer a variety of information and advice. Members of the public can use the FSA’s website to check if a firm is authorized to do certain business and also use the FSA’s Comparative Tables to compare similar financial products from various providers (e.g., charges and other basic information). The FSA also provides a range of educational resources for schools and colleges, covering the full age range, and arranges conferences and seminars for educational specialists. The FSA’s website has been vetted by the Plain Language Commission and awarded the ‘Clear English Standard’ for its clarity and ease of use. The FSA also has an active program to explain its policies and activities to the media.
Assessment	Observed
Comments
7.4.1	Financial agencies should have a publications program, including a periodic public report on their principal activities issued at least annually.
Description	The FSA issues a wide range of publications on its activities and policies – Discussion Papers, Consultation Papers, Feedback and Policy Statements, Occasional Papers – in addition to its Annual Report and annual Plan & Budget referred to above. All these publications are available on its website, as well as in hard copy.
Assessment	Observed
Comments
7.4.2	Senior financial agency officials should be ready to explain their institution’s objective(s) and performance to the public, and have a presumption in favor of releasing the text of their statements to the public.
Description	FSA senior staff appear frequently on public platforms to give an account of the Authority’s work (including an annual public meeting to discuss its Annual Report); speeches given on such occasions are often the subject of a press release and are sometimes made available in full, on its website. The FSA also has an active program to explain its policies and activities to the media.
Assessment	Observed
Comments	There were 16 published speeches on financial regulation policies and related regulatory issues by the Chairman and other FSA senior officials in 2001, and 11 in the first five months of 2002. Senior FSA officials members gave more than 170 on the record interviews to the media on regulatory and supervisory issues in 2001 and 50 in the first five months of 2002.
7.5	Texts of regulations and any other generally applicable directives and guidelines issued by financial agencies should be readily available to the public.
Description	The FSA’s rules and guidance are publicly available in a number of media – on its website, on CD ROM and in hard copy.
Assessment	Observed
Comments
7.6	Where there are deposit insurance guarantees, policyholder guarantees, and any other client asset protection schemes, information on the nature and form of such protections, the operating procedures, how the guarantee is financed, and the performance of the arrangement should be publicly disclosed.
Description	The Financial Services Compensation Scheme (FSCS) pays compensation, in appropriate cases, where a regulated firm is unable to meet its liabilities. The FSA is responsible for making the FSCS rules and for approving its annual budget. Those rules are available publicly in the same way as other FSA rules – see 7.5 above. Both the FSA and the FSCS publish information for consumers on the coverage of the FSCS and on the protection it provides – in booklets and on both organizations’ websites (www.fsa.gov.uk and www.fscs.org.uk). The FSCS makes detailed information available to consumers on how to make a claim under the Scheme. The FSMA requires the FSA to approve the FSCS annual budget and to make the rules, following consultation, governing the funding of the Scheme. The FSCS budget is disclosed. The rules on funding the Scheme are publicly available through the usual channels – see 7.5 above. The FSCS publishes an annual report on its discharge of its responsibilities. It is largely in the usual format for a company report, including information on finances (with auditor sign off), directors, committees, and highlights and summaries of the activities through the year, including on claims decisions and compensation payments.
Assessment	Observed
Comments	External observers noted, and FSCS officials conceded, that consumers’ awareness of their rights and privileges under the FSCS is limited. The FSA is aware of this issue, and issued a consultation paper in May 2002 that included proposed changes to conduct of business rules that would require firms to disclose relevant information about the compensation scheme, its coverage, and limits. Moreover, the FSCS is working with the FSA, trade associations, consumer advice organizations, and journalists to make its presence better known. Its website has recently been enhanced, an in recent months it has produced a range of booklets and other information for consumers that have been reviewed by the Plain Language Commission.
7.7	Where financial agencies oversee consumer protection arrangements (such as dispute settlement processes), information on such arrangements should be publicly disclosed.
Description	The FSMA requires the FSA to establish a scheme for resolving complaints between consumers and firms. Under this requirement, the FSA has set up the Financial Ombudsman Service (FOS), as the dispute resolution mechanism. The FSA is responsible for making rules governing complaints handling by firms, and for approving the rules which the FOS makes under the FSMA regarding its operation. These rules are publicly available in the usual ways – see 7.5 above. Both the FSA and FOS provide information to consumers – over the web, in brochures and by telephone – on how the arrangements work and on how to make a complaint. Under the FSA rules, firms are required to display in branches and sales offices a notice explaining that they are covered by the FOS. In addition, the rules oblige firms to provide a written copy of their complaints procedure to consumers on request, or when a complaint is made. The FOS annual budget is approved by the FSA and publicly consulted on yearly, before being published together with the FOS’s business plan for that year. In addition, the FOS reports publicly each year on how it has fulfilled its statutory functions. FOS publishes monthly newsletters which outline interesting cases and judgments it has made and discuss their implications. FOS also issues occasional discussion papers where it thinks an adjudication may have wider ramifications for a product type which it thinks the industry should be aware of.
Assessment	Observed
Comments
VIII. Accountability and Assurances of Integrity by Financial Agencies
8.1	Officials of financial agencies should be available to appear before a designated public authority to report on the conduct of financial policies, explain the policy objective(s) of their institution, describe their performance in pursuing their objective(s), and, as appropriate, exchange views on the state of the financial system.
Description	The FSA regularly gives evidence to parliamentary committees on all these issues. It is now an accepted convention that the FSA appears twice a year before the Treasury Committee of the House of Commons, once to discuss its Annual Report and once to answer questions on its plans for the coming year. From time to time the FSA also gives evidence to the Committee on specific regulatory issues. The Committee publishes the FSA’s evidence as part of its proceedings. In addition, the FSA from time to time gives evidence to other parliamentary committees in the context of individual inquiries – for example, on globalization, fighting financial crime, and e-commerce.
Assessment	Observed
Comments	See 7.4.2 for data and comments on public appearances.
8.2	Where applicable, financial agencies should publicly disclose audited financial statements of their operations on a preannounced schedule.
Description	As part of its Annual Report, referred to in 6.3 above, the FSA publishes, within 3 months of the financial year end, audited financial statements and information on its accounting practices. The Annual Report also includes information on internal governance and control procedures necessary to ensure the integrity of operations, including on the role of the Audit and other Committees. The FSA reports against those standards of good corporate governance which are applied in the U.K. to all listed companies and complies with those which are appropriate.
Assessment	Observed
Comments
8.2.1	Financial statements, if any, should be audited by an independent auditor. Information on accounting policies and any qualification to the statements should be an integral part of the publicly disclosed financial statements.
Description	Financial statements are audited by an independent auditor and information on accounting policies is publicly disclosed in the Annual Report, referred to in 6.3 above.
Assessment	Observed
Comments	The FSA’s financial statements are fully consistent with U.K. private sector accounting practices.
8.2.2	Internal governance procedures necessary to ensure the integrity of operations, including internal audit arrangements, should be publicly disclosed.
Description	As required by the FSMA (Schedule 1), the Annual Report includes information on internal governance and control procedures necessary to ensure the integrity of operations, including on the role of the Audit and other Committees. The FSA reports against those standards of good corporate governance which are applied in the U.K. to all listed companies and complies with those which are appropriate.
Assessment	Observed
Comments
8.3	Where applicable, information on the operating expenses and revenues of financial agencies should be publicly disclosed annually.
Description	This information is included in the FSA’s Annual Report, referred to in 6.3 above.
Assessment	Observed
Comments
8.4	Standards for the conduct of personal financial affairs of officials and staff of financial agencies and rules to prevent exploitation of conflicts of interest, including any general fiduciary obligation, should be publicly disclosed.
Description	The terms and conditions in the employment contracts of FSA officials and staff include such standards. All staff are required to comply with a code of conduct designed to address the issue of possible, actual or perceived financial conflict of interest or misuse of confidential information. This code is published on the FSA’s website.
Assessment	Observed
Comments	The FSA’s Code of Conduct for staff is clear and comprehensive with stringent disclosure requirements for all staff.
8.4.1	Information about legal protections for officials and staff of financial agencies in the conduct of their official duties should be publicly disclosed.
Description	The FSMA (Schedule 1 paragraph 19) provides that the FSA and any person who is, or is acting as, a member, officer or member of staff of the FSA is not to be liable in damages for anything done or omitted in the discharge, or purported discharge, of the FSA’s function. However this protection does not apply if the act or omission is shown to have been in bad faith, or unlawful as the result of section 6(1) of the Human Rights Act 1998.
Assessment	Observed
Comments

Table 21.

Summary Observance of IMF’s MFP Transparency Code—Financial Policies (FSA)

Table 21.

Summary Observance of IMF’s MFP Transparency Code—Financial Policies (FSA)

Assessment Grade	Practices Grouped by Assessment Grade
Assessment Grade	Count	List
Observed	33
Broadly observed
Partly observed
Not observed
Not applicable	3	5.3, 5.3.1, 7.3.1

Table 21.

Summary Observance of IMF’s MFP Transparency Code—Financial Policies (FSA)

Assessment Grade	Practices Grouped by Assessment Grade
Assessment Grade	Count	List
Observed	33
Broadly observed
Partly observed
Not observed
Not applicable	3	5.3, 5.3.1, 7.3.1

E. Recommended Action Plan and Authorities’ Response to the Assessment

160. The FSA observes all of the elements of the Transparency Code. The following technical suggestions are provided to further improve the transparency of its activities.

Some continuing uncertainty in the financial community about the process used by the FSA to manage the various objectives assigned to it suggests the need for further efforts to help regulated institutions and the general public improve their understanding of the new regulatory framework.
It would be desirable to continue to look for ways to streamline the consultation process so that stakeholders’ views can be collected and incorporated in a cost-effective fashion.

Authorities’ response

161. The authorities welcomed this positive assessment and noted that the FSA observes all of the elements of the financial policies section of the Code. They also welcomed the FSAP team’s comments about the transparency of the FSA’s policy process, the provision of information and the FSA’s high level of accountability. They accepted that under Sections 5 and 6 there may remain some uncertainty about how the FSA manages its various objectives and how it will implement its policies in practice. They noted that this is inevitable under a new regulatory regime, with a new regulator operating under a new statutory basis, but considered that any uncertainty will lessen over time as market participants learn more from the FSA’s explanations, supervision and actions. They noted that, indeed, the industry’s understanding of how they use their powers and pursue their objectives has considerably increased since the IMF visits in May 2002. The IMF mission made their assessment six months after FSMA came into force. The situation has developed and moved on and they have been operating with their new powers for over a year. Many of the uncertainties raised with the IMF assessors will have been answered.

VIII. Compliance with CPSS/IOSCO Recommendations for Securities Settlement Systems

A. Introduction

General

162. As part of the Financial Sector Assessment Program, missions from the International Monetary Fund visited the United Kingdom in the period February–July 2002. One of the objectives of the U.K. FSAP was to conduct an assessment of the observance of the Recommendations for Securities Settlements Systems (RSSS) prepared by the Committee on Payment and Settlement Systems (CPSS) and the Technical Committee of the International Organization for Securities Commissions (IOSCO). Although the Recommendations had been agreed as a standard at the time of the mission, there was not at that time an agreed methodology for the assessment. The initial assessment was therefore revised at the end of 2002 according to the newly agreed methodology for CPSS-IOSCO RSSS.

163. The assessment was made on the overall process of securities clearing and settlement in the United Kingdom, with a substantial part of the focus on the settlement systems operated by CRESTCo. A recommendation-by-recommendation assessment was made for the system covering bonds and equities, the CREST system. A more limited, but still recommendation-by-recommendation assessment was made of the settlement system for money market instruments, the Central Money Markets Office system (CMO). At the time of the assessment, work was underway to prepare for the migration of money market instruments (MMI) from CMO to CREST. The suggested timetable was to complete this migration during 2003. The London Clearing House (LCH), which undertakes the central counterparty clearinghouse role in the United Kingdom, is the focus of Recommendation 4, but is not covered in detail in this assessment.

164. The assessor was Martin Andersson from Sveriges Riksbank (Bank of Sweden) in collaboration with Tom Kokkola from the ECB.

B. Institutional and Market Structure

165. CRESTCo operates two securities settlement systems—CREST and CMO. The CREST system is used for gilts and equities, and the CMO system is used for MMIs (including T-bills, Bank Bills and CDs). CREST acts as the central securities depository (CSD) for U.K. securities, of which the vast majority are dematerialized: since November 2001, a transfer of securities in the book-entry system of CREST has constituted the legal transfer of title, with CREST records being the register for dematerialized securities under U.K. law.¹⁹ For the remaining securities held in paper form, and for those constituted under some other laws (e.g., Irish), the applicable external registrars have to separately register changes of ownership according to the changes effected in the CREST settlement.²⁰ For the CMO system, the Bank of England acts as depository for immobilized securities.

166. In addition, CRESTCo runs a fully-owned subsidiary—CREST International Nominees Limited-which acts as depository/custodian for international securities settled in CREST.²¹ CREST Depository Limited, meanwhile issues CREST Depository Interests, with exactly the same characteristics as the underlying international securities, but which can be settled in CREST according to English law.

167. Trading of securities in the United Kingdom is mainly done on a bilateral basis between market participants. The exception is equities, which can also be traded on the London Stock Exchange’s electronic order book (SETS, the Stock Exchange Electronic Trading Service). Equity transactions traded electronically are cleared by London Clearing House (LCH), acting as central counterparty (CCP), before settlement in CREST.

168. In November 2001, real-time settlement was introduced between CREST settlement banks, across accounts at the BoE. This replaced the previous end-of-day multilateral net settlement of interbank obligations arising from securities transactions, thus eliminating the substantial intraday exposures between settlement banks previously existing, and instituting securities settlement in central bank money.

169. CREST’s average daily transaction volume (for gilts and equities) in December 2001 was about 308,000 with an average daily value of £208 billion. CMO’s daily settlement averages £7 billion, with less than around 1,000 transactions.

170. On July 4, 2002, Euroclear and CRESTCo announced plans for an agreed merger. Following approval of the merger by both groups of shareholders during August and the decision on September 16 of the U.K. government not to refer the merger to the competition authorities, the merger was completed on September 23. Under the terms of the merger, CRESTCo shareholders received a 19 percent shareholding in Euroclear plc. CRESTCo itself became a wholly-owned subsidiary of Euroclear Bank, itself a subsidiary of Euroclear plc and the operator of the Euroclear system.

171. The merged entity (which besides CREST and the original international Euroclear operation, also encompasses the national securities settlement systems of Belgium, France and the Netherlands) aims to deliver efficient low-cost cross-border settlement to its users, through a combination of rationalized central infrastructure, standardized procedures and high transaction volumes. A two-phase business model for the new enlarged Euroclear group was published at the time of the merger announcement. This aims to deliver a high degree of user choice (as to, e.g., level of service, governing jurisdiction and as regards central bank or commercial bank money settlement) around a single settlement platform in an environment of strong user governance and consultation.

172. In practice there have not been any significant changes in CREST operations yet, and the assessment is therefore done on the CREST system as an individual system.

C. Description of Regulatory Structure and Practices

173. The Financial Services Authority (FSA) is the single supervisor in the U.K. Therefore, both market participants (banks, brokers, etc) are regulated and supervised by the FSA, as well as clearinghouses, CSDs and exchanges. In addition, the Bank of England takes an active role in this field in its role as overseer of payment systems and in their financial stability policymaking.

D. Information and Methodology Used for Assessment

174. The information used in the assessment included relevant laws, rules and procedures governing the systems, and a questionnaire completed by CRESTCo in cooperation with the Financial Services Authority (FSA). Discussions were held with the Bank of England (BoE), the FSA, CRESTCo Crest, London Stock Exchange, LIFFE, and a number of bank representatives as well as brokers. Information on websites of the FSA and CRESTCo was also extensively analyzed.

175. In the assessment process the key questions for assessment of implementation in section 5 of the Recommendations were used. In order to align the assessment with the subsequently-agreed RSSS methodology, these were complemented by additional key questions from the latter. The assessment has been structured in accordance with the structure for assessment in the Assessment Methodology for Recommendations for Securities Settlement Systems, September 2002.

176. Each Recommendation was assessed on a qualitative basis based on a five-fold assessment categorization: observed, broadly observed, partly observed, non-observed, and not applicable. The categorization follows the guidelines in the assessment methodology. As a general principle a Recommendation is considered observed whenever all assessment criteria are generally met without any significant deficiencies. A Recommendation is considered broadly observed whenever only minor shortcomings are found, which do not raise major concerns and when corrective actions to achieve full observance with the Recommendation are scheduled and realistically achievable within a prescribed period of time. A Recommendation is considered partly observed whenever the shortcomings are sufficient to raise doubts about the ability to achieve observance within a reasonable time frame. A Recommendation is considered non-observed whenever major shortcomings are found in adhering with the assessment criteria. Whenever a Recommendation is assessed to be broadly, partly or non-observed with a Recommendation, suggestions are proposed for achieving full observance. A Recommendation is considered not applicable whenever it does not apply given the structural, legal, and institutional conditions.

177. In accordance with the assessment methodology the assignment of an assessment category with respect to a recommendation is based on the current situation existing without regard to any proposed or ongoing actions. Material changes underway are presented in the description and/or comment sections.

E. The Assessment of the Observance with RSSS—The CREST System

Executive summary

178. The overall assessment is that the CREST system itself is reliable and effective in providing delivery versus payment settlement on a real time gross basis. The CREST system started its operations in 1996, but it was not until November 2001 that the transfer of title in CREST’s book-entry system became the legal transfer of title to securities constituted under U.K. law. At the same time, full DVP in central bank money was introduced.

179. Those recommendations where full observance is not achieved have more to do with aspects outside the scope of the CREST system, or of CRESTCo itself, and more related to others. In all these cases the grading is broadly observed, and it should not be too difficult to make the required improvements for observance. These recommendations concern the following issues:

Pre-settlement risks

180. CREST has together with exchanges been able to improve the performance with regard to confirmation, matching and settlement performance over the last year. This work needs to be continued in order to achieve full observance with this recommendation.

Central counterparty

181. Given the importance of LCH for the U.K. and the international financial market, high priority should be given to replacing the payments scheme with one based on settlement across the books of the BoE, for settlements in sterling and Euro. In addition, the placement of funds in the money market should be converted from the current unsecured basis to a collateralized basis, in order to limit unnecessary credit risk exposure of LCH. Losses from these particular risk exposures can not be covered by the default arrangements in place. Initiatives to address both these weaknesses were underway during the period of the FSAP exercise and when completed will significantly remove much of this risk. It is also important that U.K. authorities give a very high priority to ensuring that the legal uncertainties are rectified, especially with respect to the default fund.

Settlement risks

182. Most actively traded securities are dematerialized. However, MMIs are not. There are plans to introduce that in 2003 (legal amendments and certain operational and market practice changes are necessary and are underway) after which observance with this recommendation will be achieved.

Regulation and oversight

183. There is currently no specific framework for cooperation with relevant authorities outside the U.K., which is something that should be developed. In addition, the supervisory process should continue to develop towards more differentiation amongst supervised institutions, having regard in particular to the different sorts of risks in CREST and LCH (e.g., as related to different capital requirements for these institutions, a matter under consideration at the time of the assessment).

Table 22.

Summary Observance of CPSS/IOSCO Recommendations for Securities Settlement Systems—CREST

Table 22.

Summary Observance of CPSS/IOSCO Recommendations for Securities Settlement Systems—CREST

Assessment grade	Recommendations grouped by assessment grade
	Count	List
Observed	14	Rec. 1, 3, 5, 7, 8, 10, 11, 12, 13, 14, 15, 16, 17, and 19
Broadly observed	4	Rec. 2, 4, 6, and 18
Partly observed	0
Non-observed	0
Not applicable	1	Rec. 9

Table 22.

Summary Observance of CPSS/IOSCO Recommendations for Securities Settlement Systems—CREST

Assessment grade	Recommendations grouped by assessment grade
	Count	List
Observed	14	Rec. 1, 3, 5, 7, 8, 10, 11, 12, 13, 14, 15, 16, 17, and 19
Broadly observed	4	Rec. 2, 4, 6, and 18
Partly observed	0
Non-observed	0
Not applicable	1	Rec. 9

F. Recommendation-by-Recommendation Assessment

Table 23.

Detailed Assessment of Observance of CPSS/IOSCO Recommendations for Securities Settlement Systems—CREST

Table 24.

Recommended Actions to Improve Observance of CPSS/IOSCO—CREST

Table 24.

Recommended Actions to Improve Observance of CPSS/IOSCO—CREST

Reference recommendation	Recommended action
Pre-settlement risks Rec. 2 – Confirmation of trades between direct market participants should occur as soon as possible after trade execution, but no later than trade date (T+0). Where confirmation of trades by indirect market participants (such as institutional investors) is required, it should occur as soon as possible after trade execution, preferably on T+0, but no later than T+1.	CREST has together with exchanges been able to improve the performance with regard to confirmation, matching and settlement performance over the last year. This work needs to be continued in order to achieve full observance with this recommendation. Even though there is no formal requirement on the level of indirect participants the mission encourages the British authorities to work with market participants with the aim of improve the confirmation performance also at this level
Central counterparty Rec.4 – The benefits and costs of a central counterparty should be evaluated. Where such a mechanism is introduced, the central counterparty should rigorously control the risks it assumes. Settlement risk Rec. 6 Securities should be immobilized or dematerialized and transferred by book entry in CSDs to the greatest extent possible.	Given the importance of LCH for the U.K. and the international financial market, high priority should be given to replacing the payments scheme with one based on settlement across the books of the BoE, for settlements in sterling and Euro. In addition, the placement of funds in the money market should be converted from the current unsecured basis to a collateralized basis, in order to limit unnecessary credit risk exposure of LCH. Losses from these particular risk exposures can not be covered by the default arrangements in place. Initiatives to address both these weaknesses were underway during the period of the FSAP exercise and when completed will significantly remove much of this risk. It is important that U.K. authorities give a very high priority to ensuring that the remaining legal uncertainties are rectified, especially with respect to the default fund. Most actively traded securities are dematerialized. However, MMIs are not. There are plans to introduce that in 2003 (legal amendments are necessary and are in hand) after which observance with this recommendation will be achieved. The fact that as much as 15% of the value of equities and still 1% of gilts are not dematerialized involves operational costs and risks for market participants. It would be beneficial for the market if steps were taken to lower these numbers. A mandatory dematerialization, as in many other countries (e.g., France and Sweden), could be considered.
Regulation and oversight Rec. 18 - Securities settlement systems should be subject to transparent and effective regulation and oversight. Central banks and securities regulators should cooperate with each other and with other relevant authorities.	It is important that the FSA continues to adapt its supervisory regime to the risks inherent in institutions like CREST and LCH. (Indeed, it might be worth considering if it really is beneficial to have the same supervisory handbook--“the sourcebook”--for such diverging institutions as LCH and CREST.) Progress is being made in this area, however:, e.g., FSA is considering lowering the capital requirement for CRESTCo, reflecting supervisory differentiation between it and LCH. There is currently no framework for cooperation with relevant authorities outside the U.K., which is a part of this recommendation. Such a framework should be established, and the supervisory process further developed with respect to actual risks in CREST and LCH, to improve observance of this Recommendation. The current phase of consolidation of CSDs/SSSs and CCPs in both a European and a global context is a challenge not only for the institutions involved but also for the overseer/supervisors. Issues to focus on include, e.g., whether internal controls can keep pace with business developments.

Table 24.

Recommended Actions to Improve Observance of CPSS/IOSCO—CREST

Reference recommendation	Recommended action
Pre-settlement risks Rec. 2 – Confirmation of trades between direct market participants should occur as soon as possible after trade execution, but no later than trade date (T+0). Where confirmation of trades by indirect market participants (such as institutional investors) is required, it should occur as soon as possible after trade execution, preferably on T+0, but no later than T+1.	CREST has together with exchanges been able to improve the performance with regard to confirmation, matching and settlement performance over the last year. This work needs to be continued in order to achieve full observance with this recommendation. Even though there is no formal requirement on the level of indirect participants the mission encourages the British authorities to work with market participants with the aim of improve the confirmation performance also at this level
Central counterparty Rec.4 – The benefits and costs of a central counterparty should be evaluated. Where such a mechanism is introduced, the central counterparty should rigorously control the risks it assumes. Settlement risk Rec. 6 Securities should be immobilized or dematerialized and transferred by book entry in CSDs to the greatest extent possible.	Given the importance of LCH for the U.K. and the international financial market, high priority should be given to replacing the payments scheme with one based on settlement across the books of the BoE, for settlements in sterling and Euro. In addition, the placement of funds in the money market should be converted from the current unsecured basis to a collateralized basis, in order to limit unnecessary credit risk exposure of LCH. Losses from these particular risk exposures can not be covered by the default arrangements in place. Initiatives to address both these weaknesses were underway during the period of the FSAP exercise and when completed will significantly remove much of this risk. It is important that U.K. authorities give a very high priority to ensuring that the remaining legal uncertainties are rectified, especially with respect to the default fund. Most actively traded securities are dematerialized. However, MMIs are not. There are plans to introduce that in 2003 (legal amendments are necessary and are in hand) after which observance with this recommendation will be achieved. The fact that as much as 15% of the value of equities and still 1% of gilts are not dematerialized involves operational costs and risks for market participants. It would be beneficial for the market if steps were taken to lower these numbers. A mandatory dematerialization, as in many other countries (e.g., France and Sweden), could be considered.
Regulation and oversight Rec. 18 - Securities settlement systems should be subject to transparent and effective regulation and oversight. Central banks and securities regulators should cooperate with each other and with other relevant authorities.	It is important that the FSA continues to adapt its supervisory regime to the risks inherent in institutions like CREST and LCH. (Indeed, it might be worth considering if it really is beneficial to have the same supervisory handbook--“the sourcebook”--for such diverging institutions as LCH and CREST.) Progress is being made in this area, however:, e.g., FSA is considering lowering the capital requirement for CRESTCo, reflecting supervisory differentiation between it and LCH. There is currently no framework for cooperation with relevant authorities outside the U.K., which is a part of this recommendation. Such a framework should be established, and the supervisory process further developed with respect to actual risks in CREST and LCH, to improve observance of this Recommendation. The current phase of consolidation of CSDs/SSSs and CCPs in both a European and a global context is a challenge not only for the institutions involved but also for the overseer/supervisors. Issues to focus on include, e.g., whether internal controls can keep pace with business developments.

184. In addition to the above, some further technical improvements or refinements would be desirable in several areas where the U.K. arrangements are already considered to observe the RSSS. Specifically:

Rec. 7: Even if USD transactions presently are small, it should be noted that there is an interbank credit risk stemming form the securities settlement mechanism. CRESTCo together with the U.K. authorities should evaluate alternative payment schemes that can reduce this exposure. If no such mechanism is found, it is important that supervisors are aware of this risk exposure and can discuss it with banks in their risk assessments.
Rec. 10: Although CREST believes that larger members generally have arrangements for immediate finality, there is currently no specific information to verify this. The authorities should seek more specific information from CREST or its members about current payment finality arrangements between members and their banks, and examine whether and how they should ensure that the finality arrangements are appropriate.

Even though USD transactions presently are small, it should be noted that there is an interbank credit risk stemming from the securities settlement mechanism. It is recommended that CREST together with the U.K. authorities explore this issue in more depth.

The high concentration of activities in two settlement banks should be noted by banking supervisors. Although these banks are very large and well-supervised banks, it is important that this particular dimension is carefully reflected in the supervisory process. In addition, the rules that settlement banks must approve new settlement banks before entering the scheme is of no relevance with today’s RTGS DVP settlement and should therefore be removed, due to the risk of it limiting the competitive pressure on existing settlement banks.
Rec. 12. There is a need to better communicate the safeguards and the legal support for the custodial activity to market participants, some of whom have expressed concern in this area.

G. The Assessment of the Observance with RSSS—The CMO System

Executive summary

185. A more limited, but still recommendation-by-recommendation assessment was made of the settlement system for money market instruments, the Central Money Markets Office system (CMO).

186. The CMO system settles trades in money market instrument, including treasury bills, bank bills, and CDs, and handles both sterling and Euro settlements. The CMO system has one major shortcoming, in that settlement is not on a full delivery versus payment basis. The securities leg of a transaction is settled gross on a real time basis and is irrevocable upon settlement. However, the payment leg of the transaction settles on a net basis at the end of day, in the settlement banks’ accounts with the Bank of England. In contrast to the assured payments used for USD in the CREST system, banks are not obliged to make payments on behalf of their customers. Therefore, all participants in the money market are faced with a full principal risk from the settlement of the securities leg of the transaction intraday, until payments have been settled at the end of the day.

187. At the time of the assessment, work was underway to prepare for the migration of MMI from CMO to CREST. The suggested timetable was to complete this migration during 2003. Legislative changes are needed to change the status of money market instruments, which presently are bearer instruments and therefore not fungible, to make it possible to integrate CMO into the CREST system. This process is reportedly in hand, and no other changes are either planned or recommended for the CMO system in this assessment. It is important, however, that as long as the CMO system remains the U.K. authorities take account of this risk exposure in their work on financial stability and supervision of institutions.

Table 25.

Summary Observance of CPSS/IOSCO Recommendations for Securities Settlement Systems—CMO

Table 25.

Summary Observance of CPSS/IOSCO Recommendations for Securities Settlement Systems—CMO

Assessment grade	Recommendations grouped by assessment grade
Assessment grade	Count	List
Observed	6	Rec. 2, 3, 11, 12, 13, and 14
Broadly observed	3	Rec. 1, and 18
Partly observed	4	Rec. 5, 6, 8, 10, and 17
Non-observed	4	Rec. 7, 9, 15, and 16
Not applicable	2	Rec. 4 and 19

Table 25.

Summary Observance of CPSS/IOSCO Recommendations for Securities Settlement Systems—CMO

Assessment grade	Recommendations grouped by assessment grade
Assessment grade	Count	List
Observed	6	Rec. 2, 3, 11, 12, 13, and 14
Broadly observed	3	Rec. 1, and 18
Partly observed	4	Rec. 5, 6, 8, 10, and 17
Non-observed	4	Rec. 7, 9, 15, and 16
Not applicable	2	Rec. 4 and 19

H. Recommendation-by-recommendation assessment

Table 26.

Detailed Assessment of Observance of CPSS/IOSCO Recommendations for Securities Settlement Systems—CMO

188. The following table sets out the recommended actions to improve the observance of the CMO system with the CPSS/IOSCO RSSS. As will be clear, most of these issues will be resolved once the current plans to shift MMI into the CREST system (along with the requisite underlying legal changes) are implemented. In a broader sense then, our recommendations in this area mainly reduce to one broad theme: encouraging the authorities to proceed as planned, and as soon as possible, with the migration to CREST.

Table 27.

Recommended Actions to Improve Observance of CPSS/IOSCO—CMO

Table 27.

Recommended Actions to Improve Observance of CPSS/IOSCO—CMO

Reference recommendation		Recommended action
	Rec. 1 – Securities settlement systems should have a well-founded, clear and transparent legal basis in the relevant jurisdictions. Rec. 5 - Securities lending and borrowing (or repurchase agreements and other economically equivalent transactions) should be encouraged as a method for expediting the settlement of securities transactions. Barriers that inhibit the practice of lending securities for this purpose should be removed.	The legislative changes necessary to make the instruments fungible should be a high priority issue for the HMT, since this is necessary to fully include CMO within CREST and thereby achieve true DVP. Being bearer instrument is a major shortcoming for developing the CMO system and developing an active securities lending market, which should be rectified. See also next recommendation.
Settlement risk
	Rec. 6 – Securities should be immobilized or dematerialized and transferred by book entry in CSDs to the greatest extent possible	A mandatory dematerialization, at least for gilts and money market instruments, would be beneficial for the market.
	Rec. 7 – CSDs should eliminate principal risk by linking securities transfers to funds transfers in a way that achieves delivery versus payment.	Since principal risk is not eliminated CMO is not compliant with international standards. A fundamental change is planned for 2003 to bring CMO transactions fully into the CREST system: it is important that this change be pushed through on schedule, and it will need to be supported by action to address the fact that instruments are not fungible. In that regard, appropriate legislative changes should be made to allow achievement of DVP settlement. It is also important that these exposures receive supervisor’s attention.
	Rec. 8 - Final settlement should occur no later than the end of the settlement day. Intraday or real-time finality should be provided where necessary to reduce risks.	See above.
	Rec. 9 - CSDs that extend intraday credit to participants, including CSDs that operate net settlement systems, should institute risk controls that, at a minimum, ensure timely settlement in the event that the participant with the largest payment obligation is unable to settle. The most reliable set of controls is a combination of collateral requirements and limits.	See above.
	Rec. 10 – Assets used to settle the ultimate payment obligation arising from securities transactions should carry little or no credit or liquidity risk. If central bank money is not used, steps must be taken to protect CSD members from potential losses and liquidity pressures arising from the failure of the cash settlement agent whose assets are used for that purpose.	As above, it is important that the planned fundamental overhaul of the CMO arrangement should be pushed through as scheduled. As per the CREST assessment, it is also important that the high concentration of interbank transaction in two settlement banks should be noted by banking supervisors.
Other issues
	Rec. 15 – While maintaining safe and secure operations, securities settlement systems should be cost-effective in meeting the requirements of users. Rec. 16 – Securities settlement systems should use or accommodate the relevant international communication procedures and standards in order to facilitate efficient settlement of cross-border transactions.	This should be addressed with the replacement of current CMO arrangements in 2003. This will also be solved when money market instruments can be included in the CREST system under the changes planned for 2003.
	Rec. 17 – CSDs and central counterparties should provide market participants with sufficient information for them to identify and accurately evaluate the risks and costs associated with using the CSD or central counterparty services.	In the past, CMO has claimed that it provides DVP settlement, since a payment instruction is issued in real time when the securities leg of the transaction is settled. This was misleading since the rationale behind DVP is that it should eliminate principal risk. As noted above, this is not the case in the CMO system, and a correction to the CREST website in this regard has since been made. Pending the fundamental overhaul noted above, it is important that the risk in the current system is not understated. This is not prudent.
	Rec. 18 – Securities settlement systems should be subject to transparent and effective regulation and oversight. Central banks and securities regulators should cooperate with each other and with other relevant authorities.	As per Rec. 18 under the assessment for CREST (Table 3)

Table 27.

Recommended Actions to Improve Observance of CPSS/IOSCO—CMO

Reference recommendation		Recommended action
	Rec. 1 – Securities settlement systems should have a well-founded, clear and transparent legal basis in the relevant jurisdictions. Rec. 5 - Securities lending and borrowing (or repurchase agreements and other economically equivalent transactions) should be encouraged as a method for expediting the settlement of securities transactions. Barriers that inhibit the practice of lending securities for this purpose should be removed.	The legislative changes necessary to make the instruments fungible should be a high priority issue for the HMT, since this is necessary to fully include CMO within CREST and thereby achieve true DVP. Being bearer instrument is a major shortcoming for developing the CMO system and developing an active securities lending market, which should be rectified. See also next recommendation.
Settlement risk
	Rec. 6 – Securities should be immobilized or dematerialized and transferred by book entry in CSDs to the greatest extent possible	A mandatory dematerialization, at least for gilts and money market instruments, would be beneficial for the market.
	Rec. 7 – CSDs should eliminate principal risk by linking securities transfers to funds transfers in a way that achieves delivery versus payment.	Since principal risk is not eliminated CMO is not compliant with international standards. A fundamental change is planned for 2003 to bring CMO transactions fully into the CREST system: it is important that this change be pushed through on schedule, and it will need to be supported by action to address the fact that instruments are not fungible. In that regard, appropriate legislative changes should be made to allow achievement of DVP settlement. It is also important that these exposures receive supervisor’s attention.
	Rec. 8 - Final settlement should occur no later than the end of the settlement day. Intraday or real-time finality should be provided where necessary to reduce risks.	See above.
	Rec. 9 - CSDs that extend intraday credit to participants, including CSDs that operate net settlement systems, should institute risk controls that, at a minimum, ensure timely settlement in the event that the participant with the largest payment obligation is unable to settle. The most reliable set of controls is a combination of collateral requirements and limits.	See above.
	Rec. 10 – Assets used to settle the ultimate payment obligation arising from securities transactions should carry little or no credit or liquidity risk. If central bank money is not used, steps must be taken to protect CSD members from potential losses and liquidity pressures arising from the failure of the cash settlement agent whose assets are used for that purpose.	As above, it is important that the planned fundamental overhaul of the CMO arrangement should be pushed through as scheduled. As per the CREST assessment, it is also important that the high concentration of interbank transaction in two settlement banks should be noted by banking supervisors.
Other issues
	Rec. 15 – While maintaining safe and secure operations, securities settlement systems should be cost-effective in meeting the requirements of users. Rec. 16 – Securities settlement systems should use or accommodate the relevant international communication procedures and standards in order to facilitate efficient settlement of cross-border transactions.	This should be addressed with the replacement of current CMO arrangements in 2003. This will also be solved when money market instruments can be included in the CREST system under the changes planned for 2003.
	Rec. 17 – CSDs and central counterparties should provide market participants with sufficient information for them to identify and accurately evaluate the risks and costs associated with using the CSD or central counterparty services.	In the past, CMO has claimed that it provides DVP settlement, since a payment instruction is issued in real time when the securities leg of the transaction is settled. This was misleading since the rationale behind DVP is that it should eliminate principal risk. As noted above, this is not the case in the CMO system, and a correction to the CREST website in this regard has since been made. Pending the fundamental overhaul noted above, it is important that the risk in the current system is not understated. This is not prudent.
	Rec. 18 – Securities settlement systems should be subject to transparent and effective regulation and oversight. Central banks and securities regulators should cooperate with each other and with other relevant authorities.	As per Rec. 18 under the assessment for CREST (Table 3)

Authorities’ response to the assessments of CREST and CMO

189. The authorities indicated that the assessment has been a valuable and effective review of the observance by U.K. SSSs of the CPSS/IOSCO recommendations. They noted, however, a number of areas where they feel that some issues, while identified by the FSAP team and themselves as risks, can be effectively monitored (rather than removed) due to their relatively low impact (and especially when measured against the costs of remedial action). It is important to acknowledge the cost/benefit issues inherent in tackling low-impact and non-material risks. This is relevant regarding the recommendation for the very low value of US$ settlement in Crest. The authorities, Crest and APACS have, since the assessment, discussed this issue and will continue to monitor the size of US$ flows, but feel that the values are currently too small to justify a significant and costly solution.

190. The authorities were able to report progress on a number of areas highlighted by the IMF. The recommendation relating to central counterparty arrangements notes that priority should be given to replacing LCH’s payment scheme with one based primarily on settlement across the books of the Bank of England: detailed discussions are currently underway between the Bank and LCH. Furthermore, LCH has started to deposit its cash margin on a secured basis. The authorities and LCH are in discussion regarding how to provide further legal certainty to the small proportion of the default fund where there is currently some uncertainty regarding its treatment in the event of a member insolvency. Since the assessment was carried out, substantial progress has been made towards the implementation of money market instrument dematerialization. Most significantly, HM Treasury published a consultation paper on September 13, 2002 that incorporated detailed proposed changes to the relevant legislation (the Uncertificated Securities Regulations 2001). Comments were asked for by December 6, with the aim of achieving the necessary Parliamentary approval by end H1 2003, so that dematerialized money market instruments can start being issued and settled in CREST from September 2003 and CMO can be closed at end-2003. This high priority work will address the points raised in relation to Recommendation 6 of the Crest assessment (dematerialization of MMIs) and most of the recommended actions in the CMO assessment will become redundant.

191. The authorities noted the IMF’s observations on the supervisory regime in the U.K. and the application of the sourcebook to CREST and LCH. They are satisfied that the FSA’s current approach provides sufficient flexibility to be able to deal effectively and efficiently with the issues that arise at those institutions. They believe that this view is also shared by the institutions themselves. The FSA have taken the opportunity to compare their approach and regime to those of other European regulators as a result of the various initiatives and mergers being pursued by our exchanges and clearing houses and are satisfied that the FSA’s approach compares very favorably in such circumstances.

192. Finally, the authorities also noted, in terms of a specific framework for international cooperation that the committee of European Securities Regulators provides a wide ranging mechanism for cooperation between securities commissions across the EU (and through it for cooperation with ECB on central bank/stability issues). The authorities have also been supplementing that arrangement with additional bilateral MoUs as necessary with certain EU authorities who have oversight responsibilities for clearing and settlement issues.

IX. Assessment of Anti-Money Laundering and Combating the Financing of Terrorism²²

A. General

Information and methodology used for the assessment

193. A detailed assessment of the anti-money laundering (AML) and combating the financing of terrorism (CFT) regime of the United Kingdom was prepared by a team of assessors that included staff of the International Monetary Fund (IMF), an expert under the supervision of IMF staff, and an expert not under the supervision of IMF staff who was selected by the authorities to assess criminal law enforcement aspects of the U.K. AML/CFT regime. The assessment team examined the relevant AML/CFT laws and regulations, and supervisory and regulatory systems in place to deter money laundering (ML) and financing of terrorism (FT) among prudentially regulated financial institutions and among “money service businesses” (“MSBs”, defined to include bureaux de change, money transmitters and check cashers). The assessment is generally based on the information available at the time it was completed on December 20, 2002.

194. A broad range of legal, regulatory and supervisory materials were examined in the context of the assessment, including:

Various statutes, including the Proceeds of Crime Act 2002 (“PCA 2002”), Drug Trafficking Act 1994 (“DTA”), Criminal Justice Act 1988, as amended (“CJA”), Criminal Justice (International Cooperation) Act 1990 (“CJICA”), Terrorism Act 2000 (“Terrorism Act”), Anti-Terrorism, Crime and Security Act 2001 (“ATCS 2001”), Police Act 1997 (“Police Act”), Extradition Act 1989 (“Extradition Act”), Regulation of Investigatory Powers Act 2001 (“RIPA”), and Financial Services and Markets Act 2000 (“FSMA”);
Various statutory instruments, including the Money Laundering Regulations 1993 (the “1993 Regulations”), Money Laundering Regulations 2001 (the “2001 Regulations”), and the Terrorism (United Nations Measures) Order 2001; and
Supervisory materials issued by the Financial Services Authority (“FSA”), including the FSA’s Money Laundering Sourcebook (the “Sourcebook”), Money Laundering Theme Report, and FSA Handbook; as well as supervisory materials issued by Her Majesty’s Customs and Excise (“HMCE”) with respect to MSBs.

195. In addition, discussions were held with officials and technical experts from a number of U.K. government departments and agencies, including the FSA, Her Majesty’s Treasury (“HMT”), the U.K. Home Office, HMCE, the National Criminal Intelligence Service (“NCIS”), the Crown Prosecution Service, the Serious Fraud Office, City of London Police, and the Charity Commission. Discussions were also held with financial institution representatives, and with private sector experts that provide AML/CFT compliance advice to the regulated sector.

196. IMF staff members were John Abbott (MAE) and Rhoda Weeks-Brown (LEG). The team also included Paolo Constanza of the Ufficio Italiano dei Cambi, Italy, who worked under the supervision of the IMF staff; and Ted Greenberg of the U.S. Department of Justice, who handled issues related to implementation of criminal law provisions, served as the team’s Independent Anti-Money Laundering Expert (“IAE”) and did not work under the supervision of IMF staff.²³

197. U.K.-wide AML legislation will be simplified in important respects once the PCA 2002 becomes effective, as the PCA would, among many other things, unify confiscation and ML provisions across England and Wales, Scotland and Northern Ireland in important respects. Nonetheless, a number of procedural differences remain (for example, owing to the fact of different court systems among U.K. jurisdictions). There are also some substantive differences (for example, the Director of the new Asset Recovery Agency provided for in the PCA 2002 generally has no role in criminal confiscation in Scotland). Nonetheless, the analysis of statutory matters in this assessment focus primarily on measures in force in England and Wales, as the assessors understand that comparable (even if not identical) legislation is generally in place in Scotland and Northern Ireland.

Overview of measures to prevent money laundering and terrorism financing

198. The U.K. has a strong and comprehensive legal, institutional and supervisory regime for AML/CFT. The system has been made more robust over the last few years, including through the recent passage into law of the PCA 2002 (which received Royal Assent in July 2002);²⁴ adoption of new legislation on terrorist financing (2000 and 2001); issuance of regulations providing a framework for the registration and limited supervision of MSBs (2001); and issuance of the FSA Money Laundering Sourcebook (2001). Further important improvements and refinements would be secured by other anticipated reforms, including the adoption of legal requirements concerning the inclusion of originator information on money transfers originated in the U.K.; and expansion of the AML regime to cover a broader range of non-prudentially supervised entities and professions as provided for under the Second EU Directive on Money Laundering. The U.K. is compliant or largely compliant with all of the FATF 40+8 Recommendations, other than Special Recommendation VII concerning the inclusion of originator information on wire transfers.

199. The U.K.’s institutional arrangements for AML/CFT are complex. Relevant institutions include (1) the FSA, which not only has responsibility for regulatory and supervisory oversight, but also has power to initiate criminal proceedings against regulated persons for breach of the 1993 Regulations; (2) HMCE, which has recently been given responsibility for the oversight of MSBs, and additionally exercises a wide range of law enforcement and prosecution responsibilities; (3) HMT and the U.K. Home Office, each of which has responsibilities for aspects of the legal framework for AML/CFT; (4) NCIS, whose Economic Crime Unit serves as the U.K.’s FIU; (5) over 50 national and local law enforcement agencies; (6) agencies with responsibility for prosecution of ML/FT and for confiscation and other judicial proceedings, including the Crown Prosecution Service, the Serious Fraud Office and, as noted above, HMCE; and (7) a variety of additional governmental agencies and interagency groups with responsibility for various aspects of ML/FT and other serious crimes, including the National Crimes Squad and the Asset Recovery Agency provided for under the PCA 2002.

200. The multiplicity of institutions involved in AML/CFT could result in inefficiencies and in extreme cases even undermine the effective implementation of AML/CFT. For example, the government’s November 2001 Asset Recovery Strategy cites poor interagency cooperation as a reason for underperformance in enforcing confiscation orders. A Money Laundering Advisory Committee (“MLAC”) comprised of representatives of key government agencies, industry groups and consumer groups was recently established and is expected to significantly improve strategic level coordination between those involved in the AML/CFT regime. In addition, HMT is preparing a strategy document to set out its aims in tackling money laundering and to identify issues that need future attention. It is important that such efforts continue, in order to ensure effective, comprehensive and high-level coordination among all of the relevant departments and agencies.

201. The supervisory regime for AML/CFT applies to most persons and firms regulated by the FSA, with a notable gap resulting from the fact that general insurance companies are excluded from coverage. Enforcement of the supervisory regime was strengthened with the coming into force of the FSMA, which lists prevention of financial crime among the four statutory objectives of the FSA, and gives broad enforcement powers to the FSA including to bring criminal prosecution for breach of the 1993 Regulations.

202. Despite the strength and comprehensiveness of the U.K. AML/CFT regime, there is room for improvement and refinement in a number of the areas covered under the Fund/Bank AML/CFT Methodology. These issues, and a more detailed analysis of the U.K. system for AML/CFT, are discussed in greater detail below.

B. Detailed Assessment

203. The following detailed assessment was conducted using the October 11, 2002 version of the Methodology for assessing compliance with the AML/CFT international standard, i.e., the Financial Action Task Force (FATF) 40 Recommendations for Anti-Money Laundering and 8 Special Recommendations for Combating the Financing of Terrorism. In conformity with the Methodology, the AML/CFT framework was assessed on the basis of the following definitions.

204. A requirement is considered compliant whenever it is fully observed. A requirement is considered largely compliant whenever only discrete and non-systemic shortcomings are observed which do not raise major concerns and when corrective actions to achieve full observance with the requirement are readily identified and have been scheduled within a reasonable period of time. A requirement is considered materially non-compliant whenever discrete or non-systemic shortcomings are observed that are not addressed, or whenever numerous or systemic shortcomings are observed and corrective actions are identified and have been scheduled within a reasonable period of time. A requirement is considered non-compliant whenever the jurisdiction has not addressed the issue or has addressed it in a manner that cannot reasonably lead to substantial observance. A requirement is considered not applicable whenever, in the view of the assessor, the requirement does not apply, given the structural, legal and institutional features of a jurisdiction.

C. Assessing the Criminal Justice Measures and International Cooperation

Table 28:

Detailed Assessment of the Criminal Justice Measures and International Corporation

D. Assessing the Preventive Measures for Financial Institutions

205. The legal and institutional framework for all financial institutions and its effective implementation.

206. In order to assess compliance with the following criteria (43-67), assessors must verify that:

(a) the laws and institutional framework are in place; and
(b) there are effective supervisory/regulatory measures in force that ensure that those criteria are being properly and effectively implemented by all financial institutions.

207. Both aspects are of equal importance.

Table 29.

Detailed Assessment of the Legal and Institutional Framework for All Financial Institutions and its Effective Implementation

E. Specific Criteria for the Banking, Securities, and Insurance Sectors

208. The core assessment criteria for the legal and institutional framework of an AML/CFT system for financial institutions are set out in 2.2.1 above. These criteria are largely drawn from the FATF Recommendations, and are broadly applicable to all financial institutions. However, for the banking, insurance, and securities sectors, the AML/CFT elements and assessment criteria also draw from the supervisory and regulatory principles issued by the Basel Committee (Part A: Assessing the Banking Sector based on Sector-Specific Criteria); the IAIS (Part B: Assessing the Insurance Sector based on Sector Specific Criteria); and IOSCO (Part C: Assessing the Securities Sector based on Sector Specific Criteria).²⁶ These additional criteria are set out below.²⁷

209. As with section 2.2.1 above, assessors must not only check that all the legal and institutional requirements in sections 2.2.2, 2.2.3 and 2.2.4 have been imposed or exist, but must also verify that there are effective supervisory/regulatory measures in force that ensure that those criteria are being properly and effectively implemented in the banking, insurance and securities sectors.

210. The assessments of sector specific criteria should be considered when drafting the relevant overall description and analysis parts of the core criteria assessments.

Introduction to U.K. Sector Specific Assessment

The Financial Services Authority functions as an integrated regulator of the U.K. financial services sector. Accordingly, most of the sector specific AML/CFT criteria for the banking, securities, and insurance sectors identified in Section 2.2.2 of the methodology have common applicability across all three sectors. This introductory section provides an overview of FSA’s role as the AML/CFT supervisor of the three sectors and describes FSA policies and procedures for ensuring compliance by the three sectors with the AML/CFT regime. This overview, particularly the sections describing how the AML/CFT regime is implemented throughout FSA, supports individual conclusions in the assessments that follow of criteria 68-120. However, since the methodology calls for the sector specific criteria to me met by the relevant sector, but not necessarily by all sectors, criteria 68-120 are evaluated on the basis of whether the criteria are or are not met for the banking, insurance and securities sectors, respectively.

Authorities. As elaborated in above, FSA’s AML/CFT authority extends over the banking, securities and insurance sector, except for general insurance, plus some activities of professional practitioners that require FSA authorization. General insurance is currently not subject to the 1993 Regulations nor to prudential oversight by the FSA for compliance with anti-money laundering laws. The U.K. authorities noted that the EU Money Laundering Directive, which forms the basis of the U.K.’s AML regime, does not include general insurance. FSA noted that under the predecessor regulatory regime, general insurance had been subject only to prudential regulation, not conduct of business regulation. Nor had general insurance been brought under the 93 AML Regulations. FSA specifically considered whether to include general insurance business within the scope of the ML Sourcebook, and concluded that the costs of imposing the Sourcebook’s requirements could not be justified, given that the Directive and the Regulations do not include general insurance within their scope. The U.K.’s view is that, while it may be possible to launder criminal funds in the high-value, wholesale general insurance business, the potential in retail transactions is minimal. FSA indicated that policy with respect to inclusion of general insurance will be kept under review. (In the ML Sourcebook and in the JMLSG Guidance Notes, reference is made to “relevant” firms and “relevant” insurance firms to indicate that some parts of the insurance industry are not subject to FSA oversight for AML/CFT purposes.) The assessors recommend that general insurance be brought within the coverage of the 1993 Regulations and the Sourcebook.

