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

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.

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

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Table 2.

Summary Compliance of the Basel Core Principles

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C: Compliant.

LC: Largely compliant.

MNC: Materially non-compliant.

NC: Non-compliant.

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

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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)

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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

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Source: ABI 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 6.

Holdings of U.K. Securities 1998

(% of outstanding value)

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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

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Table 8.

Summary Observance of IAIS Insurance Core Principles

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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

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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

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Table 11.

Summary Observance of the IOSCO Objectives and Principles of Securities Regulation

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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.

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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):

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Average transaction values (£):

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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:

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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):

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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

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Table 13.

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

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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

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Table 15.

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

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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

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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.

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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

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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

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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)

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Table 21.

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

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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

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F. Recommendation-by-Recommendation Assessment

Table 23.

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

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Table 24.

Recommended Actions to Improve Observance of CPSS/IOSCO—CREST

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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

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H. Recommendation-by-recommendation assessment

Table 26.

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

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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

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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

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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

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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

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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

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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

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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?

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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

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Table 35.

Summary of Effectiveness of AML/CFT Efforts for Each Heading

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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

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Authorities’ response to the assessment

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

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

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

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

  • On scope of the criminal offence of ML, the definitions of money laundering under the 1993 Money Laundering Regulations will be updated when the Regulations are revised in June 2003, to implement the 2nd EU Money Laundering Directive. The U.K. authorities note that the current technical deficiencies in the definition have no practical effect on the ability to detect and prosecute money laundering.

  • On provisional measures and confiscation, the referenced provisions will be made effective in the early months of 2003.

  • On general role of financial system in combating ML, consideration will be given to the proposal here, but the U.K. authorities are not convinced, at present, that this would be proportionate to the money laundering risk in this sector.

  • On customer identification and record-keeping rules, consideration will be given to all the suggestions. The basis will be whether they can be justified on cost-benefit principles given the extent of the vulnerability in these areas. Several of these proposals have been examined before and rejected because they have not been regarded as proportionate to the risk e.g. the risk of money laundering through general insurance business is generally acknowledged to be low. However, all these issues are kept under review.

  • On increased diligence of financial institutions, the PCA 2002 provisions governing suspicious transaction reporting will be implemented on 24 February 2003. Consideration will be given to the suggestions on suspicious transaction reporting and monitoring of accounts and transactions, applying the risk-based criteria discussed above.

  • On implementation & role of regulatory and other administrative authorities, the recommendations will be considered, applying the risk-based criteria discussed above.

  • On other forms of cooperation, legislation is currently before Parliament to do this.

  • On wire transfers, the U.K. will legislate to do this when the FATF Interpretative Note clarifying some details has been adopted by the FATF.

  • On law enforcement and prosecution, the proposal for a national law enforcement organization raises issues that go well beyond the investigation of and collection of intelligence about money laundering. It would also require new legislation and fundamental changes in policing and intelligence collection. The assessors’ comments are a valuable contribution to that wider discussion. With respect to wire-tapping legislation, there are good arguments for and against this suggestion which has been considered in the past and is kept under review. With respect to the proposed trend analysis and vulnerability study, NCIS is planning to conduct further analysis along those lines with contributions from partner agencies. On training of prosecutors and judges, such training programs are currently being arranged following the passage of the PCA 2002 and the new legislative provisions in these areas.

1

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’.

2

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.

3

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.

4

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

5

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.

6

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.

7

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

8

CHAPS is an acronym for Clearing House Automated Payment System.

9

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

10

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.

11

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”.

12

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

13

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.

14

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

15

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

16

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.

17

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

18

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

19

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

20

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.

21

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).

22

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

23

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.

24

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.

25

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

26

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.

27

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.

28

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

29

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