The laws, regulations and supporting not legally mandatory industry JMLSG Guidance Notes on AML/CFT are applied across all entities and persons subject to FSA supervision (apart from the exclusion of general insurance noted above.) As elaborated above, with certain exceptions, the legal and institutional framework administered by FSA generally addresses all the core requirements for financial service providers: organizational and administrative arrangements, customer due diligence, suspicious transactions reporting, record keeping and controls, information sharing and cooperation; and licensing and authorizations.

FSA Legal Framework. For the financial sector, the multi-level legal framework is founded on a general statutory framework in which the fundamental objectives and requirements are established in laws and regulations, and on a flexible set of industry-produced guidance, the JMLSG Guidance Notes, which provide operational, not legally mandatory guidelines for persons regulated by the FSA.

Under FSMA prevention of financial crime is one of the four statutory objectives of FSA. Both the 1993 Regulations (Regulation 5) and the FSA’s Money Laundering Sourcebook require regulated firms to have effective AML systems and controls in place. These cover: (a) adequate processes for identifying customers, (b) procedures for internal and external reporting of suspicious transactions (to the NCIS), and (c) training of relevant staff.

A variety of other FSA Rules underpin the more specific anti-money laundering requirements of the ML Sourcebook. The systems and controls requirements set out in the FSA’s Handbook apply in a prudential context to U.K. firms with respect to activities wherever they are carried on. [Handbook, SYSC 1.1.9 R]. Accordingly, the FSA would expect that the AML systems and controls in place in firms’ overseas branches should be appropriate and effective in the same way that they should be within the U.K. For firms subject to consolidated supervision, FSA would expect that the AML systems and controls in place in overseas subsidiaries should meet the higher of the local standards or U.K. standards.

The Sourcebook’s requirements apply only to activities conducted from an establishment in the U.K. Firms are required, however, to notify the FSA of any matter that could have a significant impact on their reputation. (Handbook, SUP 15.3.1 R (2)) Accordingly, FSA would expect to be informed if any regulated firm’s foreign branches or subsidiaries were unable to observe the appropriate U.K. AML standards.

The FSA’s Threshold Conditions require firms to satisfy the FSA that they are fit and proper to have permissions to carry out regulated activities. This would extend to qualifications and integrity of staff. Prior law violations and disqualifications are considered in relation to (but are not dispositive of) satisfaction of Threshold Condition 5 (Suitability). In determining satisfaction of TC 5 FSA considers whether the firm has competent and prudent management and exercises due skill, care and diligence (FSA Handbook, COND 2.5.4 G). COND 2.5.7.G provides guidance that the governing body of the firm should be “organized in a way that enables it to address and control the regulated activities of the firm, including those carried on by managers to whom particular functions have been delegated” and that “the firm has made arrangements to put in place an adequate system of internal control to comply with the requirements and standards under the regulatory system.” In determining compliance, the FSA will consider whether the firms have procedures in place to ensure that employees are made aware of the requirements and standards under the regulatory system that apply to the firm and its regulated activities.

The 1993 Regulations (Regulation 5(1)(b) and (c)) require regulated firms to carry out appropriate AML awareness and training of staff. The Sourcebook (6.1.1G) similarly states that staff in relevant firms should be (i) made aware of; and (ii) given regular training about what is expected of them in relation to prevention of money laundering, and what the consequences are – for both themselves and the firm – if they fail to meet that expectation. Firms are required to insure that staff are aware of their responsibilities and of the legal and regulatory framework and to provide appropriate AML training for all their staff who handle, or are managerially responsible for the handling of, transactions that may involve money laundering. This training must be given at least every 2 years. In addition, the not legally mandatory JMLSG Guidance Notes deal with Awareness and Training.

Firms are required to comply with the FSA’s Principles for Businesses, which are a general statement of fundamental obligations under the regulatory system. Breaching a Principle makes a regulated firm liable for disciplinary sanctions. Principle 1 states that a firm “must conduct its business with integrity” and Principle 2 states that it “must conduct its business with due skill, care and diligence.” There is no specific FSA requirement that these Principles be communicated to all members of a regulated firm’s staff.

Implementation. Assuring compliance with AML/CFT requirements is an integral component of FSA activities as a financial supervisor. Compliance is insured through a range of supervisory tools. These include: fit-and-proper evaluations of key personnel as part of the authorized persons regime, on-site monitoring of systems and controls, theme supervision involving horizontal evaluations of a sampling of firms for AML/CFT compliance, off-site reviews of internal reports filed by a sample of firms, risk mitigation programs applied at individual firms, public censure, fines and disciplinary actions, and outreach activities to increase awareness within the financial industry and among consumers.

The FSA operates a risk-based approach to assessing the AML controls maintained by regulated persons. This is designed to concentrate resources on those areas that pose the greatest threat to the FSA’s regulatory objectives, with reduction in financial crime being the key objective considered for this purpose. Key AML priorities for FSA are established based on a comprehensive industry-wide risk assessment. The assessment draws together information on: scale of the sector, number of customers, nature and complexity of products, perceived quality of control environment, capability of sector, number of NCIS referrals, and the nature of the customer base. Priorities for supervision are then established based on judgments about vulnerabilities and the probability that these could pose risks that would negatively impact FSA’s ability to meet its statutory objectives. Scale of business activity is an important factor in determining the impact of identified vulnerabilities. For the current year the money laundering theme has identified six clusters of activities for priority attention. These are: international banking, domestic banking, independent financial advisers handling client money from abroad, on-line broking, spread betting, and credit unions.

The FSMA gives the FSA power effectively to test the internal systems of firms. However, the extent to which the FSA seeks to confirm an individual firm’s compliance with the Sourcebook and other regulatory requirements will depend on the FSA’s risk assessment of the firm, which would generally have regard to: the firm’s regulatory history; information made available by other sources, including the firm’s own notifications; and other information obtained by the FSA.

An FSA examination of an intermediary for compliance with the AML/FSA regime might address: client classification, terms of business and client agreements, “know your customer” information, customer suitability information, disclosure, dealing and managing rules, customer reports and client assets. The FSA may also examine the internal measures that the firm has in place to check its own compliance, including internal audit and compliance arrangements, risk management systems, and AML controls, as well as escalation procedures.

In addition to line supervisors and relationship managers, to aid in assessing regulated firms compliance with the Regulations and the Sourcebook, FSA has:

A Risk Review Team that includes approximately eleven staff with expertise in both AML and fraud issues;
An Intelligence and Records Department which liaises with national and international law enforcement agencies;
A Financial Crime Policy Unit, which, among its activities, provides advice on AML compliance issues and guidance on the requirements of the Sourcebook.

In addition, FSA has the power to appoint what are termed “skilled persons” to investigate compliance issues (SUP 5).

FSA has a very wide range of enforcement powers to take actions against a regulated entity and its management, and directors for noncompliance with supervisory, regulatory, or legal requirements for deterring ML. Based on a risk assessment, for firms deemed to pose a ML risk to FSA’s objectives, a risk mitigation program to address weakness may be applied. Under the authorized persons regime, the MLRO in each firm must meet fit and proper requirements on an ongoing basis. FSA has authority to withdraw or vary permission to carry out regulated activities based on non-compliance. It may also impose fines or public censure on firms and individuals. Under the FSMA, the FSA also has criminal prosecution powers for violation of the 1993 Regulations. Except for criminal prosecution, FSA provided concrete examples of the application of these authorities in specific cases.

As described above, FSA uses a variety of on-site and Off-site techniques to monitor and Enforce compliance with its risk-based customer identification requirements. In line with its own Risk Based Approach to Supervision, intensity of FSA oversight varies across sectors. The following general observations were made with respect to FSA implementation of the AML/CFT regime in the three different sectors:

Banking: FSA oversight of AML/CFT requirements in the banking sector, including KYC requirements, is active and comprehensive. Banking industry awareness is high. No significant issues were identified with respect to FSA implementation of the AML/CFT regime as it applies to the banking industry.

Securities. FSA Oversight of AML/CFT requirements, including KYC requirements, is active and comprehensive among the securities firms of any significant size and, Among these firms, AML/CFT awareness is high. However, under the FSA’s risk based approach to supervision, compliance checks among the large number of very small, low impact securities firms are limited and, for this sector of the securities industry, awareness is likewise less well developed. The assessment mission considers the low level of compliance checking among these small, low impact firms is a significant gap in the overall implementation of the AML/CFT regime. This gap is significant since the overall AML/CFT framework assumes that persons and entities regulated by FSA for AML/CFT purposes may place some reliance on the fact that other counterparts subject to FSA oversight are similarly supervised.

Insurance. As noted in the introductory section, the exclusion of general insurance is a significant gap in the U.K. AML/CFT regime. The standards on which the methodology is based anticipate that the entire insurance industry will be subject to supervision for AML/CFT purposes.

Joint Money Laundering Steering Group Guidance Notes. The JMLSG Guidance Notes are a basic reference work for identifying the standards that are expected of financial sector firms regarding AML requirements. As noted under criterion 46 above, the Guidance Notes are comprehensive and provide detailed guidance on a very broad range of AML/CFT issues firms face in implementing the AML/CFT regime. As discussed above, the JMLSG Guidance Notes are not legally mandated. However, the 1993 Regulations provide that a court may “take account” of such guidance. Likewise, the ML Sourcebook states that FSA “will have regard to” a firms compliance with the JMLSG Guidance Notes in assessing compliance with AML/CFT. While the Guidance Notes are not mandatory, FSA follows a “comply or explain” approach to the Guidance Notes. The authorities report that, in practice, the Guidance Notes are treated as a “safe harbor,” and that financial services firms are expected to provide justification where they follow procedures other than those recommended in the Guidance Notes; as a result, it is reported that most firms follow the Guidance Notes strictly. This understanding was confirmed in discussions with trade associations and with a number of individual firms.

Therefore, in evaluating below whether individual, sector specific criteria for banking, securities and insurance are satisfied we have looked for evidence that the specific subject matter is addressed either in the 1993 Regulations, FSA Rules or in the JMLSG Guidance Notes. In addition, we have considered whether the general FSA supervisory regime described above is applied to the individual, sector specific criterion.

Part A: Assessing the banking sector based on sector specific criteria

211. The Basel Committee’s Core Principles for Effective Banking Supervision (BCP) set out the necessary foundations of a sound supervisory system. The following principles are relevant to AML/CFT: BCP1 on arrangements for sharing information between supervisors; BCP3-5 on licensing and structure; BCP14 on adequate internal controls; BCP15 on adequate policies to prevent use by criminal elements; and BCP23-25 on co-operation between home and host supervisors. In October 2001, the Basel Committee issued detailed AML/CFT recommendations in its “Customer due diligence for banks” paper. The specific criteria for banks in this section are drawn extensively from this paper and should be interpreted with reference to the corresponding paragraphs in this paper. There are no additional criteria for sections I (General framework), V (Suspicious transactions reporting), VII (Integrity standards). The additional specific criteria for banks are as follows:

Table 30.

Detailed Assessment of the Banking Sector Based on Sector-Specific Criteria

Part B: Assessing the insurance sector based on sector specific criteria

212. Insurance entities²⁸ are expected to adopt and enforce AML/CFT policies that will govern the activities of their staff. They also need to ensure that their internal control systems are such as to ensure that policies adopted by their boards and management for preventing and deterring ML and FT are fully implemented, and that prompt follow-up action, such as reporting suspicious transactions to the FIU or other competent authority is taken.

213. The IAIS Core Principles of Insurance Supervision (Insurance Core Principles or ICP). Principles 1, 2, 3, 4, 5, 10, and 16, contain criteria that are relevant for AML/CFT efforts. Most important among these principles for AML/CFT purposes are internal controls. That said, experience with ICP assessments has revealed that in many cases internal control procedures within insurance entities are not well established and supervisors have been weak in promoting their development. If management and supervisors are not able to rely on internal control systems for general operating purposes, it will be unlikely that company management and staff will have effective AML/CFT controls.

214. The sector-specific criteria draw extensively from the IAIS “AML Guidance Notes for insurance supervisors and insurance entities” as of January 2002. There are no additional criteria for sections I (General framework), VII (Integrity standards), VIII (Enforcement powers and sanctions), and IX (Financial Supervisors). The additional specific criteria for insurance entities are as follows:

Table 31.

Detailed Assessment of the Insurance Sector Based on Sector Specific Criteria

Part C: Assessing the securities sector based on sector specific criteria

215. The international standards for securities regulation are set out in the “Objectives and Principles of Regulation” of the International Organization of Securities Commissions (IOSCO Core Principles) (issued in September 1998 and updated in February 2002). The IOSCO Core Principles document sets forth the objectives and principles upon which sound and effective securities regulation is based. Other IOSCO Public Documents and Resolutions also may provide further explanatory material relating to matters addressed by the IOSCO Principles. IOSCO Reports are cross-referenced to the IOSCO Principles in the February 2002 edition of the Principles. IOSCO Public Document No. 26, Report on Money Laundering, IOSCO Technical Committee, October 1992, is especially relevant. ²⁹

216. It is important to note that the IOSCO Core Principles were not created for the purpose of achieving an anti-money laundering regime. However, securities regulation complements the fight against money laundering, and the particular IOSCO Core Principles set forth below are relevant to assessing compliance with AML/CFT standards.

217. In assessing the securities sector for compliance with AML/CFT standards, the assessor should view Sections 2.2.1 and 2.2.2 (Part C) as integral components. Additionally, it is preferable that assessment of compliance with the criteria in Sections 2.2.1 and 2.2.4 (Part C) should be done either by or in close consultation with the assessor responsible for assessing a jurisdiction’s compliance with the IOSCO Core Principles. The assessor responsible for assessing compliance with the IOSCO Core Principles will be intimately familiar with the criteria for which an IOSCO Core Principle will be deemed implemented.

218. There are no additional sector-specific criteria for sections I (General framework), III (Ongoing monitoring of accounts and transactions), and V (Suspicious transactions reporting). The additional specific criteria for the securities sector are as follows:

Table 32.

Detailed Assessment of Securities Sector based on Sector Specific Criteria

F. Description of the Controls and Monitoring of Cash and Cross Border Transactions

219. This section, based on FATF 22-23, is designed to collect information on any measures that may exist to control or monitor large cash transactions, and cross border movements of currency, monetary instruments or wire transfers. The section will not be used to assess compliance with AML/CFT criteria, but is included in the detailed assessment report to gain a broader understanding of the AML/CFT system. The questions include general financial conditions that influence the use of cash and any particular factors that have resulted in increase or decrease in the use of cash in transactions (e.g., existence of financial transaction taxes, use of credit or debit cards; limitations on size denomination of bank notes; confidence in the banking system, etc).

Table 33.

Description of the Controls and Monitoring of Cash and Cross Border Transactions What has the jurisdiction done in response to the following FATF Recommendations?

G. Ratings of Compliance with FATF Recommendations, Summary of Effectiveness of AML/CFT efforts, Recommended Action Plan and Authorities’ Response to the Assessment

Table 34.

Ratings of Compliance with FATF Recommendations Requiring Specific Action

Table 34.

Ratings of Compliance with FATF Recommendations Requiring Specific Action

FATF Recommendation	Based on Criteria Rating	Rating
1 – Ratification and implementation of the Vienna Convention	1	COMPLIANT
2 – Secrecy laws consistent with the 40 Recommendations	43	LARGELY COMPLIANT
3 – Multilateral cooperation and mutual legal assistance in combating ML	34, 36, 38, 40	COMPLIANT
4 – ML a criminal offense (Vienna Convention) based on drug ML and other serious offenses.	2	COMPLIANT
5 – Knowing ML activity a criminal offense (Vienna Convention)	4	COMPLIANT
7 – Legal and administrative conditions for provisional measures, such as freezing, seizing, and confiscation (Vienna Convention)	7, 7.3, 8, 9, 10, 11	LARGELY COMPLIANT
8 – FATF Recommendations 10 to 29 applied to non-bank financial institutions; (e.g., foreign exchange houses)		See answers to 10 to 29
10 – Prohibition of anonymous accounts and implementation of customer identification policies	45, 46, 46.1	LARGELY COMPLIANT
11 – Obligation to take reasonable measures to obtain information about customer identity	46.1, 47	LARGELY COMPLIANT
12 – Comprehensive record keeping for five years of transactions, accounts, correspondence, and customer identification documents	52, 53, 54	LARGELY COMPLIANT
14 – Detection and analysis of unusual large or otherwise suspicious transactions	17.2, 49	LARGELY COMPLIANT
15 – If financial institutions suspect that funds stem from a criminal activity, they should be required to report promptly their suspicions to the FIU	55	LARGELY COMPLIANT
16 – Legal protection for financial institutions, their directors and staff if they report their suspicions in good faith to the FIU	56	COMPLIANT
17 – Directors, officers and employees, should not warn customers when information relating to them is reported to the FIU	57	COMPLIANT
18 – Compliance with instructions for suspicious transactions reporting	57	COMPLIANT
19 – Internal policies, procedures, controls, audit, and training programs	58, 58.1, 59, 60	LARGELY COMPLIANT
20 – AML rules and procedures applied to branches and subsidiaries located abroad	61	COMPLIANT
21 – Special attention given to transactions with higher risk countries	50, 50.1	LARGELY COMPLIANT
26 – Adequate AML programs in supervised banks, financial institutions or intermediaries; authority to cooperate with judicial and law enforcement	66	COMPLIANT
28 – Guidelines for suspicious transactions’ detection	17.2, 50.1, 55.2	LARGELY COMPLIANT
29 – Preventing control of, or significant participation in financial institutions by criminals	62	LARGELY COMPLIANT
32 – International exchange of information relating to suspicious transactions, and to persons or corporations involved	22, 22.1, 34	COMPLIANT
33 – Bilateral or multilateral agreement on information exchange when legal standards are different should not affect willingness to provide mutual assistance	34.2, 35.1	COMPLIANT
34 – Bilateral and multilateral agreements and arrangements for widest possible range of mutual assistance	34, 34.1, 36, 37	COMPLIANT
37 – Existence of procedures for mutual assistance in criminal matters for production of records, search of persons and premises, seizure and obtaining of evidence for ML investigations and prosecution	27, 34, 34.1, 35.2	COMPLIANT
38 – Authority to take expeditious actions in response to foreign countries’ requests to identify, freeze, seize and confiscate proceeds or other property	11, 15, 16, 34, 34.1, 35.2, 39	COMPLIANT
40 – ML an extraditable offense	34, 40	COMPLIANT
SR I – Take steps to ratify and implement relevant United Nations instruments	1, 34	COMPLIANT
SR II – Criminalize the FT and terrorist organizations	2.3, 3, 3.1	COMPLIANT
SR III – Freeze and confiscate terrorist assets	7, 7.3, 8, 13	LARGELY COMPLIANT
SR IV – Report suspicious transactions linked to terrorism	55	LARGELY COMPLIANT
SR V – provide assistance to other countries’ FT investigations	34, 34.1, 37, 40, 41	COMPLIANT
SR VI – impose AML requirements on alternative remittance systems	45, 46, 46.1, 47, 49, 50, 50.1, 52, 53, 54, 55, 56, 57, 58, 58.1, 59, 60, 61, 62	rated where applicable NA
SR VII – Strengthen customer identification measures for wire transfers	48, 51	NON-COMPLIANT

Table 34.

Ratings of Compliance with FATF Recommendations Requiring Specific Action

FATF Recommendation	Based on Criteria Rating	Rating
1 – Ratification and implementation of the Vienna Convention	1	COMPLIANT
2 – Secrecy laws consistent with the 40 Recommendations	43	LARGELY COMPLIANT
3 – Multilateral cooperation and mutual legal assistance in combating ML	34, 36, 38, 40	COMPLIANT
4 – ML a criminal offense (Vienna Convention) based on drug ML and other serious offenses.	2	COMPLIANT
5 – Knowing ML activity a criminal offense (Vienna Convention)	4	COMPLIANT
7 – Legal and administrative conditions for provisional measures, such as freezing, seizing, and confiscation (Vienna Convention)	7, 7.3, 8, 9, 10, 11	LARGELY COMPLIANT
8 – FATF Recommendations 10 to 29 applied to non-bank financial institutions; (e.g., foreign exchange houses)		See answers to 10 to 29
10 – Prohibition of anonymous accounts and implementation of customer identification policies	45, 46, 46.1	LARGELY COMPLIANT
11 – Obligation to take reasonable measures to obtain information about customer identity	46.1, 47	LARGELY COMPLIANT
12 – Comprehensive record keeping for five years of transactions, accounts, correspondence, and customer identification documents	52, 53, 54	LARGELY COMPLIANT
14 – Detection and analysis of unusual large or otherwise suspicious transactions	17.2, 49	LARGELY COMPLIANT
15 – If financial institutions suspect that funds stem from a criminal activity, they should be required to report promptly their suspicions to the FIU	55	LARGELY COMPLIANT
16 – Legal protection for financial institutions, their directors and staff if they report their suspicions in good faith to the FIU	56	COMPLIANT
17 – Directors, officers and employees, should not warn customers when information relating to them is reported to the FIU	57	COMPLIANT
18 – Compliance with instructions for suspicious transactions reporting	57	COMPLIANT
19 – Internal policies, procedures, controls, audit, and training programs	58, 58.1, 59, 60	LARGELY COMPLIANT
20 – AML rules and procedures applied to branches and subsidiaries located abroad	61	COMPLIANT
21 – Special attention given to transactions with higher risk countries	50, 50.1	LARGELY COMPLIANT
26 – Adequate AML programs in supervised banks, financial institutions or intermediaries; authority to cooperate with judicial and law enforcement	66	COMPLIANT
28 – Guidelines for suspicious transactions’ detection	17.2, 50.1, 55.2	LARGELY COMPLIANT
29 – Preventing control of, or significant participation in financial institutions by criminals	62	LARGELY COMPLIANT
32 – International exchange of information relating to suspicious transactions, and to persons or corporations involved	22, 22.1, 34	COMPLIANT
33 – Bilateral or multilateral agreement on information exchange when legal standards are different should not affect willingness to provide mutual assistance	34.2, 35.1	COMPLIANT
34 – Bilateral and multilateral agreements and arrangements for widest possible range of mutual assistance	34, 34.1, 36, 37	COMPLIANT
37 – Existence of procedures for mutual assistance in criminal matters for production of records, search of persons and premises, seizure and obtaining of evidence for ML investigations and prosecution	27, 34, 34.1, 35.2	COMPLIANT
38 – Authority to take expeditious actions in response to foreign countries’ requests to identify, freeze, seize and confiscate proceeds or other property	11, 15, 16, 34, 34.1, 35.2, 39	COMPLIANT
40 – ML an extraditable offense	34, 40	COMPLIANT
SR I – Take steps to ratify and implement relevant United Nations instruments	1, 34	COMPLIANT
SR II – Criminalize the FT and terrorist organizations	2.3, 3, 3.1	COMPLIANT
SR III – Freeze and confiscate terrorist assets	7, 7.3, 8, 13	LARGELY COMPLIANT
SR IV – Report suspicious transactions linked to terrorism	55	LARGELY COMPLIANT
SR V – provide assistance to other countries’ FT investigations	34, 34.1, 37, 40, 41	COMPLIANT
SR VI – impose AML requirements on alternative remittance systems	45, 46, 46.1, 47, 49, 50, 50.1, 52, 53, 54, 55, 56, 57, 58, 58.1, 59, 60, 61, 62	rated where applicable NA
SR VII – Strengthen customer identification measures for wire transfers	48, 51	NON-COMPLIANT

Table 35.

Summary of Effectiveness of AML/CFT Efforts for Each Heading

Table 35.

Summary of Effectiveness of AML/CFT Efforts for Each Heading

Heading	Assessment of Effectiveness
Criminal Justice Measures and International Cooperation
I—Criminalization of ML and FT	U.K. law generally criminalizes money laundering on the basis of the Vienna and Palermo Conventions. Additional significant enhancements are provided for under the PCA 2002, which updates, unifies, and expands the applicable ML offenses, inter alia, by broadening the criminal intent requirement for certain crimes, removing the distinctions between drug and non-drug ML, and consolidating into one statute the dispersed provisions of U.K. law governing the criminalization of ML. The U.K. has criminalized FT on the basis of the 1999 UN International Convention for the Suppression of the Financing of Terrorism. Adequate and dissuasive sanctions are available for persons that commit ML or FT offences.
II—Confiscation of proceeds of crime or property used to finance terrorism	U.K. law provides broad authority for the competent authorities to confiscate property related to ML and FT, including laundered property or proceeds from, instrumentalities used in or instrumentalities intended for use in the commission of ML/FT offences. The PCA 2002 would enhance these provisions, inter alia, by expanding the circumstances in which restraint (freezing) orders can be issued; greatly expanding civil recovery powers; improving the procedures governing confiscation of the proceeds of crime; and creating a new ARA with functions focused on increasing criminal confiscation, implementing the PCA’s new civil recovery powers, and taxing the proceeds of crime. Heretofore, confiscation has not been a priority of the U.K. Crown Prosecution Services, which also lacks resources to handle confiscation matters.
III—The FIU and processes for receiving, analyzing, and disseminating financial information and other intelligence at the domestic and international levels	NCIS functions as an effective FIU within the National Criminal Intelligence Service with functions related to all serious crimes. It has broad powers to gather, store and analyze information in order to provide and disseminate criminal intelligence. Its systems are modern and sophisticated. It cooperates effectively with national and overseas counterparts. Implementation of PCA 2002 will substantially enhance NCIS operating arrangements and authority.
IV—Law enforcement and prosecution authorities, powers and duties	U.K. law provides the various law enforcement agencies with a broad range of powers to conduct investigations of ML, FT and predicate offenses, including the power to compel production of financial records. U.K. law provides an adequate legal basis to use a wide range of investigative techniques, including controlled delivery and undercover operations. When the PCA 2002 enters into effect, certain more robust information gathering methods (customer information orders and account monitoring orders) would become available in all criminal investigations, rather than only FT and other terrorism investigations as is currently the case. A range of law enforcement and prosecution agencies undertake the investigation and prosecution of ML and FT and the U.K. is committed to ensuring that its law enforcement, supervisory and judicial systems are properly resourced. When fully implemented the new legal tools available to the U.K. authorities will make it harder for money launderers to move their money and are essential components of an overall strategy to combat ML. However, a national ML strategy, drawing on the work of all relevant agencies, needs to be articulated. An important precursor to establishing a strategy and priorities is NCIS’ work in preparing trend analyses and vulnerability reviews to guide policy makers. There are other areas of concern, including the fact that there is no single law enforcement entity that covers all aspects of ML in the U.K.; there is no law enforcement entity that has as its mission the investigation of criminal acts and foreign counter-intelligence; the Crown Prosecution Service does not prosecute any matters other than narcotic ML; beyond the work done by NCIS on typologies, there does not appear to be any effort to identify on a national basis the U.K.’s vulnerabilities to ML and FT. The willingness of FSA to use its new criminal prosecution authority has not yet been established and is likely to be hampered by FSA total reliance on a risk based approach to determine which financial institutions to subject to on site examination.
V—International cooperation	The U.K. has laws and informal arrangements and procedures that allow comprehensive cooperation in AML/CFT matters. Most assistance is provided through informal processes rather than through the formal routes embodied in the criminal statutes and international treaties. There are also multilateral and bilateral arrangements for extradition, as well as statutory procedures for one-off extradition arrangements, the latter of which are reported to be cumbersome in practice. A bill to improve extradition procedures has been submitted to Parliament. The U.K. has a comprehensive system in place for the provision of mutual legal assistance and the arrangements are coordinated by the U.K.CA. The U.K. has improved its response rate and turnaround times by devoting extra resources to this activity. The extensive efforts undertaken by HMT in supporting the FATF and the regional FATF-style bodies have been essential to their success in changing and enhancing the effectiveness with which the world addresses money laundering and now the financing of terrorism.

Legal and Institutional Framework for All Financial Institutions
I—General framework	With one noteworthy exception, confidentiality and secrecy laws or agreements do not in the U.K. inhibit implementation of the criteria called for by the methodology. The exception is due to legal requirements applicable to attorneys and accountants that may prevent financial institutions and MSBs from inquiring into (and preclude lawyers and accountants from divulging) the identity of the underlying clients when an attorney or accountant opens an account to hold client’s funds. The operational significance of these secrecy provisions has not be established. The FSA is the designated agency for ensuring that the FATF 40 + 8 Recommendations are effectively implemented in almost all of the prudentially regulated financial sector. General insurance is not included in this regime, however. FSA supervision is generally effective, although compliance checking of small securities firms is limited. HMCE has recently been given responsibility for insuring that AML-CFT requirements are implanted by money service businesses. By design, HMCE applies a “light touch” supervisory regime to MSBs. In general, HMCE’s oversight of MSBs is too recent to be evaluated under the criteria set forth in the Methodology.
II—Customer identification	Legal requirements for customer due diligence for financial firms and MSBs are contained in the 1993 Regulations and for certain FSA-supervised firms, in the FSA Money Laundering Sourcebook. Legal requirements are supplemented by detailed guidance provided in the non-mandatory industry-issued Guidance Notes. Taken together, these legal requirements and guidance provide a comprehensive standard that, on a day to day basis, is effectively enforced or (in the case of the Guidance Notes) encouraged by supervisors.
III—Ongoing monitoring of accounts and transactions	U.K. law imposes criminal liability on financial institutions and MSBs to report knowledge or suspicion of ML or FT. However, neither law nor regulation imposes an affirmative obligation to pay special attention to complex transactions, to give special attention to transactions with persons in jurisdictions that do not have adequate AML-CFT requirements, nor to give enhanced scrutiny to wire transfers. However, the guidance in the non-mandatory Guidance Notes calls for firms to monitor accounts and transactions in line with the standards set out in the Methodology. FSA monitoring of compliance in this area by regulated financial firms is effective.
IV—Record keeping	With minor exceptions the U.K. has comprehensive record keeping requirements in line with the standards called for in the methodology. Subject to the exceptions noted for general insurance and small securities firms, FSA monitoring of compliance in this area by regulated financial firms is effective.
V—Suspicious transactions reporting	Financial institutions and MSBs are required to report suspicions of ML or FT under the criminal laws and the 1993 Regulations, as well as under the Sourcebook (in the case of certain financial). When it comes into force PCA 2002 will strengthen and streamline the legal requirements for suspicious transaction reporting, inter alia, by expanding the applicable criminal intent requirement, requiring that all STRs of regulated entities be filed with NCIS (rather than with any “constable” as is currently the case), and providing for use of a uniform, system-wide STR form. Subject to the exceptions noted above, FSA implementation of the suspicious transactions reporting requirement is effective.
VI—Internal controls, compliance and audit	With a few exceptions, the U.K. requires internal controls and compliance functions applicable to AML that satisfy the standards specified in the Methodology. However, there are no express requirements concerning CFT internal controls and procedures. Although the definition of ML includes various FT predicate crimes, it is doubtful that the obligation to have AML systems and controls can be read as requiring CFT systems and controls where no ML is involved (e.g., where the source of funds used for FT is legitimate). There is as yet no comprehensive best practices or agreed upon approach concerning CFT controls, but the U.K. may be an appropriate jurisdiction to take a lead in this area. FSA supervision provides effective implementation of the requirements for internal systems and controls. subject to the qualifications noted with respect to general insurance and small securities firms.
VII—Integrity standards	The integrity standards established under U.K. law and regulation generally conform to the standards specified in the Methodology. FSA supervision achieves effective implementation of these standards among regulated firms. While fit and proper requirements are a prominent feature of U.K. regulation of financial institutions, U.K. laws and regulations do not explicitly bar criminals from holding or controlling a significant investment in financial institutions or MSBs, and there is no fit and proper or other integrity-based regime for MSBs.
VIII—Enforcement powers and sanctions	Violations of the Regulation’s requirements to adopt appropriate AML procedures and controls for customer identification, record keeping, suspicious transactions reporting, employee awareness and training, and other aspects of ML prevention are punishable as a criminal offense. No criminal sanctions apply for violation of the regulatory requirements established in the Sourcebook. However, under its general enforcement authority FSA has a broad range of enforcement tools at its disposal to deal with breaches of those requirements. The 1993 regulations do not provide for the imposition of civil penalties for violations of AML-CFT systems and controls requirements. Other than criminal sanctions, HMCE has only limited civil sanctions available to it to enforce compliance by MSBs with AML-CFT requirements.
IX—Co-operation between supervisors and other competent authorities	FSA is generally adequately funded, staffed and provided with technical resources and specialized expertise to carry out its AML-CFT responsibilities. Additional resources would permit more thorough compliance checking. HMCE has adequate technical resources and specialized expertise but it is unclear if the planned self – financing scheme for supervision of MSBs will provide adequate funding to allow HMCE to carry out its responsibilities under the 2001 Regulations. Under FSMA, FSA has broad authority to cooperate and share information with other competent authorities. Gateways are provided. These provisions enable the FSA, on its own initiative or upon request, to exchange information relating to suspicious transactions with other domestic and foreign financial supervisors and law enforcement agencies. No court authorization is required for such disclosure of information by FSA. FSA is proactive in exercising its authority to co-operate and exchange information with other competent authorities. HMCE has similar authority although it is too early to evaluate its operational practices as they relate to MSB’s.

Table 35.

Summary of Effectiveness of AML/CFT Efforts for Each Heading

Heading	Assessment of Effectiveness
Criminal Justice Measures and International Cooperation
I—Criminalization of ML and FT	U.K. law generally criminalizes money laundering on the basis of the Vienna and Palermo Conventions. Additional significant enhancements are provided for under the PCA 2002, which updates, unifies, and expands the applicable ML offenses, inter alia, by broadening the criminal intent requirement for certain crimes, removing the distinctions between drug and non-drug ML, and consolidating into one statute the dispersed provisions of U.K. law governing the criminalization of ML. The U.K. has criminalized FT on the basis of the 1999 UN International Convention for the Suppression of the Financing of Terrorism. Adequate and dissuasive sanctions are available for persons that commit ML or FT offences.
II—Confiscation of proceeds of crime or property used to finance terrorism	U.K. law provides broad authority for the competent authorities to confiscate property related to ML and FT, including laundered property or proceeds from, instrumentalities used in or instrumentalities intended for use in the commission of ML/FT offences. The PCA 2002 would enhance these provisions, inter alia, by expanding the circumstances in which restraint (freezing) orders can be issued; greatly expanding civil recovery powers; improving the procedures governing confiscation of the proceeds of crime; and creating a new ARA with functions focused on increasing criminal confiscation, implementing the PCA’s new civil recovery powers, and taxing the proceeds of crime. Heretofore, confiscation has not been a priority of the U.K. Crown Prosecution Services, which also lacks resources to handle confiscation matters.
III—The FIU and processes for receiving, analyzing, and disseminating financial information and other intelligence at the domestic and international levels	NCIS functions as an effective FIU within the National Criminal Intelligence Service with functions related to all serious crimes. It has broad powers to gather, store and analyze information in order to provide and disseminate criminal intelligence. Its systems are modern and sophisticated. It cooperates effectively with national and overseas counterparts. Implementation of PCA 2002 will substantially enhance NCIS operating arrangements and authority.
IV—Law enforcement and prosecution authorities, powers and duties	U.K. law provides the various law enforcement agencies with a broad range of powers to conduct investigations of ML, FT and predicate offenses, including the power to compel production of financial records. U.K. law provides an adequate legal basis to use a wide range of investigative techniques, including controlled delivery and undercover operations. When the PCA 2002 enters into effect, certain more robust information gathering methods (customer information orders and account monitoring orders) would become available in all criminal investigations, rather than only FT and other terrorism investigations as is currently the case. A range of law enforcement and prosecution agencies undertake the investigation and prosecution of ML and FT and the U.K. is committed to ensuring that its law enforcement, supervisory and judicial systems are properly resourced. When fully implemented the new legal tools available to the U.K. authorities will make it harder for money launderers to move their money and are essential components of an overall strategy to combat ML. However, a national ML strategy, drawing on the work of all relevant agencies, needs to be articulated. An important precursor to establishing a strategy and priorities is NCIS’ work in preparing trend analyses and vulnerability reviews to guide policy makers. There are other areas of concern, including the fact that there is no single law enforcement entity that covers all aspects of ML in the U.K.; there is no law enforcement entity that has as its mission the investigation of criminal acts and foreign counter-intelligence; the Crown Prosecution Service does not prosecute any matters other than narcotic ML; beyond the work done by NCIS on typologies, there does not appear to be any effort to identify on a national basis the U.K.’s vulnerabilities to ML and FT. The willingness of FSA to use its new criminal prosecution authority has not yet been established and is likely to be hampered by FSA total reliance on a risk based approach to determine which financial institutions to subject to on site examination.
V—International cooperation	The U.K. has laws and informal arrangements and procedures that allow comprehensive cooperation in AML/CFT matters. Most assistance is provided through informal processes rather than through the formal routes embodied in the criminal statutes and international treaties. There are also multilateral and bilateral arrangements for extradition, as well as statutory procedures for one-off extradition arrangements, the latter of which are reported to be cumbersome in practice. A bill to improve extradition procedures has been submitted to Parliament. The U.K. has a comprehensive system in place for the provision of mutual legal assistance and the arrangements are coordinated by the U.K.CA. The U.K. has improved its response rate and turnaround times by devoting extra resources to this activity. The extensive efforts undertaken by HMT in supporting the FATF and the regional FATF-style bodies have been essential to their success in changing and enhancing the effectiveness with which the world addresses money laundering and now the financing of terrorism.

Legal and Institutional Framework for All Financial Institutions
I—General framework	With one noteworthy exception, confidentiality and secrecy laws or agreements do not in the U.K. inhibit implementation of the criteria called for by the methodology. The exception is due to legal requirements applicable to attorneys and accountants that may prevent financial institutions and MSBs from inquiring into (and preclude lawyers and accountants from divulging) the identity of the underlying clients when an attorney or accountant opens an account to hold client’s funds. The operational significance of these secrecy provisions has not be established. The FSA is the designated agency for ensuring that the FATF 40 + 8 Recommendations are effectively implemented in almost all of the prudentially regulated financial sector. General insurance is not included in this regime, however. FSA supervision is generally effective, although compliance checking of small securities firms is limited. HMCE has recently been given responsibility for insuring that AML-CFT requirements are implanted by money service businesses. By design, HMCE applies a “light touch” supervisory regime to MSBs. In general, HMCE’s oversight of MSBs is too recent to be evaluated under the criteria set forth in the Methodology.
II—Customer identification	Legal requirements for customer due diligence for financial firms and MSBs are contained in the 1993 Regulations and for certain FSA-supervised firms, in the FSA Money Laundering Sourcebook. Legal requirements are supplemented by detailed guidance provided in the non-mandatory industry-issued Guidance Notes. Taken together, these legal requirements and guidance provide a comprehensive standard that, on a day to day basis, is effectively enforced or (in the case of the Guidance Notes) encouraged by supervisors.
III—Ongoing monitoring of accounts and transactions	U.K. law imposes criminal liability on financial institutions and MSBs to report knowledge or suspicion of ML or FT. However, neither law nor regulation imposes an affirmative obligation to pay special attention to complex transactions, to give special attention to transactions with persons in jurisdictions that do not have adequate AML-CFT requirements, nor to give enhanced scrutiny to wire transfers. However, the guidance in the non-mandatory Guidance Notes calls for firms to monitor accounts and transactions in line with the standards set out in the Methodology. FSA monitoring of compliance in this area by regulated financial firms is effective.
IV—Record keeping	With minor exceptions the U.K. has comprehensive record keeping requirements in line with the standards called for in the methodology. Subject to the exceptions noted for general insurance and small securities firms, FSA monitoring of compliance in this area by regulated financial firms is effective.
V—Suspicious transactions reporting	Financial institutions and MSBs are required to report suspicions of ML or FT under the criminal laws and the 1993 Regulations, as well as under the Sourcebook (in the case of certain financial). When it comes into force PCA 2002 will strengthen and streamline the legal requirements for suspicious transaction reporting, inter alia, by expanding the applicable criminal intent requirement, requiring that all STRs of regulated entities be filed with NCIS (rather than with any “constable” as is currently the case), and providing for use of a uniform, system-wide STR form. Subject to the exceptions noted above, FSA implementation of the suspicious transactions reporting requirement is effective.
VI—Internal controls, compliance and audit	With a few exceptions, the U.K. requires internal controls and compliance functions applicable to AML that satisfy the standards specified in the Methodology. However, there are no express requirements concerning CFT internal controls and procedures. Although the definition of ML includes various FT predicate crimes, it is doubtful that the obligation to have AML systems and controls can be read as requiring CFT systems and controls where no ML is involved (e.g., where the source of funds used for FT is legitimate). There is as yet no comprehensive best practices or agreed upon approach concerning CFT controls, but the U.K. may be an appropriate jurisdiction to take a lead in this area. FSA supervision provides effective implementation of the requirements for internal systems and controls. subject to the qualifications noted with respect to general insurance and small securities firms.
VII—Integrity standards	The integrity standards established under U.K. law and regulation generally conform to the standards specified in the Methodology. FSA supervision achieves effective implementation of these standards among regulated firms. While fit and proper requirements are a prominent feature of U.K. regulation of financial institutions, U.K. laws and regulations do not explicitly bar criminals from holding or controlling a significant investment in financial institutions or MSBs, and there is no fit and proper or other integrity-based regime for MSBs.
VIII—Enforcement powers and sanctions	Violations of the Regulation’s requirements to adopt appropriate AML procedures and controls for customer identification, record keeping, suspicious transactions reporting, employee awareness and training, and other aspects of ML prevention are punishable as a criminal offense. No criminal sanctions apply for violation of the regulatory requirements established in the Sourcebook. However, under its general enforcement authority FSA has a broad range of enforcement tools at its disposal to deal with breaches of those requirements. The 1993 regulations do not provide for the imposition of civil penalties for violations of AML-CFT systems and controls requirements. Other than criminal sanctions, HMCE has only limited civil sanctions available to it to enforce compliance by MSBs with AML-CFT requirements.
IX—Co-operation between supervisors and other competent authorities	FSA is generally adequately funded, staffed and provided with technical resources and specialized expertise to carry out its AML-CFT responsibilities. Additional resources would permit more thorough compliance checking. HMCE has adequate technical resources and specialized expertise but it is unclear if the planned self – financing scheme for supervision of MSBs will provide adequate funding to allow HMCE to carry out its responsibilities under the 2001 Regulations. Under FSMA, FSA has broad authority to cooperate and share information with other competent authorities. Gateways are provided. These provisions enable the FSA, on its own initiative or upon request, to exchange information relating to suspicious transactions with other domestic and foreign financial supervisors and law enforcement agencies. No court authorization is required for such disclosure of information by FSA. FSA is proactive in exercising its authority to co-operate and exchange information with other competent authorities. HMCE has similar authority although it is too early to evaluate its operational practices as they relate to MSB’s.

Table 36.

Recommended Action Plan to Improve the Legal and Institutional Framework and to Strengthen the Implementation of AML/CFT Measures in Banking, Insurance and Securities Sectors

Table 36.

Recommended Action Plan to Improve the Legal and Institutional Framework and to Strengthen the Implementation of AML/CFT Measures in Banking, Insurance and Securities Sectors

Criminal Justice Measures and International Cooperation	Recommended Action
I—Criminalization of ML and FT	1. The U.K. should ratify as soon as possible the UN Convention Against Transnational Organized Crime 2000 (Palermo Convention). 2. The definition of ML under the 1993 Regulations (section 2 (3)) should be corrected to cross-reference current laws (including recent FT legislation) and delete obsolete cross-references.
II—Confiscation of proceeds of crime or property used to finance terrorism	The PCA 2002 provisions governing confiscation, seizure, assets recovery and civil recovery should be made effective as soon as possible, given the significant enhancements they make to the U.K. regime.
III—The FIU and processes for receiving, analyzing, and disseminating financial information and other intelligence at the domestic and international levels	1. The PCA should be made effective as soon as possible, given its substantial enhancements to the arrangements under which NCIS functions. 2. NCIS (or other appropriate government agency) should be given authority to impose civil fines on reporting parties – other than prudential regulated financial institutions – that fail to comply with their reporting obligations under the 1993 Regulations. 3. Consideration should be given to providing NCIS with the power to get supporting documents (rather than general information) from reporting parties that file STRs with it.
IV—Law enforcement and prosecution authorities, powers and duties	1. As there is no law enforcement entity that has as its mission the investigation of criminal acts and foreign counter-intelligence, the U.K. should seriously consider the creation of a national law enforcement organization which has both these elements. 2. Consideration should be given to passing legislation that makes wiretap evidence admissible in judicial proceedings. 3. Special legislative considerations should be given to protecting national security information while balancing the defendants right to have access (in some form) to relevant evidence. 4. NCIS or other competent authorities should undertake a U.K. trend analysis and vulnerability study of how and where money—especially cash—is laundered in the United Kingdom, in order to focus priorities and successfully use the new PCA 2002 and ARA powers. 5. Prosecutors and judges should be trained on ML and asset confiscation so as to ensure adequate application of U.K. legislation.
V—International cooperation	Legislation to enhance the statutory provisions on extradition should be adopted as soon as possible.

Legal and Institutional Framework for Financial Institutions
I—General framework	1. Existing legal constraints should be relaxed on the ability of attorneys and accountants to identify their clients when acting on behalf of those clients. Financial institutions and MSBs should be cautioned against doing business with attorneys and accountants that are unable to provide information about the customers for whom they are opening accounts. 2. The self-financing scheme for HMCE supervision of MSBs should be kept under close review, to determine whether or not it can reasonably be expected to produce enough fees to enable HMCE to reasonably carry out its functions under the 2001 Regulations.
II—Customer identification	1. Financial institutions and MSBs should be required by law to include accurate and meaningful originator information on funds transfers and related messages that should remain with the transfer or message through the payment chain. 3. General insurance should be brought within the scope of the 1993 Regulations and FSA Rules with compliance checking of the insurance sector strengthened. 4. Small securities firms should be subject to systematic checks by FSA for compliance with AML-CFT due diligence and record keeping requirements, if only on a sampling basis. 4. Industry Guidance Notes should be prepared for MSBs. 5. Tighter limits should be placed on the circumstances in which firms may accept funds from applicants before satisfactory identity is obtained. In addition, the “financial exclusion” provision of the FSA Sourcebook should be drafted more narrowly so as to cover only financially disadvantaged persons. 6. Consideration could be given to assigning a supervisory authority to ensure compliance with the 1993 Regulations by covered entities that are not financial institutions or MSBs.
III—Ongoing monitoring of accounts and transactions	The 1993 Regulations and FSA Sourcebook should be revised (or other appropriate legal instrument issued) to impose an affirmative legal obligation for financial institutions and MSBs: a) to pay special attention to unusual transactions with no apparent economic or lawful purpose; b) to give special attention to business relations and transactions with persons in jurisdictions that do not have adequate systems in place to prevent or deter ML and FT; and c) to give enhanced scrutiny to wire transfers that do not contain complete originator information.
IV—Record keeping	1. Minimum information requirements should be made mandatory by amending the 1993 Regulations and the Sourcebook. 2. Financial institutions and MSBs should be required to keep records of the basis on which exceptions are granted to customer due diligence requirements.
V—Suspicious transactions reporting	1. Part 7 of the PCA 2002 will significantly strengthen the legal regime for suspicious transactions reporting and should be made effective as soon as possible. 2. Consideration should be given to amending the 1993 Regulations and the Sourcebook, or to introducing new regulations, to impose FT-related suspicious transactions reporting requirements.
VI—Internal controls, compliance and audit	1. Consideration should be given to requiring financial institutions and MSBs to adopt internal controls and procedures, and designate an appropriate compliance person, to prevent their institutions from being used for FT as such (rather than only for ML and FT-related predicate offenses). 2. Consideration should be given to expressly requiring that the AML/CFT programs of financial institutions and MSBs must include an audit function. 3. The 1993 Regulations should be revised to expressly require that the “appropriate person’ required under the Regulations to handle the internal and external reporting requirements of the Regulations must be at management level. 4. MSBs should be required to put in place adequate screening procedures to ensure high standards when hiring employees.
VII—Integrity standards	1. The 1993 Regulations, Sourcebook or other appropriate legal provisions should be revised to explicitly prohibit criminals from holding or controlling a significant investment in financial institutions and MSBs. 2. The 2001 Regulations should also be revised to give HMCE powers to deny or cancel the registration of MSBs for integrity-related factors (e.g., previous convictions for ML, FT or similar serious crimes of the MSB, its controlling shareholders or managers).
VIII—Enforcement powers and sanctions	The 1993 Regulations should be revised to provide for civil penalties (administrative fines), in addition to the existing criminal penalties, for failure to observe the Regulations’ requirements to adopt appropriate AML procedures and controls. This is particularly important with respect to strengthening HMCE’s enforcement authority over MSB’s.
IX—Co-operation between supervisors and other competent authorities
Banking Sector based on Sector-Specific Criteria
II—Customer identification	As noted above, Financial institutions and MSBs should be cautioned against doing business with attorneys and accountants that are unable to provide information about the customers for whom they are opening accounts.
III—On-going monitoring of accounts and transactions
IV—Record keeping
VI—Internal controls, compliance and audit
VIII—Enforcement powers and sanctions
IX—Co-operation between supervisors and other competent authorities
Insurance Sector based on Sector-Specific Criteria
II—Customer identification	1. General insurance should be brought under the 1993 Regulations and the FSA Money Laundering Rules. 2. FSA monitoring of the insurance sector for compliance with AML-CFT requirements should be intensified. 3. The JMLSG Guidance Notes should be updated to address the identification requirements where claims, commissions, and other monies are to be paid to persons (including partnerships, companies, etc.) other than the policyholder.
III—On-going monitoring of accounts and transactions	The JMLSG Guidance Notes should be updated to address specifically procedures for dealing with the AML/CFT risks from the practice of buying and selling second endowment policies, as well as the risks associated with use of single premium unit-linked policies. Similarly, the notes should be updated to include guidance that reinsurance or retrocessions should be checked to ensure that monies are paid to bona fide re-insurance entities at rates commensurate with the risks undertaken.
IV—Record keeping
V—Suspicious transaction reporting	The guidance notes have relatively few references to insurance business. It would be useful to include more such references, both to orient relevant insurance firms in compliance with AML/CFT and to raise awareness of AML/CFT risks in the insurance sector.
VI—Internal controls, compliance and audit
Securities Sector based on Sector-Specific Criteria
II—Customer identification	Procedures should by developed for more systematic, if randomized, verification of compliance with AML/CFT requirements by this group of firms. The U.K. AML/CFT regimes anticipates that financial service providers will be able to rely on the on the due diligence procedures followed by other entities subject to FSA supervision. (see discussion of criterion 79). The very limited oversight by FSA of AML/CFT compliance by the large number of small, low impact firms undermines the reliability of this system with respect to customer identification practices by these firms.
IV—Record keeping
VI—Internal controls, compliance and audit
Vii—Integrity standards
VIII—Enforcement powers and sanctions
IX—Co-operation between supervisors and other competent authorities

Table 36.

Recommended Action Plan to Improve the Legal and Institutional Framework and to Strengthen the Implementation of AML/CFT Measures in Banking, Insurance and Securities Sectors

Criminal Justice Measures and International Cooperation	Recommended Action
I—Criminalization of ML and FT	1. The U.K. should ratify as soon as possible the UN Convention Against Transnational Organized Crime 2000 (Palermo Convention). 2. The definition of ML under the 1993 Regulations (section 2 (3)) should be corrected to cross-reference current laws (including recent FT legislation) and delete obsolete cross-references.
II—Confiscation of proceeds of crime or property used to finance terrorism	The PCA 2002 provisions governing confiscation, seizure, assets recovery and civil recovery should be made effective as soon as possible, given the significant enhancements they make to the U.K. regime.
III—The FIU and processes for receiving, analyzing, and disseminating financial information and other intelligence at the domestic and international levels	1. The PCA should be made effective as soon as possible, given its substantial enhancements to the arrangements under which NCIS functions. 2. NCIS (or other appropriate government agency) should be given authority to impose civil fines on reporting parties – other than prudential regulated financial institutions – that fail to comply with their reporting obligations under the 1993 Regulations. 3. Consideration should be given to providing NCIS with the power to get supporting documents (rather than general information) from reporting parties that file STRs with it.
IV—Law enforcement and prosecution authorities, powers and duties	1. As there is no law enforcement entity that has as its mission the investigation of criminal acts and foreign counter-intelligence, the U.K. should seriously consider the creation of a national law enforcement organization which has both these elements. 2. Consideration should be given to passing legislation that makes wiretap evidence admissible in judicial proceedings. 3. Special legislative considerations should be given to protecting national security information while balancing the defendants right to have access (in some form) to relevant evidence. 4. NCIS or other competent authorities should undertake a U.K. trend analysis and vulnerability study of how and where money—especially cash—is laundered in the United Kingdom, in order to focus priorities and successfully use the new PCA 2002 and ARA powers. 5. Prosecutors and judges should be trained on ML and asset confiscation so as to ensure adequate application of U.K. legislation.
V—International cooperation	Legislation to enhance the statutory provisions on extradition should be adopted as soon as possible.

Legal and Institutional Framework for Financial Institutions
I—General framework	1. Existing legal constraints should be relaxed on the ability of attorneys and accountants to identify their clients when acting on behalf of those clients. Financial institutions and MSBs should be cautioned against doing business with attorneys and accountants that are unable to provide information about the customers for whom they are opening accounts. 2. The self-financing scheme for HMCE supervision of MSBs should be kept under close review, to determine whether or not it can reasonably be expected to produce enough fees to enable HMCE to reasonably carry out its functions under the 2001 Regulations.
II—Customer identification	1. Financial institutions and MSBs should be required by law to include accurate and meaningful originator information on funds transfers and related messages that should remain with the transfer or message through the payment chain. 3. General insurance should be brought within the scope of the 1993 Regulations and FSA Rules with compliance checking of the insurance sector strengthened. 4. Small securities firms should be subject to systematic checks by FSA for compliance with AML-CFT due diligence and record keeping requirements, if only on a sampling basis. 4. Industry Guidance Notes should be prepared for MSBs. 5. Tighter limits should be placed on the circumstances in which firms may accept funds from applicants before satisfactory identity is obtained. In addition, the “financial exclusion” provision of the FSA Sourcebook should be drafted more narrowly so as to cover only financially disadvantaged persons. 6. Consideration could be given to assigning a supervisory authority to ensure compliance with the 1993 Regulations by covered entities that are not financial institutions or MSBs.
III—Ongoing monitoring of accounts and transactions	The 1993 Regulations and FSA Sourcebook should be revised (or other appropriate legal instrument issued) to impose an affirmative legal obligation for financial institutions and MSBs: a) to pay special attention to unusual transactions with no apparent economic or lawful purpose; b) to give special attention to business relations and transactions with persons in jurisdictions that do not have adequate systems in place to prevent or deter ML and FT; and c) to give enhanced scrutiny to wire transfers that do not contain complete originator information.
IV—Record keeping	1. Minimum information requirements should be made mandatory by amending the 1993 Regulations and the Sourcebook. 2. Financial institutions and MSBs should be required to keep records of the basis on which exceptions are granted to customer due diligence requirements.
V—Suspicious transactions reporting	1. Part 7 of the PCA 2002 will significantly strengthen the legal regime for suspicious transactions reporting and should be made effective as soon as possible. 2. Consideration should be given to amending the 1993 Regulations and the Sourcebook, or to introducing new regulations, to impose FT-related suspicious transactions reporting requirements.
VI—Internal controls, compliance and audit	1. Consideration should be given to requiring financial institutions and MSBs to adopt internal controls and procedures, and designate an appropriate compliance person, to prevent their institutions from being used for FT as such (rather than only for ML and FT-related predicate offenses). 2. Consideration should be given to expressly requiring that the AML/CFT programs of financial institutions and MSBs must include an audit function. 3. The 1993 Regulations should be revised to expressly require that the “appropriate person’ required under the Regulations to handle the internal and external reporting requirements of the Regulations must be at management level. 4. MSBs should be required to put in place adequate screening procedures to ensure high standards when hiring employees.
VII—Integrity standards	1. The 1993 Regulations, Sourcebook or other appropriate legal provisions should be revised to explicitly prohibit criminals from holding or controlling a significant investment in financial institutions and MSBs. 2. The 2001 Regulations should also be revised to give HMCE powers to deny or cancel the registration of MSBs for integrity-related factors (e.g., previous convictions for ML, FT or similar serious crimes of the MSB, its controlling shareholders or managers).
VIII—Enforcement powers and sanctions	The 1993 Regulations should be revised to provide for civil penalties (administrative fines), in addition to the existing criminal penalties, for failure to observe the Regulations’ requirements to adopt appropriate AML procedures and controls. This is particularly important with respect to strengthening HMCE’s enforcement authority over MSB’s.
IX—Co-operation between supervisors and other competent authorities
Banking Sector based on Sector-Specific Criteria
II—Customer identification	As noted above, Financial institutions and MSBs should be cautioned against doing business with attorneys and accountants that are unable to provide information about the customers for whom they are opening accounts.
III—On-going monitoring of accounts and transactions
IV—Record keeping
VI—Internal controls, compliance and audit
VIII—Enforcement powers and sanctions
IX—Co-operation between supervisors and other competent authorities
Insurance Sector based on Sector-Specific Criteria
II—Customer identification	1. General insurance should be brought under the 1993 Regulations and the FSA Money Laundering Rules. 2. FSA monitoring of the insurance sector for compliance with AML-CFT requirements should be intensified. 3. The JMLSG Guidance Notes should be updated to address the identification requirements where claims, commissions, and other monies are to be paid to persons (including partnerships, companies, etc.) other than the policyholder.
III—On-going monitoring of accounts and transactions	The JMLSG Guidance Notes should be updated to address specifically procedures for dealing with the AML/CFT risks from the practice of buying and selling second endowment policies, as well as the risks associated with use of single premium unit-linked policies. Similarly, the notes should be updated to include guidance that reinsurance or retrocessions should be checked to ensure that monies are paid to bona fide re-insurance entities at rates commensurate with the risks undertaken.
IV—Record keeping
V—Suspicious transaction reporting	The guidance notes have relatively few references to insurance business. It would be useful to include more such references, both to orient relevant insurance firms in compliance with AML/CFT and to raise awareness of AML/CFT risks in the insurance sector.
VI—Internal controls, compliance and audit
Securities Sector based on Sector-Specific Criteria
II—Customer identification	Procedures should by developed for more systematic, if randomized, verification of compliance with AML/CFT requirements by this group of firms. The U.K. AML/CFT regimes anticipates that financial service providers will be able to rely on the on the due diligence procedures followed by other entities subject to FSA supervision. (see discussion of criterion 79). The very limited oversight by FSA of AML/CFT compliance by the large number of small, low impact firms undermines the reliability of this system with respect to customer identification practices by these firms.
IV—Record keeping
VI—Internal controls, compliance and audit
Vii—Integrity standards
VIII—Enforcement powers and sanctions
IX—Co-operation between supervisors and other competent authorities

Authorities’ response to the assessment

220. The U.K. authorities welcomed the assessment that the U.K. complies well with the FATF 40+8 Recommendations, with the exception of Special Recommendation VII concerning the inclusion of originator information on wire transfers. As the assessment acknowledges, the U.K. plans to legislate to implement this Recommendation when the FATF has issued an Interpretative Note clarifying some important details arising from this Recommendation.

221. The authorities noted that many of the suggestions in the FSAP for further improvements would be implemented when the Proceeds of Crime Act is brought fully into effect in the early part of 2003. The Assets Recovery Agency, which will commence operations on 24 February 2003, will focus on increasing criminal confiscation proceeds, implementing the new civil recovery powers, and improving training through the establishment of a new Centre of Excellence. A review of the arrangements for dealing with suspicious transaction reports was underway and the government intended to publish a national Money Laundering Strategy in 2003.

222. The authorities said that they would consider the rest of the FSAP recommendations, some of which would require new legislation, against their general policy of applying AML/CFT controls on a risk basis, with the tightest controls and greatest resources focused on the areas with the greatest vulnerability. Proposals for new measures would be assessed using cost-benefit principles. The authorities are not convinced that some of the recommendations contained in the FSAP could be justified applying risk-based principles. However, they stressed that all aspects of the system are kept under review and changes will be made to it in the light of emerging evidence about vulnerability to money laundering and terrorist financing.

223. The authorities had the following specific comments on the recommendations:

On scope of the criminal offence of ML, the definitions of money laundering under the 1993 Money Laundering Regulations will be updated when the Regulations are revised in June 2003, to implement the 2^nd EU Money Laundering Directive. The U.K. authorities note that the current technical deficiencies in the definition have no practical effect on the ability to detect and prosecute money laundering.
On provisional measures and confiscation, the referenced provisions will be made effective in the early months of 2003.
On general role of financial system in combating ML, consideration will be given to the proposal here, but the U.K. authorities are not convinced, at present, that this would be proportionate to the money laundering risk in this sector.
On customer identification and record-keeping rules, consideration will be given to all the suggestions. The basis will be whether they can be justified on cost-benefit principles given the extent of the vulnerability in these areas. Several of these proposals have been examined before and rejected because they have not been regarded as proportionate to the risk e.g. the risk of money laundering through general insurance business is generally acknowledged to be low. However, all these issues are kept under review.
On increased diligence of financial institutions, the PCA 2002 provisions governing suspicious transaction reporting will be implemented on 24 February 2003. Consideration will be given to the suggestions on suspicious transaction reporting and monitoring of accounts and transactions, applying the risk-based criteria discussed above.
On implementation & role of regulatory and other administrative authorities, the recommendations will be considered, applying the risk-based criteria discussed above.
On other forms of cooperation, legislation is currently before Parliament to do this.
On wire transfers, the U.K. will legislate to do this when the FATF Interpretative Note clarifying some details has been adopted by the FATF.
On law enforcement and prosecution, the proposal for a national law enforcement organization raises issues that go well beyond the investigation of and collection of intelligence about money laundering. It would also require new legislation and fundamental changes in policing and intelligence collection. The assessors’ comments are a valuable contribution to that wider discussion. With respect to wire-tapping legislation, there are good arguments for and against this suggestion which has been considered in the past and is kept under review. With respect to the proposed trend analysis and vulnerability study, NCIS is planning to conduct further analysis along those lines with contributions from partner agencies. On training of prosecutors and judges, such training programs are currently being arranged following the passage of the PCA 2002 and the new legislative provisions in these areas.

The key override provision comes under the heading ‘Comprehensiveness’ and states that ‘the assessment must be conducted in sufficient depth to allow a judgment of whether criteria are fulfilled in practice, not just in concept’.

It has been difficult to apply one set of (somewhat general) CPs to insurance and contractual savings markets that vary from almost nonexistent to being comparable to the banking sector by some key measures. The Fund and Bank have been considering options to deal with this variability, however, in the interim assessors have had to use their own judgment in interpreting and assessing the standards.

The regulatory model rests on a very explicit risk-based philosophy (or, more precisely, a framework focusing on risk to the statutory objectives under FSMA); as discussed further below, the Tiner Report reflects the application of this framework to insurance sector supervision.

Premiums as a percentage of GDP, a widely accepted basis of comparison.

Private agencies are the best source of detailed financial performance data and analysis on the insurance sector, although at a substantial cost for the average consumer. Individual company information is available but this is likely to be opaque to most consumers.

Full title is “General Insurance Business – Code of Practice for all Intermediaries (Including Employees of Insurance Companies) Other than Registered Insurance Brokers”. The reference to registered insurance brokers is to those brokers previously registered with the Insurance Brokers Registration Council – now abolished.

Prepared by Tom Kokkola (European Central Bank) in collaboration with Martin Andersson (Sveriges Riksbank).

CHAPS is an acronym for Clearing House Automated Payment System.

Bankers’ Automated Clearing Services. A formal assessment has not been undertaken for BACS—a more general analysis contained in The Selected Issues Volume.

Y-copy mode refers to one of the main forms of RTGS message flow design: it is characterized by a central processor that, when it receives a payment message from a sending bank, strips commercial information not strictly necessary for settlement from the settlement request it passes to the central bank; then, when settlement confirmation is received back from the central bank, the central processor sends the full payment information on to the receiving bank.

If the receiving member is not able to validate the payment, the settlement finality of that payment still holds, but the member would initiate a separate “return payment”.

The assessment was prepared by Mark Zelmer, and Eric Parrado, both of the Monetary and Exchange Affairs Department of the IMF.

The transparency of the Bank’s advisory role was significantly improved in 1993 when it began publishing a quarterly Inflation Report that presented the economic outlook underpinning its advice to the Chancellor. Summaries of the discussions between the Governor and the Chancellor on monetary policy decisions were also published with a six week lag.

The U.K. national implementation of Directive 98/26/EC.

One example is the references in the Bank’s statute to the “Deputy Governor for Financial Stability”.

This is not to imply that a complete specification of policy responses to future crisis situations is needed (or possible)—rather, the point is that an updated and more accessible elaboration of broader principles, in the spirit of the 1993 Governor’s lecture, would be desirable.

This evaluation is done by the Court’s sub-committee of non-executive directors (“NEDCO”).

The assessment was prepared by Mark Zelmer, and Eric Parrado, both of the Monetary and Exchange Affairs Department of the IMF.

CREST is not a depository, however, in the narrow sense of keeping documents of title in its vaults.

Such registrars are classed as CREST “participants”, along with those who hold securities in CREST (“members”), and those who provide payment services (“settlement banks”). CREST “users” (as distinct from “participants”) are those who communicate with CREST on behalf of participants. Most corporate members are “direct members”, with their own securities accounts in CREST, while “personal members” maintain accounts in their own name but use the facilities of a CREST user. Active market participants who are not members of CREST typically hold their accounts with custodians or brokers who are direct members.

CREST also operates cross—border links with DTCC (the U.S. CSD), Euroclear (the international CSD based in Belgium) and SIS (the Swiss CSD and securities settlement system).

Assessment of Anti-Money Laundering and Combating the Financing of Terrorism Pursuant to the October 11, 2002—AML/CFT Methodology Document.

This report was prepared using the November 7, 2002 provisional version of the AML/CFT detailed assessment template. The report has not been reformatted to conform to the revised template subsequently agreed by the Fund/Bank and FATF. Throughout this report, portions of the assessment prepared by the IAE rather than IMF staff are shown in italicized text.

As noted below, the PCA 2002 provisions concerning ML offences will become effective on February 24, 2003, while the remaining provisions of the law will become effective by May 24, 2003.

Financing of terrorism (FT) includes the financing of terrorist acts, and of terrorist organisations.

It should be understood that the sector-specific information in the AML/CFT methodology will not replace any of the individual core principles of the standards issued by the Basel Committee, IAIS and IOSCO.

As with section 2.2.1 above, assessors must not only check that all the legal and institutional requirements in Parts A, B and C have been imposed or exist, but must also verify that there are effective supervisory/regulatory measures in force that ensure that those criteria are being properly and effectively implemented in the banking, insurance and securities sectors. Assessors should pay particular attention when there are increased risks of ML or FT due to factors such as a high usage of cash or cash equivalents in a jurisdiction or financial sector; or a the prevalence of financial products that can be more vulnerable to ML, e.g., single premium life insurance policies.

Insurance entities includes insurance companies and, where relevant, insurance intermediaries and reinsurers (as set out in the IAIS Guidance Notes).

The IOSCO Principles and IOSCO Public Documents and Resolutions are available on IOSCO’s website at http://www.iosco.org/iosco.html.

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United Kingdom: Financial Sector Assessment Program Technical Notes and Detailed Standards Assessments

Author:

International Monetary Fund

Volume/Issue:: Volume 2003: Issue 208

Publisher:: International Monetary Fund

ISBN:: 9781451814200

ISSN:: 1934-7685

Pages:: 402

DOI:: https://doi.org/10.5089/9781451814200.002

Keywords
I. Basel Core Principles for Effective Banking Supervision
II. IAIS Insurance Core Principles
III. IOSCO Objectives and Principles of Securities Regulation
IV. CPSS Core Principles for SIPS and Central Bank Responsibilities in Applying the CPs—NewCHAPS
V. IMF’s MFP Transparency Code-Transparency of Monetary Policy
VI. IMF’s MFP Transparency Code—Transparency of Payment Systems Oversight and Other Financial Stability functions of the Bank of England
VII. MFP Transparency Code—Transparency of Financial Policies (Financial Services Authority)
VIII. Compliance with CPSS/IOSCO Recommendations for Securities Settlement Systems
IX. Assessment of Anti-Money Laundering and Combating the Financing of Terrorism22

Table 36.

Recommended Action Plan to Improve the Legal and Institutional Framework and to Strengthen the Implementation of AML/CFT Measures in Banking, Insurance and Securities Sectors

Criminal Justice Measures and International Cooperation	Recommended Action
I—Criminalization of ML and FT	1. The U.K. should ratify as soon as possible the UN Convention Against Transnational Organized Crime 2000 (Palermo Convention). 2. The definition of ML under the 1993 Regulations (section 2 (3)) should be corrected to cross-reference current laws (including recent FT legislation) and delete obsolete cross-references.
II—Confiscation of proceeds of crime or property used to finance terrorism	The PCA 2002 provisions governing confiscation, seizure, assets recovery and civil recovery should be made effective as soon as possible, given the significant enhancements they make to the U.K. regime.
III—The FIU and processes for receiving, analyzing, and disseminating financial information and other intelligence at the domestic and international levels	1. The PCA should be made effective as soon as possible, given its substantial enhancements to the arrangements under which NCIS functions. 2. NCIS (or other appropriate government agency) should be given authority to impose civil fines on reporting parties – other than prudential regulated financial institutions – that fail to comply with their reporting obligations under the 1993 Regulations. 3. Consideration should be given to providing NCIS with the power to get supporting documents (rather than general information) from reporting parties that file STRs with it.
IV—Law enforcement and prosecution authorities, powers and duties	1. As there is no law enforcement entity that has as its mission the investigation of criminal acts and foreign counter-intelligence, the U.K. should seriously consider the creation of a national law enforcement organization which has both these elements. 2. Consideration should be given to passing legislation that makes wiretap evidence admissible in judicial proceedings. 3. Special legislative considerations should be given to protecting national security information while balancing the defendants right to have access (in some form) to relevant evidence. 4. NCIS or other competent authorities should undertake a U.K. trend analysis and vulnerability study of how and where money—especially cash—is laundered in the United Kingdom, in order to focus priorities and successfully use the new PCA 2002 and ARA powers. 5. Prosecutors and judges should be trained on ML and asset confiscation so as to ensure adequate application of U.K. legislation.
V—International cooperation	Legislation to enhance the statutory provisions on extradition should be adopted as soon as possible.

Legal and Institutional Framework for Financial Institutions
I—General framework	1. Existing legal constraints should be relaxed on the ability of attorneys and accountants to identify their clients when acting on behalf of those clients. Financial institutions and MSBs should be cautioned against doing business with attorneys and accountants that are unable to provide information about the customers for whom they are opening accounts. 2. The self-financing scheme for HMCE supervision of MSBs should be kept under close review, to determine whether or not it can reasonably be expected to produce enough fees to enable HMCE to reasonably carry out its functions under the 2001 Regulations.
II—Customer identification	1. Financial institutions and MSBs should be required by law to include accurate and meaningful originator information on funds transfers and related messages that should remain with the transfer or message through the payment chain. 3. General insurance should be brought within the scope of the 1993 Regulations and FSA Rules with compliance checking of the insurance sector strengthened. 4. Small securities firms should be subject to systematic checks by FSA for compliance with AML-CFT due diligence and record keeping requirements, if only on a sampling basis. 4. Industry Guidance Notes should be prepared for MSBs. 5. Tighter limits should be placed on the circumstances in which firms may accept funds from applicants before satisfactory identity is obtained. In addition, the “financial exclusion” provision of the FSA Sourcebook should be drafted more narrowly so as to cover only financially disadvantaged persons. 6. Consideration could be given to assigning a supervisory authority to ensure compliance with the 1993 Regulations by covered entities that are not financial institutions or MSBs.
III—Ongoing monitoring of accounts and transactions	The 1993 Regulations and FSA Sourcebook should be revised (or other appropriate legal instrument issued) to impose an affirmative legal obligation for financial institutions and MSBs: a) to pay special attention to unusual transactions with no apparent economic or lawful purpose; b) to give special attention to business relations and transactions with persons in jurisdictions that do not have adequate systems in place to prevent or deter ML and FT; and c) to give enhanced scrutiny to wire transfers that do not contain complete originator information.
IV—Record keeping	1. Minimum information requirements should be made mandatory by amending the 1993 Regulations and the Sourcebook. 2. Financial institutions and MSBs should be required to keep records of the basis on which exceptions are granted to customer due diligence requirements.
V—Suspicious transactions reporting	1. Part 7 of the PCA 2002 will significantly strengthen the legal regime for suspicious transactions reporting and should be made effective as soon as possible. 2. Consideration should be given to amending the 1993 Regulations and the Sourcebook, or to introducing new regulations, to impose FT-related suspicious transactions reporting requirements.
VI—Internal controls, compliance and audit	1. Consideration should be given to requiring financial institutions and MSBs to adopt internal controls and procedures, and designate an appropriate compliance person, to prevent their institutions from being used for FT as such (rather than only for ML and FT-related predicate offenses). 2. Consideration should be given to expressly requiring that the AML/CFT programs of financial institutions and MSBs must include an audit function. 3. The 1993 Regulations should be revised to expressly require that the “appropriate person’ required under the Regulations to handle the internal and external reporting requirements of the Regulations must be at management level. 4. MSBs should be required to put in place adequate screening procedures to ensure high standards when hiring employees.
VII—Integrity standards	1. The 1993 Regulations, Sourcebook or other appropriate legal provisions should be revised to explicitly prohibit criminals from holding or controlling a significant investment in financial institutions and MSBs. 2. The 2001 Regulations should also be revised to give HMCE powers to deny or cancel the registration of MSBs for integrity-related factors (e.g., previous convictions for ML, FT or similar serious crimes of the MSB, its controlling shareholders or managers).
VIII—Enforcement powers and sanctions	The 1993 Regulations should be revised to provide for civil penalties (administrative fines), in addition to the existing criminal penalties, for failure to observe the Regulations’ requirements to adopt appropriate AML procedures and controls. This is particularly important with respect to strengthening HMCE’s enforcement authority over MSB’s.
IX—Co-operation between supervisors and other competent authorities
Banking Sector based on Sector-Specific Criteria
II—Customer identification	As noted above, Financial institutions and MSBs should be cautioned against doing business with attorneys and accountants that are unable to provide information about the customers for whom they are opening accounts.
III—On-going monitoring of accounts and transactions
IV—Record keeping
VI—Internal controls, compliance and audit
VIII—Enforcement powers and sanctions
IX—Co-operation between supervisors and other competent authorities
Insurance Sector based on Sector-Specific Criteria
II—Customer identification	1. General insurance should be brought under the 1993 Regulations and the FSA Money Laundering Rules. 2. FSA monitoring of the insurance sector for compliance with AML-CFT requirements should be intensified. 3. The JMLSG Guidance Notes should be updated to address the identification requirements where claims, commissions, and other monies are to be paid to persons (including partnerships, companies, etc.) other than the policyholder.
III—On-going monitoring of accounts and transactions	The JMLSG Guidance Notes should be updated to address specifically procedures for dealing with the AML/CFT risks from the practice of buying and selling second endowment policies, as well as the risks associated with use of single premium unit-linked policies. Similarly, the notes should be updated to include guidance that reinsurance or retrocessions should be checked to ensure that monies are paid to bona fide re-insurance entities at rates commensurate with the risks undertaken.
IV—Record keeping
V—Suspicious transaction reporting	The guidance notes have relatively few references to insurance business. It would be useful to include more such references, both to orient relevant insurance firms in compliance with AML/CFT and to raise awareness of AML/CFT risks in the insurance sector.
VI—Internal controls, compliance and audit
Securities Sector based on Sector-Specific Criteria
II—Customer identification	Procedures should by developed for more systematic, if randomized, verification of compliance with AML/CFT requirements by this group of firms. The U.K. AML/CFT regimes anticipates that financial service providers will be able to rely on the on the due diligence procedures followed by other entities subject to FSA supervision. (see discussion of criterion 79). The very limited oversight by FSA of AML/CFT compliance by the large number of small, low impact firms undermines the reliability of this system with respect to customer identification practices by these firms.
IV—Record keeping
VI—Internal controls, compliance and audit
Vii—Integrity standards
VIII—Enforcement powers and sanctions
IX—Co-operation between supervisors and other competent authorities

Principle 1.	Objectives, Autonomy, Powers, and Resources An effective system of banking supervision will have clear responsibilities and objectives for each agency involved in the supervision of banks. Each such agency should possess operational independence and adequate resources. A suitable legal framework for banking supervision is also necessary, including provisions relating to the authorization of banking establishments and their ongoing supervision; powers to address compliance with laws, as well as safety and soundness concerns; and legal protection for supervisors. Arrangements for sharing information between supervisors and protecting the confidentiality of such information should be in place.
Principle 1(1)	An effective system of banking supervision will have clear responsibilities and objectives for each agency involved in the supervision of banks.
Description	Responsibilities and objectives of the FSA as supervisor and regulator are set out in the FSMA. The FSA’s general functions are set out in the FSMA Section 2 (4), and consist of rulemaking, preparing and issuing codes, providing guidance, and determining the general policy and principles by which the FSA will perform its functions. In carrying out the general functions, the FSA is required to act in a way that is compatible with the regulatory objectives and have regard for the principles of good regulation. The four regulatory objectives, identified in the FSMA Section 2 (6), are market confidence, public awareness, protection of consumers, and reduction of financial crime. The seven principles of good regulation identified in FSMA Section 2 (3), which FSA is required to take into consideration, include minimizing adverse effects of regulation on competition; encouraging competition among firms regulated by FSA; using its resources economically; taking account of the responsibilities of those who manage the affairs of authorized persons; following the principle that a burden or restriction imposed on a regulated firm should be proportionate to the benefits expected; being attentive to facilitating innovation in connection with regulated activities; and observing the international character of financial services and markets and the desirability of maintaining the competitive position of the U.K. The FSMA gives the FSA rulemaking powers that may be used to introduce new rules or change existing rules. Rules and Guidance are set out in the FSA Handbook, and primarily cover prudential matters. Banks are required to meet “threshold conditions” (TC), set out in FSMA Schedule 6, and elaborated on in the Threshold Conditions chapter of the FSA Handbook (COND). Banks are also required to comply with rules made by the FSA. In general, the FSA has the sole responsibility for supervising banks in the United Kingdom. Branches of EEA banks are also supervised by their home country supervisors. The FSA has broad powers under the FSMA to take action against banks that do not comply with legal and regulatory requirements. The FSA has formal powers to take action to deal with problem banks, but where appropriate may pursue informal action to resolve problem bank issues. The FSMA is a comprehensive update of previous banking laws. Prior to the enactment of the FSMA, banking laws had been amended periodically to enhance supervisory standards, increase supervisory powers, and reflect the requirements of EU directives. The FSMA requires transparency of the FSA in a number of ways. FSMA Schedule 1, paragraph 10 requires the FSA to report (on the discharge of its functions) to the Treasury at least annually, and Treasury is required to provide a copy of this report to Parliament. In addition, FSMA Schedule 1, paragraph 11 requires the FSA to hold an annual public meeting to discuss the contents of the report. Schedule 1, paragraph 12 of the FSMA charges the FSA’s non-executive committee with reviewing the FSA’s internal financial controls, and reports on these matters to the Treasury. In addition, the Treasury has the authority to make formal inquiries relating to the FSA’s use of resources in discharging its functions, and where there has been a serious failure in the regulatory system. Information on the FSA’s regulatory objectives is published in its plan and budget, and other publications. The FSMA, section 8, also requires the FSA to consult on the extent to which its general policies and practices are consistent with its general duties. The FSA does not publish regular information on the financial strength and performance of the banking industry; however, industry information is available from other sources. Historically, the Bank of England collected regulatory returns for the banks and published statistical information on the banking industry. Under the FSMA, the regulatory returns are collected by the Bank under the FSA’s authority; however, the Bank continues to publish the aggregate information on the industry. The Bank of England’s semi-annual Financial Stability Review contains prudential information on the banking industry, including information on aggregate profitability, capital, and liquidity. In addition, the Bank publishes Monetary and Financial Statistics on a monthly and quarterly basis. These statistics provide some information on the lending sector, and national accounts level information on capital and profitability. In addition, the British Bankers Association publishes an annual report that aggregates publicly available financial information from the large banks to provide an industry wide view. The FSA does have two projects (discussion papers on harnessing market forces, and on the regulatory reporting environment) underway to explore, among other things, whether they should provide any additional industry information to the public.
Assessment	Compliant
Comments	The FSMA clearly defines the FSA’s role as bank supervisor, sets out regulatory objectives and principles, and provides broad rulemaking powers. Systems are in place to ensure the FSA’s activities are carried out in a transparent manner. Information on the financial strength and performance of the banking industry is publicly available, but is published by the Bank of England and the British Bankers’ Association.
Principle 1(2)	Each such agency should possess operational independence and adequate resources.
Description	The FSA is an independent non-governmental body, established as a company limited by guarantee. The FSA is accountable to Treasury Ministers and, through them, to Parliament. A Board appointed by HM Treasury governs the FSA. In addition to the Executive Chairman, there are currently three Managing Directors and eleven non-executive members, of whom one, the Deputy Governor (Financial Stability) of the Bank of England, is an ex officio director. One of the non-executive members is Deputy Chairman and ‘lead’ non-executive. The Board sets the FSA’s overall policy, but is not involved in the day-to-day operations. The FSA’s funding is provided by the industry, and regulated firms pay annual fees directly to the FSA. The FSMA (Schedule 1, paragraph 17) gives the FSA the authority to require the payment of fees. The FSA is required to consult on its proposed fees, and has issued a series of consultation papers (CPs) that explain how the fees are calculated. CP111 addresses the post-N2 fee assessment process. FSMA requires the FSA to carry out its regulatory responsibilities in a way that uses its resources in an economic and efficient manner. To this end the FSA has developed four resources strategies -for People, Space, Cash and Information. A monthly Resources Report is published within the FSA, monitoring progress against key measures in each of the resource categories. This report includes tracking of things like staff turnover. Salaries paid by the FSA take into account pay levels within the financial services industry and the FSA is able to recruit expert assistance where needed. The FSA spent approximately £2.8million on training in 2001/2, with an average of 6.2 days per person spent on formal training activities over the same period. The FSA uses secondments from the industry and professional firms to add skills and experience not readily available in the marketplace. The FSA also provides outward secondment opportunities to staff as part of its Graduate Development Program. HM Treasury appoints the FSA Board, including the chairman, and also has the authority to remove the chairman or other board members. The FSMA does not set out a term for the chairman. In addition, the FSMA does not set out reasons for removal of the chairman, nor does it require that the reasons for removal be made public.
Assessment	Compliant
Comments	The FSA’s Board reports to HM Treasury, and ultimately the Parliament. While the day-to-day operations of the FSA are removed from HM Treasury, there is concern within the industry that political pressures, particularly related to the consumer focused objectives, may cause the FSA to become (a) more prescriptive or rule based, and (b) more consumerist. The prominence of consumer protection among the FSA’s regulatory objectives may cause tensions within its risk-based approach to supervision. The strong and transparent accountability regime surrounding all aspects of FSA operations provides the safeguard that the fiscal regime of assessments on regulated firms would not compromise its independence or autonomy. The FSA has the authority to increase assessments to fund increasing supervision needs, but has made a conscious effort to hold its expenditures relatively stable over the last few years. Detailed on-site supervision work is provided either internally by line supervisors supported by the risk review division, or externally using “skilled persons” reviews. The skilled persons reviews are directed by the FSA, but paid for by the firm directly, and represent an additional cost of supervision to the industry over the FSA’s assessments. FSA pursues a consistent theme of proportionality, considering the cost of supervision (including the use of skilled persons reports) against the risks to the FSA’s objectives. The FSA and its staff are credible and professional. Staff at the director and manager level is experienced, many coming from the Bank of England at the time the FSA was created. Bank and industry sources stated that the FSA’s level of supervision and focus was reasonable, and the FSA is focused on key risks in the industry. The sources also noted that turnover and depth of staff have been issues for the FSA. One area that bears monitoring is the adequacy of staffing levels in the supervision and risk review divisions. The FSA’s internal specialist teams are quite small considering they are a cross-sector resource. The FSA’s new risk assessment process is in the early stages of being rolled out. The level of requests for risk review assistance in relation to their available resources is not yet known, and is something that should be closely monitored to ensure that resources are sufficient to carry out risk mitigation programs. In addition, industry sources expressed some concern over the turnover rate in supervisory staff, and the level of firm specific knowledge that is lost due to turnover. However, the FSAP team was informed by the FSA that staff turnover rates have decreased recently. Turnover figures for the FSA divisions undertaking banking supervision (i.e., the Deposit Takers Division, the Major Financial Groups Division and the Investment Firms Division) have ranged from 3.5 percent to 9.7 percent in the twelve months to June 2002. The FSMA does not specify a minimum term for the head of the FSA, does not require that any removal be based on specified reasons, and does not require that the reasons for the removal be made public. HM Treasury is responsible for the processes surrounding the appointment and removal of the head of the FSA. Although the high-level safeguards in this area are thus limited, appointments are made on principles of good corporate governance known as the Nolan Principles, while senior officials’ contracts have specific terms, and an official removed could pursue a judicial review in certain circumstances. De facto, an important safeguard in the U.K. context is the close public scrutiny over the activities of public officials provided by an independent media, as well as parliamentary scrutiny. In these circumstances, it is unlikely that a senior official could be removed from office without the government having to publicly disclose and defend the reasons behind its decision.
Principle 1(3)	A suitable legal framework for banking supervision is also necessary, including provisions relating to authorization of banking establishments and their ongoing supervision.
Description	The FSMA sets out the legal framework for authorization, ongoing supervision, and enforcement. The legal framework includes secondary legislation under FSMA, and the rules made by the FSA using its rulemaking powers under section 138 of the FSMA. The FSA Handbook contains manuals on Authorization, Supervision, and Enforcement. The FSA promulgates rules with which the banks must comply. The FSA also produces guidance. The rules and guidance mainly cover prudential matters. Under FSMA section 148 the FSA also has the power to alter or revoke rules, and to modify or waive rules in certain cases. The FSA has authority to require banks to provide information under FSMA section 165. Banks are required to submit a variety of regular reports to the FSA covering their financial condition (SUP chapter 16).
Assessment	Compliant
Comments	The FSMA provides a suitable framework for the authorization and ongoing supervision of banking establishments, and clearly identifies the FSA as the body responsible for authorization and supervision of firms. The FSA produces rules and guidance on authorization and supervision. In addition, the FSA has broad powers to require banks to provide information. Rules and guidance are prepared in consultation with the industry.
Principle 1(4)	A suitable legal framework for banking supervision is also necessary, including powers to address compliance with laws, as well as safety and soundness concerns.
Description	The FSMA (Schedule 1 paragraph 6) requires the FSA to maintain a process designed to allow it to determine whether a bank is complying with requirements under the FSMA (including FSA rules). The FSA has broad authority to determine whether a bank is in compliance with regulatory requirements. The FSA has the authority under FSMA section 165 to obtain any information or documents from banks. The FSA may also obtain information through the use of an authorized person under section 166. The FSA may also appoint investigators into a bank’s affairs under FSMA sections 167 through 176. The FSA’s authority and the processes for obtaining information are set out in the Enforcement manual (ENF) section of the FSA Handbook. The FSMA gives the FSA broad powers to take action against banks that do not comply with the requirements of the FSMA, or its secondary legislation or rules. The FSA may withdraw a bank’s authorization, limit a bank’s ability to take deposits, or require a bank to cease certain activities. The FSA can take remedial action with immediate affect under FSMA Section 45, using a supervisory notice. These notices are subject to referral by an independent FSM Tribunal. Procedures relating to the Tribunal are found in Part IX of the FSMA. The FSMA Part XIV provides the FSA with the power to fine or publicly censure a bank that fails to comply with a requirement imposed by the FSA or the FSMA. This is accomplished through the issuance of a decision notice. These actions are also referable to the Tribunal, generally within 28 days of the date of the notice. The FSA may not take the action specified in these notices until after the referral period has ended, or if the matter is referred, until after the Tribunal disposed of the appeal.
Assessment	Compliant
Comments	The FSA has broad powers to supervise banks, including requiring the banks to provide information. If the FSA determines that the bank is in non-compliance with the FSMA or its rules, it has a range of supervisory and enforcement options available. The options include prompt remedial action (restricting activities, revoking authorization) where other supervisory measures are not sufficient.
Principle 1(5)	A suitable legal framework for banking supervision is also necessary, including legal protection for supervisors.
Description	The FSMA Schedule 1 paragraph 19 provides that neither the FSA or “any person who is, or is acting as, a member, officer or member of staff of the FSA” is to be liable in damages for anything done or omitted in the discharge, or purported discharge of the FSA’s functions. This protection extends to persons appointed to investigate complaints under Schedule 1 paragraph 7. An exception to the protection exists if the act or omission is in bad faith. In addition, the FSMA protection does not prevent an award of damages under Section 6(1) of the Human Rights Act of 1998. However, under the complaints scheme (FSMA Schedule 1 paragraphs 7 and 8), the appointed investigator must have the power to recommend, if he thinks it appropriate, that the FSA makes a compensatory payment to the complainant, remedies the matter complained of, or both. The FSA has the power to require the payment of fees, to cover the costs of defending its actions. The FSA covers the legal costs of defending its staff in legal actions against them in relation to their work as FSA employees.
Assessment	Compliant
Comments	The FSMA provides protection from liability to the FSA and its staff for any actions taken in good faith in the performance of their duties. However, the FSA may be required to pay compensation to complainants under the FSMA mandated compensation scheme, or awards for damages related to actions found to be unlawful under the Human Rights Act.
Principle 1(6)	Arrangements for sharing information between supervisors and protecting the confidentiality of such information should be in place.
Description	The FSA has an MOU with the Bank of England and HM Treasury, which covers among other things, the exchange of information. The MOU is published. FSMA Part XXIII places restrictions on the disclosure of information, there are exceptions that permit the FSA to disclose information to other regulators (U.K. and overseas) subject to compliance with EU directives. FSMA Section 354 requires the FSA to cooperate with persons who have functions similar to the FSA, and also to cooperate in relation to the prevention or detection of financial crime. Cooperation may include sharing of information that the FSA is not prevented from disclosing. The FSA has formal arrangements for information exchange in place with a number of domestic, EEA, and overseas supervisors. Information is exchanged on an ongoing basis. Confidential information disclosed by the FSA continues to be subject to the FSMA restrictions on disclosure. The FSA must satisfy itself that where confidential information is disclosed to an overseas supervisor the information will be subject to equivalent restrictions as those that apply to confidential information restrictions in the Banking Consolidation Directive. The FSA may refuse requests for confidential information except in limited cases such as court orders in criminal cases, Parliamentary inquiries, and to an extent, personal data subject to data protection legislation.
Assessment	Compliant
Comments	The FSMA provides a suitable framework for sharing of information with domestic and foreign supervisory agencies, and provides for safeguarding of confidential information. The FSMA also provides the FSA with the right to refuse requests for confidential information, with limited exceptions.
Principle 2.	Permissible Activities The permissible activities of institutions that are licensed and subject to supervision as banks must be clearly defined, and the use of the word “bank” in names should be controlled as far as possible.
Description	The FSMA does not expressly define the term “bank” or include it as a separate category of authorized person; however, Schedule 2 does identify deposit taking as a regulated activity. The Regulated Activities Order also sets out activities which are regulated activities for the purposes of the FSMA, and accepting deposits is one such activity. For purposes of determining which parts of the FSA Handbook apply to particular categories of firms, the FSA defines a bank as: a. A firm with Part IV permission which includes accepting deposits, and (i) which is a credit institution; or (ii) whose Part IV permission includes the requirement that it complies with IPRU (Bank); But which is not a building society, a friendly society, or a credit union. b. An EEA bank. The FSMA Section 19 provides that no person may carry on a regulated activity in the U.K. or purport to do so unless he is an authorized person or an exempt person. FSMA Section 24 provides that a person who is not an authorized person is guilty of an offense if he describes himself as an authorized person or holds himself out in a manner that is reasonably likely to be understood as indicating that he is an authorized person.
Assessment	Compliant
Comments	While “bank” isn’t expressly defined, regulated activities are defined and included deposit taking. The FSMA mandates that all persons carrying out regulated activities are properly authorized. Any person using the term bank or banking in their name would be presumed to be carrying out regulated activities and must be authorized.
Principle 3.	Licensing Criteria The licensing authority must have the right to set criteria and reject applications for establishments that do not meet the standards set. The licensing process, at a minimum, should consist of an assessment of the banking organization’s ownership structure, directors and senior management, its operating plan and internal controls, and its projected financial condition, including its capital base; where the proposed owner or parent organization is a foreign bank, the prior consent of its home country supervisor should be obtained.
Description	When granting or varying Part IV permissions, FSMA section 41(2) provides that the FSA must be satisfied that the applicant satisfies and will continue to satisfy the threshold conditions set out in the FSMA (Schedule 6) in relation to all regulated activities for which they will have permission. There are five threshold conditions: 1. Legal status. Deposit-takers must be bodies corporate or partnerships. 2. Location of offices. If the bank is a body corporate constituted under the laws of any part of the U.K., then it must have its head office and, if it has one, its registered office in the U.K. A body incorporated in one part of the U.K. may have its head office in any other part. If the bank has its head office in the U.K. but is not a body corporate, it must carry on business in the U.K. 3. Close links. This threshold condition applies when the applicant has close links with another person of such a kind as to prevent the FSA from effectively supervising the applicant. The FSMA Schedule 6 paragraph 3 provides a definition of close links. If there are close links with another person, then two tests must be satisfied. First, the links must not be likely to prevent effective supervision of the applicant by the FSA. Second, if the person to whom the applicant is linked is situated outside the EEA, then the laws, regulations, and administrative provisions that apply must not prevent effective supervision of the applicant by the FSA. 4. Adequate resources. This test is not only concerned with absolute levels of capital, but also non-financial resources and means of managing resources. Resources may include capital, provisioning, availability of liquid assets, human resources, and risk management systems. When considering adequacy of resources, the FSA will also review whether the firm is ready, willing, and organized to comply with the high level systems and controls requirements set out in the SYSC chapter of the FSA Handbook. 5. Suitability. The applicant has the burden of satisfying the fit and proper test. Section 59 of the FSMA gives the FSA the power to specify “controlled functions” within a firm that must be performed by individuals who have been assessed as fit and proper by the FSA. The FSMA also gives the FSA the power to establish how firms should apply for approval (section 60), factors to be determined (section 61), and to issue statements of principles and a code of practice which will apply to all individuals performing functions under section 59. The FSA has exercised these powers, and sets out its approach in the FIT chapter of the FSA Handbook. Additional information relating to the five threshold conditions, including assessment criteria, is set out in the Conditions (COND) chapter of the FSA Handbook. The Threshold Conditions are used to assess license applications, and are also considered as a part of the FSA’s ongoing supervision. The FSA has the power to reject an application for authorization if the applicant fails to satisfy one or more of the threshold conditions, or if the applicant provides inadequate information. Under FSMA sections 42 and 43, the FSA has the power to impose limitations or requirements on a bank’s permission, or grant permission to carry on a narrower range of activities than the applicant requested. FSMA section 45 gives the FSA the authority to vary or cancel a permission if the authorized person is failing, or is likely to fail, to satisfy the threshold conditions. The FSA Handbook chapter GN, Rule 3.3.13 requires a bank to maintain capital commensurate with the nature and scale of its business, and the risks inherent in that business. If the bank is a member of a group, those capital resources must also be commensurate with the risks inherent in the activities of the other members of the group, insofar as they impact the bank. Guidance on how banks should comply with this rule are set out in IPRU (Banks) chapter CO, with detailed guidance in a variety of other chapters. Rule 3.3.9 requires a U.K. bank and an overseas bank have capital of not less than Euro 5 million at the time it obtains its Part IV permission to accept deposits. When the FSA evaluates proposed directors and senior management, it uses the fit and proper criteria set out in the FIT chapter of the FSA Handbook. Criteria assessed as part of the fit and proper assessment include honesty, integrity and reputation (FIT 2.1); competence and capability (FIT 2.2); and the financial soundness of a person (FIT 2.3). Applicants are required to submit a variety of information, including a strategic and operating plan, a business plan, details of the applicant’s management and organizational structure, operating procedures, systems and controls, and any outsourcing arrangements. This information is assessed to determine whether the system of corporate governance is proportionate to the bank’s business, whether the bank will be managed in a competent and prudent manner, and whether appropriate systems and controls are in place. The assessment of knowledge of all types of financial activities the bank intends to pursue is carried out as part of the approval process for individuals. Cumulatively, senior management would be expected to have the experience and skills to cover all of the bank’s proposed activities. The business plan should set out the regulated and unregulated activities of the applicant along with the related risks. The business plan should include a financial budget and projections to demonstrate the applicant is able to comply with the relevant financial resource requirements. The status of the shareholders and their ability to support the business is also considered as part of this process. The FSA would obtain letters of comfort from major shareholders in some cases. Knowingly or recklessly providing false or misleading information to the FSA is an offense under FSMA section 398. The FSA is the licensing and supervisory authority for banks (but see Principle 25, i.e., branches of EEA banks). FSMA section 354 requires the FSA to cooperate in the sharing of information with other authorities in the U.K. and overseas who have functions similar to the FSA. The FSA seeks the view of the home country supervisors in assessing the application of an overseas bank wishing to establish a branch or subsidiary.
Assessment	Compliant
Comments	The FSA has the authority to set criteria for the licensing of banks, and may reject applications if they fail to meet threshold criteria or provide sufficient information. The FSA requires sufficient information to make a determination on the ownership and management structure, and the adequacy of the bank’s proposed capital, business plan, and system of controls. The FSA also has a process in place to assess the fitness and propriety of management and officers filling the key “controlled function” roles within a firm.
Principle 4.	Ownership Banking supervisors must have the authority to review and reject any proposals to transfer significant ownership or controlling interests in existing banks to other parties.
Description	The FSMA Part XII addresses control over authorized persons. Section 178 requires a person proposing to take control (or increase the degree of control) over an authorized person, including a U.K. bank, to provide the FSA with prior notification. Detailed definitions of control are set out in sections 179 and 180 of the FSMA, but 10 percent is the general threshold for control. The voting power or holdings of the controller’s associates, as defined in FSMA section 422, are also considered. The FSA may require the person giving notification to provide additional information under FSMA section 182. The FSA may object to a proposal unless it is satisfied that the acquirer is a fit and proper person to have control over the authorized person, and the interests of the consumer would not be threatened. The FSA may give unconditional approval under FSMA section 184, or may approve subject to conditions under FSMA section 185. Where shares are acquired in contravention of the FSA’s objection, or a condition imposed, the FSA may direct that the shares be subject to restriction as defined in FSMA section 189. The FSA may also apply to the court to order the sale of any shares acquired in contravention of the FSA’s objection or condition imposed. FSA rules and guidance related to controllers and close links (including required approvals or notifications, thresholds, and timeframes) are contained in Chapter SUP section 11 of the FSA Handbook. Section 11.4.10 requires banks to take reasonable steps to keep itself informed of the identity of controllers, although identification of beneficial owners is not specifically addressed. Banks must notify the FSA of its controllers and close links annually. The reports are discussed in the SUP chapter of the FSA Handbook, sections 16.4 (controllers) and 16.5 (close links).
Assessment	Compliant
Comments	FSA has full power to review and reject any proposals to transfer significant ownership or controlling interests in existing banks to other parties. Procedures for exercising this authority are spelled out in the Handbook and are carried out in practice.
Principle 5.	Investment Criteria Banking supervisors must have the authority to establish criteria for reviewing major acquisitions or investments by a bank and ensuring that corporate affiliations or structures do not expose the bank to undue risks or hinder effective supervision.
Description	The FSA’s Handbook Chapter SUP Section 15 includes a provision requiring a bank give the FSA notice of any proposed restructuring, reorganization, or business expansion which could have a significant impact on the firm’s risk profile or resources. Chapter SUP, Section 11 of the FSA Handbook addresses notification and approval requirements related to close links and changes of control in a firm. In addition, Principle 11 of the Principles for Businesses requires firms to disclose to the FSA anything relating to the firm of which the FSA could reasonably expect to be notified. The FSA’s IPRU (Bank), section LE, addresses large exposures, including investments. U.K. banks are required to notify the FSA of any investment exceeding 10 percent of its capital, and pre-notify the FSA of any investment exceeding 25 percent of capital. The FSA’s policy on large exposures does not apply to U.K. branches of overseas banks; however, U.K. branches incorporated outside the EEA have large exposure reporting requirements. The FSA is required to assess a bank’s acquisitions/investments according to whether the bank would continue to meet the Threshold Conditions, and whether the interests of consumers of regulated activities provided by the bank would be threatened by the acquisition/investment. The FSA has the power to prohibit a bank from undertaking a major acquisition or investment in cases where the bank would no longer meet the threshold conditions, or FSA rules. The FSA Handbook distinguishes between situations where notifications are required prior to the acquisition or investment, as opposed to after the fact notification. The prior notification threshold is defined in relation to the bank’s capital.
Assessment	Compliant
Comments	The FSA has rules and guidance in place regarding the notification, and in some cases prior approval, requirements of major acquisitions or investments. The approval and reporting requirements allow FSA to exercise effective supervisory oversight over corporate structures to insure that risks arising from affiliations are properly identified and controlled and that unsupervisable structures do not arise.
Principle 6.	Capital Adequacy Banking supervisors must set minimum capital adequacy requirements for banks that reflect the risks that the bank undertakes, and must define the components of capital, bearing in mind its ability to absorb losses. For internationally active banks, these requirements must not be less than those established in the Basel Capital Accord.
Description	The FSMA 2000 and the FSA’s regulations require banks to maintain both an absolute minimum amount of capital and an adequate level of capital. Threshold Condition 4 requires all banks to maintain adequate resources, both financial and non-financial. The minimum amount of capital is set at Euro 5 million (or sterling equivalent) and on an on-going basis a minimum capital ratio of 8 percent has to be maintained. The components of regulatory capital and the methodology for calculating the capital ratio have been set out in detail in IPRU Banks. The U.K. capital requirements for banks are based on the relevant EU directives, which are fully in line with the Basel Capital Accord. All U.K. incorporated banks are required to maintain capital in accordance with the Basel standards, not just those banks that are internationally active. There is a general rule requiring banks to maintain capital resources which are commensurate with the nature and scale of their business and risks inherent in that business (IPRU Ch. GN 3.3.13R). If the bank is part of a group, the capital resources must also be commensurate with the risks inherent in the activities of other members of the group in as far as these risks affect the bank. In addition to the general capital adequacy rules, for each U.K. incorporated bank an individual required capital ratio is set which in almost all cases is higher (and never lower) than the Basel minimum requirement of 8 percent. Individual bank capital ratios are determined by the overall risk profile of each institution. If the FSA determines that a bank’s business or control risks have increased, it may raise the bank’s individual required capital ratio. The individual capital ratios are applied both on a solo and on a consolidated basis. The individual ratios are reviewed periodically within a timeframe that is consistent with a bank’s supervisory cycle. Banks are required to report their solo capital ratio on a quarterly basis and their consolidated ratio on a semi-annual basis. The components of capital and the risk-weighted assets also have to be reported. Capital requirements have to be met continuously, not just on reporting dates. Banks must therefore be able to calculate their capital ratio regularly. Any breaches of individual required capital ratios must be immediately notified to the FSA. This would lead to the agreement of a clear plan and timetable to achieve swift compliance with the required ratio, either through a capital injection or a balance sheet restructuring. The FSA has a wide range of enforcement powers available if any bank fails to comply with the Threshold Conditions or the FSA’s Rules (including the capital adequacy requirements), such as variation or cancellation of permitted activities and withdrawal of the license (see Principle 1.4).
Assessment	Compliant
Comments	The FSA’s minimum capital requirements for banks are fully in line with the 1988 Basel Capital Accord and its subsequent amendments. The individual capital requirements anticipate the supervisory review process that is expected to be incorporated in the new Capital Accord that is currently being prepared. The FSA is committed to fully implementing the new Capital Accord at the earliest opportunity.
Principle 7.	Credit Policies An essential part of any supervisory system is the independent evaluation of a bank’s policies, practices, and procedures related to the granting of loans and making of investments and the ongoing management of the loan and investment portfolios.
Description	According to the Threshold Condition on Suitability, regulated firms (including banks) are expected to have identified fully, and considered, the various risks they will encounter in conducting their business and installed appropriate control systems to manage them prudently at all times. IPRU Banks Chapter AR (on accounting and other records and internal control systems) states that this can only be done if a bank has adequate accounting and other records of its business and adequate systems of control of its business and records. It is the responsibility of a bank’s directors and management to take reasonable care to establish and maintain such systems and controls as are appropriate to the nature, scale and complexity of its business. There is also a general requirement for a bank’s directors and management to take responsibility for deciding what management information is required and who are to be the recipients (IPRU Banks Chapter AR Section 3.2.3). A bank is expected to have management information accurately covering its risk exposures (ibid. Section 3.3.5). No specific rules or guidance exist for banks’ loan and investment policies, practices and procedures since these are considered to be the responsibility of management. However, the FSA expects a bank to have set prudent credit granting and investment criteria, policies and procedures, which reflect its range and type of assets. These criteria, policies and procedures must have been approved and implemented by bank management and board of directors and should be periodically reviewed. All relevant staff members are expected to receive adequate training in the bank’s internal control policies and procedures. Each bank is expected to have appropriate credit assessment procedures in place with which to identify, measure, monitor and control the credit risk. A bank’s internal records should reflect details of the analysis undertaken. A bank’s records should include details of counterparty exposure limits that have been approved by management and the bank should be able to measure actual exposures against these limits (IPRU Banks Chapter AR Section 3.2.2). Also, each bank is required to have a policy on large exposures (see Principle 9). This policy should outline the approval process for major credits, the circumstances in which limits may be exceeded and who is authorized to approve such excesses (e.g., a bank’s board or credit committee). The FSA will verify whether a bank has followed prudent credit granting criteria, policies and procedures through desk-based analysis of prudential returns. One of the methods employed, particularly for the purpose of assessing the adequacy of management information systems, is peer group review. If the desk-based analysis indicates a need for further scrutiny, various supervisory tools may be applied, if necessary in an escalating fashion, for example visits by the supervisory team to the bank, followed by specialist credit evaluation visits, and ultimately so-called skilled persons (i.e., outside auditors) investigations. Also, ad hoc meetings with senior management may be held to assess their understanding and implementation of the criteria, policies and procedures. The supervisory team will give consideration to the size, maturity, currency, marketability and sources of repayment, the geographic dispersion of assets, whether credit decisions have been taken on an arm’s-length basis and whether adequate checks are made of the total indebtedness of the entities to which the bank extends credit. No routine reviews of credit files are conducted. The FSA expects a bank to give the supervisory team full access to all information relevant to the credit and investment portfolios. However, in the event it does not prove possible to gain access to the requested information on a voluntary basis, the FSA will use its statutory powers. The FSA frequently requests receipt of banks’ own management information to help it verify adherence to the credit policies set.
Assessment	Compliant
Comments	Although no specific rules have been set, the FSA requires a bank to have credit-granting procedures that identify, monitor and control credit risk. The bank’s policies should reflect the range and type of its assets. Periodic evaluation of a bank’s credit-granting criteria is undertaken by means of a mix of desk-based analysis, on-site visits, ad hoc meetings with management and skilled persons reports.
Principle 8.	Loan Evaluation and Loan-Loss Provisioning Banking supervisors must be satisfied that banks establish and adhere to adequate policies, practices, and procedures for evaluating the quality of assets and the adequacy of loan-loss provisions and reserves.
Description	Banks are required to maintain such systems and controls as are appropriate to their business (SYSC 3.1.1R). These should include monitoring asset quality and the adequacy and value of collateral on a net realizable basis (SYSC 3.2.11 and IPRU Chapter PN). In addition, banks must maintain adequate provisions for any depreciation in the value of their assets (IPRU Chapter GN 3.3.17R). Banks are required to set out their policy on making provisions in a written statement, which should include details of their loan classification arrangement and should be reviewed annually (IPRU Banks Chapters GN 3.4.5R and PN 3). The FSA does not prescribe a particular format for the policy statement as it does not consider one format to be appropriate for the diverse range of banks authorized in the U.K. However, the FSA expects the provisioning policy statement to cover issues such as who is responsible for drawing up and monitoring the policy, what areas of the bank’s business are covered, what types of management information is generated, how is implementation of the policy checked, how are non-performing exposures identified, etcetera. A copy of the provisioning policy statement has to be supplied to the FSA. Provisioning policies should cover both on and off balance sheet positions. Provisioning and loan classification policies are not rule or formula based but must be appropriate to the bank’s business. Provisioning decisions are taken by management or the board based on a true and fair view of the quality of the assets. However, banks normally follow the accounting guidelines that have been issued by the British Bankers Association and any deviations have to be explained. These guidelines require the making of provisions once assets are identified as impaired. Loans are impaired when there is reason to believe that not all amounts (both principal and interest) will be collected in accordance with the contractual terms of the loan. The external auditor has to approve the provisioning decisions made by management in the context of his review of the financial statements. However, banks’ provisioning policy statements should include criteria for loans to be classified as non-performing. This would normally be when payments were a minimum number of days in arrears (usually 90 days), but a bank could make specific provisions earlier if this is considered appropriate. Provisioning decisions with regard to individual assets have to be based on an impairment that has actually been identified, in other words, no general provisions are to be included. In assessing the adequacy of a bank’s provisions, the FSA looks at its provisioning policies, and the methods and systems for calculating provisions in accordance with those policies. The FSA seeks to ensure through risk mitigation programs and other work that procedures and resources for monitoring and dealing with problem loans are adequate. The FSA does not as a standard practice require periodic reporting of classified and non-performing loans. However, where the FSA has concerns over a bank’s asset quality, it can seek regular reports on watch list loans. The level of provisioning is normally reported either on a quarterly or a semi-annual basis, but the frequency can be increased, and the required contents of reports expanded, if necessary. When there are doubts about a bank’s credit controls or the adequacy of provisions, the FSA will have these assessed by its own credit specialists or by an external skilled person. A plan of action would be tailored to the outcome of such reviews. If the FSA continued to have doubts on a bank’s provisioning practices, it may use its enforcement powers.
Assessment	Compliant
Comments	Banks are required to supply the FSA with policy statements outlining their approach to asset classification and provisioning arrangements. External auditors routinely review the adequacy of banks’ provisions as part of the audit process. The FSA does not have a formal requirement that loans be classified when payments are contractually a minimum number of days in arrears (as called for in *Additional Criteria 1, of the Core Principles Methodology)* as the classification and provisioning system is not rule but principle-based. In practice, loans tend to be classified after 90 days of arrears. This system works well and actual provisioning levels in U.K. banks appear to be adequate. The FSA should consider introducing a requirement for periodic reporting on credit quality based on each bank’s own asset classification policy and internal credit ratings. This would strengthen off-site monitoring by allowing early identification of asset quality trends.
Principle 9.	Large Exposure Limits Banking supervisors must be satisfied that banks have management information systems that enable management to identify concentrations within the portfolio, and supervisors must set prudential limits to restrict bank exposures to single borrowers or groups of related borrowers.
Description	Each bank must set out its policy on large exposures in a written statement (IPRU Chapter GN Section 3.4.1R). The policy should outline the circumstances in which limits (e.g., types of counterparty, individual counterparties and connected exposures) may be exceeded and who is authorized to approve such excesses (e.g., a bank’s board or credit committee). The policy statement must be approved by the bank’s board and must be agreed with and copied to the FSA. The bank must review the policy statement and if necessary update it at least once a year. Any significant departures from the stated policy, e.g., new types of lending or breaches of existing limits, should not be incorporated without prior discussion with the FSA. A bank must have adequate systems and controls to enable it to monitor and control its large exposures in conformity with its large exposures policy statement and to calculate its large exposures accurately and promptly (IPRU Chapter GN Section 3.3.19R). The supervisor will verify the existence of such systems and controls. This will be done by periodic supervisory visits to the bank, ad hoc meetings with senior management and the board, skilled person reports and any thematic work that the FSA may seek to carry out in this area. Maximum limits for exposures to individual and group borrowers are set by the EU Large Exposures Directive (now included in the Consolidated Banking Directive), which has been fully implemented in FSA guidance. The chapter on large exposures in IPRU provides a comprehensive definition of ‘exposures’, which includes both on and off balance sheet items, and guidance covering the 10 percent and 25 percent limits and the calculation of a bank’s large exposure capital base. The limits, as well as the notification and reporting requirements, have to be met both on a solo and on a consolidated basis, as appropriate. A ‘closely related group’ is defined to exist either where two or more individual counterparties constitute a single risk because one of them has directly or indirectly, control over the other(s), or where individual counterparties are connected in such a way that the financial soundness of any of them may affect the financial soundness of the other(s) or the same factors may affect the financial soundness of both or all of them. Where there is doubt as to whether a number of individual persons constitute a group of closely related counterparties banks should discuss the circumstances with the FSA to determine how the exposure(s) should be reported (IPRU Chapter LE Section 5). A U.K. bank must notify the FSA if it proposes to enter into a transaction which would result in it having an exposure which exceeds 25 percent of its capital (IPRU Chapter GN Section 3.3.21R). In conformity with the EU Capital Adequacy Directive, excesses of the 25 percent limit may be allowed in certain limited cases, relating mostly to trading book positions. In such cases, an incremental capital requirement may be applied. In addition, the FSA may allow a breach of the 25 percent limit at the solo level as long as the limit is met at the consolidated level. All breaches of large exposure limits must be notified to the FSA immediately (IPRU Chapter LE Section 3). The FSA receives details of the twenty largest bank and non-bank exposures and any exposures of 10 percent or more of a bank’s regulatory capital base via a large exposures report submitted quarterly by U.K.-incorporated banks (SUP 16.7.8R). Branches of non-EEA incorporated banks submit half-yearly reports of their twenty largest bank and non-bank exposures (SUP 16.7.12R). These reports should be completed on an unconsolidated or solo-consolidated basis and on a consolidated basis. Concentrations of risk should be covered in a bank’s large exposure policy statement and significant concentrations of risk, both sectoral and geographic, would be considered during the FSA’s regular risk assessments. The FSA also frequently requests receipt of banks’ own management information to help verify adherence to the large exposure policy statement and limits.
Assessment	Compliant
Comments	Clear and precise regulations exist with respect to large exposures, reflecting the relevant EU Directive. The FSA’s requirement for banks to submit a written policy statement on large exposures is an appropriate means of stimulating prudent behavior in banks with respect to risk concentrations. Large exposure policies are monitored and enforced by the FSA using its normal supervisory tools.
Principle 10.	Connected Lending In order to prevent abuses arising from connected lending, banking supervisors must have in place requirements that banks lend to related companies and individuals on an arm’s-length basis, that such extensions of credit are effectively monitored, and that other appropriate steps are taken to control or mitigate the risks.
Description	Banks’ policies on connected lending should be included in their large exposures policy statements (IPRU Banks Chapter LE Section 8.1). Connected exposures are defined to include intra-group lending, lending to directors, senior managers, controllers (i.e., major shareholders) and their associates (including close family members), and lending to non-group companies with which the bank’s directors or controllers are associated (ibid. Section 5.3). The FSA retains discretion to determine whether a particular counterparty should be deemed to be connected to a bank where doubt exists. The FSA normally expects connected exposures to remain an insignificant proportion of a bank’s assets. Clear and objective credit assessment processes have to be used when banks consider proposals for connected lending. Exposures to connected parties may be entered into only for the clear commercial advantage of the bank and should be negotiated and agreed on an arm’s length basis. Factors a bank has to take into account when determining whether a loan is being made on an arm’s length basis include the extent to which shareholders can influence the bank’s operations (e.g., through voting rights), the management role of shareholders (e.g., whether they are also directors of the bank) and whether the loan would be subject to the bank’s usual monitoring and recovery procedures if repayment difficulties emerged (ibid. Section 5.3.7). Aggregated connected lending should be a maximum of 25 percent of a bank’s capital base. The FSA is prepared to consider requests from banks for higher limit levels than this in certain, very limited, circumstances. An example of this might be where the bank performs a group treasury function and it is reasonable to allow a limit higher than 25 percent of capital for exposures of under one year maturity. The requirements for connected lending concessions are set out in IPRU Banks (Chapter LE 9.2.2-9.2.5). With the exception of such agreed concessions within limited parameters, aggregate regulatory limits on banks’ connected exposures are as strict as those for single borrowers and groups of related borrowers. The FSA may deduct exposures to companies or persons connected to a bank from the bank’s capital base if they are of the nature of a capital investment or are made on concessionary terms (IPRU Chapter LE 5.3). Aggregated connected lending is reported to the FSA on a quarterly basis via a large exposures report. One of the checks supervisors make when examining these data is to ensure that they remain within the agreed limits. Since the FSA requires banks to report connected exposures, it requires banks to have systems in place to identify all connected exposures. The mission team was informed that the FSA also requires banks to provide a detailed breakdown of their exposures to connected counterparties. As with credit policies generally, verification of compliance with the requirements relating to connected lending may be undertaken during the course of supervisory or specialist credit visits or by commissioning skilled persons reports.
Assessment	Compliant
Comments	The FSA’s supervisory approach towards connected lending by banks offers sufficient safeguards that such lending will be undertaken only on an arm’s length basis. The requirements for approval of proposed exposures to companies or persons connected with the bank by the bank’s board of directors and for banks to have procedures in place to prevent persons benefiting from the loan taking part in the loan assessment process or in the loan decision(*Essential Criteria 3 and 4* of the *BCP Methodology*) are covered by the general requirement for banks to take special care to ensure that a proper, objective credit assessment is undertaken for connected lending and by the more specific guidance on credit risk management and corporate governance given in the FSA’s Handbook. Also, the FSA requires the risk management function of a bank to be independent and therefore parties benefiting from a lending decision should not be part of the risk assessment process.
Principle 11.	Country Risk Banking supervisors must be satisfied that banks have adequate policies and procedures for identifying, monitoring, and controlling country risk and transfer risk in their international lending and investment activities, and for maintaining appropriate reserves against such risks.
Description	A bank’s approach to sovereign lending and to country exposure limits should be included in its large exposure policy statement (IPRU Banks Chapter LE Section 8.1). Although there is no specific requirement in this regard, the FSA expects the policy statement to include details of limits on a country-by-country basis. Exposures to overseas countries which exceed 25 percent of a bank’s capital base are not covered by the pre-notification requirements for large exposures. However, where a proposed transaction will result in an exposure which represents a significant departure from a bank’s large exposure policy statement, the FSA does expect the proposed transaction to be notified in advance and discussed with it. If the FSA is dissatisfied with a bank’s country risk policy, it may instruct the bank to reduce its exposures or to increase its capital. The FSA’s guidance for banks’ provisioning policy statements does not contain references to provisioning for country exposures. Provisioning for country risks is covered by the general requirement for banks to maintain adequate provisions. While the FSA does not set specific provisioning requirements it does expect banks to make appropriate levels of provisions after discussions with their external auditors. If the FSA thought that a bank had inadequate provisions it would seek to hold discussions with the bank and its external auditors in order to ensure that provisioning levels are reasonable. A bank’s adherence to its country risk and provisioning policies will be checked by the FSA by desk-based reviews, during on-site inspection visits or, where appropriate, by means of a skilled persons report. The FSA will obtain information on country, sectoral and regional exposures from banks’ internal monitoring systems and will discuss them with banks’ management in the context of their large exposures policies (IPRU Banks Chapter LE Section 9.2.7.21). By doing so, the FSA is able to assess whether banks have information systems, risk management systems and internal controls that enable them to comply with their country risk policy as set out in their large exposure policy statements. The FSA also has access to country exposure statistical data collected from banks by the Bank of England, including individual banks’ returns. These returns identify cross border claims by country and sector. Bank of England data relating to country risk and transfer risk are collected quarterly and must be submitted to the Bank of England within two months of the reporting date.
Assessment	Compliant
Comments	While the FSA does not provide specific guidance with regard to country risk exposures and provisioning, it does require and verify that banks devote adequate attention to these issues. The FSA has abandoned the previous policy of setting individual country risk exposure limits because it was not possible to define such exposures generically. Also, the FSA prefers to focus on control risks instead of regulating banks’ business risk policies. The approach now taken by the FSA on country risk is in line with international risk management practices.
Principle 12.	Market Risks Banking supervisors must be satisfied that banks have in place systems that accurately measure, monitor, and adequately control market risks; supervisors should have powers to impose specific limits and/or a specific capital charge on market risk exposure, if warranted.
Description	Banks are required (IPRU Chapter GN rule 3.4.7) to have a written Trading book policy statement that covers the way in which a bank identifies, values and measures market risks in the trading book, including interest rate risk. Each bank is expected to be able to identify, measure, monitor and control its exposures to foreign exchange and other market risks across all products (IPRU Banks Chapter AR Section 3.2). Each bank is also expected to be able to collect information that can be summarized in such a way as to enable actual exposures to be readily, accurately and regularly measured against the exposure limits authorized by management. Where relevant, these limits should relate to the level of trading positions (both intra-day and overnight) in securities, foreign exchange, futures, options, forward rate agreements and swaps. Periodic reviews are conducted to verify the adequacy of a bank’s internal control systems. The FSA has imposed specific capital charges for market risks (IPRU Chapter CO Section 3). In accordance with the 1996 amendment to the Basel Capital Accord and the EU Capital Adequacy Directive, U.K. incorporated banks are set capital charges for foreign exchange and commodities position risk in the banking and trading books combined. Separate capital requirements are set for equity and interest rate position risk, as well as counterparty, underwriting and settlement risk, in the trading book. To ensure that the calculation of capital charges for market risks is valid firms need good management systems to collate accurate data. The supervisor will determine compliance with these requirements through desk based analysis of returns, information gained from on-site visits or on-going discussions with senior management. Also, in addition to standard regulatory reporting, banks are often requested to provide ad hoc reporting of their own management information (including analyses conducted). Because of its tailor-made nature this information usually offers greater insight into the market risk being run by the bank. On-site visits to banks by supervisory staff and/or a specialist team are used to ascertain the extent of senior management’s understanding of the market risk as reflected in the risk management information. For banks with significant market risk exposure, the FSA will meet a range of staff, including senior management, staff from the front office, financial control, risk management, operations, systems development, information technology and audit areas, to assess the quality of market risk management and controls. The adequacy of a bank’s system of controls is tested by periodic reviews conducted either by FSA in-house specialists or skilled persons. The FSA has established a Traded Risk Review Team within the Risk Review Department. This team focuses on banks’ trading and markets activities and its management. It has specialists with the necessary expertise to undertake, among other activities, on-site visits to review treasury systems and controls. On-site visits by the Traded Risk Team typically last between one and three days. The purposes of on-site visits include the evaluation of whether a bank’s internal market risk measurement and pricing models can be recognized for the purposes of calculating market risk capital requirements. Once a model is recognized, the team will conduct quarterly update visits during which the control environment in which the model is operated is discussed along with model outcomes, backtesting and other relevant data. The provision of this data is shortly to be automated to enhance the FSA’s ability to track trends and make comparisons. A bank that uses an internal model to calculate supervisory capital should have in place a rigorous and comprehensive program of stress testing. As set out in IPRU (Chapter TV Section 9), the FSA attaches great importance to the stress testing of the various risks facing a bank in its overall activity. As part of the model recognition process, the FSA will examine a bank’s stress testing program, including the procedures in place to assess and respond to its results. The FSA will not normally prescribe scenarios for a bank to use in stress testing, although it may do so in the event of particular market circumstances.
Assessment	Compliant
Comments	The FSA uses specific capital requirements for separate categories of market risks. Compliance with these requirements is determined through desk-based analysis and on-site visits. The adequacy of the bank’s system of controls surrounding market operations is tested by periodic reviews conducted either by FSA in-house specialists or skilled persons. In view of the number of banks, the Traded Risk Review Team appears to be thinly staffed. This applies even though only the relatively limited number of 10 to 12 banks (most of them foreign-owned) engage in the trading of highly complex financial products, while a similar number of banks is allowed to use value-at-risk models for calculating supervisory capital adequacy requirements.
Principle 13.	Other Risks Banking supervisors must be satisfied that banks have in place a comprehensive risk management process (including appropriate board and senior management oversight) to identify, measure, monitor, and control all other material risks and, where appropriate, to hold capital against these risks.
Description	Banks are required to maintain systems and controls that are appropriate to their business (IPRU SYSC 3.1.1R). According to the Threshold Condition on Suitability, regulated firms (including banks) are expected to have identified fully, and considered, the various risks they will encounter in conducting their business and installed appropriate control systems to manage them prudently at all times. It is considered to be the responsibility of a bank’s directors and management to take reasonable care to establish and maintain such systems and controls as are appropriate to the nature, scale and complexity of its business. The FSA has provided banks with guidance on adequate controls and records (IPRU Banks Chapter AR Section 3). Among other things, the guidance states that banks should design and operate a system of internal controls that provides reasonable assurance that all the bank’s revenues accrue to its benefit, all expenditure is properly authorized and disbursed, all assets are adequately safeguarded, all liabilities are recorded, and statutory and supervisory requirements are met. Management information should be prepared to show the bank’s state of affairs and its exposure to each type of risk, compared to the relevant limits set by management. The FSA expects banks’ high level controls to include the setting of strategy and plans and the establishment and review of the organizational structure and the system for delegation (including segregation of duties). In addition, management should approve the bank’s risk policies, review its high level management information and maintain the framework for monitoring and detailed periodic review of risk management and control systems. The implementation of action points following such a review should be monitored by management. Internal control systems should provide reasonable assurance that management is able to monitor on a timely basis the adequacy of a bank’s capital, liquidity, profitability and the quality of its assets. They should enable management to monitor and control the bank’s risk and to make appropriate provisions for bad and doubtful debts. The FSA expects banks to have an internal audit function (but in some cases it may be outsourced) and an audit committee. Banks are required to provide the FSA with a statement of liquidity policy (IPRU Chapter LM Section 3) that should set out their approach to liquidity management, including a description of arrangements for management on a day-to-day basis, and should explain how much liquidity risk will be assumed. The liquidity standards that banks should maintain must be appropriate to the nature and scale of their business. A bank should have in place systems which enable it to monitor its liquidity profile on a frequent and timely basis. A bank with significant currency business should include in its policy statement the policy for monitoring and controlling its liquidity positions in individual currencies. The policy statement should also consider the management of liquidity in both normal and abnormal circumstances. The FSA monitors banks’ liquidity using either a mismatch approach or a stock approach. For the majority of banks, the FSA has set mismatch guidelines that take into consideration the volatility, diversity and source of deposits, any concentrations of deposits, the degree of reliance on marketable assets and the degree of diversification, the availability and reliability of undrawn standby lines, and the impact of other factors such as off balance sheet obligations (IPRU Chapter LM Section 8.1). For the minority of banks that have a large retail deposit base in the form of current accounts, the FSA has set a sterling stock liquidity regime that requires a bank to hold a stock of liquid sterling assets that can easily be sold to replace funding that has been withdrawn. A more limited range of assets is treated as liquid under the stock approach than under the mismatch approach to reflect the fact that significant sales of certain assets by a large bank might unsettle the market. For U.K. branches of foreign banks, the mismatch approach is normally applied, with the additional requirement that the available liquidity actually has to be present in the U.K. However, if the FSA is satisfied that a branch is fully integrated with its head office for liquidity management purpose and that it can rely on the home country supervisory regime, it may permit the branch to have its liquidity managed on a global basis by its head office. Banks on the stock liquidity regime have to report their liquidity position to the FSA on a monthly basis, while banks on the mismatch regime have to report on a quarterly basis. In case a bank is experiencing liquidity problems, it may be required to report more frequently, if necessary on a daily basis. The stock liquidity report has to be prepared on a consolidated basis. While the FSA does not normally collect liquidity data in individual currencies it may require a bank to report on this basis if it has significant operations in illiquid currency markets. Supplementary to regulatory reporting, the FSA monitors liquidity risk through on-site visits, during which discussions may be held with a bank’s ALM committee. Such visits also provide the opportunity to determine management’s ability to understand and address technical issues such as those relating to multiple currency liquidity management. No specific guidance is given with respect to banks’ interest rate risk outside the trading book. The mission was informed that the FSA does not see a need for such guidance since many banks have a large proportion of floating rate assets in their banking book, reducing the potential for interest rate risk. However, the FSA has made it known to banks that it will use the Basel Committee’s Principles for the Management of Interest Rate Risk to asses the adequacy of a bank’s interest rate risk management. The FSA conducts stress tests on interest rate positions in the banking book, particularly for the larger banks. In addition, interest rate risk in the banking book is among the issues that are explicitly considered by the FSA when setting a bank’s individual capital ratio requirement (as are operational risks). In practice, individual supervisors’ analysis of interest rate risk in the banking book, which is typically based on discussions with the bank and management information, rarely results in a material increase in a bank’s individual capital ratio. With regard to operational risk, each bank is expected to have a control environment that minimizes loss from fraud, safeguards the assets, controls the liabilities and provides reasonable reassurance that the business is conducted in adherence to established policies (IPRU Chapter AR Section 3.3). Some specific guidance is given on controls in an IT environment (ibid. Section 3.3.6), while relatively detailed guidance is given on outsourcing (IPRU Chapter OS). Furthermore, each bank is expected to have appropriate arrangements to ensure business continuity in the event of an unforeseen interruption (SYSC 3.2.19). Through on-site visits, the FSA may check the effectiveness of allocated responsibilities, lines of reporting, the delegation of authority and other operational risk controls. As noted above, operational risk is one of the factors considered by the FSA when setting banks’ individual capital ratio requirement. The FSA does not currently require a specific operational risk policy statement (in contrast to large exposures, liquidity, provisioning and, where applicable, the trading book). The FSA encourages best practice in corporate governance. This includes banks making comprehensive disclosure in their annual published accounts. The FSA has also successfully exercised pressure on individual banks to inform their customers of significant issues by means of a letter.
Assessment	Compliant
Comments	Each bank is required to maintain systems and controls that are appropriate to the risks in conducting its business. The FSA has issued guidance relating to liquidity risk, interest rate risk and key aspects of operational risk, and it applies specific capital requirements to foreign exchange risk. The FSA verifies the extent to which a bank’s risk management system addresses the key banking risks during on-site visits. The FSA’s approach to monitoring liquidity under the mismatch or stock regimes appears somewhat dated in that it is not aligned to banks’ own approaches to measuring and managing liquidity, at least for the more sophisticated banks. The FSA has recently begun considering the development of a new approach which would give banks a choice between a standardized measurement technique and the use of liquidity modeling techniques for liabilities with a behavioral maturity and contingent claims. Such an approach would be designed to create incentives for banks to further develop their own liquidity measuring and management techniques. Although the actual implementation of this new approach still appears to be some years off, the mission believes it could constitute a significant step forward.
Principle 14.	Internal Control and Audit Banking supervisors must determine that banks have in place internal controls that are adequate for the nature and scale of their business. These should include clear arrangements for delegating authority and responsibility; separation of the functions that involve committing the bank, paying away its funds, and accounting for its assets and liabilities; reconciliation of these processes; safeguarding its assets; and appropriate independent internal or external audit and compliance functions to test adherence to these controls, as well as applicable laws and regulations.
Description	The Companies Act 1985 prescribes the duties of directors who manage a company and are responsible for protecting the interests of members (shareholders) and employees. The Act applies to all companies, including banks. Any bank listed on the London Stock Exchange is subject to a Listing Rule and Combined Code which reflect the recommendations of the Committee on Corporate Governance (‘the Hampel Committee’). There is a requirement to produce a statement of directors’ responsibilities. The Combined Code is not prescriptive about the contents of the statement but there is an expectation that it will cover the responsibility of the directors for keeping proper accounting records, for safeguarding the assets of the company and for taking reasonable steps for the prevention and detection of fraud and other irregularities. In addition, the Combined Code (provision D.2.1) states that ‘the directors should, at least annually, conduct a review of the effectiveness of the group’s system of internal control and should report to the shareholders that they have done so. The review should cover all controls including financial, operational and compliance controls and risk management.’ Specific internal control requirements for banks, together with adequate record keeping requirements, are outlined in SYSC and IPRU Banks (Chapter AR). SYSC requires a bank to allocate appropriately to one or more individuals the functions of dealing with the apportionment of significant responsibilities and of overseeing the establishment and maintenance of systems and controls. Banks must take reasonable care to establish and maintain such systems of controls as are appropriate to the nature and scale of their business (SYSC, 3.1.1R). Banks are also required to have documented high level controls defining responsibilities of management and identifying lines of reporting and outlining the implementation of the requirements with respect to segregation of duties, accounting records and measures to safeguard assets (SYSC 3.2 and IPRU Chapter AR Section 3.3.5). The FSA also requires that banks have procedures to ensure that personnel have capabilities commensurate with their responsibilities and that they have implemented effective segregation of duties (IPRU Chapter AR Section 3.3.5). Furthermore, it is a requirement of IPRU (Chapter AR Sections 3.3.9 and 3.3.10) that banks have an internal audit function. However, the primary responsibility for preventing internal fraud lies with senior management. The internal audit function should have clear responsibilities and its objectivity and independence should be supported by appropriate reporting lines. In most cases this would be dual reporting lines from the head of internal audit to the chief executive officer, or equivalent, and access to the audit committee (IPRU Chapter AR Sections 3.3.9 and SYSC 3.2.16G). The internal audit function should have unrestricted access to all of a bank’s activities, records, property and personnel. A bank may outsource its internal audit function but normally not to its external auditors or skilled persons, unless certain conditions aimed at safeguarding the independence of internal audit are met. Any proposals to outsource the internal audit function should be notified to the FSA (IPRU Chapter OS Section 4.7). External auditors test a bank’s accounting procedures during their audit of the financial statements. They report significant deficiencies they have found in a letter to the bank’s management. External auditors are allowed to notify the FSA of any information they have found and which appears to be relevant to the FSA’s supervisory objectives (FSMA section 342). However, if the auditors consider any deficiency they have found to be material, they normally expect the bank’s management to forward the management letter to the FSA. Failure to do so would be interpreted as a lack of integrity on the part of the bank’s management. This would be reported to the FSA by the external auditors themselves. To carry out the role of directors and senior management, individuals have to be vetted and approved by the FSA. To gain approval they have to be considered fit and proper (FSMA Schedule 6, paragraph 5) which consists of being honest, competent to carry out their function and financially sound. The applicant has the burden of satisfying the FSA that he is a fit and proper person having regard to all circumstances. The FSA takes into account the distribution of expertise within the board when considering individual applicants. Once approved these individuals must maintain their fitness and propriety. If any of the senior management is deemed to be no longer fit and proper, the FSA has the power to initiate proceedings for the individual to be removed. The FSA follows both the Cadbury and Hampel guidance on Audit Committees and the inclusion of non-executive directors (IPRU Chapter AR Section 3.3.10). In accordance with the FSA’s internal Guidance for firm specific risk assessment and risk mitigation (Appendix 3, Corporate Governance, version 5, November 2001), there should be an appropriate proportion of nonexecutive directors to executive board members. The FSA checks through meetings during on-site visits and reviews of relevant documentation (e.g., board minutes and audit committee minutes) that a bank’s non-executive directors (a) have the necessary skills and background, (b) participate fully in committee meetings and (c) exercise independent judgment. Non-executive directors have to be vetted and approved by the FSA. The FSA has wide powers to require banks to provide information (FSMA Section 165) and the power to require the provision of a report on the firm by a skilled person (FSMA Section 166). If deemed necessary, the FSA can request copies of internal audit reports and minutes of audit committee meetings. The quality of the internal audit function may be assessed during on-site visits. The FSA also meets, at least annually, with the chairman of a bank’s audit committee. The effectiveness of front, middle and back office functions may be reviewed either through regular on-site supervisory visits, specialist visits or via the use of skilled persons.
Assessment	Compliant
Comments	The duties of directors are prescribed by company law and banks are expected to adhere to the accepted standards of corporate governance. The FSA requires banks to take reasonable care to put in place controls that are appropriate to the nature and scale of their business. This includes high level management controls (covering management responsibilities, reporting lines, segregation of duties and measures to safeguard assets). The FSA expects banks to have an appropriately resourced internal audit function which reports to an audit committee chaired by an independent director.
Principle 15.	Money Laundering Banking supervisors must determine that banks have adequate policies, practices, and procedures in place, including strict “know-your-customer” rules, that promote high ethical and professional standards in the financial sector and prevent the bank being used, intentionally or unintentionally, by criminal elements.
Description	*Essential criteria* As a statutory objective FSMA requires the FSA to reduce the potential for regulated businesses, including banks, to be used for a purpose connected with financial crime. Under FSMA financial crime is defined as money laundering, fraud or dishonesty, and criminal market misconduct. FSMA provides the FSA with a range of powers to make rules on firm’s systems and controls relating to money laundering, to supervise firms’ compliance with those requirements and to prosecute firms for systems and controls failures in this area. FSA’s Money Laundering Rules and regulatory requirements are set out in the Money Laundering Sourcebook in the Handbook. The requirements for effective systems and controls to protect against money laundering are elaborated in ML 7.2. ML 3 details customer identification requirements. ML 4 specifies the requirements with respect of suspicious transactions reporting. ML 7.3 specifies record keeping requirements on customer identification and individual transactions and the record keeping period. Awareness and training are required under ML 6 and the appointment of a senior officer as Money Laundering Reporting Officer (MLRO), including the requirement that the MLRO be an approved person by FSA, is provided for in ML 7. Both the FSA’s Rules and the Money Laundering Regulations 1993 (“the “Regulations”) require banks to verify the identity of customers as soon as is reasonably practicable after contact is first made, in order to carry out any regulated financial activities for them. The obligation to verify identity extends to business undertaken on behalf of another person. To assist a bank in meeting these statutory and regulatory obligations, industry guidance has been prepared in the form of the Joint Money Laundering Steering Group’s (JMLSG) Guidance Notes. The guidance notes provide extensive information on how and when to identify customers. The guidance notes are not mandatory but the FSA will take them into consideration in evaluating whether a bank has proper customer identification procedures. Neither the FSA’s Rules nor the Regulations explicitly require banks to have formal procedures in place to recognize suspicious transactions. However, the practices recommended in the JMLSG Guidance Notes cover many of the elements that might be incorporated in formal procedures. The Guidance Notes set out that appropriate ‘know your customer’ procedures, combined with adequate staff training, are the key to recognizing transactions or patterns of activity that are inconsistent with a customer’s known legitimate business, or with the normal business for that type of account. Accordingly, many banks routinely monitor cash deposits/withdrawals, and wire transfers over a certain monetary threshold (typically a few thousand pounds) and some major banks have developed or purchased sophisticated anti-fraud and money laundering monitoring systems. FSA Rules and Regulations require all bank staff to report (to the MLRO) any information that gives rise to knowledge or suspicion of money laundering. Further, the bank is required to take reasonable steps to insure that staff who handle or have responsibility for transactions that may involve money laundering report promptly. Reporting the suspicion or knowledge to the MLRO discharges the individual’s statutory and regulatory responsibilities. The MLRO, as an Approved Person, has the designated responsibility to receive internal reports of suspicious activities, to report suspicious activities to NCIS, to insure adequate awareness and training, to monitor day-to-day compliance with anti-money laundering policies and to prepare an annual report to management. The purpose of the annual report is to highlight any compliance problems, which it is the responsibility of the bank’s senior management to remedy. FSA supervisors can request a copy of the report to assist in assessing the bank’s level of compliance with its statutory and regulatory obligations. A bank is not specifically required to report to FSA suspicions of money laundering; the obligation is to report to NCIS. But banks do have a regulatory obligation to notify the FSA of significant incidences of fraud. In determining whether a fraud incident is significant, the firm must consider (i) size of loss in relation either to the bank itself or to customers; (ii) risk of reputational loss; and (iii) whether the incident reflects weaknesses in the bank’s internal controls. The FSA operates a risk-based approach to verifying that banks have the necessary controls to comply with anti-money laundering rules and regulations. The approach is designed to allocate resources in the most efficient manner to ensure that supervisory attention is directed at those areas that pose the greatest threat to the FSA’s regulatory objectives, with deterrence of financial crime being one of those objectives. To assess the vulnerability of a bank to money laundering, FSA identifies key risk criteria drawn from money laundering typologies. These criteria are scored against the business profile of individual banks. Taking into account the robustness of a bank’s control regime, FSA makes an evaluation of the extent to which the business of the bank exposes it to money laundering risk and the probability that risk will materialize. A further judgment is made about the impact if such risks do materialize and the threat this would pose to FSA’s ability to meet its statutory objectives. For banks, size is a major factor in scaling the risks to FSA’s objectives. Based on this analysis FSA arrives at a judgment about the supervisory tools and resources to be devoted to the supervision of money laundering and the intensity and focus of oversight on individual firms. In a July 2001 report, “The Money Laundering Theme,” FSA announced that it had identified six “clusters” of activities which were particularly vulnerable to money laundering and on which regulatory attention would focus. Two of these clusters concerned banks. Theme supervision provides FSA with a tool for horizontal review of practices across banks without regard to the risk profile of the bank in other business areas. Thematic work includes on-site testing of anti-money laundering procedures. Theme reviews, however, are also targeted based on risk assessments. To assist line supervisors assess the level of a bank’s compliance with the FSA’s Rules and Regulations the FSA has: a Money Laundering Review Team (supervisors with expertise in the area of money laundering); the power to appoint “skilled persons” to investigate money laundering compliance issues; an Intelligence and Records Department, which liaises with national and international law enforcement agencies; and the Financial Crime Policy Unit, which provides guidance on the Rules Line supervision includes periodic meetings with senior management responsible for fraud prevention to discuss current issues that may be of concern. MLRO reports may be copied to the FSA and followed-up as necessary. They will also be used in horizontal reviews. FSA has a broad range of tools to compel banks to comply with its rules. These include powers to impose financial penalties, public censure, and to vary and even cancel permissions. FSA is also a criminal prosecuting authority under the Regulations. FSA cannot disclose confidential information (as defined under relevant legislation) unless a gateway exists. The FSA may disclose information to its international equivalents, i.e., bodies with equivalent functions, to assist them in carrying out those functions. In the case of information covered by the EU single market directives, disclosure can only be made under a co-operation agreement and where equivalent confidentiality restrictions apply under the laws applying to the other regulator. Banks are required to comply with the FSA’s Principles for Businesses, which are a general statement of fundamental obligations under the regulatory system. Breaching a Principle makes a bank liable to disciplinary sanctions. Principle 1 states that ‘a firm must conduct its business with integrity and Principle 2 states that it “must conduct its business with due skill, care and diligence.” There is no specific FSA requirement that these Principles be communicated to all members of a bank’s staff. *Additional Criteria* U.K. laws and regulations embody international sound practices and are largely compliant with the FATF recommendations. FSA Rules require relevant staff to receive training at least every 24 months. Validation follows supervisory practices outlined above. FSA Regulations require an FSA supervisor to report knowledge or suspicion of money laundering in the same way as a member of staff employed by a bank. Criminal law gateways allow for the sharing of information for the purpose of criminal proceedings and criminal investigation in the U.K. or elsewhere. The FSA has in-house specialist expertise in financial crime matters, as outlined above.
Assessment	Largely compliant
Comments	FSA has strong powers and a comprehensive program for supervising the U.K. anti-money laundering practices and procedures of banks. The regime has been reinforced and energized within the last two years, notably by the implementation of FSMA with the additional responsibility and powers it provides to FSA in the area of financial crime. The regime will be further reinforced with passage of the Proceeds of Crime Act which is expected to be approved by Parliament in 2002. Increased FSA authority has been paralleled by intensified supervisory effort in the area of money laundering. The intensification of FSA supervision was confirmed in numerous contacts across the banking industry. *Essential Criteria 3* requires that “banks have formal procedures to recognize potentially suspicious transactions.” Although FSA does not make such procedures a formal requirement of its AML/CFT rules and regulations, other elements of the supervisory regime effectively require banks to have structured procedures and practices that address the requirement to recognize potentially suspicious transactions. The JMLSG Guidance Notes cover many of the elements that might be incorporated in formal procedures, including “know your customer” guidance. For example, JMLSG Note 5.9 outlines tests to apply for determining whether suspicion of money laundering arises. These include: is the size of the transaction consistent with the normal activity of the customer? is the transaction rational in the context of the customer’s business or personal activities? etc. Guidance Notes 5.62-5.64 identify issues to be considered with respect to wire transfers. AML training requirements established in the Handbook require bank staff to be familiar with the Guidance Notes. Although the Guidance Notes are advisory, not mandatory, FSA takes them into account in determining compliance with its rules and regulations. In addition, the FSA Handbook requires all staff to report (to the MLRO) any information that gives rise to knowledge or suspicion of money laundering. Under the Regulations and under the Handbook FSA has authority to impose sanctions if firms fail to report suspicious transactions. While the substance of Essential Criteria 3 is satisfied, the FSAP team believes bank’s internal governance would be strengthened by a requirement for a formal policy on recognition of potentially suspicious transactions. *Essential Criteria 11* calls for the supervisor to determine that banks have a policy statement on ethics and professional behavior that is clearly communicated to all staff. Although FSA does not explicitly require banks to have such a policy statement, the substance of Criteria 11 is achieved in other ways. Requirements for ethical and professional behavior animate FSA’s approach to financial supervision. For example, such behavior is required under FSA’s Principles for Business. Principle 1, Integrity, states that a firm must conduct its business with integrity. Principle 6, Customer’s interest, states that a firm must pay due regard to the interests of its customers and treat them fairly. The FSA’s Statements of Principle for Approved Persons require bank’s Approved Persons to act with integrity and due skill, care and diligence in carrying out controlled functions. Furthermore, under Regulation 5(1)(a) of the 1993 Money Laundering Regulations FSA may find a firm to be in breach of the Regulations if a business relationship is formed, or a one-off transaction takes place, without the required ethical and professional procedures being applied to that particular relationship. The FSA risk based approach to supervision allows for considerable selectivity in the firms and risks that attract close supervision, with high risk/high impact firms being the primary focus of attention. The FSAP team considered the possibility that the selectivity of this approach posed a hazard that anti-money laundering compliance in smaller, low impact firms might not be sufficiently disciplined by the supervisory process. The FSAP team satisfied itself that, at least with respect to banks, this is not the case. In the last year one-third of the small number of banks classified as low impact have been subject to theme visits for compliance with anti-money laundering requirements and all are expected to be visited over a three-year cycle. Also, in practice, money laundering theme reviews of banks cover the full scope of money laundering risks and are not limited to the two risk clusters identified in “The Money Laundering Theme” report.
Principle 16.	On-Site and Off-Site Supervision An effective banking supervisory system should consist of some form of both on-site and off-site supervision.
Description	The FSA utilizes a combination of on-site examinations and desk-based analysis to acquire a thorough understanding of banks’ safety and soundness. The regular supervisory staff is supported by risk review teams with specialized expertise in areas such as corporate governance, risk management, internal audit, IT, anti-money laundering controls and quantitative modeling techniques. To assist in the supervision of financial firms the FSA has the power to appoint so-called skilled persons (section 166 of the FSMA). In the case of banks, these are usually auditors from the big five accountancy firms. The number of skilled persons reports commissioned has been greatly reduced as they are no longer used to perform routine validation of supervisory returns. The skilled persons’ reports are discussed generically with the accountancy firms to ensure consistency of standards and the FSA forms its own judgment on the materiality of the issues raised in the reports. Through these mechanisms the FSA is able to examine any aspect of a bank’s operations, including compliance with legal requirements and prudential regulations. In addition, the FSA carries out sector-wide statistical analysis of prudential returns, financial statements, share price movements, credit ratings and other quantitative information to monitor industry trends and to identify outliers. The FSA has developed a risk-focused assessment model, covering all regulated entities in the financial industry. The model is designed to identify the key risks that institutions pose to the FSA’s statutory objectives, which in turn determine the degree of attention that the FSA devotes to individual institutions. This risk assessment is based on a view of the impact and the probability of a problem occurring at a particular institution. For prudential issues in banks, the impact is seen as being determined mostly by the size of the bank, while the judgment on probability depends on the FSA’s view of the business and control risks at a particular bank. Banks are rated either as high impact, medium high impact, medium low impact, or low impact. The risk based approach, in combination with the FSMA’s philosophy that it is neither possible nor desirable to remove all risk of failure from the financial system, has led the FSA to concentrate its supervisory activities with regard to banks on the larger institutions. In addition to the industry-wide risk assessment model, the FSA uses a firm-specific model to assess risks in individual institutions. This assessment is based on a detailed breakdown of business and control risks in individual banks. For a large bank, up to about 35 different business lines may be distinguished. Inputs into the firm-specific risk assessment model may include information from on-site work, interviews with management, prudential returns, firms’ annual AML report, external auditors’ management letters, special information requests and publicly available information. Findings of a bank’s internal auditors may be taken into account if the FSA is satisfied that the audit work has been independently and competently performed. The FSA encourages internal auditors to devote attention to issues of interest to the supervisor in their work. On-site and off-site work are thus integrated through the firm-specific risk assessment model. The firm-specific risk assessment process will take three to six months to complete and, for large banks, is carried out on a one and a half to two year cycle. The process results in a risk mitigation program that details the supervisory work with regard to the institution over the period until the next risk assessment cycle as well as actions to be undertaken by the institution itself. The supervisory work planned in this manner leaves room to undertake event-driven work as the need arises. On-site supervision is most active in high impact firms, including regular visits by the dedicated supervisory team, focused reviews by experts drawn from the FSA’s risk review department, as well as frequent contacts with high and middle level managers. Low impact banks, on the other hand, are largely supervised through off-site baseline monitoring supplemented occasionally by on-site visits in the context of the FSA’s thematic work, to deal with issues that have arisen from the off-site monitoring, or on the occasion of events such as the bank entering into new activities or the appointment of a new director. On-site visits at low impact banks will be held at least once every three years, but on average they are held more often in practice. Under the new regime, low impact banks no longer have a dedicated relationship manager within the supervisory authority. As of June 2002, 44 banks had been graded by the FSA as low impact (excluding 7 EEA branches and 9 banks which are part of a wider group). Sixteen of these were branches of overseas banks and the other 28 included small retail banks as well as some banks specializing in wholesale operations. Six low impact banks were subject to intensive supervision because risks had crystallized. Total deposit liabilities of the low impact banks amounted to 0.03 percent of total deposit liabilities of all U.K. banks. On-site visits are designed to provide a focused review of well specified topics. They typically require around three days extending up to one week in some cases. The scope of visits and the intended outcomes are detailed in the risk mitigation program generated by the firm-specific risk assessment. On-site visits by a bank’s dedicated supervisory team consist of extensive discussions with various managers supplemented by some file reviews. Topics addressed may cut across the full range of supervisory interests, including all significant business and control risks as well as compliance issues. The dedicated teams are guided by methodological aide-mémoires outlining specific points for attention in particular risk areas. For international firms, the FSA has a regular program of on-site visits to the overseas parents of the branches and subsidiaries of foreign firms operating in the U.K. and to the affiliates of U.K. banks operating overseas. The FSA has recently begun development of so-called thematic regulation, which is aimed at analyzing industry or sector wide issues by focusing on a sample of institutions. This has been assisted by the establishment of Risk Management Units throughout the FSA, including one devoted to banking issues, which have responsibility for monitoring industry-wide risk. The sample of institutions usually includes some low impact firms. Themes that have been covered so far in the banking sector include credit risk, systems and controls, anti-money laundering measures as well as other topics. The thematic work helps inform the FSA’s views on particular risk areas and may lead to follow-up work at individual institutions. The outcome of the thematic work may be rule changes, guidance letters to bank directors, seminars or speeches to draw banks’ attention to particular issues. The thematic work may also lead to enforcement action against a firm that was included in the sample. Such action would be publicized to set an example for other banks. If significant issues have been uncovered, the FSA may decide to extend the thematic work to banks outside the initial sample. The effectiveness of on-site and off-site functions is reviewed by a panel of senior and independent supervisors as part of the FSA’s formal risk assessment process. The panel focuses on the risk mitigation programs for individual banks, particularly the ones assessed as high impact or medium high impact, assessing the priorities set for supervisory work and giving advice on the proposed deployment of supervisory tools. In case of disagreement with a bank’s relationship manager, a decision is taken at a higher level within the FSA. This work is supplemented by an internal Quality Assurance Department, which is in the Chairman’s Office, that focuses on supervisory processes generically. The FSMA (Part XXIII) sets out restrictions that apply to the disclosure of supervisory information which is confidential under the Act. However, the FSMA and secondary legislation do allow the FSA to provide confidential information to other regulators, on condition that the information continues to be subject to restrictions on disclosure equivalent to those in the FSMA. In case another regulator requests the FSA to provide it with confidential information, the FSA will satisfy itself that this condition is met. The FSA is able to refuse requests for confidential information except in limited cases relating to court orders in criminal proceedings or Parliamentary enquiries.
Assessment	Largely compliant
Comments	The FSA’s supervisory process for banks consists of a combination of on-site visits, desk-based analysis and formal firm-specific risk assessment. Information from a variety of sources feeds into the process, including skilled persons’ and internal and external auditors’ reports. In addition, the FSA has begun developing thematic regulation. The FSA’s risk based supervisory approach implies that it focuses its resources on those firms that pose the highest potential risks to its objectives. Thus, banks that are considered to have a high potential impact on the objectives receive extensive supervisory attention. They are assigned a dedicated supervisory team, consisting of up to seven staff members, that will maintain frequent management contact and conduct on-site visits. The dedicated teams may request focused investigations into specific risk areas by specialized risk review teams or skilled persons. Banks graded as medium high or medium low impact will have a less intensive supervisory relationship with the FSA than the high impact banks but will nevertheless receive regular on-site visits. For some banks, however, in particular those that are considered to pose a low potential risk to the FSA’s objectives, the risk-based approach implies that they will not have a close and continuous interaction with the FSA. No on-site examinations will normally be held at these banks to verify adherence to legal and prudential requirements, and management contact will be relatively infrequent. Unless specific risks have crystallized, reliance is placed primarily on off-site monitoring of prudential returns and external auditors reports, occasionally supplemented by work conducted in the context of thematic regulation or event-driven work. In terms of protecting consumers and safeguarding market confidence, and obviously also simply because of size, it is clearly justified to concentrate scarce supervisory resources on the larger banks. However, as Essential Criterion 1, requiring an in-depth understanding of individual banks’ operations, does not distinguish between large and small banks, it applies to smaller banks’ operations as well. Undue reliance on off-site monitoring makes it difficult to achieve this level of understanding, particularly with respect to control arrangements and compliance requirements in, for example, the area of anti-money laundering. The FSA recognizes this and is considering refining its risk assessment methodology to take more explicit account of all four of its statutory objectives, including the one on combating financial crime. In fact, in the period from January 2000 to July 2002, it has already conducted anti-money laundering visits to 14 of the 44 low impact banks. To the extent that risk based supervision will continue to entail less reliance on direct oversight of lower impact banks and more reliance on baseline monitoring, consideration should be given to more frequent reporting of audited returns and more regular disclosures by all banks, along the lines recommended in the comments on Principle 19 below. Audited returns would to some extent provide indirect confirmation of the integrity of the bank’s internal systems and controls in view of the auditors’ duty to report to the supervisor any material shortcomings revealed in the audit. They would also provide stronger underpinning for offsite monitoring. Some concern was expressed by industry sources that the turnover rate of supervisory staff in the dedicated teams was too high to enable the FSA to build up thorough firm-specific knowledge. However, it is the mission’s view that this is a relatively minor issue of a transitory nature as it appears to be related to the changeover to the new supervisory regime (see also Principle 1(2)). The number of staff in the risk review teams (46 budgeted as of May 2002) appears to be somewhat small considering that they are not exclusively devoted to the banking sector but are also contributing to the supervision of the other sectors regulated by the FSA. Skilled persons reports may be commissioned to augment specialist supervisory capacity. However, skilled persons investigations are expensive relative to the FSA’s own on-site work and the FSA strives to keep the costs of supervision proportionate with the risks to its objectives. The FSA should take care to ensure that sufficient supervisory attention is devoted to specific risk areas that require highly specialized expertise, such as credit risk classification systems, market risk management and IT security.
Principle 17.	Bank Management Contact Banking supervisors must have regular contact with bank management and a thorough understanding of the institution’s operations.
Description	The intensity of the FSA’s supervisory relationship with individual banks is influenced by the assessment of the bank’s risk management procedures and practice and by the FSA’s assessment of the risks that banks pose to its statutory objectives. The FSA considers that well-managed banks whose own risk management is sophisticated and effective will require less supervisory attention than banks conducting similar business but with controls of lesser quality. Banks deemed to be high impact will have a close supervisory relationship with the FSA. Thus, for large banks, there will be frequent other contacts with directors and senior management, as well as bank specific on-site visits and thematic visits involving contacts with middle management and various other bank employees. Banks considered to be low-impact will receive occasional thematic visits on cross-industry issues, together with less frequent meetings with directors and senior management to discuss bank specific issues. The FSA nevertheless feels that it has a good understanding of smaller banks’ operations, in part because these are usually relatively straightforward. The FSA has a full range of supervisory tools available to achieve a thorough understanding of banks’ operations. In addition to meetings with management and other representatives of a bank, this includes on-site visits, desk based reviews, liaison with other regulators and analysis of periodic returns and notifications. The FSA has access to internal auditors’ reports and external auditors’ management letters. Furthermore, the FSA may commission so-called skilled persons to conduct investigations of special topics at institutions under its supervision. Banks and other supervised firms are required to provide the FSA with a wide range of information. Principle 11 of the FSA’s Principles for Business require firms to deal with their regulator in an open and cooperative way, and to disclose to the FSA anything of which the FSA could reasonably expect to receive notice. This includes any significant failures in the bank’s systems and controls, any action which would result in a significant change in its capital adequacy, and any proposed change in the bank’s operations which could have a significant impact on its risk profile. These requirements imply that banks have to notify the FSA of any significant new activities, which they would have to do in any case if a variation of the bank’s permission would be required. SUP Section 15.3 requires specifically that the FSA must be notified immediately if a firm becomes aware that any of the following has occurred or may occur in the foreseeable future: The firm’s failing to satisfy one or more of the threshold conditions Any matter which could have a significant adverse impact on the firm’s reputation Any matter in respect of the firm that could result in serious financial consequences to the financial system or to other firms Any offences and breaches of the FSMA or rules established under the FSMA. The quality of a bank’s management is considered on application for regulated status and thereafter during the normal supervisory process. Banks have to meet the threshold conditions for authorization on an on-going basis and key individuals within the bank have to be vetted and approved to carry out their particular functions. An individual that does not meet the FSA’s fit and proper standards can be disapproved for carrying out particular functions or banned from employment in the regulated financial sector altogether.
Assessment	Compliant
Comments	The FSA has frequent contacts, both through face-to-face meetings and other means, with various levels of management at the larger banks. Any issue relevant to a bank’s operations may be covered in the course of these contacts. Meetings with managers of small banks, however, appear to be rare. This is a reflection of the FSA’s risk based approach to supervision which implies that scarce supervisory resources should be allocated primarily to those areas where the potential risks to the FSA’s objectives are highest, i.e., to the larger banks (in the context of banking supervision). For low impact banks, the FSA relies mostly on desk based review of prudential returns, written material such as external auditors’ management letters and other quantitative and qualitative material, except for occasional visits to some of these banks in the course of thematic reviews. Management contact with these banks takes place once every three years at a minimum but in practice usually more often, especially after risks have crystallized (see also Principle 16). The FSA expects to be notified if a low impact bank were to experience safety or soundness problems or to enter risky new business. It would be useful to identify criteria that would require low impact banks (as well as other banks) to notify the FSA of emerging problems at an earlier stage. The mission welcomes the FSA’s intention to establish clearer guidelines for offsite monitoring triggers that would prompt it to initiate contact with low impact firms. Such triggers are also useful for medium-low impact firms, and, in general, would be useful for all firms.
Principle 18.	Off-Site Supervision Banking supervisors must have a means of collecting, reviewing, and analyzing prudential reports and statistical returns from banks on a solo and consolidated basis.
Description	Banks are required to submit a variety of statistical and prudential returns either directly to the FSA or via the Bank of England. Requirements for banks to report regularly to FSA are laid out in Chapter 16 of the Supervision (SUP) chapter of the Handbook. The requirements relate to a firm’s financial condition and to its compliance with other rules and requirements which apply to the firm. Under Principle 11 banks are required to deal with their regulators in an open and cooperative way, and to tell the FSA appropriately anything of which the FSA would reasonably expect notice. The required compliance reports include an annual report on controllers (SUP 16.4.), an annual close links report (SUP 16.5), an annual report listing all overseas regulators for each legal entity of a firm’s group and an annual organogram showing the authorized entities in the firm’s group (SUP 16.6.5). Beyond this SUP 16.7.7 identifies eleven separate reports that banks are required to submit with varying frequency over the course of the year. Standardized forms address capital adequacy, large exposures and liquidity. The standardized BSD3 Capital Adequacy Return filed semi-annually provides detailed information on both a solo and consolidated basis for both on-balance sheet and off-balance sheet assets and liabilities, divided between the banking book and the traded book, profits and losses, counterparty exposure on derivative contracts, repos and similar transactions, large exposures, provisions against bad and doubtful debts and investments, deposit sources and market risk in the trading book. The return provides supporting details for on and off balance sheet activities and provides a step-by-step calculation of capital adequacy on both a solo and consolidated basis. IPRU (Chapter CS) sets out the basis on which consolidation will be required and the consolidation techniques that are to be applied for U.K. incorporated banks and banking groups with U.K. non-bank parents only. For banks subject to the liquidity mismatch requirements, quarterly reporting is required using Form LR. For firms subject to the stock liquidity regime, monthly reports are required, using Form SL R1. The Liquidity Management (LM) chapter of the Handbook provides detailed guidance on the information to be provided in the liquidity reports. U.K. banking groups are required to report quarterly on large exposures, on both a solo and a consolidated basis, using Form LE 2. The Large Exposures (LE) chapter of the Handbook provided detailed guidance on the information to be provided in the large exposure reports. U.K. branches of non-EEA banks are required to report on profits, large exposures, balance sheet, off-balance sheet items, and bad and doubtful debt provisions using the half-yearly Form B7. They are also required to provide liquidity information quarterly, using Form LR. To insure the consistency and reliability of prudential returns, FSA policies regarding valuation of assets and liabilities are spelled out in considerable detail in the Valuation (VA) chapter of the Handbook. FSA has strong powers to enforce compliance with reporting requirements. Knowingly or recklessly giving information which is false or misleading in a material particular may be a criminal offence under sections 398 and 400 of FSMA. The handbook (SUP 15.6.1R and SUP 15.6.3R) requires an authorized person to take reasonable steps to ensure the accuracy and completeness of returns and to notify FSA immediately if material or inaccurate information has been provided. Failure to do so may result in fines or other disciplinary sanctions (ENF 13.5). FSMA (Section 165) gives the FSA statutory powers to require the provision of information.
Assessment	Largely compliant
Comments	FSA has a well structured system of prudential reporting requirements for banking groups that covers both financial and compliance information. For U.K. banking groups standardized reports are required on capital adequacy, large exposures and liquidity. Reports are required to be on both a solo and a consolidated basis, where appropriate. U.K. branches of overseas banks are required to provide liquidity and large exposure reports. The scope of reporting and the policies with respect to valuation of assets and liabilities are spelled out in detail in the handbook. Essential Criteria 4 of Principle 18, dealing with information required to be submitted for statistical and prudential reporting, states: *“Inclusion of data on loan classification and provisioning is also required.”* FSA does not routinely collect standardized data on classified or non-performing loans. As a matter of policy, FSA has not established regulatory loan classification or loan delinquency systems, preferring instead to emphasize that proper loan classification and asset valuation are responsibilities of bank management based on the circumstances of the individual institutions. While an entirely legitimate supervisory strategy, the FSAP team believes the absence of reporting on classified loans and non-performing loans handicaps the ability of FSA to verify the credit risk environment of banks, particularly on an offsite basis. This is a particularly important gap given the importance of baseline monitoring in the risk based supervisory regime, (See comments on Principle 19 below.) Peer group analysis would be strengthened if standardized information were available on classified and non-performing assets. Forthcoming adoption of Basel II and IAS 39 will require changes in firm practices with respect to provisioning and loan classification so now would be opportune time to close this gap in FSA’s reporting regime. IAS 39 will require a more rigorous approach to recognition of impaired assets and loan loss provisioning and Basel II will emphasize more rigorous internal loan classification systems.
Principle 19.	Validation of Supervisory Information Banking supervisors must have a means of independent validation of supervisory information either through on-site examinations or use of external auditors.
Description	Section 165 of the FSMA gives the FSA the authority to obtain information from banks. These powers extend to providing the FSA with access to a bank’s directors, senior management, and key personnel. The FSA uses on-site visits to most banks as part of its formal risk assessment process; however, a small number of small banks considered to be “low impact” do not receive a formal risk assessment. The low impact banks are reviewed primarily using desktop baseline monitoring, with on-site visits being event driven. The risk assessment visits for the high, medium-high, and medium-low impact banks take the form of on-site high-level reviews by the supervisory team. Results of the risk assessment are used to develop a risk mitigation program (RMP) which establishes to supervisory objectives for the bank for the forthcoming period, including identifying areas for further on-site review. Such on-site reviews may be conducted by frontline supervision, by the FSA’s internal risk review teams, or by engaging skilled persons, e.g., external auditors, to validate supervisory information provided by banks. The FSA Handbook (SUP 3) provides rules and guidance on the role auditors play in the FSA’s monitoring of a bank’s compliance with its rules and standards. This chapter addresses the auditors’ qualifications, independence, reporting, and the duty to notify the FSA of any significant matters raised by the auditor. The FSA rules place the duty on the bank to ensure the auditor is qualified and independent; however they prohibit a bank from appointing an auditor the FSA has disqualified. The FSA rules establish specific areas to be covered in the auditor’s report, and require a copy of all reports be provided to the FSA. In addition, SUP 3.8.2R requires the auditor to co-operate with the FSA. While the rules in SUP 3 do not provide for FSA’s monitoring of the quality of the auditor’s work, there are provisions in SUP 5 relating to skilled persons reports that provide for monitoring of work related to skilled persons reports. The FSA meets periodically with the bank’s external auditors, on a bilateral basis. In addition to periodic meetings, external auditors have a statutory duty to inform the FSA of any concerns arising during the course of their work. Section 166 of the FSMA gives the FSA the authority to require the bank to obtain a skilled persons report. The FSMA section 166(4) requires that the skilled person must be nominated or approved by the FSA, and that the skilled person must appear to the FSA to have the skills necessary to make a report on the matter concerned. Additional rules and guidance relating to the use of skilled persons is found in the FSA Handbook (SUP 5). The large international accountancy firms produce the vast majority of skilled persons reports. The FSA will direct the scope of the review using a commissioning letter, and the nature of work to be completed may be discussed by the FSA in advance. The rules pertaining to reporting and notification in SUP 3 also apply to skilled person’s reports. The FSA may hold bilateral meetings with individual partners within these firms to provide feedback from the supervisory teams on the scope and quality of their work. Trilateral meetings are held to discuss the findings of skilled person’s reports. The FSA has a formal, structured process in place for skilled persons reports (SUP 5). The process includes preliminary discussions about scope, the engagement/scoping letter to the skilled person, and the objectives to be accomplished by the review. Procedures for internal risk review visits carried out by FSA’s Risk Review Division are less formalized. These procedures typically involve a detailed scoping paper prepared by frontline supervisors. The firm is typically asked to provide supporting information which is analyzed prior to the visit. The visit itself builds on the information supplied and involves interviews with management and staff as well as an examination of files. For certain areas (money laundering, credit) aide-mémoires have been prepared that guide the procedures performed in the review. Supervisory returns are reviewed by supervisors for consistency and plausibility. An initial check is required within 2 days of receipt and a more detailed check is required to be completed within ten days of receipt. These reviews consist of trend analysis and plausibility checks involving comparisons with previous returns and checks against audited accounts for capital adequacy and large exposures capital base. These reviews are supplemented by peer group analysis. Validation checks completed by one supervisor must be checked and signed off by another supervisor. Follow-up with the bank will take place to reconcile outlier data and inconsistencies. Banks are subject to fines for late returns. The FSA does not require that the auditors examine certain key supervisory returns, such as capital adequacy, at least annually nor do FSA examiners routinely validate the returns to bank records. FSA has a variety of powers to ensure the validity of supervisory returns, including authority under 5165 of FSMA to request additional information from the bank at any time, the authority under 5166 to require skilled persons report to verify the accuracy of information provided, and the ability to request supplementary information from the bank’s auditors under the provisions of SUP 3.8.2R which covers an Auditor’s duty to cooperate with FSA. The FSA does have the means to independently validate supervisory returns, through supervisory visits, risk review division visits, or skilled person’s reports. Supervisory visits (during the risk assessment process) are used to review the bank’s process for completing the reports, and do not include validating key returns. The use of the internal risk review or skilled persons report tools depends on whether an issue was raised during the supervisory visit, the impact rating of the firm and the availability of these resources. FSA has identified validation of supervisory returns as a topic for theme supervision over the next year. There is no requirement that the FSA meets with the management or board each year. The FSA may hold meetings with a bank’s board, or hold separate meetings with non-executive directors, when it is deemed appropriate. The FSA determines the level of supervision based on its assessment of the risk a bank poses to the FSA’s regulatory objectives, and this assessment will drive whether a meeting with a bank’s board is required.
Assessment	Largely Compliant
Comments	The FSA has the means to independently validate supervisory information, through supervisory visits, risk review division visits, or by commissioning skilled person’s reports. However, costs and resource constraints limit the use that is made of skilled persons reports or on-site risk review visits to validate supervisory information. The FSAP team was told that, partly because of their expense, FSA has discontinued the routine use of skilled persons reports to validate regulatory returns, but they may be used on an exceptional basis. Going forward, use of skilled persons reports will focus on situations where remedial work is needed quickly or the FSA does not have the resources and/or expertise to conduct the review internally. The Major Financial Groups Division (MFGD) estimated that 70-120 skilled persons reports would be ordered per year across the 52 largest bank, securities and insurance groups firms that are supervised by the division. The Deposit Takers Division (DTD) estimated that they would order about 15-20 skilled persons reports, across about 200 banks. Internal risk review is a scarce resource, with an approved head count of 46 (including administrative support) to support work across all of FSA. MFGD supervisors indicated that risk review currently is unable to fill all requests for their services, so requests are prioritized, and some reviews may be negotiated or deferred. *Essential criteria 5* provides that the supervisor should require that certain key supervisory returns, such as capital adequacy, be examined at least annually by the auditors and a report submitted to the supervisor. The FSA has no explicit requirement that supervisory returns be validated in the manner called for by *criteria 5, although elements of this criteria are met through the requirement for an annual audit of the statutory accounts and FSA’s ability to consult with and request information from auditors. Recommendation. The FSA relies on the supervisory returns as a key part of its risk based approach to supervision and particularly for its baseline-monitoring program., so it is very important that the FSA is able to place reliance on the accuracy of that information. In addition, greater disclosure of such information would add to market discipline. Given the resource constraints on the ability of FSA itself to comprehensively validate supervisory returns, the FSAP team recommends that FSA should consider going beyond the literal requirements of Essential Criteria 5* and consider requiring all banking groups to provide annual audits of key supervisory returns. It would be useful if validation of supervision were made a regular topic for theme supervision. In addition it would be desirable for all U.K. banks be required to publish audited financial reports on an annual basis, coupled with a continuous disclosure requirement – currently these requirements apply only to listed companies. There does not appear to be a compelling reason to limit market disciplines that arise from financial disclosures to only banks (public issuers) that are listed.
Principle 20.	Consolidated Supervision An essential element of banking supervision is the ability of the supervisors to supervise the banking group on a consolidated basis.
Description	The FSA approach to consolidated supervision is set out in IPRU (CS Chapter) which is the principle vehicle for implementing the EU Banking Consolidation Directive (date) and the EU Post-BCCI Directive (date) The FSA’s consolidation policy addresses three main areas of concern arising from group membership: losses in another group entity that could lead to financial pressure on the bank because of financial or reputational linkages; capital that is subject to double-gearing or leveraging: that is, a solo assessment of a firm overestimates the quantity of capital which is available to support the bank’s risks, because of the way the capital has been raised or accounted for within the group; and business that is booked in an unauthorized group entity to avoid regulatory requirements. The FSA views its consolidated supervision as a complement to individual firm requirements rather than as a substitute. The objective is to enhance the overall effectiveness of the prudential supervision of the bank by ensuring that risks related to the bank’s membership of a group are taken into account in the supervision of the bank. Consolidated supervision does not, however, constitute supervision of undertakings within the group which are not authorized. The FSA is required to undertake supervision on a consolidated basis by EU legislation, in particular the Banking Consolidation Directive. The FSA’s consolidated supervision framework consists of two main elements: A qualitative assessment of the group as a whole. This is made in relation to the group’s significant business units and their potential material bearing on the bank. It focuses on the group’s business, controls, organization and management. A quantitative, consolidated assessment of relevant financial companies within the group that establishes prudential requirements, for instance with respect to capital adequacy and large exposures. The FSA approach identifies where group risk arises, sets systems and controls requirements for managing that risk, and establishes a methodology for the calculation of consolidated capital (Principle 18). The scope of the FSA’s consolidated supervision includes all parents and subsidiaries of the bank, any of their parents or subsidiaries; or any undertaking in which those parents or subsidiaries or the bank have a participation. In addition, the FSA may require a bank to include within its group consolidation an undertaking that is not a member of group as defined but which has links to the group that would make its omission from the scope of the consolidation assessment misleading. (CS 3.1.3) requires that the bank have adequate controls to produce any data required to supervise on a consolidated basis. (CS 3.3.19) requires adequate controls to identify and monitor large exposures. Consolidated returns are required twice annually and large exposures must be reported quarterly. (CS 3.3.7) requires a detailed organization chart and identification of subsidiaries supervised by others. Section 166 exams may be required to cover internal control systems used to generate consolidated accounts. Consolidation usually applies to financial subsidiaries. For purpose of consolidated supervision, insurance and insurance broking are not defined as financial activities and are therefore not normally consolidated (CS 4.3). For activities undertaken within the U.K. coordination among functional regulators of a group takes place within FSA. A variety of arrangements are in place with home and host supervisors overseas to allow exchanges of information on the financial condition and adequacy of risk management and controls of overseas undertakings. Where FSA is unable to satisfy itself that the overseas parent of a branch or subsidiary in the U.K. is subject to adequate home country consolidated supervision FSA may require solo consolidation at the U.K. level. Fit and proper tests may be applied to senior management of parent companies under the FSA’s authorized persons regime. Consolidated supervision encompasses the activities of U.K. banks in offshore centers through several mechanisms. Exposures in offshore centers are included in the quantitative requirements for consolidation and the capital adequacy ratio and the controls on large exposures. Where FSA is concerned about such exposures it may impose additional capital requirements, require deconsolidation of the capital and assets in the offshore jurisdiction, and restrict transactions with the jurisdiction. U.K. financial institutions are required to be able to provide FSA all the information it requires to carry out effective consolidated supervision wherever their business is conducted, including in jurisdictions with strict secrecy provisions. Under the qualitative element of its consolidated supervision, FSA requires that banks have the ability to measure, monitor, manage and control the risks in all their significant business lines, wherever that business is conducted. This will apply to business lines such as private banking, asset management, insurance, and capital markets operations, all of which can have links to offshore centers. FSA anti-money laundering policies include an expectation that the practices of overseas affiliates of U.K. banks will conform to the higher of U.K. or local standards. Compliance with this policy is one of the duties the bank’s MLRO, an individual who must be authorized by FSA. In evaluating the risks in business lines, FSA places a strong emphasis on the quality of counterpart financial supervision in the jurisdictions where the business is conducted. This is also a key consideration in granting permission for U.K. banks to establish or operate in those jurisdictions or in granting FSA authorizations to firms from those jurisdictions. For FSA an important factor in evaluating the practices of other supervisors is their willingness to share information. In this regard FSA takes into account the FATF NCCT classifications as well as its own experience. FSA has an active involvement with numerous offshore centers, particularly in the U.K. overseas territories and dependencies. This includes participation in regional organizations and regular liaison with offshore supervisors.
Assessment	Compliant
Comments	FSA has comprehensive arrangements to be able to supervise U.K. banking groups on a consolidated basis, both quantitatively and qualitatively, regardless of where their business is carried out. Capital requirements set out clearly the procedures to be followed in consolidating group accounts to insure that the U.K. banking activities of a group are adequately capitalized, both on a solo and a consolidated basis. Large exposure limits are governed by clear policies with limits enforced on both a solo and a consolidated basis. Management systems and controls are required so that risks arising from the bank’s dealing with other parts of the group are properly identified, measured, monitored and controlled. A variety of arrangements are in place for coordinating and cooperating with other regulators, both at home and overseas, who have responsibility for other legal entities within the group.
Principle 21.	Accounting Standards Banking supervisors must be satisfied that each bank maintains adequate records drawn up in accordance with consistent accounting policies and practices that enable the supervisor to obtain a true and fair view of the financial condition of the bank and the profitability of its business, and that the bank publishes on a regular basis financial statements that fairly reflect its condition.
Description	The threshold conditions require that banks must have adequate resources, including high level systems and controls. SYSC 3.1.1R and 3.2.20R require that a bank’s directors and management ensure that the bank maintains adequate records (including accounting records) that are appropriate to the scale, nature and complexity of its business. IPRU (Banks) Chapter AR provides further guidance on adequate accounting (and other) records and internal control systems. The FSA does not publish a comprehensive list of the accounting and other records which a bank should maintain; however, banks are required to capture and record accurately and on a timely basis every transaction and commitment which the bank enters into and record details as appropriate for each transaction and commitment (IPRU Chapter AR 3.2.2). These provisions apply for all U.K. banks and branches of non-EEA banks. [For U.K. incorporated banks further accounting record requirements are set out in the Companies Act 1985.] The FSA has powers to enforce the records requirements, and may fine banks for late and inaccurate supervisory returns. The FSA has the authority under FSMA Section 166 to commission a skilled persons report to verify bank records in particular areas. In addition, the FSA’s internal risk review division may be used for verification of a bank’s records. These tools would be employed as part of a risk mitigation program if the supervisors identified a concern during their risk assessment process. Regulatory reporting forms are accompanied by detailed guidance notes that include information on accounting treatment. Banks are required to use generally accepted accounting principles when valuing assets. FSA reports should be prepared using book value of assets and liabilities, and the banking and trading books should be valued on an accrual basis, unless a different practice has been agreed in writing with the FSA. CAD banks should value trading books on a mark-to-market basis, and banking books on an accrual basis. IPRU (Banks), Chapter GN 3.3.17R requires all U.K. banks and non-EEA overseas branches to maintain adequate provisions for depreciation or diminution in the value of assets (including loan loss provisions), for liabilities which will or may fail to be met by the bank and for losses which it may incur. IPRU (Banks), Chapters VA and PN discuss the valuation and provisioning policies that banks should adopt. The Companies Act 1985 requires all U.K. banks to prepare accounts that give a true and fair view of the results and financial position of the bank and/or group. The accounts are subject to public filing requirements. Detailed provisions on the form and content of the accounts of banks and banking groups are contained in Schedule 9 to the Act. There is a general presumption that compliance with U.K. Financial Reporting Standards (FRS) and Statements of Standard Accounting Practice (SSAP) is necessary in order for the accounts to give a true and fair view. Banks accounts must state whether they have been prepared in accordance with these standards, and give details of any departure from the standards and the reasons. Banks are also expected to comply with the five industry-specific Statements of Recommended accounting Practice (SORP), and are required to state in their accounts whether they have complied, and if not, explain why they have not complied with them. All U.K.-incorporated banks must appoint an external auditor (SUP 3.3.2R) and the bank’s published accounts must bear an opinion by the external auditor as to the completeness and accuracy of the financial statements (SUP 16.7.8R). Auditors are required under the rules of their professional bodies to comply with Statements of Auditing Standards issued by the U.K. Auditing Practices Board. If the bank failed to comply with the relevant accounting standards, the external auditor would qualify the opinion. The FSA has periodic contact with external auditors to discuss annual accounts and skilled persons reviews. Auditors have a legal duty to report to the FSA breaches or possible breaches of laws or rules, and other matters that they reasonably believe are, or may be, significant. The FSMA Section 342 and the SUP 3.8.10R require that the external auditors inform the FSA if they have any material concerns as a result of their work. Sections 342 and 343 of the FSMA also provide protections for auditors that report in good faith matters that are, or are likely to be, of material significance to the FSA. Guidance regarding an auditor’s duty to report is provided in SUP 3.8. The FSMA gives the FSA the authority to disqualify auditors if they have failed to comply with a duty imposed on them under the FSMA. Banks are prohibited from using disqualified auditor under SUP 3.4.5R. If the FSA had concerns over the abilities of a bank’s external auditors, it may request management to change the audit firm. Under Section 166 of the FSMA, the FSA may appoint a skilled person to do onsite work on its behalf. The skilled person process includes a determination by the FSA that the skilled person has appropriate expertise to carry out the review. In practice, the large international firms perform the majority of banks’ external audits and skilled persons reports. SUP Chapter 3 provides rules and guidance governing the FSA’s relationship with external auditors, and SUP Chapter 5 addresses skilled persons reports. The FSA has a procedure in place for skilled persons reports to establish the scope of the engagement and the objectives to be accomplished by the review (SUP 5). The FSA does not have specific guidelines addressing the scope and conduct of internal audits. However, the FSA does look at the audit universe, and may guide the scope of an internal audit when it meets supervisory needs. The FSA would expect that internal audit would have a risk based approach to its audit Chapter 349 of the FSMA imposes confidentiality requirements on the FSA. Refer to CP 1(6) for further details on confidentiality. The FSA supports Basel and EU proposals to promote public disclosure by banks as a means of strengthening market discipline as a complement to other regulatory efforts.
Assessment	Compliant
Comments	A comprehensive accounting and reporting structure is in place to provide for financial statements on a regular basis. A bank’s annual accounts are required by the Companies Act to be prepared in a way that gives a true and fair view of the results and financial position of the bank and follow the detailed provisions of the Act on form and content of the accounts. The accounts are also expected to comply with other accounting standards such as FRS and SORP, and are subject to public filing requirements. Banks are also required to file regulatory reports with the FSA. These reports have detailed guidance notes to assist in preparation. The FSA requires banks to use generally accepted accounting principles when valuing assets.
Principle 22.	Remedial Measures Banking supervisors must have at their disposal adequate supervisory measures to bring about timely corrective action when banks fail to meet prudential requirements (such as minimum capital adequacy ratios), when there are regulatory violations, or where depositors are threatened in any other way. In extreme circumstances, this should include the ability to revoke the banking license or recommend its revocation.
Description	The FSA has a broad range of supervisory measures available address such problems as failure to meet the FSMA threshold conditions and non-compliance with the FSA’s rules. The range of possible actions available is broad, as the FSA is able to use its powers under FSMA Section 43 to place requirements or restrictions in a bank’s permission. The power can be used to require a bank to take specified action or to require it to refrain from taking specified action. The FSA may also vary or cancel a bank’s permission under Section 45, and also has the authority to take disciplinary measures against a bank or individual, including fines (Section 206) and public censure (Section 205). The FSMA Section 53(3) provides that FSA may take Section 45 actions that have immediate effect if the FSA reasonably determines that immediate effect is necessary. The FSA may require that any actions or requirements imposed under its Section 45 powers be taken within a specified time period. Injunctive relief is also available to the FSA under Section 380, and restitution orders are available under Section 382. These remedies are commonly used against unauthorized firms where the other disciplinary powers are not available. The FSMA Section 61 requires the FSA to exercise control over individuals performing “controlled functions” by requiring that they be approved by the FSA. Controlled functions are functions involving key responsibility and are typically director and senior management level positions. A list of controlled functions is in the SUP chapter of the FSA Handbook (Section 10, Approved Persons). In order to be an “approved person”, the FSA must be satisfied that the person is fit and proper to perform those functions. If the FSA no longer considers a person fit and proper, they may withdraw their approval under FSMA section 63. The FSA may also take action against an approved person if it appears to the FSA that the person is guilty of misconduct under FSMA Section 66. The FSA also has the power to prohibit a person from performing functions in relation to a regulated activity if the FSA finds the person is not fit and proper. If a prohibition order is made, the FSA is required to follow the procedures in FSMA section 347 regarding publication of information about the prohibited person. The FSA’s Regulatory Decisions Committee (RDC, a committee of practitioners and public interest members appointed by the Board, but independent of the FSA’s executive staff) may take major regulatory decisions. The RDC exercises regulatory powers on behalf of, and is answerable to, the FSA’s Board. The FSM Tribunal, an independent body, will consider major regulatory decisions made by the FSA if the firm or individual concerned decides to refer the matter on. The FSMA contains no express requirement that the FSA take action within any particular time frame, with the exception of representations or referrals to the FSM Tribunal. Nor is there guidance or formal voluntary commitment by the FSA to any timeframe. If the FSA does not take action in a timely manner, firms or individuals may raise this in proceedings against them under the general jurisdiction of the courts and Tribunal, and the ordinary principles of fairness that must apply in such proceedings. In addition, the FSA must comply with Article 6 of the European Declaration of Human Rights that requires there to be a right to an independent determination of civil rights and liabilities within a reasonable time frame. For these reasons, and as a matter of general good regulatory practice, the FSA does ensure that remedial actions are in practice taken in a timely manner. Once the FSA has initiated formal supervisory or disciplinary action by service of a notice, a statutory a time frame applies to the completion of the process for making representations or referring the matter to the Tribunal. There are however no constraints on the initiation of action. FSMA Part XXVI requires compliance with formal written notice procedures when the FSA exercises any of the formal disciplinary or supervisory powers.
Assessment	Compliant
Comments	The FSMA provides the FSA with broad powers to take remedial and enforcement actions, and also provides for sanctions against individuals and firms. Adequate protections, in the form of referral to the Tribunal, are in place to protect against abusive enforcement or disciplinary actions. The new enforcement powers granted under the FSMA are very recent, and have only been used in a handful of actions to date, so it is difficult to make a proper assessment of the effectiveness of the FSA’s use of its powers.
Principle 23.	Globally Consolidated Supervision Banking supervisors must practice global consolidated supervision over their internationally active banking organizations, adequately monitoring and applying appropriate prudential norms to all aspects of the business conducted by these banking organizations worldwide, primarily at their foreign branches, joint ventures, and subsidiaries.
Description	Authority to supervise the overseas activities of U.K. incorporated banks is provided for in Threshold Condition 3: (Close Links), based on Paragraph 3, schedule 6 of FSMA. The close links provisions implement and expand on the requirements of the EU Post BCCI Directive. For U.K. based banking groups, FSA carries out global consolidated supervision covering all aspects of supervision, specifically including non-U.K. group companies. Foreign branches of U.K. banks, not being separate legal entities, are considered to be an integral part of the U.K. bank itself, and are supervised on that basis. Quantitative consolidation (see Principle 18) is applied to the global undertakings of U.K.-based banking groups. Under FSA’s risk based approach to supervision the supervisory effort concentrates on significant business units. These may be identifiable on a geographical, legal or business basis. Consistent with the qualitative element of FSA’s general approach to consolidated supervision, supervisory effort is directed at ensuring that banks have information systems and controls adequate to manage risks in all business units, wherever they are located. Heads of significant business units will be seen during the risk assessment stage or during the following supervisory period. In conducting reviews of high level controls at the center, the FSA considers the quality of the control system both centrally and locally. Supervisors periodically visit major overseas operations to supplement reviews made at the center. If circumstances require the FSA will impose limitations on the activities of overseas operations of U.K. banks through liaison with home country senior management. The FSA may impose limitations on the activities of overseas operations in order to ensure that the close links/supervisability of group structures requirement in the Threshold Conditions is met in particular cases. In addition to regular contact with senior management based in the U.K. responsible for the international operations of internationally active groups, FSA is also in periodic contact with the locally based management responsible for significant business units overseas. Direct supervision of significant international operations is supplemented by close co-operation and liaison with the banking supervisors of the host country. If necessary, plans for remedial action are discussed and agreed with the host supervisor. If, as part of the risk assessment process, the FSA determines that an overseas operation of a U.K. banking group is presenting significant unmitigated risks the FSA would initiate discussions with the bank’s senior management. These discussions could ultimately require the closure of a bank’s overseas operation. FSA has the power to conduct on-site examinations of overseas branches and subsidiaries of U.K. banking groups. The FSA conducts periodic on-site examinations of a sample of the more significant overseas offices of U.K. banks, usually in conjunction with the host country supervisor. Following FSA’s risk based approach to supervision, oversight of the foreign operations of U.K. banks focuses on significant activities with higher risk profiles and those that are subject to weaker host country supervision. FSA routinely undertakes assessments of the extent of supervision undertaken by other supervisors relevant to the U.K. In particular, it forms its own judgment as to their compliance with the Basel Core Principles.
Assessment	Compliant
Comments	FSA supervises internationally active U.K. banking organizations on a globally consolidated basis, both quantitatively and qualitatively. The international dimension places particular emphasis on ensuring that banks have information systems and controls to manage risks in all business units, wherever they are located. FSA insures that overseas activities are structured in a way that can be properly supervised and, where it is not satisfied, imposes restrictions or limits activities. Overseas visits and cooperation with foreign supervisors are important aspects of FSA’s supervision on a globally consolidated basis.
Principle 24.	Host Country Supervision A key component of consolidated supervision is establishing contact and information exchange with the various other supervisors involved, primarily host country supervisory authorities.
Description	The FSA has established an extensive network of formal and informal contacts with overseas banking supervisors to provide for the exchange of information necessary for effective global consolidated supervision. These contacts are both multilateral and bilateral. At the level of international organizations, FSA is an active participant in supervisory groups such the Basel committee and EU groupings such as the Banking Advisory Committee and the Groupe de Contact. Bilateral memoranda of understandings with numerous countries provide for information exchanges and on-site examinations of branches and subsidiaries of U.K. banks. FSA maintains a very active dialogue with supervisors in offshore centers particularly those that are in overseas territories and crown dependencies. Information exchanges are both formal and informal and range across the full spectrum of supervisory information, from written documentation in support of authorizations to oral sharing of supervisory judgments about individuals and institutions. In line with its risk based approach to supervision FSA, in consultation with local supervisors, regularly visits the major overseas offices of U.K. banking groups and on such visits frequently conducts joint examinations with the host country supervisors. The readiness of an overseas supervisor to provide information is a consideration for the FSA in determining the extent to which it can take into account the work of the overseas supervisory in its supervision of the overseas subsidiaries of U.K. banks. Threshold Condition 3 (Close Links) would be breached if the regulations or administrative provisions of a territory, which is not an EEA state, would prevent the FSA’s effective supervision of a bank or affiliate. COND 2.3.3G also notes that the FSA considers branches when assessing whether a firm meets Threshold Condition 3. Restrictions on information flows also impact on Principle for Business (PRIN) which provides that a firm must deal with its regulators in an open and cooperative way and must disclose to the FSA appropriately anything relating to the firm of which the FSA would reasonably expect notice. This principle is enforced in Rule 2.1.1 in SUP. COND 2.3.3G also indicates that restrictions on information flow could stop a firm complying with the rules in SUP on information gathering. In discussions with host country supervisors FSA will focus on the local banking group and the group as a whole.
Assessment	Compliant
Comments	FSA has a very broad network of contacts and arrangements with foreign supervisors whereby it exchanges supervisory information necessary to carry out globally consolidated supervision. This includes participation in numerous international and bilateral supervisory groups, as well as formal and informal bilateral contacts with other supervisors responsible for affiliates of banking organizations in the U.K. Where practical, the FSA will consult with an overseas supervisor providing information before taking action in relation to a bank that it supervises (and more widely where any action could have consequences for its supervision of other banks or financial companies). The FSA must consult a firm’s EEA home state regulator before taking actions in certain specified cases. The FSA discloses information to host country supervisors in a wide variety of circumstances whether or not at the specific request of the host supervisor.
Principle 25.	Supervision Over Foreign Banks’ Establishments Banking supervisors must require the local operations of foreign banks to be conducted with the same high standards as are required of domestic institutions and must have powers to share information needed by the home country supervisors of those banks for the purpose of carrying out consolidated supervision.
Description	All banks, whether U.K. incorporated or branches of foreign banks, are required to satisfy and continue to satisfy the Threshold Conditions set out in FSMA. The Principles for Business likewise are applicable to all banks whether U.K. incorporated or branches of foreign banks. FSA’s risk based approach to supervision does not differentiate between foreign and domestic banks. Foreign banks are subject to the same risk assessment and risk mitigation process as domestic banks. Reporting requirements are similar for all banks, although there are differences in the prudential returns relating to capital and large exposures. These differences apply mainly to branches of foreign banks and the differences are spelled out in SUP 16 of the Handbook. Prudential supervision of branches of EEA banks operating in the U.K. under the EU passport arrangements are primarily the responsibility of the home country supervisor and, hence, prudential returns to FSA are limited. For branches of non-EEA banks the FSA relies on the home country supervisor for capital adequacy and large exposures. Although FSA has responsibility for supervising the liquidity of foreign branches on a case-by-case bases it may agree to defer to the home country supervisor for the oversight of branch liquidity. In both its licensing and ongoing supervision of branches and subsidiaries of foreign banks, FSA takes into account the extent to which home country supervisors carry out effective global consolidated supervision. Before authorizing deposit taking activities of a foreign branch of a non-EEA bank the FSA confirms both that the bank is subject to consolidated supervision and that the home country supervisor approves the proposal. Similar procedures do not apply to approval of branches of EEA banks operating under EU passport arrangements. If, on a continuing basis, FSA is unable to rely on the home country supervisor, it is FSA policy that branches of non-EEA banks close or the branch should subsidiarise. This policy has been enforced in individual cases. For U.K. subsidiaries of overseas banks the FSA seeks confirmation that the home country supervisor practices effective consolidated supervision. If FSA is not satisfied on this point then it will require that the corporate governance and risk management policies of the subsidiary be sufficiently robust to provide adequate ring-fencing from the parent bank. This policy has been enforced in individual cases. FSMA provides authority for the FSA to share supervisory information with foreign supervisors subject to confidentiality safeguards. All home country supervisors are permitted to conduct on-site visits and examinations of U.K. branches and subsidiaries and FSA encourages this practice. FSA informs home country supervisors of risk assessments and supervisory actions that it is taking in relation to the operations of banks from their countries. Urgent remedial actions are promptly communicated. FSA systematically informs itself of business strategies and risk and control regimes of parent banking groups in order to provide the context necessary for supervision of branches and subsidiaries of foreign banks operating in the U.K. This done through contacts with the banking group supplemented by information provided by the home country supervisor.
Assessment	Compliant
Comments	The U.K. operations of foreign banks are subject to the same high level standards and principles the FSA applies to U.K. banking organizations and FSA applies the same risk based supervisory tools to both foreign and domestic banks. Reporting requirements are similar for all banks, taking into account differences applicable to branches of foreign banks and the special legal arrangements for EEA branches established under the EU passport regime. FSA licensing and ongoing supervision of U.K. branches and subsidiaries of foreign banks takes into account the reliance FSA believes it can place on home country consolidated supervision. FSA has wide authority to share supervisory information with home country supervisors and, as a matter of policy, FSA encourages home country supervisors to carry out on-site visits of the U.K. operations of their banks.

Principle 1.	Objectives, Autonomy, Powers, and Resources An effective system of banking supervision will have clear responsibilities and objectives for each agency involved in the supervision of banks. Each such agency should possess operational independence and adequate resources. A suitable legal framework for banking supervision is also necessary, including provisions relating to the authorization of banking establishments and their ongoing supervision; powers to address compliance with laws, as well as safety and soundness concerns; and legal protection for supervisors. Arrangements for sharing information between supervisors and protecting the confidentiality of such information should be in place.
Principle 1(1)	An effective system of banking supervision will have clear responsibilities and objectives for each agency involved in the supervision of banks.
Description	Responsibilities and objectives of the FSA as supervisor and regulator are set out in the FSMA. The FSA’s general functions are set out in the FSMA Section 2 (4), and consist of rulemaking, preparing and issuing codes, providing guidance, and determining the general policy and principles by which the FSA will perform its functions. In carrying out the general functions, the FSA is required to act in a way that is compatible with the regulatory objectives and have regard for the principles of good regulation. The four regulatory objectives, identified in the FSMA Section 2 (6), are market confidence, public awareness, protection of consumers, and reduction of financial crime. The seven principles of good regulation identified in FSMA Section 2 (3), which FSA is required to take into consideration, include minimizing adverse effects of regulation on competition; encouraging competition among firms regulated by FSA; using its resources economically; taking account of the responsibilities of those who manage the affairs of authorized persons; following the principle that a burden or restriction imposed on a regulated firm should be proportionate to the benefits expected; being attentive to facilitating innovation in connection with regulated activities; and observing the international character of financial services and markets and the desirability of maintaining the competitive position of the U.K. The FSMA gives the FSA rulemaking powers that may be used to introduce new rules or change existing rules. Rules and Guidance are set out in the FSA Handbook, and primarily cover prudential matters. Banks are required to meet “threshold conditions” (TC), set out in FSMA Schedule 6, and elaborated on in the Threshold Conditions chapter of the FSA Handbook (COND). Banks are also required to comply with rules made by the FSA. In general, the FSA has the sole responsibility for supervising banks in the United Kingdom. Branches of EEA banks are also supervised by their home country supervisors. The FSA has broad powers under the FSMA to take action against banks that do not comply with legal and regulatory requirements. The FSA has formal powers to take action to deal with problem banks, but where appropriate may pursue informal action to resolve problem bank issues. The FSMA is a comprehensive update of previous banking laws. Prior to the enactment of the FSMA, banking laws had been amended periodically to enhance supervisory standards, increase supervisory powers, and reflect the requirements of EU directives. The FSMA requires transparency of the FSA in a number of ways. FSMA Schedule 1, paragraph 10 requires the FSA to report (on the discharge of its functions) to the Treasury at least annually, and Treasury is required to provide a copy of this report to Parliament. In addition, FSMA Schedule 1, paragraph 11 requires the FSA to hold an annual public meeting to discuss the contents of the report. Schedule 1, paragraph 12 of the FSMA charges the FSA’s non-executive committee with reviewing the FSA’s internal financial controls, and reports on these matters to the Treasury. In addition, the Treasury has the authority to make formal inquiries relating to the FSA’s use of resources in discharging its functions, and where there has been a serious failure in the regulatory system. Information on the FSA’s regulatory objectives is published in its plan and budget, and other publications. The FSMA, section 8, also requires the FSA to consult on the extent to which its general policies and practices are consistent with its general duties. The FSA does not publish regular information on the financial strength and performance of the banking industry; however, industry information is available from other sources. Historically, the Bank of England collected regulatory returns for the banks and published statistical information on the banking industry. Under the FSMA, the regulatory returns are collected by the Bank under the FSA’s authority; however, the Bank continues to publish the aggregate information on the industry. The Bank of England’s semi-annual Financial Stability Review contains prudential information on the banking industry, including information on aggregate profitability, capital, and liquidity. In addition, the Bank publishes Monetary and Financial Statistics on a monthly and quarterly basis. These statistics provide some information on the lending sector, and national accounts level information on capital and profitability. In addition, the British Bankers Association publishes an annual report that aggregates publicly available financial information from the large banks to provide an industry wide view. The FSA does have two projects (discussion papers on harnessing market forces, and on the regulatory reporting environment) underway to explore, among other things, whether they should provide any additional industry information to the public.
Assessment	Compliant
Comments	The FSMA clearly defines the FSA’s role as bank supervisor, sets out regulatory objectives and principles, and provides broad rulemaking powers. Systems are in place to ensure the FSA’s activities are carried out in a transparent manner. Information on the financial strength and performance of the banking industry is publicly available, but is published by the Bank of England and the British Bankers’ Association.
Principle 1(2)	Each such agency should possess operational independence and adequate resources.
Description	The FSA is an independent non-governmental body, established as a company limited by guarantee. The FSA is accountable to Treasury Ministers and, through them, to Parliament. A Board appointed by HM Treasury governs the FSA. In addition to the Executive Chairman, there are currently three Managing Directors and eleven non-executive members, of whom one, the Deputy Governor (Financial Stability) of the Bank of England, is an ex officio director. One of the non-executive members is Deputy Chairman and ‘lead’ non-executive. The Board sets the FSA’s overall policy, but is not involved in the day-to-day operations. The FSA’s funding is provided by the industry, and regulated firms pay annual fees directly to the FSA. The FSMA (Schedule 1, paragraph 17) gives the FSA the authority to require the payment of fees. The FSA is required to consult on its proposed fees, and has issued a series of consultation papers (CPs) that explain how the fees are calculated. CP111 addresses the post-N2 fee assessment process. FSMA requires the FSA to carry out its regulatory responsibilities in a way that uses its resources in an economic and efficient manner. To this end the FSA has developed four resources strategies -for People, Space, Cash and Information. A monthly Resources Report is published within the FSA, monitoring progress against key measures in each of the resource categories. This report includes tracking of things like staff turnover. Salaries paid by the FSA take into account pay levels within the financial services industry and the FSA is able to recruit expert assistance where needed. The FSA spent approximately £2.8million on training in 2001/2, with an average of 6.2 days per person spent on formal training activities over the same period. The FSA uses secondments from the industry and professional firms to add skills and experience not readily available in the marketplace. The FSA also provides outward secondment opportunities to staff as part of its Graduate Development Program. HM Treasury appoints the FSA Board, including the chairman, and also has the authority to remove the chairman or other board members. The FSMA does not set out a term for the chairman. In addition, the FSMA does not set out reasons for removal of the chairman, nor does it require that the reasons for removal be made public.
Assessment	Compliant
Comments	The FSA’s Board reports to HM Treasury, and ultimately the Parliament. While the day-to-day operations of the FSA are removed from HM Treasury, there is concern within the industry that political pressures, particularly related to the consumer focused objectives, may cause the FSA to become (a) more prescriptive or rule based, and (b) more consumerist. The prominence of consumer protection among the FSA’s regulatory objectives may cause tensions within its risk-based approach to supervision. The strong and transparent accountability regime surrounding all aspects of FSA operations provides the safeguard that the fiscal regime of assessments on regulated firms would not compromise its independence or autonomy. The FSA has the authority to increase assessments to fund increasing supervision needs, but has made a conscious effort to hold its expenditures relatively stable over the last few years. Detailed on-site supervision work is provided either internally by line supervisors supported by the risk review division, or externally using “skilled persons” reviews. The skilled persons reviews are directed by the FSA, but paid for by the firm directly, and represent an additional cost of supervision to the industry over the FSA’s assessments. FSA pursues a consistent theme of proportionality, considering the cost of supervision (including the use of skilled persons reports) against the risks to the FSA’s objectives. The FSA and its staff are credible and professional. Staff at the director and manager level is experienced, many coming from the Bank of England at the time the FSA was created. Bank and industry sources stated that the FSA’s level of supervision and focus was reasonable, and the FSA is focused on key risks in the industry. The sources also noted that turnover and depth of staff have been issues for the FSA. One area that bears monitoring is the adequacy of staffing levels in the supervision and risk review divisions. The FSA’s internal specialist teams are quite small considering they are a cross-sector resource. The FSA’s new risk assessment process is in the early stages of being rolled out. The level of requests for risk review assistance in relation to their available resources is not yet known, and is something that should be closely monitored to ensure that resources are sufficient to carry out risk mitigation programs. In addition, industry sources expressed some concern over the turnover rate in supervisory staff, and the level of firm specific knowledge that is lost due to turnover. However, the FSAP team was informed by the FSA that staff turnover rates have decreased recently. Turnover figures for the FSA divisions undertaking banking supervision (i.e., the Deposit Takers Division, the Major Financial Groups Division and the Investment Firms Division) have ranged from 3.5 percent to 9.7 percent in the twelve months to June 2002. The FSMA does not specify a minimum term for the head of the FSA, does not require that any removal be based on specified reasons, and does not require that the reasons for the removal be made public. HM Treasury is responsible for the processes surrounding the appointment and removal of the head of the FSA. Although the high-level safeguards in this area are thus limited, appointments are made on principles of good corporate governance known as the Nolan Principles, while senior officials’ contracts have specific terms, and an official removed could pursue a judicial review in certain circumstances. De facto, an important safeguard in the U.K. context is the close public scrutiny over the activities of public officials provided by an independent media, as well as parliamentary scrutiny. In these circumstances, it is unlikely that a senior official could be removed from office without the government having to publicly disclose and defend the reasons behind its decision.
Principle 1(3)	A suitable legal framework for banking supervision is also necessary, including provisions relating to authorization of banking establishments and their ongoing supervision.
Description	The FSMA sets out the legal framework for authorization, ongoing supervision, and enforcement. The legal framework includes secondary legislation under FSMA, and the rules made by the FSA using its rulemaking powers under section 138 of the FSMA. The FSA Handbook contains manuals on Authorization, Supervision, and Enforcement. The FSA promulgates rules with which the banks must comply. The FSA also produces guidance. The rules and guidance mainly cover prudential matters. Under FSMA section 148 the FSA also has the power to alter or revoke rules, and to modify or waive rules in certain cases. The FSA has authority to require banks to provide information under FSMA section 165. Banks are required to submit a variety of regular reports to the FSA covering their financial condition (SUP chapter 16).
Assessment	Compliant
Comments	The FSMA provides a suitable framework for the authorization and ongoing supervision of banking establishments, and clearly identifies the FSA as the body responsible for authorization and supervision of firms. The FSA produces rules and guidance on authorization and supervision. In addition, the FSA has broad powers to require banks to provide information. Rules and guidance are prepared in consultation with the industry.
Principle 1(4)	A suitable legal framework for banking supervision is also necessary, including powers to address compliance with laws, as well as safety and soundness concerns.
Description	The FSMA (Schedule 1 paragraph 6) requires the FSA to maintain a process designed to allow it to determine whether a bank is complying with requirements under the FSMA (including FSA rules). The FSA has broad authority to determine whether a bank is in compliance with regulatory requirements. The FSA has the authority under FSMA section 165 to obtain any information or documents from banks. The FSA may also obtain information through the use of an authorized person under section 166. The FSA may also appoint investigators into a bank’s affairs under FSMA sections 167 through 176. The FSA’s authority and the processes for obtaining information are set out in the Enforcement manual (ENF) section of the FSA Handbook. The FSMA gives the FSA broad powers to take action against banks that do not comply with the requirements of the FSMA, or its secondary legislation or rules. The FSA may withdraw a bank’s authorization, limit a bank’s ability to take deposits, or require a bank to cease certain activities. The FSA can take remedial action with immediate affect under FSMA Section 45, using a supervisory notice. These notices are subject to referral by an independent FSM Tribunal. Procedures relating to the Tribunal are found in Part IX of the FSMA. The FSMA Part XIV provides the FSA with the power to fine or publicly censure a bank that fails to comply with a requirement imposed by the FSA or the FSMA. This is accomplished through the issuance of a decision notice. These actions are also referable to the Tribunal, generally within 28 days of the date of the notice. The FSA may not take the action specified in these notices until after the referral period has ended, or if the matter is referred, until after the Tribunal disposed of the appeal.
Assessment	Compliant
Comments	The FSA has broad powers to supervise banks, including requiring the banks to provide information. If the FSA determines that the bank is in non-compliance with the FSMA or its rules, it has a range of supervisory and enforcement options available. The options include prompt remedial action (restricting activities, revoking authorization) where other supervisory measures are not sufficient.
Principle 1(5)	A suitable legal framework for banking supervision is also necessary, including legal protection for supervisors.
Description	The FSMA Schedule 1 paragraph 19 provides that neither the FSA or “any person who is, or is acting as, a member, officer or member of staff of the FSA” is to be liable in damages for anything done or omitted in the discharge, or purported discharge of the FSA’s functions. This protection extends to persons appointed to investigate complaints under Schedule 1 paragraph 7. An exception to the protection exists if the act or omission is in bad faith. In addition, the FSMA protection does not prevent an award of damages under Section 6(1) of the Human Rights Act of 1998. However, under the complaints scheme (FSMA Schedule 1 paragraphs 7 and 8), the appointed investigator must have the power to recommend, if he thinks it appropriate, that the FSA makes a compensatory payment to the complainant, remedies the matter complained of, or both. The FSA has the power to require the payment of fees, to cover the costs of defending its actions. The FSA covers the legal costs of defending its staff in legal actions against them in relation to their work as FSA employees.
Assessment	Compliant
Comments	The FSMA provides protection from liability to the FSA and its staff for any actions taken in good faith in the performance of their duties. However, the FSA may be required to pay compensation to complainants under the FSMA mandated compensation scheme, or awards for damages related to actions found to be unlawful under the Human Rights Act.
Principle 1(6)	Arrangements for sharing information between supervisors and protecting the confidentiality of such information should be in place.
Description	The FSA has an MOU with the Bank of England and HM Treasury, which covers among other things, the exchange of information. The MOU is published. FSMA Part XXIII places restrictions on the disclosure of information, there are exceptions that permit the FSA to disclose information to other regulators (U.K. and overseas) subject to compliance with EU directives. FSMA Section 354 requires the FSA to cooperate with persons who have functions similar to the FSA, and also to cooperate in relation to the prevention or detection of financial crime. Cooperation may include sharing of information that the FSA is not prevented from disclosing. The FSA has formal arrangements for information exchange in place with a number of domestic, EEA, and overseas supervisors. Information is exchanged on an ongoing basis. Confidential information disclosed by the FSA continues to be subject to the FSMA restrictions on disclosure. The FSA must satisfy itself that where confidential information is disclosed to an overseas supervisor the information will be subject to equivalent restrictions as those that apply to confidential information restrictions in the Banking Consolidation Directive. The FSA may refuse requests for confidential information except in limited cases such as court orders in criminal cases, Parliamentary inquiries, and to an extent, personal data subject to data protection legislation.
Assessment	Compliant
Comments	The FSMA provides a suitable framework for sharing of information with domestic and foreign supervisory agencies, and provides for safeguarding of confidential information. The FSMA also provides the FSA with the right to refuse requests for confidential information, with limited exceptions.
Principle 2.	Permissible Activities The permissible activities of institutions that are licensed and subject to supervision as banks must be clearly defined, and the use of the word “bank” in names should be controlled as far as possible.
Description	The FSMA does not expressly define the term “bank” or include it as a separate category of authorized person; however, Schedule 2 does identify deposit taking as a regulated activity. The Regulated Activities Order also sets out activities which are regulated activities for the purposes of the FSMA, and accepting deposits is one such activity. For purposes of determining which parts of the FSA Handbook apply to particular categories of firms, the FSA defines a bank as: a. A firm with Part IV permission which includes accepting deposits, and (i) which is a credit institution; or (ii) whose Part IV permission includes the requirement that it complies with IPRU (Bank); But which is not a building society, a friendly society, or a credit union. b. An EEA bank. The FSMA Section 19 provides that no person may carry on a regulated activity in the U.K. or purport to do so unless he is an authorized person or an exempt person. FSMA Section 24 provides that a person who is not an authorized person is guilty of an offense if he describes himself as an authorized person or holds himself out in a manner that is reasonably likely to be understood as indicating that he is an authorized person.
Assessment	Compliant
Comments	While “bank” isn’t expressly defined, regulated activities are defined and included deposit taking. The FSMA mandates that all persons carrying out regulated activities are properly authorized. Any person using the term bank or banking in their name would be presumed to be carrying out regulated activities and must be authorized.
Principle 3.	Licensing Criteria The licensing authority must have the right to set criteria and reject applications for establishments that do not meet the standards set. The licensing process, at a minimum, should consist of an assessment of the banking organization’s ownership structure, directors and senior management, its operating plan and internal controls, and its projected financial condition, including its capital base; where the proposed owner or parent organization is a foreign bank, the prior consent of its home country supervisor should be obtained.
Description	When granting or varying Part IV permissions, FSMA section 41(2) provides that the FSA must be satisfied that the applicant satisfies and will continue to satisfy the threshold conditions set out in the FSMA (Schedule 6) in relation to all regulated activities for which they will have permission. There are five threshold conditions: 1. Legal status. Deposit-takers must be bodies corporate or partnerships. 2. Location of offices. If the bank is a body corporate constituted under the laws of any part of the U.K., then it must have its head office and, if it has one, its registered office in the U.K. A body incorporated in one part of the U.K. may have its head office in any other part. If the bank has its head office in the U.K. but is not a body corporate, it must carry on business in the U.K. 3. Close links. This threshold condition applies when the applicant has close links with another person of such a kind as to prevent the FSA from effectively supervising the applicant. The FSMA Schedule 6 paragraph 3 provides a definition of close links. If there are close links with another person, then two tests must be satisfied. First, the links must not be likely to prevent effective supervision of the applicant by the FSA. Second, if the person to whom the applicant is linked is situated outside the EEA, then the laws, regulations, and administrative provisions that apply must not prevent effective supervision of the applicant by the FSA. 4. Adequate resources. This test is not only concerned with absolute levels of capital, but also non-financial resources and means of managing resources. Resources may include capital, provisioning, availability of liquid assets, human resources, and risk management systems. When considering adequacy of resources, the FSA will also review whether the firm is ready, willing, and organized to comply with the high level systems and controls requirements set out in the SYSC chapter of the FSA Handbook. 5. Suitability. The applicant has the burden of satisfying the fit and proper test. Section 59 of the FSMA gives the FSA the power to specify “controlled functions” within a firm that must be performed by individuals who have been assessed as fit and proper by the FSA. The FSMA also gives the FSA the power to establish how firms should apply for approval (section 60), factors to be determined (section 61), and to issue statements of principles and a code of practice which will apply to all individuals performing functions under section 59. The FSA has exercised these powers, and sets out its approach in the FIT chapter of the FSA Handbook. Additional information relating to the five threshold conditions, including assessment criteria, is set out in the Conditions (COND) chapter of the FSA Handbook. The Threshold Conditions are used to assess license applications, and are also considered as a part of the FSA’s ongoing supervision. The FSA has the power to reject an application for authorization if the applicant fails to satisfy one or more of the threshold conditions, or if the applicant provides inadequate information. Under FSMA sections 42 and 43, the FSA has the power to impose limitations or requirements on a bank’s permission, or grant permission to carry on a narrower range of activities than the applicant requested. FSMA section 45 gives the FSA the authority to vary or cancel a permission if the authorized person is failing, or is likely to fail, to satisfy the threshold conditions. The FSA Handbook chapter GN, Rule 3.3.13 requires a bank to maintain capital commensurate with the nature and scale of its business, and the risks inherent in that business. If the bank is a member of a group, those capital resources must also be commensurate with the risks inherent in the activities of the other members of the group, insofar as they impact the bank. Guidance on how banks should comply with this rule are set out in IPRU (Banks) chapter CO, with detailed guidance in a variety of other chapters. Rule 3.3.9 requires a U.K. bank and an overseas bank have capital of not less than Euro 5 million at the time it obtains its Part IV permission to accept deposits. When the FSA evaluates proposed directors and senior management, it uses the fit and proper criteria set out in the FIT chapter of the FSA Handbook. Criteria assessed as part of the fit and proper assessment include honesty, integrity and reputation (FIT 2.1); competence and capability (FIT 2.2); and the financial soundness of a person (FIT 2.3). Applicants are required to submit a variety of information, including a strategic and operating plan, a business plan, details of the applicant’s management and organizational structure, operating procedures, systems and controls, and any outsourcing arrangements. This information is assessed to determine whether the system of corporate governance is proportionate to the bank’s business, whether the bank will be managed in a competent and prudent manner, and whether appropriate systems and controls are in place. The assessment of knowledge of all types of financial activities the bank intends to pursue is carried out as part of the approval process for individuals. Cumulatively, senior management would be expected to have the experience and skills to cover all of the bank’s proposed activities. The business plan should set out the regulated and unregulated activities of the applicant along with the related risks. The business plan should include a financial budget and projections to demonstrate the applicant is able to comply with the relevant financial resource requirements. The status of the shareholders and their ability to support the business is also considered as part of this process. The FSA would obtain letters of comfort from major shareholders in some cases. Knowingly or recklessly providing false or misleading information to the FSA is an offense under FSMA section 398. The FSA is the licensing and supervisory authority for banks (but see Principle 25, i.e., branches of EEA banks). FSMA section 354 requires the FSA to cooperate in the sharing of information with other authorities in the U.K. and overseas who have functions similar to the FSA. The FSA seeks the view of the home country supervisors in assessing the application of an overseas bank wishing to establish a branch or subsidiary.
Assessment	Compliant
Comments	The FSA has the authority to set criteria for the licensing of banks, and may reject applications if they fail to meet threshold criteria or provide sufficient information. The FSA requires sufficient information to make a determination on the ownership and management structure, and the adequacy of the bank’s proposed capital, business plan, and system of controls. The FSA also has a process in place to assess the fitness and propriety of management and officers filling the key “controlled function” roles within a firm.
Principle 4.	Ownership Banking supervisors must have the authority to review and reject any proposals to transfer significant ownership or controlling interests in existing banks to other parties.
Description	The FSMA Part XII addresses control over authorized persons. Section 178 requires a person proposing to take control (or increase the degree of control) over an authorized person, including a U.K. bank, to provide the FSA with prior notification. Detailed definitions of control are set out in sections 179 and 180 of the FSMA, but 10 percent is the general threshold for control. The voting power or holdings of the controller’s associates, as defined in FSMA section 422, are also considered. The FSA may require the person giving notification to provide additional information under FSMA section 182. The FSA may object to a proposal unless it is satisfied that the acquirer is a fit and proper person to have control over the authorized person, and the interests of the consumer would not be threatened. The FSA may give unconditional approval under FSMA section 184, or may approve subject to conditions under FSMA section 185. Where shares are acquired in contravention of the FSA’s objection, or a condition imposed, the FSA may direct that the shares be subject to restriction as defined in FSMA section 189. The FSA may also apply to the court to order the sale of any shares acquired in contravention of the FSA’s objection or condition imposed. FSA rules and guidance related to controllers and close links (including required approvals or notifications, thresholds, and timeframes) are contained in Chapter SUP section 11 of the FSA Handbook. Section 11.4.10 requires banks to take reasonable steps to keep itself informed of the identity of controllers, although identification of beneficial owners is not specifically addressed. Banks must notify the FSA of its controllers and close links annually. The reports are discussed in the SUP chapter of the FSA Handbook, sections 16.4 (controllers) and 16.5 (close links).
Assessment	Compliant
Comments	FSA has full power to review and reject any proposals to transfer significant ownership or controlling interests in existing banks to other parties. Procedures for exercising this authority are spelled out in the Handbook and are carried out in practice.
Principle 5.	Investment Criteria Banking supervisors must have the authority to establish criteria for reviewing major acquisitions or investments by a bank and ensuring that corporate affiliations or structures do not expose the bank to undue risks or hinder effective supervision.
Description	The FSA’s Handbook Chapter SUP Section 15 includes a provision requiring a bank give the FSA notice of any proposed restructuring, reorganization, or business expansion which could have a significant impact on the firm’s risk profile or resources. Chapter SUP, Section 11 of the FSA Handbook addresses notification and approval requirements related to close links and changes of control in a firm. In addition, Principle 11 of the Principles for Businesses requires firms to disclose to the FSA anything relating to the firm of which the FSA could reasonably expect to be notified. The FSA’s IPRU (Bank), section LE, addresses large exposures, including investments. U.K. banks are required to notify the FSA of any investment exceeding 10 percent of its capital, and pre-notify the FSA of any investment exceeding 25 percent of capital. The FSA’s policy on large exposures does not apply to U.K. branches of overseas banks; however, U.K. branches incorporated outside the EEA have large exposure reporting requirements. The FSA is required to assess a bank’s acquisitions/investments according to whether the bank would continue to meet the Threshold Conditions, and whether the interests of consumers of regulated activities provided by the bank would be threatened by the acquisition/investment. The FSA has the power to prohibit a bank from undertaking a major acquisition or investment in cases where the bank would no longer meet the threshold conditions, or FSA rules. The FSA Handbook distinguishes between situations where notifications are required prior to the acquisition or investment, as opposed to after the fact notification. The prior notification threshold is defined in relation to the bank’s capital.
Assessment	Compliant
Comments	The FSA has rules and guidance in place regarding the notification, and in some cases prior approval, requirements of major acquisitions or investments. The approval and reporting requirements allow FSA to exercise effective supervisory oversight over corporate structures to insure that risks arising from affiliations are properly identified and controlled and that unsupervisable structures do not arise.
Principle 6.	Capital Adequacy Banking supervisors must set minimum capital adequacy requirements for banks that reflect the risks that the bank undertakes, and must define the components of capital, bearing in mind its ability to absorb losses. For internationally active banks, these requirements must not be less than those established in the Basel Capital Accord.
Description	The FSMA 2000 and the FSA’s regulations require banks to maintain both an absolute minimum amount of capital and an adequate level of capital. Threshold Condition 4 requires all banks to maintain adequate resources, both financial and non-financial. The minimum amount of capital is set at Euro 5 million (or sterling equivalent) and on an on-going basis a minimum capital ratio of 8 percent has to be maintained. The components of regulatory capital and the methodology for calculating the capital ratio have been set out in detail in IPRU Banks. The U.K. capital requirements for banks are based on the relevant EU directives, which are fully in line with the Basel Capital Accord. All U.K. incorporated banks are required to maintain capital in accordance with the Basel standards, not just those banks that are internationally active. There is a general rule requiring banks to maintain capital resources which are commensurate with the nature and scale of their business and risks inherent in that business (IPRU Ch. GN 3.3.13R). If the bank is part of a group, the capital resources must also be commensurate with the risks inherent in the activities of other members of the group in as far as these risks affect the bank. In addition to the general capital adequacy rules, for each U.K. incorporated bank an individual required capital ratio is set which in almost all cases is higher (and never lower) than the Basel minimum requirement of 8 percent. Individual bank capital ratios are determined by the overall risk profile of each institution. If the FSA determines that a bank’s business or control risks have increased, it may raise the bank’s individual required capital ratio. The individual capital ratios are applied both on a solo and on a consolidated basis. The individual ratios are reviewed periodically within a timeframe that is consistent with a bank’s supervisory cycle. Banks are required to report their solo capital ratio on a quarterly basis and their consolidated ratio on a semi-annual basis. The components of capital and the risk-weighted assets also have to be reported. Capital requirements have to be met continuously, not just on reporting dates. Banks must therefore be able to calculate their capital ratio regularly. Any breaches of individual required capital ratios must be immediately notified to the FSA. This would lead to the agreement of a clear plan and timetable to achieve swift compliance with the required ratio, either through a capital injection or a balance sheet restructuring. The FSA has a wide range of enforcement powers available if any bank fails to comply with the Threshold Conditions or the FSA’s Rules (including the capital adequacy requirements), such as variation or cancellation of permitted activities and withdrawal of the license (see Principle 1.4).
Assessment	Compliant
Comments	The FSA’s minimum capital requirements for banks are fully in line with the 1988 Basel Capital Accord and its subsequent amendments. The individual capital requirements anticipate the supervisory review process that is expected to be incorporated in the new Capital Accord that is currently being prepared. The FSA is committed to fully implementing the new Capital Accord at the earliest opportunity.
Principle 7.	Credit Policies An essential part of any supervisory system is the independent evaluation of a bank’s policies, practices, and procedures related to the granting of loans and making of investments and the ongoing management of the loan and investment portfolios.
Description	According to the Threshold Condition on Suitability, regulated firms (including banks) are expected to have identified fully, and considered, the various risks they will encounter in conducting their business and installed appropriate control systems to manage them prudently at all times. IPRU Banks Chapter AR (on accounting and other records and internal control systems) states that this can only be done if a bank has adequate accounting and other records of its business and adequate systems of control of its business and records. It is the responsibility of a bank’s directors and management to take reasonable care to establish and maintain such systems and controls as are appropriate to the nature, scale and complexity of its business. There is also a general requirement for a bank’s directors and management to take responsibility for deciding what management information is required and who are to be the recipients (IPRU Banks Chapter AR Section 3.2.3). A bank is expected to have management information accurately covering its risk exposures (ibid. Section 3.3.5). No specific rules or guidance exist for banks’ loan and investment policies, practices and procedures since these are considered to be the responsibility of management. However, the FSA expects a bank to have set prudent credit granting and investment criteria, policies and procedures, which reflect its range and type of assets. These criteria, policies and procedures must have been approved and implemented by bank management and board of directors and should be periodically reviewed. All relevant staff members are expected to receive adequate training in the bank’s internal control policies and procedures. Each bank is expected to have appropriate credit assessment procedures in place with which to identify, measure, monitor and control the credit risk. A bank’s internal records should reflect details of the analysis undertaken. A bank’s records should include details of counterparty exposure limits that have been approved by management and the bank should be able to measure actual exposures against these limits (IPRU Banks Chapter AR Section 3.2.2). Also, each bank is required to have a policy on large exposures (see Principle 9). This policy should outline the approval process for major credits, the circumstances in which limits may be exceeded and who is authorized to approve such excesses (e.g., a bank’s board or credit committee). The FSA will verify whether a bank has followed prudent credit granting criteria, policies and procedures through desk-based analysis of prudential returns. One of the methods employed, particularly for the purpose of assessing the adequacy of management information systems, is peer group review. If the desk-based analysis indicates a need for further scrutiny, various supervisory tools may be applied, if necessary in an escalating fashion, for example visits by the supervisory team to the bank, followed by specialist credit evaluation visits, and ultimately so-called skilled persons (i.e., outside auditors) investigations. Also, ad hoc meetings with senior management may be held to assess their understanding and implementation of the criteria, policies and procedures. The supervisory team will give consideration to the size, maturity, currency, marketability and sources of repayment, the geographic dispersion of assets, whether credit decisions have been taken on an arm’s-length basis and whether adequate checks are made of the total indebtedness of the entities to which the bank extends credit. No routine reviews of credit files are conducted. The FSA expects a bank to give the supervisory team full access to all information relevant to the credit and investment portfolios. However, in the event it does not prove possible to gain access to the requested information on a voluntary basis, the FSA will use its statutory powers. The FSA frequently requests receipt of banks’ own management information to help it verify adherence to the credit policies set.
Assessment	Compliant
Comments	Although no specific rules have been set, the FSA requires a bank to have credit-granting procedures that identify, monitor and control credit risk. The bank’s policies should reflect the range and type of its assets. Periodic evaluation of a bank’s credit-granting criteria is undertaken by means of a mix of desk-based analysis, on-site visits, ad hoc meetings with management and skilled persons reports.
Principle 8.	Loan Evaluation and Loan-Loss Provisioning Banking supervisors must be satisfied that banks establish and adhere to adequate policies, practices, and procedures for evaluating the quality of assets and the adequacy of loan-loss provisions and reserves.
Description	Banks are required to maintain such systems and controls as are appropriate to their business (SYSC 3.1.1R). These should include monitoring asset quality and the adequacy and value of collateral on a net realizable basis (SYSC 3.2.11 and IPRU Chapter PN). In addition, banks must maintain adequate provisions for any depreciation in the value of their assets (IPRU Chapter GN 3.3.17R). Banks are required to set out their policy on making provisions in a written statement, which should include details of their loan classification arrangement and should be reviewed annually (IPRU Banks Chapters GN 3.4.5R and PN 3). The FSA does not prescribe a particular format for the policy statement as it does not consider one format to be appropriate for the diverse range of banks authorized in the U.K. However, the FSA expects the provisioning policy statement to cover issues such as who is responsible for drawing up and monitoring the policy, what areas of the bank’s business are covered, what types of management information is generated, how is implementation of the policy checked, how are non-performing exposures identified, etcetera. A copy of the provisioning policy statement has to be supplied to the FSA. Provisioning policies should cover both on and off balance sheet positions. Provisioning and loan classification policies are not rule or formula based but must be appropriate to the bank’s business. Provisioning decisions are taken by management or the board based on a true and fair view of the quality of the assets. However, banks normally follow the accounting guidelines that have been issued by the British Bankers Association and any deviations have to be explained. These guidelines require the making of provisions once assets are identified as impaired. Loans are impaired when there is reason to believe that not all amounts (both principal and interest) will be collected in accordance with the contractual terms of the loan. The external auditor has to approve the provisioning decisions made by management in the context of his review of the financial statements. However, banks’ provisioning policy statements should include criteria for loans to be classified as non-performing. This would normally be when payments were a minimum number of days in arrears (usually 90 days), but a bank could make specific provisions earlier if this is considered appropriate. Provisioning decisions with regard to individual assets have to be based on an impairment that has actually been identified, in other words, no general provisions are to be included. In assessing the adequacy of a bank’s provisions, the FSA looks at its provisioning policies, and the methods and systems for calculating provisions in accordance with those policies. The FSA seeks to ensure through risk mitigation programs and other work that procedures and resources for monitoring and dealing with problem loans are adequate. The FSA does not as a standard practice require periodic reporting of classified and non-performing loans. However, where the FSA has concerns over a bank’s asset quality, it can seek regular reports on watch list loans. The level of provisioning is normally reported either on a quarterly or a semi-annual basis, but the frequency can be increased, and the required contents of reports expanded, if necessary. When there are doubts about a bank’s credit controls or the adequacy of provisions, the FSA will have these assessed by its own credit specialists or by an external skilled person. A plan of action would be tailored to the outcome of such reviews. If the FSA continued to have doubts on a bank’s provisioning practices, it may use its enforcement powers.
Assessment	Compliant
Comments	Banks are required to supply the FSA with policy statements outlining their approach to asset classification and provisioning arrangements. External auditors routinely review the adequacy of banks’ provisions as part of the audit process. The FSA does not have a formal requirement that loans be classified when payments are contractually a minimum number of days in arrears (as called for in *Additional Criteria 1, of the Core Principles Methodology)* as the classification and provisioning system is not rule but principle-based. In practice, loans tend to be classified after 90 days of arrears. This system works well and actual provisioning levels in U.K. banks appear to be adequate. The FSA should consider introducing a requirement for periodic reporting on credit quality based on each bank’s own asset classification policy and internal credit ratings. This would strengthen off-site monitoring by allowing early identification of asset quality trends.
Principle 9.	Large Exposure Limits Banking supervisors must be satisfied that banks have management information systems that enable management to identify concentrations within the portfolio, and supervisors must set prudential limits to restrict bank exposures to single borrowers or groups of related borrowers.
Description	Each bank must set out its policy on large exposures in a written statement (IPRU Chapter GN Section 3.4.1R). The policy should outline the circumstances in which limits (e.g., types of counterparty, individual counterparties and connected exposures) may be exceeded and who is authorized to approve such excesses (e.g., a bank’s board or credit committee). The policy statement must be approved by the bank’s board and must be agreed with and copied to the FSA. The bank must review the policy statement and if necessary update it at least once a year. Any significant departures from the stated policy, e.g., new types of lending or breaches of existing limits, should not be incorporated without prior discussion with the FSA. A bank must have adequate systems and controls to enable it to monitor and control its large exposures in conformity with its large exposures policy statement and to calculate its large exposures accurately and promptly (IPRU Chapter GN Section 3.3.19R). The supervisor will verify the existence of such systems and controls. This will be done by periodic supervisory visits to the bank, ad hoc meetings with senior management and the board, skilled person reports and any thematic work that the FSA may seek to carry out in this area. Maximum limits for exposures to individual and group borrowers are set by the EU Large Exposures Directive (now included in the Consolidated Banking Directive), which has been fully implemented in FSA guidance. The chapter on large exposures in IPRU provides a comprehensive definition of ‘exposures’, which includes both on and off balance sheet items, and guidance covering the 10 percent and 25 percent limits and the calculation of a bank’s large exposure capital base. The limits, as well as the notification and reporting requirements, have to be met both on a solo and on a consolidated basis, as appropriate. A ‘closely related group’ is defined to exist either where two or more individual counterparties constitute a single risk because one of them has directly or indirectly, control over the other(s), or where individual counterparties are connected in such a way that the financial soundness of any of them may affect the financial soundness of the other(s) or the same factors may affect the financial soundness of both or all of them. Where there is doubt as to whether a number of individual persons constitute a group of closely related counterparties banks should discuss the circumstances with the FSA to determine how the exposure(s) should be reported (IPRU Chapter LE Section 5). A U.K. bank must notify the FSA if it proposes to enter into a transaction which would result in it having an exposure which exceeds 25 percent of its capital (IPRU Chapter GN Section 3.3.21R). In conformity with the EU Capital Adequacy Directive, excesses of the 25 percent limit may be allowed in certain limited cases, relating mostly to trading book positions. In such cases, an incremental capital requirement may be applied. In addition, the FSA may allow a breach of the 25 percent limit at the solo level as long as the limit is met at the consolidated level. All breaches of large exposure limits must be notified to the FSA immediately (IPRU Chapter LE Section 3). The FSA receives details of the twenty largest bank and non-bank exposures and any exposures of 10 percent or more of a bank’s regulatory capital base via a large exposures report submitted quarterly by U.K.-incorporated banks (SUP 16.7.8R). Branches of non-EEA incorporated banks submit half-yearly reports of their twenty largest bank and non-bank exposures (SUP 16.7.12R). These reports should be completed on an unconsolidated or solo-consolidated basis and on a consolidated basis. Concentrations of risk should be covered in a bank’s large exposure policy statement and significant concentrations of risk, both sectoral and geographic, would be considered during the FSA’s regular risk assessments. The FSA also frequently requests receipt of banks’ own management information to help verify adherence to the large exposure policy statement and limits.
Assessment	Compliant
Comments	Clear and precise regulations exist with respect to large exposures, reflecting the relevant EU Directive. The FSA’s requirement for banks to submit a written policy statement on large exposures is an appropriate means of stimulating prudent behavior in banks with respect to risk concentrations. Large exposure policies are monitored and enforced by the FSA using its normal supervisory tools.
Principle 10.	Connected Lending In order to prevent abuses arising from connected lending, banking supervisors must have in place requirements that banks lend to related companies and individuals on an arm’s-length basis, that such extensions of credit are effectively monitored, and that other appropriate steps are taken to control or mitigate the risks.
Description	Banks’ policies on connected lending should be included in their large exposures policy statements (IPRU Banks Chapter LE Section 8.1). Connected exposures are defined to include intra-group lending, lending to directors, senior managers, controllers (i.e., major shareholders) and their associates (including close family members), and lending to non-group companies with which the bank’s directors or controllers are associated (ibid. Section 5.3). The FSA retains discretion to determine whether a particular counterparty should be deemed to be connected to a bank where doubt exists. The FSA normally expects connected exposures to remain an insignificant proportion of a bank’s assets. Clear and objective credit assessment processes have to be used when banks consider proposals for connected lending. Exposures to connected parties may be entered into only for the clear commercial advantage of the bank and should be negotiated and agreed on an arm’s length basis. Factors a bank has to take into account when determining whether a loan is being made on an arm’s length basis include the extent to which shareholders can influence the bank’s operations (e.g., through voting rights), the management role of shareholders (e.g., whether they are also directors of the bank) and whether the loan would be subject to the bank’s usual monitoring and recovery procedures if repayment difficulties emerged (ibid. Section 5.3.7). Aggregated connected lending should be a maximum of 25 percent of a bank’s capital base. The FSA is prepared to consider requests from banks for higher limit levels than this in certain, very limited, circumstances. An example of this might be where the bank performs a group treasury function and it is reasonable to allow a limit higher than 25 percent of capital for exposures of under one year maturity. The requirements for connected lending concessions are set out in IPRU Banks (Chapter LE 9.2.2-9.2.5). With the exception of such agreed concessions within limited parameters, aggregate regulatory limits on banks’ connected exposures are as strict as those for single borrowers and groups of related borrowers. The FSA may deduct exposures to companies or persons connected to a bank from the bank’s capital base if they are of the nature of a capital investment or are made on concessionary terms (IPRU Chapter LE 5.3). Aggregated connected lending is reported to the FSA on a quarterly basis via a large exposures report. One of the checks supervisors make when examining these data is to ensure that they remain within the agreed limits. Since the FSA requires banks to report connected exposures, it requires banks to have systems in place to identify all connected exposures. The mission team was informed that the FSA also requires banks to provide a detailed breakdown of their exposures to connected counterparties. As with credit policies generally, verification of compliance with the requirements relating to connected lending may be undertaken during the course of supervisory or specialist credit visits or by commissioning skilled persons reports.
Assessment	Compliant
Comments	The FSA’s supervisory approach towards connected lending by banks offers sufficient safeguards that such lending will be undertaken only on an arm’s length basis. The requirements for approval of proposed exposures to companies or persons connected with the bank by the bank’s board of directors and for banks to have procedures in place to prevent persons benefiting from the loan taking part in the loan assessment process or in the loan decision(*Essential Criteria 3 and 4* of the *BCP Methodology*) are covered by the general requirement for banks to take special care to ensure that a proper, objective credit assessment is undertaken for connected lending and by the more specific guidance on credit risk management and corporate governance given in the FSA’s Handbook. Also, the FSA requires the risk management function of a bank to be independent and therefore parties benefiting from a lending decision should not be part of the risk assessment process.
Principle 11.	Country Risk Banking supervisors must be satisfied that banks have adequate policies and procedures for identifying, monitoring, and controlling country risk and transfer risk in their international lending and investment activities, and for maintaining appropriate reserves against such risks.
Description	A bank’s approach to sovereign lending and to country exposure limits should be included in its large exposure policy statement (IPRU Banks Chapter LE Section 8.1). Although there is no specific requirement in this regard, the FSA expects the policy statement to include details of limits on a country-by-country basis. Exposures to overseas countries which exceed 25 percent of a bank’s capital base are not covered by the pre-notification requirements for large exposures. However, where a proposed transaction will result in an exposure which represents a significant departure from a bank’s large exposure policy statement, the FSA does expect the proposed transaction to be notified in advance and discussed with it. If the FSA is dissatisfied with a bank’s country risk policy, it may instruct the bank to reduce its exposures or to increase its capital. The FSA’s guidance for banks’ provisioning policy statements does not contain references to provisioning for country exposures. Provisioning for country risks is covered by the general requirement for banks to maintain adequate provisions. While the FSA does not set specific provisioning requirements it does expect banks to make appropriate levels of provisions after discussions with their external auditors. If the FSA thought that a bank had inadequate provisions it would seek to hold discussions with the bank and its external auditors in order to ensure that provisioning levels are reasonable. A bank’s adherence to its country risk and provisioning policies will be checked by the FSA by desk-based reviews, during on-site inspection visits or, where appropriate, by means of a skilled persons report. The FSA will obtain information on country, sectoral and regional exposures from banks’ internal monitoring systems and will discuss them with banks’ management in the context of their large exposures policies (IPRU Banks Chapter LE Section 9.2.7.21). By doing so, the FSA is able to assess whether banks have information systems, risk management systems and internal controls that enable them to comply with their country risk policy as set out in their large exposure policy statements. The FSA also has access to country exposure statistical data collected from banks by the Bank of England, including individual banks’ returns. These returns identify cross border claims by country and sector. Bank of England data relating to country risk and transfer risk are collected quarterly and must be submitted to the Bank of England within two months of the reporting date.
Assessment	Compliant
Comments	While the FSA does not provide specific guidance with regard to country risk exposures and provisioning, it does require and verify that banks devote adequate attention to these issues. The FSA has abandoned the previous policy of setting individual country risk exposure limits because it was not possible to define such exposures generically. Also, the FSA prefers to focus on control risks instead of regulating banks’ business risk policies. The approach now taken by the FSA on country risk is in line with international risk management practices.
Principle 12.	Market Risks Banking supervisors must be satisfied that banks have in place systems that accurately measure, monitor, and adequately control market risks; supervisors should have powers to impose specific limits and/or a specific capital charge on market risk exposure, if warranted.
Description	Banks are required (IPRU Chapter GN rule 3.4.7) to have a written Trading book policy statement that covers the way in which a bank identifies, values and measures market risks in the trading book, including interest rate risk. Each bank is expected to be able to identify, measure, monitor and control its exposures to foreign exchange and other market risks across all products (IPRU Banks Chapter AR Section 3.2). Each bank is also expected to be able to collect information that can be summarized in such a way as to enable actual exposures to be readily, accurately and regularly measured against the exposure limits authorized by management. Where relevant, these limits should relate to the level of trading positions (both intra-day and overnight) in securities, foreign exchange, futures, options, forward rate agreements and swaps. Periodic reviews are conducted to verify the adequacy of a bank’s internal control systems. The FSA has imposed specific capital charges for market risks (IPRU Chapter CO Section 3). In accordance with the 1996 amendment to the Basel Capital Accord and the EU Capital Adequacy Directive, U.K. incorporated banks are set capital charges for foreign exchange and commodities position risk in the banking and trading books combined. Separate capital requirements are set for equity and interest rate position risk, as well as counterparty, underwriting and settlement risk, in the trading book. To ensure that the calculation of capital charges for market risks is valid firms need good management systems to collate accurate data. The supervisor will determine compliance with these requirements through desk based analysis of returns, information gained from on-site visits or on-going discussions with senior management. Also, in addition to standard regulatory reporting, banks are often requested to provide ad hoc reporting of their own management information (including analyses conducted). Because of its tailor-made nature this information usually offers greater insight into the market risk being run by the bank. On-site visits to banks by supervisory staff and/or a specialist team are used to ascertain the extent of senior management’s understanding of the market risk as reflected in the risk management information. For banks with significant market risk exposure, the FSA will meet a range of staff, including senior management, staff from the front office, financial control, risk management, operations, systems development, information technology and audit areas, to assess the quality of market risk management and controls. The adequacy of a bank’s system of controls is tested by periodic reviews conducted either by FSA in-house specialists or skilled persons. The FSA has established a Traded Risk Review Team within the Risk Review Department. This team focuses on banks’ trading and markets activities and its management. It has specialists with the necessary expertise to undertake, among other activities, on-site visits to review treasury systems and controls. On-site visits by the Traded Risk Team typically last between one and three days. The purposes of on-site visits include the evaluation of whether a bank’s internal market risk measurement and pricing models can be recognized for the purposes of calculating market risk capital requirements. Once a model is recognized, the team will conduct quarterly update visits during which the control environment in which the model is operated is discussed along with model outcomes, backtesting and other relevant data. The provision of this data is shortly to be automated to enhance the FSA’s ability to track trends and make comparisons. A bank that uses an internal model to calculate supervisory capital should have in place a rigorous and comprehensive program of stress testing. As set out in IPRU (Chapter TV Section 9), the FSA attaches great importance to the stress testing of the various risks facing a bank in its overall activity. As part of the model recognition process, the FSA will examine a bank’s stress testing program, including the procedures in place to assess and respond to its results. The FSA will not normally prescribe scenarios for a bank to use in stress testing, although it may do so in the event of particular market circumstances.
Assessment	Compliant
Comments	The FSA uses specific capital requirements for separate categories of market risks. Compliance with these requirements is determined through desk-based analysis and on-site visits. The adequacy of the bank’s system of controls surrounding market operations is tested by periodic reviews conducted either by FSA in-house specialists or skilled persons. In view of the number of banks, the Traded Risk Review Team appears to be thinly staffed. This applies even though only the relatively limited number of 10 to 12 banks (most of them foreign-owned) engage in the trading of highly complex financial products, while a similar number of banks is allowed to use value-at-risk models for calculating supervisory capital adequacy requirements.
Principle 13.	Other Risks Banking supervisors must be satisfied that banks have in place a comprehensive risk management process (including appropriate board and senior management oversight) to identify, measure, monitor, and control all other material risks and, where appropriate, to hold capital against these risks.
Description	Banks are required to maintain systems and controls that are appropriate to their business (IPRU SYSC 3.1.1R). According to the Threshold Condition on Suitability, regulated firms (including banks) are expected to have identified fully, and considered, the various risks they will encounter in conducting their business and installed appropriate control systems to manage them prudently at all times. It is considered to be the responsibility of a bank’s directors and management to take reasonable care to establish and maintain such systems and controls as are appropriate to the nature, scale and complexity of its business. The FSA has provided banks with guidance on adequate controls and records (IPRU Banks Chapter AR Section 3). Among other things, the guidance states that banks should design and operate a system of internal controls that provides reasonable assurance that all the bank’s revenues accrue to its benefit, all expenditure is properly authorized and disbursed, all assets are adequately safeguarded, all liabilities are recorded, and statutory and supervisory requirements are met. Management information should be prepared to show the bank’s state of affairs and its exposure to each type of risk, compared to the relevant limits set by management. The FSA expects banks’ high level controls to include the setting of strategy and plans and the establishment and review of the organizational structure and the system for delegation (including segregation of duties). In addition, management should approve the bank’s risk policies, review its high level management information and maintain the framework for monitoring and detailed periodic review of risk management and control systems. The implementation of action points following such a review should be monitored by management. Internal control systems should provide reasonable assurance that management is able to monitor on a timely basis the adequacy of a bank’s capital, liquidity, profitability and the quality of its assets. They should enable management to monitor and control the bank’s risk and to make appropriate provisions for bad and doubtful debts. The FSA expects banks to have an internal audit function (but in some cases it may be outsourced) and an audit committee. Banks are required to provide the FSA with a statement of liquidity policy (IPRU Chapter LM Section 3) that should set out their approach to liquidity management, including a description of arrangements for management on a day-to-day basis, and should explain how much liquidity risk will be assumed. The liquidity standards that banks should maintain must be appropriate to the nature and scale of their business. A bank should have in place systems which enable it to monitor its liquidity profile on a frequent and timely basis. A bank with significant currency business should include in its policy statement the policy for monitoring and controlling its liquidity positions in individual currencies. The policy statement should also consider the management of liquidity in both normal and abnormal circumstances. The FSA monitors banks’ liquidity using either a mismatch approach or a stock approach. For the majority of banks, the FSA has set mismatch guidelines that take into consideration the volatility, diversity and source of deposits, any concentrations of deposits, the degree of reliance on marketable assets and the degree of diversification, the availability and reliability of undrawn standby lines, and the impact of other factors such as off balance sheet obligations (IPRU Chapter LM Section 8.1). For the minority of banks that have a large retail deposit base in the form of current accounts, the FSA has set a sterling stock liquidity regime that requires a bank to hold a stock of liquid sterling assets that can easily be sold to replace funding that has been withdrawn. A more limited range of assets is treated as liquid under the stock approach than under the mismatch approach to reflect the fact that significant sales of certain assets by a large bank might unsettle the market. For U.K. branches of foreign banks, the mismatch approach is normally applied, with the additional requirement that the available liquidity actually has to be present in the U.K. However, if the FSA is satisfied that a branch is fully integrated with its head office for liquidity management purpose and that it can rely on the home country supervisory regime, it may permit the branch to have its liquidity managed on a global basis by its head office. Banks on the stock liquidity regime have to report their liquidity position to the FSA on a monthly basis, while banks on the mismatch regime have to report on a quarterly basis. In case a bank is experiencing liquidity problems, it may be required to report more frequently, if necessary on a daily basis. The stock liquidity report has to be prepared on a consolidated basis. While the FSA does not normally collect liquidity data in individual currencies it may require a bank to report on this basis if it has significant operations in illiquid currency markets. Supplementary to regulatory reporting, the FSA monitors liquidity risk through on-site visits, during which discussions may be held with a bank’s ALM committee. Such visits also provide the opportunity to determine management’s ability to understand and address technical issues such as those relating to multiple currency liquidity management. No specific guidance is given with respect to banks’ interest rate risk outside the trading book. The mission was informed that the FSA does not see a need for such guidance since many banks have a large proportion of floating rate assets in their banking book, reducing the potential for interest rate risk. However, the FSA has made it known to banks that it will use the Basel Committee’s Principles for the Management of Interest Rate Risk to asses the adequacy of a bank’s interest rate risk management. The FSA conducts stress tests on interest rate positions in the banking book, particularly for the larger banks. In addition, interest rate risk in the banking book is among the issues that are explicitly considered by the FSA when setting a bank’s individual capital ratio requirement (as are operational risks). In practice, individual supervisors’ analysis of interest rate risk in the banking book, which is typically based on discussions with the bank and management information, rarely results in a material increase in a bank’s individual capital ratio. With regard to operational risk, each bank is expected to have a control environment that minimizes loss from fraud, safeguards the assets, controls the liabilities and provides reasonable reassurance that the business is conducted in adherence to established policies (IPRU Chapter AR Section 3.3). Some specific guidance is given on controls in an IT environment (ibid. Section 3.3.6), while relatively detailed guidance is given on outsourcing (IPRU Chapter OS). Furthermore, each bank is expected to have appropriate arrangements to ensure business continuity in the event of an unforeseen interruption (SYSC 3.2.19). Through on-site visits, the FSA may check the effectiveness of allocated responsibilities, lines of reporting, the delegation of authority and other operational risk controls. As noted above, operational risk is one of the factors considered by the FSA when setting banks’ individual capital ratio requirement. The FSA does not currently require a specific operational risk policy statement (in contrast to large exposures, liquidity, provisioning and, where applicable, the trading book). The FSA encourages best practice in corporate governance. This includes banks making comprehensive disclosure in their annual published accounts. The FSA has also successfully exercised pressure on individual banks to inform their customers of significant issues by means of a letter.
Assessment	Compliant
Comments	Each bank is required to maintain systems and controls that are appropriate to the risks in conducting its business. The FSA has issued guidance relating to liquidity risk, interest rate risk and key aspects of operational risk, and it applies specific capital requirements to foreign exchange risk. The FSA verifies the extent to which a bank’s risk management system addresses the key banking risks during on-site visits. The FSA’s approach to monitoring liquidity under the mismatch or stock regimes appears somewhat dated in that it is not aligned to banks’ own approaches to measuring and managing liquidity, at least for the more sophisticated banks. The FSA has recently begun considering the development of a new approach which would give banks a choice between a standardized measurement technique and the use of liquidity modeling techniques for liabilities with a behavioral maturity and contingent claims. Such an approach would be designed to create incentives for banks to further develop their own liquidity measuring and management techniques. Although the actual implementation of this new approach still appears to be some years off, the mission believes it could constitute a significant step forward.
Principle 14.	Internal Control and Audit Banking supervisors must determine that banks have in place internal controls that are adequate for the nature and scale of their business. These should include clear arrangements for delegating authority and responsibility; separation of the functions that involve committing the bank, paying away its funds, and accounting for its assets and liabilities; reconciliation of these processes; safeguarding its assets; and appropriate independent internal or external audit and compliance functions to test adherence to these controls, as well as applicable laws and regulations.
Description	The Companies Act 1985 prescribes the duties of directors who manage a company and are responsible for protecting the interests of members (shareholders) and employees. The Act applies to all companies, including banks. Any bank listed on the London Stock Exchange is subject to a Listing Rule and Combined Code which reflect the recommendations of the Committee on Corporate Governance (‘the Hampel Committee’). There is a requirement to produce a statement of directors’ responsibilities. The Combined Code is not prescriptive about the contents of the statement but there is an expectation that it will cover the responsibility of the directors for keeping proper accounting records, for safeguarding the assets of the company and for taking reasonable steps for the prevention and detection of fraud and other irregularities. In addition, the Combined Code (provision D.2.1) states that ‘the directors should, at least annually, conduct a review of the effectiveness of the group’s system of internal control and should report to the shareholders that they have done so. The review should cover all controls including financial, operational and compliance controls and risk management.’ Specific internal control requirements for banks, together with adequate record keeping requirements, are outlined in SYSC and IPRU Banks (Chapter AR). SYSC requires a bank to allocate appropriately to one or more individuals the functions of dealing with the apportionment of significant responsibilities and of overseeing the establishment and maintenance of systems and controls. Banks must take reasonable care to establish and maintain such systems of controls as are appropriate to the nature and scale of their business (SYSC, 3.1.1R). Banks are also required to have documented high level controls defining responsibilities of management and identifying lines of reporting and outlining the implementation of the requirements with respect to segregation of duties, accounting records and measures to safeguard assets (SYSC 3.2 and IPRU Chapter AR Section 3.3.5). The FSA also requires that banks have procedures to ensure that personnel have capabilities commensurate with their responsibilities and that they have implemented effective segregation of duties (IPRU Chapter AR Section 3.3.5). Furthermore, it is a requirement of IPRU (Chapter AR Sections 3.3.9 and 3.3.10) that banks have an internal audit function. However, the primary responsibility for preventing internal fraud lies with senior management. The internal audit function should have clear responsibilities and its objectivity and independence should be supported by appropriate reporting lines. In most cases this would be dual reporting lines from the head of internal audit to the chief executive officer, or equivalent, and access to the audit committee (IPRU Chapter AR Sections 3.3.9 and SYSC 3.2.16G). The internal audit function should have unrestricted access to all of a bank’s activities, records, property and personnel. A bank may outsource its internal audit function but normally not to its external auditors or skilled persons, unless certain conditions aimed at safeguarding the independence of internal audit are met. Any proposals to outsource the internal audit function should be notified to the FSA (IPRU Chapter OS Section 4.7). External auditors test a bank’s accounting procedures during their audit of the financial statements. They report significant deficiencies they have found in a letter to the bank’s management. External auditors are allowed to notify the FSA of any information they have found and which appears to be relevant to the FSA’s supervisory objectives (FSMA section 342). However, if the auditors consider any deficiency they have found to be material, they normally expect the bank’s management to forward the management letter to the FSA. Failure to do so would be interpreted as a lack of integrity on the part of the bank’s management. This would be reported to the FSA by the external auditors themselves. To carry out the role of directors and senior management, individuals have to be vetted and approved by the FSA. To gain approval they have to be considered fit and proper (FSMA Schedule 6, paragraph 5) which consists of being honest, competent to carry out their function and financially sound. The applicant has the burden of satisfying the FSA that he is a fit and proper person having regard to all circumstances. The FSA takes into account the distribution of expertise within the board when considering individual applicants. Once approved these individuals must maintain their fitness and propriety. If any of the senior management is deemed to be no longer fit and proper, the FSA has the power to initiate proceedings for the individual to be removed. The FSA follows both the Cadbury and Hampel guidance on Audit Committees and the inclusion of non-executive directors (IPRU Chapter AR Section 3.3.10). In accordance with the FSA’s internal Guidance for firm specific risk assessment and risk mitigation (Appendix 3, Corporate Governance, version 5, November 2001), there should be an appropriate proportion of nonexecutive directors to executive board members. The FSA checks through meetings during on-site visits and reviews of relevant documentation (e.g., board minutes and audit committee minutes) that a bank’s non-executive directors (a) have the necessary skills and background, (b) participate fully in committee meetings and (c) exercise independent judgment. Non-executive directors have to be vetted and approved by the FSA. The FSA has wide powers to require banks to provide information (FSMA Section 165) and the power to require the provision of a report on the firm by a skilled person (FSMA Section 166). If deemed necessary, the FSA can request copies of internal audit reports and minutes of audit committee meetings. The quality of the internal audit function may be assessed during on-site visits. The FSA also meets, at least annually, with the chairman of a bank’s audit committee. The effectiveness of front, middle and back office functions may be reviewed either through regular on-site supervisory visits, specialist visits or via the use of skilled persons.
Assessment	Compliant
Comments	The duties of directors are prescribed by company law and banks are expected to adhere to the accepted standards of corporate governance. The FSA requires banks to take reasonable care to put in place controls that are appropriate to the nature and scale of their business. This includes high level management controls (covering management responsibilities, reporting lines, segregation of duties and measures to safeguard assets). The FSA expects banks to have an appropriately resourced internal audit function which reports to an audit committee chaired by an independent director.
Principle 15.	Money Laundering Banking supervisors must determine that banks have adequate policies, practices, and procedures in place, including strict “know-your-customer” rules, that promote high ethical and professional standards in the financial sector and prevent the bank being used, intentionally or unintentionally, by criminal elements.
Description	*Essential criteria* As a statutory objective FSMA requires the FSA to reduce the potential for regulated businesses, including banks, to be used for a purpose connected with financial crime. Under FSMA financial crime is defined as money laundering, fraud or dishonesty, and criminal market misconduct. FSMA provides the FSA with a range of powers to make rules on firm’s systems and controls relating to money laundering, to supervise firms’ compliance with those requirements and to prosecute firms for systems and controls failures in this area. FSA’s Money Laundering Rules and regulatory requirements are set out in the Money Laundering Sourcebook in the Handbook. The requirements for effective systems and controls to protect against money laundering are elaborated in ML 7.2. ML 3 details customer identification requirements. ML 4 specifies the requirements with respect of suspicious transactions reporting. ML 7.3 specifies record keeping requirements on customer identification and individual transactions and the record keeping period. Awareness and training are required under ML 6 and the appointment of a senior officer as Money Laundering Reporting Officer (MLRO), including the requirement that the MLRO be an approved person by FSA, is provided for in ML 7. Both the FSA’s Rules and the Money Laundering Regulations 1993 (“the “Regulations”) require banks to verify the identity of customers as soon as is reasonably practicable after contact is first made, in order to carry out any regulated financial activities for them. The obligation to verify identity extends to business undertaken on behalf of another person. To assist a bank in meeting these statutory and regulatory obligations, industry guidance has been prepared in the form of the Joint Money Laundering Steering Group’s (JMLSG) Guidance Notes. The guidance notes provide extensive information on how and when to identify customers. The guidance notes are not mandatory but the FSA will take them into consideration in evaluating whether a bank has proper customer identification procedures. Neither the FSA’s Rules nor the Regulations explicitly require banks to have formal procedures in place to recognize suspicious transactions. However, the practices recommended in the JMLSG Guidance Notes cover many of the elements that might be incorporated in formal procedures. The Guidance Notes set out that appropriate ‘know your customer’ procedures, combined with adequate staff training, are the key to recognizing transactions or patterns of activity that are inconsistent with a customer’s known legitimate business, or with the normal business for that type of account. Accordingly, many banks routinely monitor cash deposits/withdrawals, and wire transfers over a certain monetary threshold (typically a few thousand pounds) and some major banks have developed or purchased sophisticated anti-fraud and money laundering monitoring systems. FSA Rules and Regulations require all bank staff to report (to the MLRO) any information that gives rise to knowledge or suspicion of money laundering. Further, the bank is required to take reasonable steps to insure that staff who handle or have responsibility for transactions that may involve money laundering report promptly. Reporting the suspicion or knowledge to the MLRO discharges the individual’s statutory and regulatory responsibilities. The MLRO, as an Approved Person, has the designated responsibility to receive internal reports of suspicious activities, to report suspicious activities to NCIS, to insure adequate awareness and training, to monitor day-to-day compliance with anti-money laundering policies and to prepare an annual report to management. The purpose of the annual report is to highlight any compliance problems, which it is the responsibility of the bank’s senior management to remedy. FSA supervisors can request a copy of the report to assist in assessing the bank’s level of compliance with its statutory and regulatory obligations. A bank is not specifically required to report to FSA suspicions of money laundering; the obligation is to report to NCIS. But banks do have a regulatory obligation to notify the FSA of significant incidences of fraud. In determining whether a fraud incident is significant, the firm must consider (i) size of loss in relation either to the bank itself or to customers; (ii) risk of reputational loss; and (iii) whether the incident reflects weaknesses in the bank’s internal controls. The FSA operates a risk-based approach to verifying that banks have the necessary controls to comply with anti-money laundering rules and regulations. The approach is designed to allocate resources in the most efficient manner to ensure that supervisory attention is directed at those areas that pose the greatest threat to the FSA’s regulatory objectives, with deterrence of financial crime being one of those objectives. To assess the vulnerability of a bank to money laundering, FSA identifies key risk criteria drawn from money laundering typologies. These criteria are scored against the business profile of individual banks. Taking into account the robustness of a bank’s control regime, FSA makes an evaluation of the extent to which the business of the bank exposes it to money laundering risk and the probability that risk will materialize. A further judgment is made about the impact if such risks do materialize and the threat this would pose to FSA’s ability to meet its statutory objectives. For banks, size is a major factor in scaling the risks to FSA’s objectives. Based on this analysis FSA arrives at a judgment about the supervisory tools and resources to be devoted to the supervision of money laundering and the intensity and focus of oversight on individual firms. In a July 2001 report, “The Money Laundering Theme,” FSA announced that it had identified six “clusters” of activities which were particularly vulnerable to money laundering and on which regulatory attention would focus. Two of these clusters concerned banks. Theme supervision provides FSA with a tool for horizontal review of practices across banks without regard to the risk profile of the bank in other business areas. Thematic work includes on-site testing of anti-money laundering procedures. Theme reviews, however, are also targeted based on risk assessments. To assist line supervisors assess the level of a bank’s compliance with the FSA’s Rules and Regulations the FSA has: a Money Laundering Review Team (supervisors with expertise in the area of money laundering); the power to appoint “skilled persons” to investigate money laundering compliance issues; an Intelligence and Records Department, which liaises with national and international law enforcement agencies; and the Financial Crime Policy Unit, which provides guidance on the Rules Line supervision includes periodic meetings with senior management responsible for fraud prevention to discuss current issues that may be of concern. MLRO reports may be copied to the FSA and followed-up as necessary. They will also be used in horizontal reviews. FSA has a broad range of tools to compel banks to comply with its rules. These include powers to impose financial penalties, public censure, and to vary and even cancel permissions. FSA is also a criminal prosecuting authority under the Regulations. FSA cannot disclose confidential information (as defined under relevant legislation) unless a gateway exists. The FSA may disclose information to its international equivalents, i.e., bodies with equivalent functions, to assist them in carrying out those functions. In the case of information covered by the EU single market directives, disclosure can only be made under a co-operation agreement and where equivalent confidentiality restrictions apply under the laws applying to the other regulator. Banks are required to comply with the FSA’s Principles for Businesses, which are a general statement of fundamental obligations under the regulatory system. Breaching a Principle makes a bank liable to disciplinary sanctions. Principle 1 states that ‘a firm must conduct its business with integrity and Principle 2 states that it “must conduct its business with due skill, care and diligence.” There is no specific FSA requirement that these Principles be communicated to all members of a bank’s staff. *Additional Criteria* U.K. laws and regulations embody international sound practices and are largely compliant with the FATF recommendations. FSA Rules require relevant staff to receive training at least every 24 months. Validation follows supervisory practices outlined above. FSA Regulations require an FSA supervisor to report knowledge or suspicion of money laundering in the same way as a member of staff employed by a bank. Criminal law gateways allow for the sharing of information for the purpose of criminal proceedings and criminal investigation in the U.K. or elsewhere. The FSA has in-house specialist expertise in financial crime matters, as outlined above.
Assessment	Largely compliant
Comments	FSA has strong powers and a comprehensive program for supervising the U.K. anti-money laundering practices and procedures of banks. The regime has been reinforced and energized within the last two years, notably by the implementation of FSMA with the additional responsibility and powers it provides to FSA in the area of financial crime. The regime will be further reinforced with passage of the Proceeds of Crime Act which is expected to be approved by Parliament in 2002. Increased FSA authority has been paralleled by intensified supervisory effort in the area of money laundering. The intensification of FSA supervision was confirmed in numerous contacts across the banking industry. *Essential Criteria 3* requires that “banks have formal procedures to recognize potentially suspicious transactions.” Although FSA does not make such procedures a formal requirement of its AML/CFT rules and regulations, other elements of the supervisory regime effectively require banks to have structured procedures and practices that address the requirement to recognize potentially suspicious transactions. The JMLSG Guidance Notes cover many of the elements that might be incorporated in formal procedures, including “know your customer” guidance. For example, JMLSG Note 5.9 outlines tests to apply for determining whether suspicion of money laundering arises. These include: is the size of the transaction consistent with the normal activity of the customer? is the transaction rational in the context of the customer’s business or personal activities? etc. Guidance Notes 5.62-5.64 identify issues to be considered with respect to wire transfers. AML training requirements established in the Handbook require bank staff to be familiar with the Guidance Notes. Although the Guidance Notes are advisory, not mandatory, FSA takes them into account in determining compliance with its rules and regulations. In addition, the FSA Handbook requires all staff to report (to the MLRO) any information that gives rise to knowledge or suspicion of money laundering. Under the Regulations and under the Handbook FSA has authority to impose sanctions if firms fail to report suspicious transactions. While the substance of Essential Criteria 3 is satisfied, the FSAP team believes bank’s internal governance would be strengthened by a requirement for a formal policy on recognition of potentially suspicious transactions. *Essential Criteria 11* calls for the supervisor to determine that banks have a policy statement on ethics and professional behavior that is clearly communicated to all staff. Although FSA does not explicitly require banks to have such a policy statement, the substance of Criteria 11 is achieved in other ways. Requirements for ethical and professional behavior animate FSA’s approach to financial supervision. For example, such behavior is required under FSA’s Principles for Business. Principle 1, Integrity, states that a firm must conduct its business with integrity. Principle 6, Customer’s interest, states that a firm must pay due regard to the interests of its customers and treat them fairly. The FSA’s Statements of Principle for Approved Persons require bank’s Approved Persons to act with integrity and due skill, care and diligence in carrying out controlled functions. Furthermore, under Regulation 5(1)(a) of the 1993 Money Laundering Regulations FSA may find a firm to be in breach of the Regulations if a business relationship is formed, or a one-off transaction takes place, without the required ethical and professional procedures being applied to that particular relationship. The FSA risk based approach to supervision allows for considerable selectivity in the firms and risks that attract close supervision, with high risk/high impact firms being the primary focus of attention. The FSAP team considered the possibility that the selectivity of this approach posed a hazard that anti-money laundering compliance in smaller, low impact firms might not be sufficiently disciplined by the supervisory process. The FSAP team satisfied itself that, at least with respect to banks, this is not the case. In the last year one-third of the small number of banks classified as low impact have been subject to theme visits for compliance with anti-money laundering requirements and all are expected to be visited over a three-year cycle. Also, in practice, money laundering theme reviews of banks cover the full scope of money laundering risks and are not limited to the two risk clusters identified in “The Money Laundering Theme” report.
Principle 16.	On-Site and Off-Site Supervision An effective banking supervisory system should consist of some form of both on-site and off-site supervision.
Description	The FSA utilizes a combination of on-site examinations and desk-based analysis to acquire a thorough understanding of banks’ safety and soundness. The regular supervisory staff is supported by risk review teams with specialized expertise in areas such as corporate governance, risk management, internal audit, IT, anti-money laundering controls and quantitative modeling techniques. To assist in the supervision of financial firms the FSA has the power to appoint so-called skilled persons (section 166 of the FSMA). In the case of banks, these are usually auditors from the big five accountancy firms. The number of skilled persons reports commissioned has been greatly reduced as they are no longer used to perform routine validation of supervisory returns. The skilled persons’ reports are discussed generically with the accountancy firms to ensure consistency of standards and the FSA forms its own judgment on the materiality of the issues raised in the reports. Through these mechanisms the FSA is able to examine any aspect of a bank’s operations, including compliance with legal requirements and prudential regulations. In addition, the FSA carries out sector-wide statistical analysis of prudential returns, financial statements, share price movements, credit ratings and other quantitative information to monitor industry trends and to identify outliers. The FSA has developed a risk-focused assessment model, covering all regulated entities in the financial industry. The model is designed to identify the key risks that institutions pose to the FSA’s statutory objectives, which in turn determine the degree of attention that the FSA devotes to individual institutions. This risk assessment is based on a view of the impact and the probability of a problem occurring at a particular institution. For prudential issues in banks, the impact is seen as being determined mostly by the size of the bank, while the judgment on probability depends on the FSA’s view of the business and control risks at a particular bank. Banks are rated either as high impact, medium high impact, medium low impact, or low impact. The risk based approach, in combination with the FSMA’s philosophy that it is neither possible nor desirable to remove all risk of failure from the financial system, has led the FSA to concentrate its supervisory activities with regard to banks on the larger institutions. In addition to the industry-wide risk assessment model, the FSA uses a firm-specific model to assess risks in individual institutions. This assessment is based on a detailed breakdown of business and control risks in individual banks. For a large bank, up to about 35 different business lines may be distinguished. Inputs into the firm-specific risk assessment model may include information from on-site work, interviews with management, prudential returns, firms’ annual AML report, external auditors’ management letters, special information requests and publicly available information. Findings of a bank’s internal auditors may be taken into account if the FSA is satisfied that the audit work has been independently and competently performed. The FSA encourages internal auditors to devote attention to issues of interest to the supervisor in their work. On-site and off-site work are thus integrated through the firm-specific risk assessment model. The firm-specific risk assessment process will take three to six months to complete and, for large banks, is carried out on a one and a half to two year cycle. The process results in a risk mitigation program that details the supervisory work with regard to the institution over the period until the next risk assessment cycle as well as actions to be undertaken by the institution itself. The supervisory work planned in this manner leaves room to undertake event-driven work as the need arises. On-site supervision is most active in high impact firms, including regular visits by the dedicated supervisory team, focused reviews by experts drawn from the FSA’s risk review department, as well as frequent contacts with high and middle level managers. Low impact banks, on the other hand, are largely supervised through off-site baseline monitoring supplemented occasionally by on-site visits in the context of the FSA’s thematic work, to deal with issues that have arisen from the off-site monitoring, or on the occasion of events such as the bank entering into new activities or the appointment of a new director. On-site visits at low impact banks will be held at least once every three years, but on average they are held more often in practice. Under the new regime, low impact banks no longer have a dedicated relationship manager within the supervisory authority. As of June 2002, 44 banks had been graded by the FSA as low impact (excluding 7 EEA branches and 9 banks which are part of a wider group). Sixteen of these were branches of overseas banks and the other 28 included small retail banks as well as some banks specializing in wholesale operations. Six low impact banks were subject to intensive supervision because risks had crystallized. Total deposit liabilities of the low impact banks amounted to 0.03 percent of total deposit liabilities of all U.K. banks. On-site visits are designed to provide a focused review of well specified topics. They typically require around three days extending up to one week in some cases. The scope of visits and the intended outcomes are detailed in the risk mitigation program generated by the firm-specific risk assessment. On-site visits by a bank’s dedicated supervisory team consist of extensive discussions with various managers supplemented by some file reviews. Topics addressed may cut across the full range of supervisory interests, including all significant business and control risks as well as compliance issues. The dedicated teams are guided by methodological aide-mémoires outlining specific points for attention in particular risk areas. For international firms, the FSA has a regular program of on-site visits to the overseas parents of the branches and subsidiaries of foreign firms operating in the U.K. and to the affiliates of U.K. banks operating overseas. The FSA has recently begun development of so-called thematic regulation, which is aimed at analyzing industry or sector wide issues by focusing on a sample of institutions. This has been assisted by the establishment of Risk Management Units throughout the FSA, including one devoted to banking issues, which have responsibility for monitoring industry-wide risk. The sample of institutions usually includes some low impact firms. Themes that have been covered so far in the banking sector include credit risk, systems and controls, anti-money laundering measures as well as other topics. The thematic work helps inform the FSA’s views on particular risk areas and may lead to follow-up work at individual institutions. The outcome of the thematic work may be rule changes, guidance letters to bank directors, seminars or speeches to draw banks’ attention to particular issues. The thematic work may also lead to enforcement action against a firm that was included in the sample. Such action would be publicized to set an example for other banks. If significant issues have been uncovered, the FSA may decide to extend the thematic work to banks outside the initial sample. The effectiveness of on-site and off-site functions is reviewed by a panel of senior and independent supervisors as part of the FSA’s formal risk assessment process. The panel focuses on the risk mitigation programs for individual banks, particularly the ones assessed as high impact or medium high impact, assessing the priorities set for supervisory work and giving advice on the proposed deployment of supervisory tools. In case of disagreement with a bank’s relationship manager, a decision is taken at a higher level within the FSA. This work is supplemented by an internal Quality Assurance Department, which is in the Chairman’s Office, that focuses on supervisory processes generically. The FSMA (Part XXIII) sets out restrictions that apply to the disclosure of supervisory information which is confidential under the Act. However, the FSMA and secondary legislation do allow the FSA to provide confidential information to other regulators, on condition that the information continues to be subject to restrictions on disclosure equivalent to those in the FSMA. In case another regulator requests the FSA to provide it with confidential information, the FSA will satisfy itself that this condition is met. The FSA is able to refuse requests for confidential information except in limited cases relating to court orders in criminal proceedings or Parliamentary enquiries.
Assessment	Largely compliant
Comments	The FSA’s supervisory process for banks consists of a combination of on-site visits, desk-based analysis and formal firm-specific risk assessment. Information from a variety of sources feeds into the process, including skilled persons’ and internal and external auditors’ reports. In addition, the FSA has begun developing thematic regulation. The FSA’s risk based supervisory approach implies that it focuses its resources on those firms that pose the highest potential risks to its objectives. Thus, banks that are considered to have a high potential impact on the objectives receive extensive supervisory attention. They are assigned a dedicated supervisory team, consisting of up to seven staff members, that will maintain frequent management contact and conduct on-site visits. The dedicated teams may request focused investigations into specific risk areas by specialized risk review teams or skilled persons. Banks graded as medium high or medium low impact will have a less intensive supervisory relationship with the FSA than the high impact banks but will nevertheless receive regular on-site visits. For some banks, however, in particular those that are considered to pose a low potential risk to the FSA’s objectives, the risk-based approach implies that they will not have a close and continuous interaction with the FSA. No on-site examinations will normally be held at these banks to verify adherence to legal and prudential requirements, and management contact will be relatively infrequent. Unless specific risks have crystallized, reliance is placed primarily on off-site monitoring of prudential returns and external auditors reports, occasionally supplemented by work conducted in the context of thematic regulation or event-driven work. In terms of protecting consumers and safeguarding market confidence, and obviously also simply because of size, it is clearly justified to concentrate scarce supervisory resources on the larger banks. However, as Essential Criterion 1, requiring an in-depth understanding of individual banks’ operations, does not distinguish between large and small banks, it applies to smaller banks’ operations as well. Undue reliance on off-site monitoring makes it difficult to achieve this level of understanding, particularly with respect to control arrangements and compliance requirements in, for example, the area of anti-money laundering. The FSA recognizes this and is considering refining its risk assessment methodology to take more explicit account of all four of its statutory objectives, including the one on combating financial crime. In fact, in the period from January 2000 to July 2002, it has already conducted anti-money laundering visits to 14 of the 44 low impact banks. To the extent that risk based supervision will continue to entail less reliance on direct oversight of lower impact banks and more reliance on baseline monitoring, consideration should be given to more frequent reporting of audited returns and more regular disclosures by all banks, along the lines recommended in the comments on Principle 19 below. Audited returns would to some extent provide indirect confirmation of the integrity of the bank’s internal systems and controls in view of the auditors’ duty to report to the supervisor any material shortcomings revealed in the audit. They would also provide stronger underpinning for offsite monitoring. Some concern was expressed by industry sources that the turnover rate of supervisory staff in the dedicated teams was too high to enable the FSA to build up thorough firm-specific knowledge. However, it is the mission’s view that this is a relatively minor issue of a transitory nature as it appears to be related to the changeover to the new supervisory regime (see also Principle 1(2)). The number of staff in the risk review teams (46 budgeted as of May 2002) appears to be somewhat small considering that they are not exclusively devoted to the banking sector but are also contributing to the supervision of the other sectors regulated by the FSA. Skilled persons reports may be commissioned to augment specialist supervisory capacity. However, skilled persons investigations are expensive relative to the FSA’s own on-site work and the FSA strives to keep the costs of supervision proportionate with the risks to its objectives. The FSA should take care to ensure that sufficient supervisory attention is devoted to specific risk areas that require highly specialized expertise, such as credit risk classification systems, market risk management and IT security.
Principle 17.	Bank Management Contact Banking supervisors must have regular contact with bank management and a thorough understanding of the institution’s operations.
Description	The intensity of the FSA’s supervisory relationship with individual banks is influenced by the assessment of the bank’s risk management procedures and practice and by the FSA’s assessment of the risks that banks pose to its statutory objectives. The FSA considers that well-managed banks whose own risk management is sophisticated and effective will require less supervisory attention than banks conducting similar business but with controls of lesser quality. Banks deemed to be high impact will have a close supervisory relationship with the FSA. Thus, for large banks, there will be frequent other contacts with directors and senior management, as well as bank specific on-site visits and thematic visits involving contacts with middle management and various other bank employees. Banks considered to be low-impact will receive occasional thematic visits on cross-industry issues, together with less frequent meetings with directors and senior management to discuss bank specific issues. The FSA nevertheless feels that it has a good understanding of smaller banks’ operations, in part because these are usually relatively straightforward. The FSA has a full range of supervisory tools available to achieve a thorough understanding of banks’ operations. In addition to meetings with management and other representatives of a bank, this includes on-site visits, desk based reviews, liaison with other regulators and analysis of periodic returns and notifications. The FSA has access to internal auditors’ reports and external auditors’ management letters. Furthermore, the FSA may commission so-called skilled persons to conduct investigations of special topics at institutions under its supervision. Banks and other supervised firms are required to provide the FSA with a wide range of information. Principle 11 of the FSA’s Principles for Business require firms to deal with their regulator in an open and cooperative way, and to disclose to the FSA anything of which the FSA could reasonably expect to receive notice. This includes any significant failures in the bank’s systems and controls, any action which would result in a significant change in its capital adequacy, and any proposed change in the bank’s operations which could have a significant impact on its risk profile. These requirements imply that banks have to notify the FSA of any significant new activities, which they would have to do in any case if a variation of the bank’s permission would be required. SUP Section 15.3 requires specifically that the FSA must be notified immediately if a firm becomes aware that any of the following has occurred or may occur in the foreseeable future: The firm’s failing to satisfy one or more of the threshold conditions Any matter which could have a significant adverse impact on the firm’s reputation Any matter in respect of the firm that could result in serious financial consequences to the financial system or to other firms Any offences and breaches of the FSMA or rules established under the FSMA. The quality of a bank’s management is considered on application for regulated status and thereafter during the normal supervisory process. Banks have to meet the threshold conditions for authorization on an on-going basis and key individuals within the bank have to be vetted and approved to carry out their particular functions. An individual that does not meet the FSA’s fit and proper standards can be disapproved for carrying out particular functions or banned from employment in the regulated financial sector altogether.
Assessment	Compliant
Comments	The FSA has frequent contacts, both through face-to-face meetings and other means, with various levels of management at the larger banks. Any issue relevant to a bank’s operations may be covered in the course of these contacts. Meetings with managers of small banks, however, appear to be rare. This is a reflection of the FSA’s risk based approach to supervision which implies that scarce supervisory resources should be allocated primarily to those areas where the potential risks to the FSA’s objectives are highest, i.e., to the larger banks (in the context of banking supervision). For low impact banks, the FSA relies mostly on desk based review of prudential returns, written material such as external auditors’ management letters and other quantitative and qualitative material, except for occasional visits to some of these banks in the course of thematic reviews. Management contact with these banks takes place once every three years at a minimum but in practice usually more often, especially after risks have crystallized (see also Principle 16). The FSA expects to be notified if a low impact bank were to experience safety or soundness problems or to enter risky new business. It would be useful to identify criteria that would require low impact banks (as well as other banks) to notify the FSA of emerging problems at an earlier stage. The mission welcomes the FSA’s intention to establish clearer guidelines for offsite monitoring triggers that would prompt it to initiate contact with low impact firms. Such triggers are also useful for medium-low impact firms, and, in general, would be useful for all firms.
Principle 18.	Off-Site Supervision Banking supervisors must have a means of collecting, reviewing, and analyzing prudential reports and statistical returns from banks on a solo and consolidated basis.
Description	Banks are required to submit a variety of statistical and prudential returns either directly to the FSA or via the Bank of England. Requirements for banks to report regularly to FSA are laid out in Chapter 16 of the Supervision (SUP) chapter of the Handbook. The requirements relate to a firm’s financial condition and to its compliance with other rules and requirements which apply to the firm. Under Principle 11 banks are required to deal with their regulators in an open and cooperative way, and to tell the FSA appropriately anything of which the FSA would reasonably expect notice. The required compliance reports include an annual report on controllers (SUP 16.4.), an annual close links report (SUP 16.5), an annual report listing all overseas regulators for each legal entity of a firm’s group and an annual organogram showing the authorized entities in the firm’s group (SUP 16.6.5). Beyond this SUP 16.7.7 identifies eleven separate reports that banks are required to submit with varying frequency over the course of the year. Standardized forms address capital adequacy, large exposures and liquidity. The standardized BSD3 Capital Adequacy Return filed semi-annually provides detailed information on both a solo and consolidated basis for both on-balance sheet and off-balance sheet assets and liabilities, divided between the banking book and the traded book, profits and losses, counterparty exposure on derivative contracts, repos and similar transactions, large exposures, provisions against bad and doubtful debts and investments, deposit sources and market risk in the trading book. The return provides supporting details for on and off balance sheet activities and provides a step-by-step calculation of capital adequacy on both a solo and consolidated basis. IPRU (Chapter CS) sets out the basis on which consolidation will be required and the consolidation techniques that are to be applied for U.K. incorporated banks and banking groups with U.K. non-bank parents only. For banks subject to the liquidity mismatch requirements, quarterly reporting is required using Form LR. For firms subject to the stock liquidity regime, monthly reports are required, using Form SL R1. The Liquidity Management (LM) chapter of the Handbook provides detailed guidance on the information to be provided in the liquidity reports. U.K. banking groups are required to report quarterly on large exposures, on both a solo and a consolidated basis, using Form LE 2. The Large Exposures (LE) chapter of the Handbook provided detailed guidance on the information to be provided in the large exposure reports. U.K. branches of non-EEA banks are required to report on profits, large exposures, balance sheet, off-balance sheet items, and bad and doubtful debt provisions using the half-yearly Form B7. They are also required to provide liquidity information quarterly, using Form LR. To insure the consistency and reliability of prudential returns, FSA policies regarding valuation of assets and liabilities are spelled out in considerable detail in the Valuation (VA) chapter of the Handbook. FSA has strong powers to enforce compliance with reporting requirements. Knowingly or recklessly giving information which is false or misleading in a material particular may be a criminal offence under sections 398 and 400 of FSMA. The handbook (SUP 15.6.1R and SUP 15.6.3R) requires an authorized person to take reasonable steps to ensure the accuracy and completeness of returns and to notify FSA immediately if material or inaccurate information has been provided. Failure to do so may result in fines or other disciplinary sanctions (ENF 13.5). FSMA (Section 165) gives the FSA statutory powers to require the provision of information.
Assessment	Largely compliant
Comments	FSA has a well structured system of prudential reporting requirements for banking groups that covers both financial and compliance information. For U.K. banking groups standardized reports are required on capital adequacy, large exposures and liquidity. Reports are required to be on both a solo and a consolidated basis, where appropriate. U.K. branches of overseas banks are required to provide liquidity and large exposure reports. The scope of reporting and the policies with respect to valuation of assets and liabilities are spelled out in detail in the handbook. Essential Criteria 4 of Principle 18, dealing with information required to be submitted for statistical and prudential reporting, states: *“Inclusion of data on loan classification and provisioning is also required.”* FSA does not routinely collect standardized data on classified or non-performing loans. As a matter of policy, FSA has not established regulatory loan classification or loan delinquency systems, preferring instead to emphasize that proper loan classification and asset valuation are responsibilities of bank management based on the circumstances of the individual institutions. While an entirely legitimate supervisory strategy, the FSAP team believes the absence of reporting on classified loans and non-performing loans handicaps the ability of FSA to verify the credit risk environment of banks, particularly on an offsite basis. This is a particularly important gap given the importance of baseline monitoring in the risk based supervisory regime, (See comments on Principle 19 below.) Peer group analysis would be strengthened if standardized information were available on classified and non-performing assets. Forthcoming adoption of Basel II and IAS 39 will require changes in firm practices with respect to provisioning and loan classification so now would be opportune time to close this gap in FSA’s reporting regime. IAS 39 will require a more rigorous approach to recognition of impaired assets and loan loss provisioning and Basel II will emphasize more rigorous internal loan classification systems.
Principle 19.	Validation of Supervisory Information Banking supervisors must have a means of independent validation of supervisory information either through on-site examinations or use of external auditors.
Description	Section 165 of the FSMA gives the FSA the authority to obtain information from banks. These powers extend to providing the FSA with access to a bank’s directors, senior management, and key personnel. The FSA uses on-site visits to most banks as part of its formal risk assessment process; however, a small number of small banks considered to be “low impact” do not receive a formal risk assessment. The low impact banks are reviewed primarily using desktop baseline monitoring, with on-site visits being event driven. The risk assessment visits for the high, medium-high, and medium-low impact banks take the form of on-site high-level reviews by the supervisory team. Results of the risk assessment are used to develop a risk mitigation program (RMP) which establishes to supervisory objectives for the bank for the forthcoming period, including identifying areas for further on-site review. Such on-site reviews may be conducted by frontline supervision, by the FSA’s internal risk review teams, or by engaging skilled persons, e.g., external auditors, to validate supervisory information provided by banks. The FSA Handbook (SUP 3) provides rules and guidance on the role auditors play in the FSA’s monitoring of a bank’s compliance with its rules and standards. This chapter addresses the auditors’ qualifications, independence, reporting, and the duty to notify the FSA of any significant matters raised by the auditor. The FSA rules place the duty on the bank to ensure the auditor is qualified and independent; however they prohibit a bank from appointing an auditor the FSA has disqualified. The FSA rules establish specific areas to be covered in the auditor’s report, and require a copy of all reports be provided to the FSA. In addition, SUP 3.8.2R requires the auditor to co-operate with the FSA. While the rules in SUP 3 do not provide for FSA’s monitoring of the quality of the auditor’s work, there are provisions in SUP 5 relating to skilled persons reports that provide for monitoring of work related to skilled persons reports. The FSA meets periodically with the bank’s external auditors, on a bilateral basis. In addition to periodic meetings, external auditors have a statutory duty to inform the FSA of any concerns arising during the course of their work. Section 166 of the FSMA gives the FSA the authority to require the bank to obtain a skilled persons report. The FSMA section 166(4) requires that the skilled person must be nominated or approved by the FSA, and that the skilled person must appear to the FSA to have the skills necessary to make a report on the matter concerned. Additional rules and guidance relating to the use of skilled persons is found in the FSA Handbook (SUP 5). The large international accountancy firms produce the vast majority of skilled persons reports. The FSA will direct the scope of the review using a commissioning letter, and the nature of work to be completed may be discussed by the FSA in advance. The rules pertaining to reporting and notification in SUP 3 also apply to skilled person’s reports. The FSA may hold bilateral meetings with individual partners within these firms to provide feedback from the supervisory teams on the scope and quality of their work. Trilateral meetings are held to discuss the findings of skilled person’s reports. The FSA has a formal, structured process in place for skilled persons reports (SUP 5). The process includes preliminary discussions about scope, the engagement/scoping letter to the skilled person, and the objectives to be accomplished by the review. Procedures for internal risk review visits carried out by FSA’s Risk Review Division are less formalized. These procedures typically involve a detailed scoping paper prepared by frontline supervisors. The firm is typically asked to provide supporting information which is analyzed prior to the visit. The visit itself builds on the information supplied and involves interviews with management and staff as well as an examination of files. For certain areas (money laundering, credit) aide-mémoires have been prepared that guide the procedures performed in the review. Supervisory returns are reviewed by supervisors for consistency and plausibility. An initial check is required within 2 days of receipt and a more detailed check is required to be completed within ten days of receipt. These reviews consist of trend analysis and plausibility checks involving comparisons with previous returns and checks against audited accounts for capital adequacy and large exposures capital base. These reviews are supplemented by peer group analysis. Validation checks completed by one supervisor must be checked and signed off by another supervisor. Follow-up with the bank will take place to reconcile outlier data and inconsistencies. Banks are subject to fines for late returns. The FSA does not require that the auditors examine certain key supervisory returns, such as capital adequacy, at least annually nor do FSA examiners routinely validate the returns to bank records. FSA has a variety of powers to ensure the validity of supervisory returns, including authority under 5165 of FSMA to request additional information from the bank at any time, the authority under 5166 to require skilled persons report to verify the accuracy of information provided, and the ability to request supplementary information from the bank’s auditors under the provisions of SUP 3.8.2R which covers an Auditor’s duty to cooperate with FSA. The FSA does have the means to independently validate supervisory returns, through supervisory visits, risk review division visits, or skilled person’s reports. Supervisory visits (during the risk assessment process) are used to review the bank’s process for completing the reports, and do not include validating key returns. The use of the internal risk review or skilled persons report tools depends on whether an issue was raised during the supervisory visit, the impact rating of the firm and the availability of these resources. FSA has identified validation of supervisory returns as a topic for theme supervision over the next year. There is no requirement that the FSA meets with the management or board each year. The FSA may hold meetings with a bank’s board, or hold separate meetings with non-executive directors, when it is deemed appropriate. The FSA determines the level of supervision based on its assessment of the risk a bank poses to the FSA’s regulatory objectives, and this assessment will drive whether a meeting with a bank’s board is required.
Assessment	Largely Compliant
Comments	The FSA has the means to independently validate supervisory information, through supervisory visits, risk review division visits, or by commissioning skilled person’s reports. However, costs and resource constraints limit the use that is made of skilled persons reports or on-site risk review visits to validate supervisory information. The FSAP team was told that, partly because of their expense, FSA has discontinued the routine use of skilled persons reports to validate regulatory returns, but they may be used on an exceptional basis. Going forward, use of skilled persons reports will focus on situations where remedial work is needed quickly or the FSA does not have the resources and/or expertise to conduct the review internally. The Major Financial Groups Division (MFGD) estimated that 70-120 skilled persons reports would be ordered per year across the 52 largest bank, securities and insurance groups firms that are supervised by the division. The Deposit Takers Division (DTD) estimated that they would order about 15-20 skilled persons reports, across about 200 banks. Internal risk review is a scarce resource, with an approved head count of 46 (including administrative support) to support work across all of FSA. MFGD supervisors indicated that risk review currently is unable to fill all requests for their services, so requests are prioritized, and some reviews may be negotiated or deferred. *Essential criteria 5* provides that the supervisor should require that certain key supervisory returns, such as capital adequacy, be examined at least annually by the auditors and a report submitted to the supervisor. The FSA has no explicit requirement that supervisory returns be validated in the manner called for by *criteria 5, although elements of this criteria are met through the requirement for an annual audit of the statutory accounts and FSA’s ability to consult with and request information from auditors. Recommendation. The FSA relies on the supervisory returns as a key part of its risk based approach to supervision and particularly for its baseline-monitoring program., so it is very important that the FSA is able to place reliance on the accuracy of that information. In addition, greater disclosure of such information would add to market discipline. Given the resource constraints on the ability of FSA itself to comprehensively validate supervisory returns, the FSAP team recommends that FSA should consider going beyond the literal requirements of Essential Criteria 5* and consider requiring all banking groups to provide annual audits of key supervisory returns. It would be useful if validation of supervision were made a regular topic for theme supervision. In addition it would be desirable for all U.K. banks be required to publish audited financial reports on an annual basis, coupled with a continuous disclosure requirement – currently these requirements apply only to listed companies. There does not appear to be a compelling reason to limit market disciplines that arise from financial disclosures to only banks (public issuers) that are listed.
Principle 20.	Consolidated Supervision An essential element of banking supervision is the ability of the supervisors to supervise the banking group on a consolidated basis.
Description	The FSA approach to consolidated supervision is set out in IPRU (CS Chapter) which is the principle vehicle for implementing the EU Banking Consolidation Directive (date) and the EU Post-BCCI Directive (date) The FSA’s consolidation policy addresses three main areas of concern arising from group membership: losses in another group entity that could lead to financial pressure on the bank because of financial or reputational linkages; capital that is subject to double-gearing or leveraging: that is, a solo assessment of a firm overestimates the quantity of capital which is available to support the bank’s risks, because of the way the capital has been raised or accounted for within the group; and business that is booked in an unauthorized group entity to avoid regulatory requirements. The FSA views its consolidated supervision as a complement to individual firm requirements rather than as a substitute. The objective is to enhance the overall effectiveness of the prudential supervision of the bank by ensuring that risks related to the bank’s membership of a group are taken into account in the supervision of the bank. Consolidated supervision does not, however, constitute supervision of undertakings within the group which are not authorized. The FSA is required to undertake supervision on a consolidated basis by EU legislation, in particular the Banking Consolidation Directive. The FSA’s consolidated supervision framework consists of two main elements: A qualitative assessment of the group as a whole. This is made in relation to the group’s significant business units and their potential material bearing on the bank. It focuses on the group’s business, controls, organization and management. A quantitative, consolidated assessment of relevant financial companies within the group that establishes prudential requirements, for instance with respect to capital adequacy and large exposures. The FSA approach identifies where group risk arises, sets systems and controls requirements for managing that risk, and establishes a methodology for the calculation of consolidated capital (Principle 18). The scope of the FSA’s consolidated supervision includes all parents and subsidiaries of the bank, any of their parents or subsidiaries; or any undertaking in which those parents or subsidiaries or the bank have a participation. In addition, the FSA may require a bank to include within its group consolidation an undertaking that is not a member of group as defined but which has links to the group that would make its omission from the scope of the consolidation assessment misleading. (CS 3.1.3) requires that the bank have adequate controls to produce any data required to supervise on a consolidated basis. (CS 3.3.19) requires adequate controls to identify and monitor large exposures. Consolidated returns are required twice annually and large exposures must be reported quarterly. (CS 3.3.7) requires a detailed organization chart and identification of subsidiaries supervised by others. Section 166 exams may be required to cover internal control systems used to generate consolidated accounts. Consolidation usually applies to financial subsidiaries. For purpose of consolidated supervision, insurance and insurance broking are not defined as financial activities and are therefore not normally consolidated (CS 4.3). For activities undertaken within the U.K. coordination among functional regulators of a group takes place within FSA. A variety of arrangements are in place with home and host supervisors overseas to allow exchanges of information on the financial condition and adequacy of risk management and controls of overseas undertakings. Where FSA is unable to satisfy itself that the overseas parent of a branch or subsidiary in the U.K. is subject to adequate home country consolidated supervision FSA may require solo consolidation at the U.K. level. Fit and proper tests may be applied to senior management of parent companies under the FSA’s authorized persons regime. Consolidated supervision encompasses the activities of U.K. banks in offshore centers through several mechanisms. Exposures in offshore centers are included in the quantitative requirements for consolidation and the capital adequacy ratio and the controls on large exposures. Where FSA is concerned about such exposures it may impose additional capital requirements, require deconsolidation of the capital and assets in the offshore jurisdiction, and restrict transactions with the jurisdiction. U.K. financial institutions are required to be able to provide FSA all the information it requires to carry out effective consolidated supervision wherever their business is conducted, including in jurisdictions with strict secrecy provisions. Under the qualitative element of its consolidated supervision, FSA requires that banks have the ability to measure, monitor, manage and control the risks in all their significant business lines, wherever that business is conducted. This will apply to business lines such as private banking, asset management, insurance, and capital markets operations, all of which can have links to offshore centers. FSA anti-money laundering policies include an expectation that the practices of overseas affiliates of U.K. banks will conform to the higher of U.K. or local standards. Compliance with this policy is one of the duties the bank’s MLRO, an individual who must be authorized by FSA. In evaluating the risks in business lines, FSA places a strong emphasis on the quality of counterpart financial supervision in the jurisdictions where the business is conducted. This is also a key consideration in granting permission for U.K. banks to establish or operate in those jurisdictions or in granting FSA authorizations to firms from those jurisdictions. For FSA an important factor in evaluating the practices of other supervisors is their willingness to share information. In this regard FSA takes into account the FATF NCCT classifications as well as its own experience. FSA has an active involvement with numerous offshore centers, particularly in the U.K. overseas territories and dependencies. This includes participation in regional organizations and regular liaison with offshore supervisors.
Assessment	Compliant
Comments	FSA has comprehensive arrangements to be able to supervise U.K. banking groups on a consolidated basis, both quantitatively and qualitatively, regardless of where their business is carried out. Capital requirements set out clearly the procedures to be followed in consolidating group accounts to insure that the U.K. banking activities of a group are adequately capitalized, both on a solo and a consolidated basis. Large exposure limits are governed by clear policies with limits enforced on both a solo and a consolidated basis. Management systems and controls are required so that risks arising from the bank’s dealing with other parts of the group are properly identified, measured, monitored and controlled. A variety of arrangements are in place for coordinating and cooperating with other regulators, both at home and overseas, who have responsibility for other legal entities within the group.
Principle 21.	Accounting Standards Banking supervisors must be satisfied that each bank maintains adequate records drawn up in accordance with consistent accounting policies and practices that enable the supervisor to obtain a true and fair view of the financial condition of the bank and the profitability of its business, and that the bank publishes on a regular basis financial statements that fairly reflect its condition.
Description	The threshold conditions require that banks must have adequate resources, including high level systems and controls. SYSC 3.1.1R and 3.2.20R require that a bank’s directors and management ensure that the bank maintains adequate records (including accounting records) that are appropriate to the scale, nature and complexity of its business. IPRU (Banks) Chapter AR provides further guidance on adequate accounting (and other) records and internal control systems. The FSA does not publish a comprehensive list of the accounting and other records which a bank should maintain; however, banks are required to capture and record accurately and on a timely basis every transaction and commitment which the bank enters into and record details as appropriate for each transaction and commitment (IPRU Chapter AR 3.2.2). These provisions apply for all U.K. banks and branches of non-EEA banks. [For U.K. incorporated banks further accounting record requirements are set out in the Companies Act 1985.] The FSA has powers to enforce the records requirements, and may fine banks for late and inaccurate supervisory returns. The FSA has the authority under FSMA Section 166 to commission a skilled persons report to verify bank records in particular areas. In addition, the FSA’s internal risk review division may be used for verification of a bank’s records. These tools would be employed as part of a risk mitigation program if the supervisors identified a concern during their risk assessment process. Regulatory reporting forms are accompanied by detailed guidance notes that include information on accounting treatment. Banks are required to use generally accepted accounting principles when valuing assets. FSA reports should be prepared using book value of assets and liabilities, and the banking and trading books should be valued on an accrual basis, unless a different practice has been agreed in writing with the FSA. CAD banks should value trading books on a mark-to-market basis, and banking books on an accrual basis. IPRU (Banks), Chapter GN 3.3.17R requires all U.K. banks and non-EEA overseas branches to maintain adequate provisions for depreciation or diminution in the value of assets (including loan loss provisions), for liabilities which will or may fail to be met by the bank and for losses which it may incur. IPRU (Banks), Chapters VA and PN discuss the valuation and provisioning policies that banks should adopt. The Companies Act 1985 requires all U.K. banks to prepare accounts that give a true and fair view of the results and financial position of the bank and/or group. The accounts are subject to public filing requirements. Detailed provisions on the form and content of the accounts of banks and banking groups are contained in Schedule 9 to the Act. There is a general presumption that compliance with U.K. Financial Reporting Standards (FRS) and Statements of Standard Accounting Practice (SSAP) is necessary in order for the accounts to give a true and fair view. Banks accounts must state whether they have been prepared in accordance with these standards, and give details of any departure from the standards and the reasons. Banks are also expected to comply with the five industry-specific Statements of Recommended accounting Practice (SORP), and are required to state in their accounts whether they have complied, and if not, explain why they have not complied with them. All U.K.-incorporated banks must appoint an external auditor (SUP 3.3.2R) and the bank’s published accounts must bear an opinion by the external auditor as to the completeness and accuracy of the financial statements (SUP 16.7.8R). Auditors are required under the rules of their professional bodies to comply with Statements of Auditing Standards issued by the U.K. Auditing Practices Board. If the bank failed to comply with the relevant accounting standards, the external auditor would qualify the opinion. The FSA has periodic contact with external auditors to discuss annual accounts and skilled persons reviews. Auditors have a legal duty to report to the FSA breaches or possible breaches of laws or rules, and other matters that they reasonably believe are, or may be, significant. The FSMA Section 342 and the SUP 3.8.10R require that the external auditors inform the FSA if they have any material concerns as a result of their work. Sections 342 and 343 of the FSMA also provide protections for auditors that report in good faith matters that are, or are likely to be, of material significance to the FSA. Guidance regarding an auditor’s duty to report is provided in SUP 3.8. The FSMA gives the FSA the authority to disqualify auditors if they have failed to comply with a duty imposed on them under the FSMA. Banks are prohibited from using disqualified auditor under SUP 3.4.5R. If the FSA had concerns over the abilities of a bank’s external auditors, it may request management to change the audit firm. Under Section 166 of the FSMA, the FSA may appoint a skilled person to do onsite work on its behalf. The skilled person process includes a determination by the FSA that the skilled person has appropriate expertise to carry out the review. In practice, the large international firms perform the majority of banks’ external audits and skilled persons reports. SUP Chapter 3 provides rules and guidance governing the FSA’s relationship with external auditors, and SUP Chapter 5 addresses skilled persons reports. The FSA has a procedure in place for skilled persons reports to establish the scope of the engagement and the objectives to be accomplished by the review (SUP 5). The FSA does not have specific guidelines addressing the scope and conduct of internal audits. However, the FSA does look at the audit universe, and may guide the scope of an internal audit when it meets supervisory needs. The FSA would expect that internal audit would have a risk based approach to its audit Chapter 349 of the FSMA imposes confidentiality requirements on the FSA. Refer to CP 1(6) for further details on confidentiality. The FSA supports Basel and EU proposals to promote public disclosure by banks as a means of strengthening market discipline as a complement to other regulatory efforts.
Assessment	Compliant
Comments	A comprehensive accounting and reporting structure is in place to provide for financial statements on a regular basis. A bank’s annual accounts are required by the Companies Act to be prepared in a way that gives a true and fair view of the results and financial position of the bank and follow the detailed provisions of the Act on form and content of the accounts. The accounts are also expected to comply with other accounting standards such as FRS and SORP, and are subject to public filing requirements. Banks are also required to file regulatory reports with the FSA. These reports have detailed guidance notes to assist in preparation. The FSA requires banks to use generally accepted accounting principles when valuing assets.
Principle 22.	Remedial Measures Banking supervisors must have at their disposal adequate supervisory measures to bring about timely corrective action when banks fail to meet prudential requirements (such as minimum capital adequacy ratios), when there are regulatory violations, or where depositors are threatened in any other way. In extreme circumstances, this should include the ability to revoke the banking license or recommend its revocation.
Description	The FSA has a broad range of supervisory measures available address such problems as failure to meet the FSMA threshold conditions and non-compliance with the FSA’s rules. The range of possible actions available is broad, as the FSA is able to use its powers under FSMA Section 43 to place requirements or restrictions in a bank’s permission. The power can be used to require a bank to take specified action or to require it to refrain from taking specified action. The FSA may also vary or cancel a bank’s permission under Section 45, and also has the authority to take disciplinary measures against a bank or individual, including fines (Section 206) and public censure (Section 205). The FSMA Section 53(3) provides that FSA may take Section 45 actions that have immediate effect if the FSA reasonably determines that immediate effect is necessary. The FSA may require that any actions or requirements imposed under its Section 45 powers be taken within a specified time period. Injunctive relief is also available to the FSA under Section 380, and restitution orders are available under Section 382. These remedies are commonly used against unauthorized firms where the other disciplinary powers are not available. The FSMA Section 61 requires the FSA to exercise control over individuals performing “controlled functions” by requiring that they be approved by the FSA. Controlled functions are functions involving key responsibility and are typically director and senior management level positions. A list of controlled functions is in the SUP chapter of the FSA Handbook (Section 10, Approved Persons). In order to be an “approved person”, the FSA must be satisfied that the person is fit and proper to perform those functions. If the FSA no longer considers a person fit and proper, they may withdraw their approval under FSMA section 63. The FSA may also take action against an approved person if it appears to the FSA that the person is guilty of misconduct under FSMA Section 66. The FSA also has the power to prohibit a person from performing functions in relation to a regulated activity if the FSA finds the person is not fit and proper. If a prohibition order is made, the FSA is required to follow the procedures in FSMA section 347 regarding publication of information about the prohibited person. The FSA’s Regulatory Decisions Committee (RDC, a committee of practitioners and public interest members appointed by the Board, but independent of the FSA’s executive staff) may take major regulatory decisions. The RDC exercises regulatory powers on behalf of, and is answerable to, the FSA’s Board. The FSM Tribunal, an independent body, will consider major regulatory decisions made by the FSA if the firm or individual concerned decides to refer the matter on. The FSMA contains no express requirement that the FSA take action within any particular time frame, with the exception of representations or referrals to the FSM Tribunal. Nor is there guidance or formal voluntary commitment by the FSA to any timeframe. If the FSA does not take action in a timely manner, firms or individuals may raise this in proceedings against them under the general jurisdiction of the courts and Tribunal, and the ordinary principles of fairness that must apply in such proceedings. In addition, the FSA must comply with Article 6 of the European Declaration of Human Rights that requires there to be a right to an independent determination of civil rights and liabilities within a reasonable time frame. For these reasons, and as a matter of general good regulatory practice, the FSA does ensure that remedial actions are in practice taken in a timely manner. Once the FSA has initiated formal supervisory or disciplinary action by service of a notice, a statutory a time frame applies to the completion of the process for making representations or referring the matter to the Tribunal. There are however no constraints on the initiation of action. FSMA Part XXVI requires compliance with formal written notice procedures when the FSA exercises any of the formal disciplinary or supervisory powers.
Assessment	Compliant
Comments	The FSMA provides the FSA with broad powers to take remedial and enforcement actions, and also provides for sanctions against individuals and firms. Adequate protections, in the form of referral to the Tribunal, are in place to protect against abusive enforcement or disciplinary actions. The new enforcement powers granted under the FSMA are very recent, and have only been used in a handful of actions to date, so it is difficult to make a proper assessment of the effectiveness of the FSA’s use of its powers.
Principle 23.	Globally Consolidated Supervision Banking supervisors must practice global consolidated supervision over their internationally active banking organizations, adequately monitoring and applying appropriate prudential norms to all aspects of the business conducted by these banking organizations worldwide, primarily at their foreign branches, joint ventures, and subsidiaries.
Description	Authority to supervise the overseas activities of U.K. incorporated banks is provided for in Threshold Condition 3: (Close Links), based on Paragraph 3, schedule 6 of FSMA. The close links provisions implement and expand on the requirements of the EU Post BCCI Directive. For U.K. based banking groups, FSA carries out global consolidated supervision covering all aspects of supervision, specifically including non-U.K. group companies. Foreign branches of U.K. banks, not being separate legal entities, are considered to be an integral part of the U.K. bank itself, and are supervised on that basis. Quantitative consolidation (see Principle 18) is applied to the global undertakings of U.K.-based banking groups. Under FSA’s risk based approach to supervision the supervisory effort concentrates on significant business units. These may be identifiable on a geographical, legal or business basis. Consistent with the qualitative element of FSA’s general approach to consolidated supervision, supervisory effort is directed at ensuring that banks have information systems and controls adequate to manage risks in all business units, wherever they are located. Heads of significant business units will be seen during the risk assessment stage or during the following supervisory period. In conducting reviews of high level controls at the center, the FSA considers the quality of the control system both centrally and locally. Supervisors periodically visit major overseas operations to supplement reviews made at the center. If circumstances require the FSA will impose limitations on the activities of overseas operations of U.K. banks through liaison with home country senior management. The FSA may impose limitations on the activities of overseas operations in order to ensure that the close links/supervisability of group structures requirement in the Threshold Conditions is met in particular cases. In addition to regular contact with senior management based in the U.K. responsible for the international operations of internationally active groups, FSA is also in periodic contact with the locally based management responsible for significant business units overseas. Direct supervision of significant international operations is supplemented by close co-operation and liaison with the banking supervisors of the host country. If necessary, plans for remedial action are discussed and agreed with the host supervisor. If, as part of the risk assessment process, the FSA determines that an overseas operation of a U.K. banking group is presenting significant unmitigated risks the FSA would initiate discussions with the bank’s senior management. These discussions could ultimately require the closure of a bank’s overseas operation. FSA has the power to conduct on-site examinations of overseas branches and subsidiaries of U.K. banking groups. The FSA conducts periodic on-site examinations of a sample of the more significant overseas offices of U.K. banks, usually in conjunction with the host country supervisor. Following FSA’s risk based approach to supervision, oversight of the foreign operations of U.K. banks focuses on significant activities with higher risk profiles and those that are subject to weaker host country supervision. FSA routinely undertakes assessments of the extent of supervision undertaken by other supervisors relevant to the U.K. In particular, it forms its own judgment as to their compliance with the Basel Core Principles.
Assessment	Compliant
Comments	FSA supervises internationally active U.K. banking organizations on a globally consolidated basis, both quantitatively and qualitatively. The international dimension places particular emphasis on ensuring that banks have information systems and controls to manage risks in all business units, wherever they are located. FSA insures that overseas activities are structured in a way that can be properly supervised and, where it is not satisfied, imposes restrictions or limits activities. Overseas visits and cooperation with foreign supervisors are important aspects of FSA’s supervision on a globally consolidated basis.
Principle 24.	Host Country Supervision A key component of consolidated supervision is establishing contact and information exchange with the various other supervisors involved, primarily host country supervisory authorities.
Description	The FSA has established an extensive network of formal and informal contacts with overseas banking supervisors to provide for the exchange of information necessary for effective global consolidated supervision. These contacts are both multilateral and bilateral. At the level of international organizations, FSA is an active participant in supervisory groups such the Basel committee and EU groupings such as the Banking Advisory Committee and the Groupe de Contact. Bilateral memoranda of understandings with numerous countries provide for information exchanges and on-site examinations of branches and subsidiaries of U.K. banks. FSA maintains a very active dialogue with supervisors in offshore centers particularly those that are in overseas territories and crown dependencies. Information exchanges are both formal and informal and range across the full spectrum of supervisory information, from written documentation in support of authorizations to oral sharing of supervisory judgments about individuals and institutions. In line with its risk based approach to supervision FSA, in consultation with local supervisors, regularly visits the major overseas offices of U.K. banking groups and on such visits frequently conducts joint examinations with the host country supervisors. The readiness of an overseas supervisor to provide information is a consideration for the FSA in determining the extent to which it can take into account the work of the overseas supervisory in its supervision of the overseas subsidiaries of U.K. banks. Threshold Condition 3 (Close Links) would be breached if the regulations or administrative provisions of a territory, which is not an EEA state, would prevent the FSA’s effective supervision of a bank or affiliate. COND 2.3.3G also notes that the FSA considers branches when assessing whether a firm meets Threshold Condition 3. Restrictions on information flows also impact on Principle for Business (PRIN) which provides that a firm must deal with its regulators in an open and cooperative way and must disclose to the FSA appropriately anything relating to the firm of which the FSA would reasonably expect notice. This principle is enforced in Rule 2.1.1 in SUP. COND 2.3.3G also indicates that restrictions on information flow could stop a firm complying with the rules in SUP on information gathering. In discussions with host country supervisors FSA will focus on the local banking group and the group as a whole.
Assessment	Compliant
Comments	FSA has a very broad network of contacts and arrangements with foreign supervisors whereby it exchanges supervisory information necessary to carry out globally consolidated supervision. This includes participation in numerous international and bilateral supervisory groups, as well as formal and informal bilateral contacts with other supervisors responsible for affiliates of banking organizations in the U.K. Where practical, the FSA will consult with an overseas supervisor providing information before taking action in relation to a bank that it supervises (and more widely where any action could have consequences for its supervision of other banks or financial companies). The FSA must consult a firm’s EEA home state regulator before taking actions in certain specified cases. The FSA discloses information to host country supervisors in a wide variety of circumstances whether or not at the specific request of the host supervisor.
Principle 25.	Supervision Over Foreign Banks’ Establishments Banking supervisors must require the local operations of foreign banks to be conducted with the same high standards as are required of domestic institutions and must have powers to share information needed by the home country supervisors of those banks for the purpose of carrying out consolidated supervision.
Description	All banks, whether U.K. incorporated or branches of foreign banks, are required to satisfy and continue to satisfy the Threshold Conditions set out in FSMA. The Principles for Business likewise are applicable to all banks whether U.K. incorporated or branches of foreign banks. FSA’s risk based approach to supervision does not differentiate between foreign and domestic banks. Foreign banks are subject to the same risk assessment and risk mitigation process as domestic banks. Reporting requirements are similar for all banks, although there are differences in the prudential returns relating to capital and large exposures. These differences apply mainly to branches of foreign banks and the differences are spelled out in SUP 16 of the Handbook. Prudential supervision of branches of EEA banks operating in the U.K. under the EU passport arrangements are primarily the responsibility of the home country supervisor and, hence, prudential returns to FSA are limited. For branches of non-EEA banks the FSA relies on the home country supervisor for capital adequacy and large exposures. Although FSA has responsibility for supervising the liquidity of foreign branches on a case-by-case bases it may agree to defer to the home country supervisor for the oversight of branch liquidity. In both its licensing and ongoing supervision of branches and subsidiaries of foreign banks, FSA takes into account the extent to which home country supervisors carry out effective global consolidated supervision. Before authorizing deposit taking activities of a foreign branch of a non-EEA bank the FSA confirms both that the bank is subject to consolidated supervision and that the home country supervisor approves the proposal. Similar procedures do not apply to approval of branches of EEA banks operating under EU passport arrangements. If, on a continuing basis, FSA is unable to rely on the home country supervisor, it is FSA policy that branches of non-EEA banks close or the branch should subsidiarise. This policy has been enforced in individual cases. For U.K. subsidiaries of overseas banks the FSA seeks confirmation that the home country supervisor practices effective consolidated supervision. If FSA is not satisfied on this point then it will require that the corporate governance and risk management policies of the subsidiary be sufficiently robust to provide adequate ring-fencing from the parent bank. This policy has been enforced in individual cases. FSMA provides authority for the FSA to share supervisory information with foreign supervisors subject to confidentiality safeguards. All home country supervisors are permitted to conduct on-site visits and examinations of U.K. branches and subsidiaries and FSA encourages this practice. FSA informs home country supervisors of risk assessments and supervisory actions that it is taking in relation to the operations of banks from their countries. Urgent remedial actions are promptly communicated. FSA systematically informs itself of business strategies and risk and control regimes of parent banking groups in order to provide the context necessary for supervision of branches and subsidiaries of foreign banks operating in the U.K. This done through contacts with the banking group supplemented by information provided by the home country supervisor.
Assessment	Compliant
Comments	The U.K. operations of foreign banks are subject to the same high level standards and principles the FSA applies to U.K. banking organizations and FSA applies the same risk based supervisory tools to both foreign and domestic banks. Reporting requirements are similar for all banks, taking into account differences applicable to branches of foreign banks and the special legal arrangements for EEA branches established under the EU passport regime. FSA licensing and ongoing supervision of U.K. branches and subsidiaries of foreign banks takes into account the reliance FSA believes it can place on home country consolidated supervision. FSA has wide authority to share supervisory information with home country supervisors and, as a matter of policy, FSA encourages home country supervisors to carry out on-site visits of the U.K. operations of their banks.

	Life – Ordinary	Life - Industrial	Non life
1990	32.8	1.4	18.3
2000	118.0	0.7	28.7

	Life – Ordinary	Life - Industrial	Non life
1990	32.8	1.4	18.3
2000	118.0	0.7	28.7

Principle 1.	Organization of an Insurance Supervisor The insurance supervisor of a jurisdiction must be organized so that it is able to accomplish its primary task, i.e., to maintain efficient, fair, safe, and stable insurance markets for the benefit and protection of policyholders. It should, at any time, be able to carry out this task efficiently in accordance with the Insurance Core Principles. In particular, the insurance supervisor should: -be operationally independent and accountable in the exercise of its functions and powers; -have adequate powers, legal protection, and financial resources to perform its functions and exercise its powers; -adopt a clear, transparent, and consistent regulatory and supervisory process; -clearly define the responsibility for decision-making; and -hire, train, and maintain sufficient staff with high professional standards who follow the appropriate standards of confidentiality.
Description	The responsibilities and objectives of the Financial Services Authority (FSA) as the regulator and supervisor of insurers are set out in the Financial Services and Markets Act 2000 (FSMA). In discharging its general functions, the FSA is required to act in a way that is compatible with the regulatory objectives. The regulatory objectives are: (a) maintaining confidence in the financial system; (b) promoting public understanding of the financial system; (c) securing the appropriate degree of protection for consumers; and (d) reducing the extent to which it is possible for an authorized business to be used for a purpose connected with financial crime. The FSA functions as a public authority by virtue of statutory powers granted by the FSMA, but is operationally independent having been established as a private company limited by guarantee. It is responsible for its own budget and is financed by direct levies on the industry. The FSA has the ability to hire and maintain staff with the appropriate skills and is responsible for its own staff remuneration policy. It is also required to have regard to the principles of good regulation specified in the FSMA, such as the need to use its resources in the most efficient and economic way. The FSA’s Handbook of rules and guidance (“the Handbook”) is publicly available: changes in the rules are subject to consultation. A decision-making manual forms part of the Handbook. The FSA makes and maintains effective arrangements with consulting practitioners and consumers on the extent to which its general policies and practices are consistent with its general duties. It also maintains separate practitioner and consumer panels. The FSMA grants the FSA wide powers to take action against insurance firms which do not comply with the requirements set out in the Act, secondary legislation under the FSMA and the rules set out in the Handbook. Under the powers of intervention of the FSMA, actuarial or general investigations into insurers may be ordered. These may be undertaken by third parties with the required skills. The FSA is able to recruit expert assistance when needed. The FSA Code of Conduct sets out clear rules on dealing with insurance companies and conflicts of interest. When staff are appointed to the FSA, they are required to provide details to an Ethics Officer of all significant relationships that may be relevant to their work. Changes in this information must be notified. Similarly, direct holdings of shares in regulated firms need to be notified to the Ethics Officer and the information updated. Staff cannot themselves hold or deal in shares and related investments of the institutions they supervise. Nor can they accept gifts other than of a token kind, or excessive hospitality. The FSMA provides that the FSA and any person who is, or is acting as, a member officer or member of staff of the FSA, is not to be liable for damages regarding anything done or omitted in the discharge, or purported discharge, of the FSA’s functions. However, this protection does not apply if the act or omission is shown to have been in bad faith, or unlawful.
Assessment	Observed
Comments	Officially, the FSA became an integrated regulator on December 1, 2001. Consistent with the powers granted under the FSMA, the FSA is organized and operates in a manner that ensures that it is able to comply with its regulatory mandate. The essential elements of this core principle have been met but the competitive pressures faced by insurers are increasing. The resulting supervisory challenges the FSA faces in the insurance sector will no doubt require increased emphasis on resource needs and staff training and development. The FSA should consider strengthening its core insurance expertise to include individuals with significant experience in reinsurance, actuarial science and long tail, non life claims. The addition of these individuals would likely be organized in a matrix structure. The availability of their technical skills to all supervisors, particularly those working within MFGD, should be actively promoted within the FSA. The inclusion of the larger insurance firms within MFGD promotes consistent, consolidated supervision. However, since some of these insurance firms are supervised by staff whose background is in banking, the FSA runs the risk—at least transitionally—that these supervisors may not always recognize when staff, with the insurance expertise described above, may be required. The fundamental importance of the insurance risk liabilities for balance sheet and profit/loss accounting purposes (both statutory and published) underlines the seriousness of this point. Since the initial assessment was undertaken, further insurance experience has been gained in the MFGD teams, and the overall availability of insurance skills and expertise within the FSA has been enhanced.
Principle 2.	Licensing Companies wishing to underwrite insurance in the domestic insurance market should be licensed. Where the insurance supervisor has authority to grant a license, the insurance supervisor: -in granting a license, should assess the suitability of owners, directors, and/or senior management, and the soundness of the business plan, which could include proforma financial statements, a capital plan, and projected solvency margins; and -in permitting access to the domestic market, may choose to rely on the work carried out by an insurance supervisor in another jurisdiction if the prudential rules of the two jurisdictions are broadly equivalent.
Description	The effecting and carrying out of contracts of insurance as a principal is a regulated activity in the U.K. and requires authorization. The FSA must ensure that applicants satisfy and will continue to satisfy the “threshold conditions” set out in the FSMA in relation to all of the regulated activities for which they will have permission. There are five general Threshold conditions, covering legal status, location of offices, close links, adequate resources and suitability. The threshold conditions represent a framework against which an applicant can be thoroughly assessed on all relevant criteria. In that framework, an assessment is made of appropriate financial resources and projected solvency, adequate systems and controls, integrity and competence of senior management, directors and controllers, and the applicant’s regulatory history. As part of the assessment of whether an applicant satisfies and will continue to satisfy the threshold conditions, the FSA considers whether the applicant is ready, willing and organized to comply with the regulatory requirements to which it will be subject if it is granted permission. Permission to carry on regulated activities may be accompanied by specific requirements placed on the insurer. Insurers appropriately authorized in another EEA Member State may operate in the U.K. through a branch or on a cross-border services basis under a passport arrangement, based on the common standards of supervision established under the EU Insurance Directives.
Assessment	Observed
Comments	The FSA has well developed policies and procedures in place to ensure that any insurer wishing to operate in the U.K. meets the stated regulatory requirements.
Principle 3.	Changes in Control The insurance supervisor should review changes in the control of companies that are licensed in the jurisdiction. The insurance supervisor should establish clear requirements to be met when a change in control occurs. These may be the same as, or similar to, the requirements which apply in granting a license. In particular, the insurance supervisor should: -require the purchaser or the licensed insurance company to provide notification of the change in control and/or seek approval of the proposed change; and -establish criteria to assess the appropriateness of the change, which could include the assessment of the suitability of the new owners as well as any new directors and senior managers, and the soundness of any new business plan.
Description	Under existing legislation, a person proposing to take control of or vary its existing control over an insurance firm must notify the FSA. The insurance firms are also required to notify the FSA of any changes in control. The FSA has the power to object to changes in control. The specific documents that the insurers have to submit depend on the licensing requirements of the jurisdiction and are consistent with the documentation required for new license applications. When a change in control occurs, the suitability of the new owners, directors and senior managers, and the soundness of any new business plan are checked. Where changes to business strategy are proposed these too will be assessed. The normal process would involve the consideration of the proposed business strategy against the existing business strategy and the assessment of the likely benefits/drawbacks. In the case of life insurers the actuarial advice provided by the FSA’s actuarial department would be a critical consideration. In deciding whether the approval requirements are met, the FSA must ensure that the insurance firm satisfies and will continue to satisfy the Threshold conditions which are the same standards that apply to those who seek to obtain permission to carry on insurance business for the first time.
Assessment	Observed
Comments	The FSA has well-developed systems and procedures in place to address issues relating to changes in control.
Principle 4.	Corporate Governance It is desirable that standards be established in the jurisdictions which deal with corporate governance. Where the insurance supervisor has responsibility for setting requirements for corporate governance, the insurance supervisor should set requirements with respect to: -the roles and responsibilities of the board of directors; -reliance on other supervisors for companies licensed in another jurisdiction; and -the distinction between the standards to be met by companies incorporated in his jurisdiction and branch operations of companies incorporated in another jurisdiction.
Description	In respect of firms regulated by the FSA, there is a range of rules relevant to corporate governance. These rules are elaborated in Principles (eleven in total) which are fundamental obligations placed on firms, and derive from the FSA’s general rule-making power in the FSMA. However, they do not apply where the matter in question falls under the firm’s Home State regulator under EC Directives. A firm is also required to satisfy, and continue to satisfy threshold conditions in order to be given and to retain its permissions under the Act. The FSA must ensure that a firm satisfies and will continue to satisfy the Threshold conditions in relation to each regulated activity for which it has, or will have, permission. In addition to conditions governing the legal form of insurance companies, the threshold conditions require that the resources of the person concerned must, in the opinion of the FSA, be adequate in relation to the regulated activities that he/she seeks to carry on, or carries on. In reaching its opinion, the FSA may take into account the person’s membership of a group and the effect which that membership may have. If it appears that an authorized person is failing, or likely to fail, to satisfy the Threshold conditions, the FSA may take action to vary or revoke the firm’s permissions. The threshold conditions are complemented by high level systems and control requirements, which include the encouragement of firms’ directors and senior managers to take appropriate practical responsibility for their firms’ arrangements on matters that impinge on the FSA’s functions under the FSMA. The FSA is not primarily concerned with risks that threaten only the owners of a financial business except, in so far as those risks may have an impact on the FSA’s mandate. The FSA, however, does recognize the need to balance the unique interests of shareholders and consumers alike. In addition to the high level systems and controls noted above, the FSA has in place an Approved Persons’ Regime, which requires certain individuals within all financial services companies, including the directors and many senior managers, to remain fit and proper (FIT) and to comply with certain standards of behavior set out in Statements of Principle for Approved Persons and a Code of Practice (APER). The tone and layout of APER is similar to the Principles for Businesses and it describes seven Principles that govern the performance of the director’s or senior manager’s role. These include personal elements like due skill, care and integrity as well as the organization and control of the areas of business under the individual’s direct control.
Assessment	Observed
Comments	The FSA, which has considerable rule-making power under the FSMA, has in place a comprehensive set of rules and guidelines for use by its supervised firms and its own staff and these are consistent with the requirements of this core principle. Nevertheless, two recommendations are presented below. The FSA should consider making it mandatory for a Financial Condition Report (FCR) to be signed off by the Board and subsequently made available to the FSA. The Board should take responsibility for the analysis of the FCR and ensure that the level of resilience/scenario testing is appropriate to the complexity and size of the organization. The FSA may wish to work closely with the appropriate professional bodies and develop guidance for use by supervised firms when preparing the FCR. At the conclusion of every review of high impact firms, senior officials from the FSA should meet formally with the audit committees to review and present the management letter points. At these meetings, it is good practice to request an in camera meeting with only the non-executive members of the audit committee.
Principle 5.	Internal Controls The insurance supervisor should be able to: - review the internal controls that the board of directors and management approve and apply, and request strengthening of the controls where necessary; and - require the board of directors to provide suitable prudential oversight, such as setting standards for underwriting risks and setting qualitative and quantitative standards for investment and liquidity management.
Description	The FSA’s eleven Principles for Businesses apply to some aspects of internal control. These principles cover a wide array of topics and are fundamental obligations placed on firms, deriving from the FSA’s general rule-making power in the FSMA. In addition, threshold conditions represent the minimum conditions which a firm is required to satisfy, and continue to satisfy, in order to be given and to retain their permissions under the Act. The FSA must ensure that a firm satisfies and will continue to satisfy, the Threshold conditions in relation to each regulated activity for which it has, or will have, permission. Assessment of a firm’s internal controls is through a combination of off-site and on-site monitoring; however, the emphasis is on off-site monitoring. This assessment process determines whether the firm has taken reasonable steps to identify all risks of regulatory concern that it may encounter in conducting its business, and has installed appropriate systems and controls and appointed appropriate human resources to manage them prudently at all times. Firms are required to notify the FSA of any proposed restructuring, reorganization or business expansion which could have a significant impact on the firm’s risk profile, and any significant failure in the firm’s systems or controls, including those reported to the firm by the firm’s external auditor.
Assessment	Broadly Observed
Comments	Based on current practices, this core principle is rated Broadly Observed; however, when the new risk-based methodology is implemented in the insurance sector, the requirements of this principle will be met. Essential Criteria # 1 is the primary reason for the assigned rating. The completeness, appropriateness and effectiveness of a firm’s internal controls and systems are fundamental to its on-going viability and competitive position in the industry. The FSA’s requirements on systems and controls provide good guidance for the industry and, when implemented effectively, should foster a strong internal control discipline by senior management and the Board. However, the effectiveness of these controls and systems need to be independently reviewed and tested from time to time. Currently, only limited independent, on-site reviews are carried out. Again, the level of review needs to be enhanced, in order to ensure that systems and controls are effective. One way to accomplish this is to consider more effective use of external checks and balances. This could include the use of auditors, skilled persons and supervisors. Operational risk, in particular, is most effectively assessed in the field, and working in the field also affords a unique opportunity for supervisors to develop a better understanding of the firm’s operations. The FSA is strongly encouraged to devote more attention to this aspect of supervision in the future. The increasing pressures on insurance firms require management to pay more attention to risk management practices. In the current environment, most firms, particularly those in MFGD, are strengthening their risk management practices; however, where this is not true, the FSA should consider encouraging those firms to do so. Possible actions that could be taken by such firms include the establishment of a risk management function and a risk committee of the Board. Management letters issued by the FSA to a firm are important pieces of correspondence that usually deal with prudential issues which are also of interest to a firm’s auditors. Many firms routinely provide copies of management letters to their auditors, but this is not done consistently. The FSA may wish to standardize its procedures for management letters by including a requirement that firms provide a copy to their auditors on a timely basis.
Principle 6.	Assets Standards should be established with respect to the assets of companies licensed to operate in the jurisdiction. Where insurance supervisors have the authority to establish the standards, these should apply at least to an amount of assets equal to the total of the technical provisions, and should address: -diversification by type; -any limits, or restrictions, on the amount that may be held in financial instruments, property, and receivables; -the basis for valuing assets which are included in the financial reports; -the safekeeping of assets; -appropriate matching of assets and liabilities; and -liquidity.
Description	The FSA’s Principles for Business include that a firm must maintain adequate financial resources. Rules also provide comprehensive guidance for firms to follow when dealing with important issues such as asset diversification, matching of liabilities in any particular currency by assets in that currency, provisions relating to the location of assets, adequate spread, the separation of the assets and liabilities, method of valuing assets, and the extent to which an asset may be taken into account for prudential purposes. The FSA requires firms to have in place suitable control and management information systems to enable the company to implement an appropriate investment strategy. The investment strategy should be reflected in clear terms of reference by the company to its investment managers, who must be qualified and competent to carry out their assigned task and whose remuneration package should be consistent with that strategy. The work of the investment managers should be monitored sufficiently closely to ensure that the company’s strategy is being followed. Also, a life insurance company must at all times identify the assets held by it which it considers to be the most suitable to cover its obligations; and make prudent provision for the effect on the amount of its excess assets of adverse variations between the value of the assets identified and the value of the assets which it may be obliged to deliver to meet its obligations. Life insurers must apply resilience tests for which guidance is laid down by the FSA. The Integrated Prudential Sourcebook that the FSA intends to bring in will introduce similar controls for non-life insurers. In the case of life insurers, the appointed actuary plays a significant role in ensuring that the insurer has made proper provision in respect of its liabilities, and in monitoring the risks the firm runs where these are material to the firm’s ability to meet its liabilities to policyholders. Each year, as part of the annual returns, Directors are expected to certify that the company’s systems and controls comply with the FSA’s requirements. The ‘reasonableness’ of the Directors’ certification of compliance is subject to external audit opinion. These reports are reviewed by the FSA, and supervisors may also seek to verify directly with the firm that adequate controls exist.
Assessment	Broadly Observed
Comments	Based on current practices, this core principle is rated as Broadly Observed; however, the implementation of the proposed risk-based methodology will result in this principle rated as Observed. Essential Criteria 4, 5 and 7 are the primary reasons for the assigned rating. As described above, the FSA has strong standards and rules governing the assets held by a firm to cover its liabilities. These rules cover the essential elements of asset management, such as the establishment of investment policy, valuation, safe keeping, matching of assets and liabilities and the existence of adequate internal controls. Tightly controlling risks (market, credit, liquidity operational and legal) associated with investment activities is of particular significance in an insurance firm as they could affect the determination and on—going sufficiency of the technical provisions. The review of a firm’s risk management policies and systems, internal controls and internal audit programs usually requires specialized expertise and is best assessed in the field. More balance between desk review and independent testing on site is required in order to meet the requirements of this core principle which are demanding. The new risk-based methodology, which is currently being developed, will meet this objective but, at present, it is not being achieved in a consistent manner.
Principle 7.	Liabilities Insurance supervisors should establish standards with respect to the liabilities of companies licensed to operate in their jurisdiction. In developing the standards, the insurance supervisor should consider: - what is to be included as a liability of the company, for example, claims incurred but not paid, claims incurred but not reported, amounts owed to others, amounts owed that are in dispute, premiums received in advance, as well as the provision for policy liabilities or technical provisions that may be set by an actuary; - the standards for establishing policy liabilities or technical provisions; and - the amount of credit allowed to reduce liabilities for amounts recoverable under reinsurance arrangements with a given reinsurer, making provision for the ultimate collectability.
Description	The FSA’s power to prescribe standards for establishing technical provisions and other liabilities derives from its rule making powers under the FSMA. Insurers must maintain such accounting and other records as are necessary for identifying the liabilities attributable to each kind of business it carries on. The Interim Prudential Sourcebook for Insurers covers the identification and application of assets and liabilities relating to long-term business. Long-term liabilities must be determined on the basis of actuarial principles, having regard to the reasonable expectations of policyholders and relevant actuarial guidance, and make proper provision for all liabilities using prudent assumptions that include appropriate margins for adverse deviation of the relevant factors. In the case of non-life insurance, the responsibility for establishing prudent technical provisions and provisions for other liabilities rests first and foremost on the management of the insurance company and its advisers. The U.K. legislation does not generally lay down precise rules on how non-life liabilities are to be calculated. The accounting profession has developed statements of recommended practice, and independent auditors must certify that the reserves have been established in accordance with regulatory requirements and professional standards. The core requirement is that the reserves should be sufficient to meet liabilities in all reasonably foreseeable circumstances. The various sorts of technical reserves that a non-life insurance company should establish are defined in the Companies Act 1985. Discounting of outstanding long tail claims is allowed within a clearly defined framework. The annual return provided by insurers, including information on technical provisions and an abstract of the appointed actuary’s valuation report, are examined by the FSA. Where there are concerns that the technical provisions have not been appropriately calculated, the supervisory authority can use its powers of intervention to require an actuarial or general investigation. The FSA may assess the adequacy of the technical provisions through on or off-site monitoring or a combination of the two. It also has the power to require reports by skilled persons into the adequacy of the technical provisions granted by the FSMA. Regarding reinsurance use, insurers may take credit for reinsurance recoveries up to the amounts reasonably expected to be recovered. However, in the solvency margin calculation, insurers are only allowed to take credit for reinsurance recoverables up to a maximum of 50 percent.
Assessment	Broadly Observed
Comments	This core principle is rated as Observed for the life firms and Broadly Observed for the non-life firms. While the FSA’s supervisors are likely to identify problems related to long-tail, non-life claims, the scarcity of qualified non life personnel makes it difficult to perform the required follow up. The U.K. is assessed as not being fully compliant with Essential Criteria # 3. The nature of the non-life liabilities makes it increasingly important to establish rules and guidance for use by supervised firms. Long-tail non-life liabilities should be subject to a rigorous overview by the appropriate mix of professional bodies at the insurer level. Input from this multi-discipline professional team should be considered in the development of the Financial Condition Report. The determination of policy liabilities in life firms is a highly specialized task and involves the use of considerable judgment by the appointed actuary. Judgment is required even though the appointed actuary is required to calculate the policy reserves within the guidelines set out by the professional body. Judgment is particularly critical for some products as results are highly sensitive to certain assumptions and slight variations can result in material differences in reserve balances. For these reasons the assessors believe it would be good practice to require the implementation of a peer review process and the FSA may want to work with the Institute of Actuaries or other relevant professional bodies to implement such a review. Depending on the company-specific situation, a multi-discipline team may be required to do the review.
Principle 8.	Capital Adequacy and Solvency The requirements regarding the capital to be maintained by companies which are licensed, or seeking a license, in the jurisdiction should be clearly defined and should address the minimum levels of capital or the levels of deposits that should be maintained. Capital adequacy requirements should reflect the size, complexity, and business risks of the company in the jurisdiction.
Description	FSA rules require both life and non-life insurers to maintain a margin of solvency. The basic obligations reflect the EU solvency and minimum capital requirements. Whilst larger companies are clearly required to have larger solvency margins in absolute terms under these provisions, different levels of complexity or business risks are not currently reflected in specific EU or U.K. solvency requirements - except to a very limited extent in the fixed minimum capital requirements. The FSA nevertheless seeks to ensure, and has the powers to require and enforce, that individual companies maintain solvency margins appropriate to the nature of their business, which in many cases are several multiples of the EU requirements. The powers under the FSMA may be used to set an individual requirement for an insurer necessitating that they maintain a particular level of financial resources. The financial returns made to the FSA, provide the necessary information to allow the supervisor to monitor assets, liabilities and compliance with the solvency margin requirements. The FSA reviews and analyses the returns, and investigates any problems identified with the firms concerned. The FSA may also examine these areas through on-site inspections. The directors of an insurance company have to certify in respect of the annual return to the FSA that the company has maintained the required margin of solvency throughout the financial year in question. The auditor, in the report they are obliged to produce, is required to provide their opinion whether it was reasonable for the directors to have made the statement. Given the international nature of the U.K. insurance market, the ability to share prudential information with other regulators is of critical importance. The Financial Services and Markets Act 2000 (Disclosure of Confidential Information) Regulations 2001, contains gateways permitting the exchange of supervisory information with other insurance supervisory authorities.
Assessment	Observed
Comments	In May 2002 the FSA issued consultation paper 136 “Individual Capital Adequacy Standards” which will result in a comprehensive review of the capital requirements for all firms, including the informal rules currently used by non-life firms. For non-life firms, the capital requirement is a combination of formal and informal requirements. The formal requirements are set out in the EU Directives. There are adjustments for reinsurance, based on actual recoveries and subject to a maximum reduction of 50 percent. The informal requirement is determined based on “rules of thumb” which have emerged such as 200 percent of minimum requirements for less risky lines of business while for more risky lines, the norm is about 300 percent to 400 percent of minimum requirements. More formalized risk-based capital rules are clearly required and this is recognized by the FSA.
Principle 9.	Derivatives and ‘Off-Balance Sheet’ Items The insurance supervisor should be able to set requirements with respect to the use of financial instruments that may not form a part of the financial report of a company licensed in the jurisdiction. In setting these requirements, the insurance supervisor should address: -restrictions in the use of derivatives and other off-balance sheet items; -disclosure requirements for derivatives and other off-balance sheet items; and -the establishment of adequate internal controls and monitoring of derivative positions.
Description	FSA rules set out the principles governing the use of derivatives by insurers, and these are supplemented by guidance dealing with systems and controls over investments with particular reference to the use of derivatives. The U.K. approach seeks to ensure that derivatives are not used in a way that is speculative or which might have the effect of weakening the company materially. Guidance issued by FSA covers the standards to be achieved by companies’ systems and controls. This includes the requirement for insurers to have in place written guidelines on the use of derivatives which must be approved by the Board, and must be consistent with the company’s agreed investment strategy. The following must be addressed in the guidelines: objectives and policies for use of derivatives, types of instrument, the establishment of prudent limits, exposures and volumes, competence and qualifications of staff, and the segregation of functions. Directors are required to ensure derivatives use is monitored and in line with the objectives and policy contained in the guideline. Directors must also ensure that risk management and control systems are capable of analyzing and monitoring the risk of all transactions undertaken by the organization individually and in aggregate. Each year, as part of the annual returns, Directors are expected to certify that the company’s systems and controls comply with the FSA’s requirements. The ‘reasonableness’ of the Directors’ certification of compliance is subject to external audit opinion. The annual returns provide the basis for off-site monitoring of the adequacy of the internal controls over derivatives. The controls may also be checked on-site, and in this respect the FSA expects to make increasing use of its market risk review team. Every insurer must attach to the annual return covering their balance sheet, profit and loss account and revenue account a statement comprising a brief description of any investment guidelines followed by the insurer for the use of derivative contracts and of other matters concerning the use of derivatives.
Assessment	Observed
Comments	FSA rules set out the principles governing the use of derivatives by insurers, and these are supplemented by guidance dealing with systems and controls over investments with particular reference to the use of derivatives. The U.K. approach seeks to ensure that derivatives are not used in a way that is speculative or which might have the effect of weakening the company materially.
Principle 10.	Reinsurance Insurance companies use reinsurance as a means of risk containment. The insurance supervisor must be able to review reinsurance arrangements, to assess the degree of reliance placed on these arrangements and to determine the appropriateness of such reliance. Insurance companies would be expected to assess the financial positions of their reinsurers in determining an appropriate level of exposure to them. The insurance supervisor should set requirements with respect to reinsurance contracts or reinsurance companies addressing: - the amount of the credit taken for reinsurance ceded. The amount of credit taken should reflect an assessment of the ultimate collectability of the reinsurance recoverable and may take into account the supervisory control over the reinsurer; and - the amount of reliance placed on the insurance supervisor of the reinsurance business of a company which is incorporated in another jurisdiction.
Description	FSA’s rules require insurers to report to the supervisory authority on their reinsurance arrangements. This information is analyzed with respect to the appropriateness of the programme and the security provided. Non-life insurers have to provide statements covering their major reinsurers, both treaty and facultative. These statements include information on any connections the insurer might have with the reinsurer; the amount of reinsurance payments payable; and the amount of anticipated recoveries to the extent that these have been taken into account by the company in determining the reinsurers’ share of the technical provisions in respect of claims outstanding. In addition, companies have to provide a detailed statement of the business ceded. Reinsurers are subject to direct regulation in the United Kingdom, in addition to the supervision applied through the review of the reinsurance cessions of direct insurers. Primary insurers that accept reinsurance risks are supervised in respect of the whole of their business. The supervision of reinsurers is carried out in broadly the same manner as the supervision of direct insurers, though with specific attention being paid to the potential for aggregation of risk within reinsurers which might, for example, make them particularly vulnerable to a specific event or chain of events. The full range of supervisory controls apply, including reporting requirements; on and off-site monitoring; the ability to intervene; authorization by class of business; fit and proper requirements; and systems and controls requirements. As noted earlier, insurers may take the credit for reinsurance recoveries up to the amounts reasonably expected to be recovered. However, in the solvency margin calculation, insurers are only allowed to take credit for reinsurance recoverables up to a maximum of 50 percent of claims. The FSA has powers to share confidential information with other supervisors in appropriate circumstances.
Assessment	Observed
Comments	Reinsurance usually requires specialized knowledge in order to conduct any meaningful review. Reinsurance contracts tend to be company-specific and the determination of whether there is a true transfer of risk, or lack thereof, can be elusive. The Board, however, is ultimately responsible for ensuring that the proper level of reserve credit is taken by the firm. The FSA has used reinsurance specialists in the past to assist with its supervisory work but only on an ad-hoc basis. The complexity of reinsurance arrangements – particularly financial reinsurance – makes it difficult for even skilled supervisors to assess the adequacy of the reinsurance program of insurance companies relative to their level of capital and the risk profile of the underwriting book. Moreover as a considerable share of reinsurance arrangements tends to be ceded offshore, it becomes increasingly difficult for U.K. regulators to assess the recoverability of claims held by domestic insurers on their reinsurers. For this reason, the assessors strongly support the rapid introduction of an EU reinsurance directive and international standards. A further challenge with respect to reinsurance is the limitation of the current data base system to capture meaningful data on reinsurance use within the insurance industry. This is a challenge for all regulators world-wide and does serve to make supervisors’ job very difficult. The FSA may wish to consider implementing a thematic review of reinsurance operations across the firms for purposes of ensuring that, all firms and the industry in general, have put in place appropriate controls and systems to deal with this important risk.
Principle 11.	Market Conduct Insurance supervisors should ensure that insurers and intermediaries exercise the necessary knowledge, skills, and integrity in dealing with their customers. Insurers and intermediaries should: -at all times act honestly and in a straightforward manner; -act with due skill, care, and diligence in conducting their business activities; -conduct their business and organize their affairs with prudence; -pay due regard to the information needs of their customers and treat them fairly; -seek from their customers information which might reasonably be expected before giving advice or concluding a contract; -avoid conflicts of interest; -deal with their regulators in an open and cooperative way; -support a system of complaints handling, where applicable; and -organize and control their affairs effectively.
Description	The FSA is responsible for the supervision of the sale and marketing of life insurance with an investment element. Since the majority of life insurance sold within the U.K. has an investment element, the FSA effectively regulates the sale and marketing of all life insurance. The supervision of the sale and marketing of non-life insurance is in a period of transition. The Government recently announced that the sale of non-life insurance will in future be regulated by the FSA. This will require considerable preparatory work by the FSA before the transfer from the existing - non-statutory – regulatory regime can be effected in 2004. In the meantime the General Insurance Standards Council (GISC) will continue in its role as an independent, non-statutory organization to regulate the sales, advisory and service standards of its members (insurers and intermediaries - including brokers, agents, and anyone acting for them). Those insurers and intermediaries that are not members of the GISC will continue to be subject to the provisions contained in the Association of British Insurers’ Code of Practice (ABI Code).⁶ There is a continuing and enforceable requirement throughout the lifetime of all financial services firms authorized by the FSA, that all approved persons are fit and proper to hold their office. Persons requiring approval are those who exercise controlled functions within the firm. Controlled functions as defined in the Handbook include governing functions, such as director or chief executive; required functions, such as compliance oversight; and significant management functions such as financial resources or insurance underwriting. Certain customer functions, such as the investment adviser function, are also controlled functions. The FSA’s Supervision Manual notes that on-site inspection is one of the tools that may be used to monitor whether a firm, once authorized, remains in compliance with regulatory requirements. The FSA also has rules in place relating to the internal handling of complaints, including the procedures which a firm must put in place; the time limits within which a firm must deal with a complaint; the records of a complaint which a firm must make and retain, and the requirements on a firm to report information about complaints to the FSA. Complaints that cannot be resolved between insurers and private customers can be referred to the Financial Services Ombudsman.
Assessment	Observed
Comments	The FSA requires supervised firms to have well-developed systems and controls in place to deal with issues relating to market conduct. The FSA follows up in an appropriate manner to ensure that firms are distributing their products appropriately and that customers are treated fairly.
Principle 12.	Financial Reporting It is important that insurance supervisors get the information they need to properly form an opinion on the financial strength of the operations of each insurance company in their jurisdiction. The information needed to carry out this review and analysis is obtained from the financial and statistical reports that are filed on a regular basis, supported by information obtained through special information requests, on-site inspections, and communication with actuaries and external auditors. A process should be established for: -setting the scope and frequency of reports requested and received from all companies licensed in the jurisdiction, including financial reports, statistical reports, actuarial reports, and other information; -setting the accounting requirements for the preparation of financial reports in the jurisdiction; -ensuring that external audits of insurance companies operating in the jurisdiction are acceptable; and -setting the standards for the establishment of technical provisions or policy and other liabilities to be included in the financial reports in the jurisdiction. In so doing, a distinction may be made: -between the standards that apply to reports and calculations prepared for disclosure to policyholders and investors, and those prepared for the insurance supervisor; and -between the financial reports and calculations prepared for companies incorporated in the jurisdiction, and branch operations of companies incorporated in another jurisdiction.
Description	The FSA’s rule-making powers under the FSMA enables the Authority to prescribe rules for financial reporting. Insurers are required to produce an annual return for the FSA in addition to their statutory accounts for shareholders or members. The outline contents of returns laid down in the rules are: profit and loss account, revenue account and balance sheet, together with notes, statements and reports and directors’ certificates annexed thereto; an abstract of the annual investigation of the appointed actuary; and an auditor’s report. The accounts and balance sheets of every insurer must be audited by a person qualified in accordance with rules set out in the FSA’s Handbook. Assets generally have to be valued at either net asset value or current market value, although there are some specific rules as to the valuation of individual assets, such as real estate. For both long-term and general insurance business the amount of the liabilities must be determined in accordance with generally accepted accounting concepts, bases, policies and other generally accepted methods appropriate to insurers. Long-term liabilities must be determined on the basis of actuarial principles having regard to the reasonable expectations of policyholders and relevant actuarial guidance and include proper provision for all liabilities using prudent assumptions that include appropriate margins for adverse deviation of the relevant factors. Companies carrying on life assurance business are required to conduct a periodic actuarial investigation by the appointed actuary. The appointed actuary must certify, amongst other things, that proper records have been kept, that proper provisions have been made, and that assets and liabilities have been assessed in accordance with the prescribed rules. Non-EEA insurers operating in the U.K. through a branch, are required to maintain both a U.K. and global solvency margin and report accordingly. The provisions of the EU Insurance Groups Directive, requiring amongst other things a parent undertaking a solvency margin calculation, have also been reflected in reporting requirements. Reporting of material connected-party transactions is required. The annual returns of insurers are entered into FSA’s database and various ratios generated, which might indicate if the insurer is running into financial difficulties or if its performance is deteriorating. The ratio analysis helps determine the priority for a more detailed desk analysis of the returns. Problems identified as a result of this analysis, and/or as a result of other information available to the supervisor, are discussed with the insurer’s management and appropriate action taken. The FSA has powers to require companies to report more frequently, or to accelerate reports. The annual return is available to the public, but the more frequent reports are usually confidential between the insurer and the FSA.
Assessment	Broadly Observed
Comments	This core principle is rated as Broadly Observed based on current practices, which need enhancing to cope with the rapidly changing risk profile in the industry; however, the proposed implementation of the risk-based methodology for insurance firms will move the rating to Observed. The risk level of the insurance industry is increasing due to pressure points from several fronts including on-going underwriting losses (non-life); reduced returns on investment activities coupled with high expense pressures; and the uncertainty of long-tail liabilities. Currently, firms are required to file regulatory returns annually and may still use a paper medium. Given the rapidity with which an insurance firm’s risk profile can change, a move towards quarterly reporting, at least for the higher priority firms, would significantly enhance a supervisor’s ability to closely monitor his or her assigned firm(s). Firms that fall under the purview of MFGD, particularly listed firms, should be encouraged to file their MIS reports prior to public release. To accommodate this increased information flow, FSA may need to review its financial reporting data base and systems capability. Furthermore, it is necessary to carry out a review of the nature of the existing data being received as some data may no longer be relevant. Consequently, changes to the regulatory returns may be required. Public disclosure of relevant information on a timely basis is one element of the three-pillar approach proposed by the Basel Committee for banking supervision, but is equally applicable to insurance firms. There is an increasing need for all firms to disclose more relevant information in their published financial reports. For example, there is need for firms to include more information on risk management practices, risk exposures and sources of gains and losses. In this connection, the FSA has an important role to play in encouraging firms to adopt more appropriate disclosure practices.
Principle 13.	On-Site Inspection The insurance supervisor should be able to: -carry out on-site inspections to review the business and affairs of the company, including the inspection of books, records, accounts, and other documents. This may be limited to the operation of the company in the jurisdiction or, subject to the agreement of the respective supervisors, include other jurisdictions in which the company operates; and -request and receive any information from companies licensed in its jurisdiction, whether this information be specific to a company or be requested of all companies.
Description	The FSA’s approach to supervision involves a risk assessment of firms, based on the extent to which they pose risks to the FSA’s regulatory objectives. The risk assessment process applies to all firms, although the detail required may vary from firm to firm, and is subject to continuing review. In the case of firms in which risks have been identified which could have a material bearing on the FSA meeting its regulatory objectives, the FSA will also outline a programme intended to address these risks. The FSA’s use of on-site inspection for prudential purposes in relation to insurers is considered against the background of other reporting requirements and controls. The FSA places considerable reliance on the validity of the information provided in the annual returns, and in particular sees no need routinely to duplicate the work of the auditor and appointed actuary. Onsite inspections have not been a regular feature of supervisory activities to date, particularly with respect to non-life insurance firms. Nevertheless, the figures provided are carefully analyzed off-site. In the case of life insurers especially, specialist actuarial analysis is undertaken. If it seems to the FSA that an auditor or actuary has not performed their role appropriately, the FSA has the authority to disqualify that auditor or actuary. The FSA also has the ability to request further information, as the need arises, for assessment off-site, or to require reports by skilled persons. The policy with regard to on-site inspections of insurance companies is currently evolving. The FSA has announced in its Plan and Budget its intention that risk specialists and supervisors will, in future, spend more time on-site at insurance firms – with a greater proportion of that time spent at higher impact firms, in line with the Authority’s risk-based approach to supervision. On-site inspection will address suspected areas of deficiency within an individual company or specific risk/risk management factors. It is not intended to inspect smaller, low risk insurers that represent a small minority of insurance business written in the U.K. on a routine basis. Smaller insurers may, however, be inspected as part of the FSA’s examination of particular supervisory themes. The purpose of these inspections will not be routinely to analyze all insurance companies on a rotational basis, or – when an on-site inspection is initiated - all of an individual company’s activities. The FSA’s risk based approach to supervision requires the Authority’s on-site inspections, as its other activities, to be appropriately targeted. The FSA does, however, have the authority to conduct a full on-site inspection covering the elements set out in the criterion. A full-scale on-site inspection would be undertaken if the risk assessment suggested that it would be the right thing to do. In respect of life insurers conducting investment business, appointed representatives and independent financial advisers, the FSA carries out on-site inspections to determine compliance with conduct of business rules. These inspections regularly focus on the sufficiency and adequacy of the information sought from, and given to, customers. It is also the FSA’s intention to use the information on complaints and enquiries provided by the Financial Services Ombudsman to identify potential problem areas for follow-up with regulated firms.
Assessment	Materially Non-Observed
Comments	While the FSA has full authority to carry out on-site supervision of supervised firms, on-site reviews are not routine. The FSA does conduct an on-site review when a firm comes under stress, or when prudential concerns arise. The review is tailor-made to fit company-specific circumstances. The FSA is currently undertaking a major review of its approach to insurance regulation, led by John Tiner (Managing Director, Consumer, Investment & Insurance Directorate). The review is not primarily about the legal powers that apply in this area, but concerns various practical aspects of supervision and the way in which the FSA exercises its powers. It is expected that the results will place greater emphasis on on-site inspection in assessing risk exposures. In order to comply with this CP, the FSA will also need to increase the resources and skill set of supervisors who are responsible for supervising the insurance industry. Core insurance expertise should be strengthened by including individuals with experience in reinsurance, risk management, actuarial science and long-tail, non-life claims. It is expected that the results of the Tiner project will address these issues.
Principle 14.	Sanctions Insurance supervisors must have the power to take remedial action where problems involving licensed companies are identified. The insurance supervisor must have a range of actions available in order to apply appropriate sanctions to problems encountered. The legislation should set out the powers available to the insurance supervisor and may include: -the power to restrict the business activities of a company, for example, by withholding approval for new activities or acquisitions; -the power to direct a company to stop practices that are unsafe or unsound, or to take action to remedy an unsafe or unsound business practice; and -the option to invoke other sanctions on a company or its business operation in the jurisdiction, for example, by revoking the license of a company or imposing remedial measures where a company violates the insurance laws of the jurisdiction.
Description	The FSA has powers under the FSMA to take remedial action against and/or impose penalties on insurers. depending on the severity of the situation. Examples of measures that the FSA can impose include fines, public censure, imposition of requirements or limitations on permission to carry on a regulated activity, and—in extreme cases—cancellation of a permission. Approval for new activities can also be withheld where appropriate. The Regulatory Decisions Committee, which is an FSA committee outside the FSA’s management structure, normally takes major regulatory decisions. The FSA can, where necessary, ensure that these actions have immediate effect. It also has criminal prosecution powers in certain circumstances (e.g., breaches of the money laundering regulations). Additionally, the FSA can withdraw an individual’s approval to perform controlled functions, if it considers that the person in respect of whom approval was given is not a fit and proper person to perform the function to which the approval relates.
Assessment	Observed
Comments	The FSA has powers under the FSMA to require firms to take remedial action when threats to the solvency of the institutions are noted. Although there are well developed processes within the FSA for dealing with firms when prudential concerns are noted, firms which are placed on a watch list are not formally notified when such action is taken.
Principle 15.	Cross-Border Business Operations Insurance companies are becoming increasingly international in scope, establishing branches and subsidiaries outside their home jurisdiction, and sometimes conducting cross-border business on a services basis only. The insurance supervisor should ensure that: -no foreign insurance establishment escapes supervision; -all insurance establishments of international insurance groups and international insurers are subject to effective supervision; -the creation of a cross-border insurance establishment is subject to consultation between host and home supervisors; and -foreign insurers providing insurance cover on a cross-border services basis are subject to effective supervision.
Description	The FSMA includes a general prohibition on carrying on regulated activities in the U.K. without authorization or specific exemption. An EEA insurer subject to prudential supervision in its home state may operate in the U.K. via a branch or on a cross-border services basis, subject to a notification procedure. With this exception, the FSA has sole responsibility for authorizing and supervising foreign insurers wishing to carry on insurance business in the United Kingdom, including U.K. subsidiaries of foreign companies, joint ventures with one or more foreign parents, and branches of companies with a head office outside the EEA (subject to the possibility of limited lead supervision by one Member State of branches situated in more than one EEA state, which is provided for by the EC Directives). The FSA has a duty to take such steps as it considers appropriate to co-operate with other regulators. In considering an application for authorization, the FSA may discuss the application with other regulators as appropriate. In the case of branches, where an applicant has its principal place of business in a country or territory outside the EEA, the FSA will, in assessing an application for Part IV permission, have regard to the applicant as a whole and not just the proposed U.K. branch. As part of the process the FSA may, if reasonable in the circumstances, take into consideration information supplied by the relevant overseas regulator in that country or territory. The promotion of contracts of life insurance in the U.K. by non-EEA companies not authorized in the U.K. is not normally permitted where the rights under the contract constitute an investment. The exception is where the company is established in a designated territory affording adequate protection to policyholders and potential policyholders against the risk that the company may be unable to meet its liabilities. The promotion of non-life contracts on a cross-border basis is permitted, subject to disclosure requirements that apply other than in respect of large risks and reinsurance.
Assessment	Observed
Comments	The FSA has well-developed systems and controls in place to ensure that no firms escapes supervision. In carrying out this responsibility, it seeks to co-operate with other regulators as necessary.
Principle 16.	Coordination and Cooperation Increasingly, insurance supervisors liaise with each other to ensure that each is aware of the other’s concerns with respect to an insurance company that operates in more than one jurisdiction, either directly or through a separate corporate entity. In order to share relevant information with other insurance supervisors, adequate and effective communication should be developed and maintained. In developing or implementing a regulatory framework, consideration should be given to whether the insurance supervisor: -is able to enter into an agreement or understanding with any other supervisor both in other jurisdictions and in other sectors of the industry (i.e., insurance, banking, or securities) to share information or otherwise work together; -is permitted to share information, or otherwise work together, with an insurance supervisor in another jurisdiction. This may be limited to insurance supervisors who have agreed, and are legally able, to treat the information as confidential; -should be informed of findings of investigations where power to investigate fraud, money laundering, and other such activities rests with a body other than the insurance supervisor; and -is permitted to set out the types of information and the basis on which information obtained by the insurance supervisor may be shared.
Description	The FSA’s legislation permits the disclosure of information for the purpose of enabling or assisting an authority in a country or territory outside the U.K. to exercise functions corresponding to those of the FSA under the FSMA, in effect to other supervisors of insurance, banking and investment business, subject to equivalent professional secrecy/confidentiality requirements being in place. Procedures relating to the collaboration of the insurance supervisory authorities in the EEA, in particular in the application of the EC Directives on life assurance and non-life insurance, are contained in a specific Protocol agreed between the authorities. This includes provisions on the exchange of information. A further Protocol covers collaboration and information exchange in respect to the supervision of insurance groups. The FSA has to date had little experience of regular liaison and co-operation with insurance supervisory authorities outside the EEA. The contacts that have taken place have in most cases been in response to particular problems that have arisen. This situation is expected to change with the emergence of insurance groups and conglomerates. The enhancement of information exchange is being actively pursued. There are agreed guidelines in place between the FSA and key criminal investigators and prosecutors in the U.K. (Serious Fraud Office, Department of Trade and Industry, Criminal Prosecution Service, Policy and their Scottish/Northern Irish counterparts). These guidelines provide that the parties should alert each other to cases of mutual interest and that they should communicate with each other when initiating investigations and proceedings. In addition, the guidelines provide that it is best practice for agencies to notify each other on the outcome of investigations or proceedings.
Assessment	Observed
Comments	The FSA maintains close relations with overseas financial supervisors. The Authority is able to exchange information with the competent authorities in other EEA Member States relatively freely, and may conclude co-operation agreements providing for the exchange of information with competent authorities of other countries if the information disclosed is subject to equivalent guarantees of professional secrecy.
Principle 17.	Confidentiality All insurance supervisors should be subject to professional secrecy constraints in respect of information obtained in the course of their activities, including during the conduct of on-site inspections. The insurance supervisor is required to hold confidential any information received from other insurance supervisors, except where constrained by law or in situations where the insurance supervisor who provided the information provides authorization for its release. Jurisdictions whose confidentiality requirements continue to constrain or prevent the sharing of information for supervisory purposes with insurance supervisors in other jurisdictions, and jurisdictions where information received from another insurance supervisor cannot be kept confidential, are urged to review their requirements.
Description	The FSMA contains general restrictions on disclosure of information, which would apply to information received from another supervisory authority. Gateways provided for in the regulations under the Act allow the FSA to pass confidential information to other supervisors or law enforcement bodies in specified circumstances. The confidentiality requirements are not overridden by freedom of information provisions.
Assessment	Observed
Comments	The treatment of confidential information is tightly controlled and well managed by the FSA.

Topics

Countries

Series

About

Resources

Abstract

I. Basel Core Principles for Effective Banking Supervision

A. General

B. Information and Methodology Used for the Assessment

C. Institutional and Macroprudential Setting—Overview

D. General Preconditions for Effective Banking Supervision

E. Recommended Action Plan and Authorities’ Response to the Assessment

Recommended action plan

Authorities’ response to the assessment

II. IAIS Insurance Core Principles

A. General

B. Information and Methodology Used for Assessment

C. Institutional and Macroprudential Setting—Overview

D. General Preconditions for Effective Insurance Supervision

E. Principle-by-Principle Assessment

F. Recommended Action Plan and Authorities’ Response to the Assessment

Recommended action plan

Authorities’ response to the assessment

III. IOSCO Objectives and Principles of Securities Regulation

A. General

B. Information and Methodology used for Assessment

C. Institutional and Macroprudential Setting, Market Structure

D. General Preconditions for Effective Securities Regulation

E. Principle-by-Principle Assessment

F. Recommended Actions and Authorities’ Response to the Assessment

G. Authorities’ Response

IV. CPSS Core Principles for SIPS and Central Bank Responsibilities in Applying the CPs—NewCHAPS

A. General

The payment infrastructure in the United Kingdom

B. The Functioning of the NewCHAPS System

Statistical information regarding volumes and values of transactions

General preconditions for effective payment systems

Changes and reforms in process

C. Main Findings—Summary

D. Recommended Actions and Authorities’ Response to the Assessment

Recommended actions

E. Authorities’ Response

V. IMF’s MFP Transparency Code-Transparency of Monetary Policy

A. General

B. Information and Methodology Used for Assessment

C. Institutional and Market Structure—Overview

D. Practice-by-Practice Assessment

General comments

Section 1: Clarity of Roles, Responsibilities, and Objectives

Section 2: Open Process for Formulating and Reporting Monetary Policy Decisions

Section 3: Public Availability of Information on Monetary Policy

Section 4: Accountability and Assurances of Integrity by the Central Bank

E. Recommended Action Plan and Authorities’ Response to the Assessment

Recommended action plan

Authorities’ response

VI. IMF’s MFP Transparency Code—Transparency of Payment Systems Oversight and Other Financial Stability functions of the Bank of England

A. General

B. Information and Methodology Used for the Assessment

C. Institutional and Market Structure—Overview

D. Practice-by-Practice Assessment

General comments

Section 5: Clarity of Roles, Responsibilities, and Objectives

Section 6: Open process for Formulating and Reporting of Financial Policies

Section 7: Public Availability of Information on Financial Policies

Section 8: Accountability and Assurances of Integrity

Detailed assessment

E. Recommended Action Plan and Authorities’ Response to the Assessment

Recommended action plan

Authorities’ response

VII. MFP Transparency Code—Transparency of Financial Policies (Financial Services Authority)

A. General

B. Information and Methodology Used for Assessment

C. Institutional and Market Structure—Overview

D. Practice-by-Practice Assessment

General comments

Section 5: Clarity of Roles, Responsibilities, and Objectives

Section 6: Open Process for Formulating and Reporting of Financial Policies

Section 7: Public Availability of Information on Financial Policies

Section 8: Accountability and Assurances of Integrity by Financial Agencies

E. Recommended Action Plan and Authorities’ Response to the Assessment

IX. Assessment of Anti-Money Laundering and Combating the Financing of Terrorism²²