Jersey
Financial Sector Assessment Program Update: Financial System Stability Assessment

This paper examines the Financial System Stability Assessment on Jersey. Most banks in Jersey are branches or subsidiaries of large international groups, to which they provide financing. This close relationship reduces risk in normal times, given the groups’ ability to support their Jersey operations. The Jersey Financial Services Commission has significantly reformed the regulatory framework of funds, mainly to make Jersey funds more attractive to institutional investors. A key challenge in insurance supervision is to maintain effective and proportionate regulation of a small sector with limited insurance risk.

Abstract

This paper examines the Financial System Stability Assessment on Jersey. Most banks in Jersey are branches or subsidiaries of large international groups, to which they provide financing. This close relationship reduces risk in normal times, given the groups’ ability to support their Jersey operations. The Jersey Financial Services Commission has significantly reformed the regulatory framework of funds, mainly to make Jersey funds more attractive to institutional investors. A key challenge in insurance supervision is to maintain effective and proportionate regulation of a small sector with limited insurance risk.

I. Introduction

A. Purpose of the FSAP Update

1. The on-going refinement of the Jersey regulatory framework and the growth in the financial sector warrant an update of the assessment that was conducted in 2002 under the Fund’s OFC program and finalized in 2003. Furthermore, the integration of the OFC program into the FSAP (see BUFF/08/78, 06/04/08) has widened the scope of the assessment to include stability-related issues. This report, therefore, covers both the regulatory and supervisory system and matters relating to the soundness of the financial system and its ability to cope with stress. The assessment is based on information available at the time of the November 2008 mission, updated to reflect documented regulatory and economic developments since then.

B. Context

2. Jersey is one of the three British Crown Dependencies, the others being Guernsey and the Isle of Man (IOM). It is not part of the United Kingdom (UK) and has its own parliament (the States), legal and regulatory system, and tax regime. However, its economy is highly oriented toward that of the UK and uses the pound Sterling as its currency. Jersey is in a customs union with the European Union (EU) for trade in goods.

3. Jersey’s economy, which is dominated by financial services, is expected to suffer a slowdown in the context of global financial turmoil and the slowing of the British economy.1 The basis of the economy is the financial sector. The main activities are banking, fund management, and fiduciary services. The sector contributes over half of gross value added (GVA).2

4. Banking is the dominant component of the financial sector (Table 1). Banks’ principal business is the collection of retail deposits from overseas and from trusts managed on the island (Tables 2-4). These funds are mainly placed with parent banks. Many banks also offer fund management and fiduciary services. Banks have limited real estate exposure and most do not operate trading books or independent treasury functions (Table 5).

Table 1.

Jersey: Financial System Structure, 2003-2008

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Source: Jersey Financial Services Commission.

In GBP millions. Figures for Gross Value Added presented, since this is considered to be the best measure of economic activity in Jersey.

Table 2.

Jersey: Balance Sheet of Banking System, end-2008

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Sources: JFSC, and staff estimates.
Table 3.

Jersey: Structure of Total Deposits, By Region

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Source: JFSC.
Table 4.

Jersey: Structure of Deposits, by Size and Residence 1/

(end-October 2008)

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Sources: JFSC, and staff estimates.

Based on a 2008 partial survey covering only accounts of individuals.

Table 5.

Jersey: Structure of Non-Interbank Loans, by Type

(end-June, 2008)

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Sources: JFSC, and staff estimates.

5. Fund management and associated services are the other main component of the financial sector, while the insurance sector is small. The numbers of CISs and the value of their assets have been growing strongly in the past decade. The sector is increasingly dominated by schemes aimed at institutional and high net worth individuals, many of them specialist funds such as hedge fund/alternative investments. Fund services, such as management and administration, are offered by many groups. Numerous trust and company service providers operate on the island. Jersey hosts a small but diverse group of SPVs and a few Structured Investment Vehicles (SIVs) used, for example, for securitization purposes. There are only 14 insurance companies firms incorporated on the island, although many more firms incorporated overseas are licensed to write Jersey business. A wide range of legal and accountancy services are available in the island.

II. Regulatory and Supervisory System

6. The 2003 OFC assessment noted that Jersey’s financial regulatory and supervisory system complies well with international standards. The JFSC was assessed to have made progress in international standards for banking, insurance, securities, and AML/CFT. The framework for trust and company service provider regulation was largely consistent with international best practice. In addition to several specific recommendations in relation to individual principles, the assessment emphasized as areas for improvement:

  • (i) Enhancing the independence of the JFSC.

  • (ii) Increasing its resources and improving its processes, especially with respect to on-site supervision.

  • (iii) Formalizing supervisory guidance for credit policies, loan evaluation, and loan-loss provisioning.

  • (iv) Introducing prudential requirements for market risk.

7. Since 2003, the authorities have made considerable efforts to enhance regulation and supervision, in particular through more on-site supervision (see below, Appendix II, and the Annex with ROSCs). The JFSC has become more risk-oriented, for example in its use of a risk model for assessing regulated firms, and conducts extensive on- and off-site supervision across the financial sector. Legislation has been updated and initial steps taken toward the long-term objective of a single legislative framework applying to all sectors. Regulatory principles have been elucidated in new codes of practice and regulations.

A. Institutional Structure

8. The JFSC, as the integrated regulator, has as its main responsibility the supervision and development of financial services on the island. In exercising its functions, the JFSC must have regard to reducing the risk to the public of financial loss due to the dishonesty, incompetence or malpractice by or the financial unsoundness of financial institutions; protecting and enhancing the island’s reputation and integrity; protecting the best economic interests of Jersey; and countering financial crime. The JFSC also operates the companies registry, and has certain related functions, such as advising the government on financial sector matters. The responsibility for both supervision and development could lead to conflicting objectives, although the authorities haves publicly recognized that stability is a precondition for attaining the other objectives. Nonetheless, an explicit ranking, giving highest priority to financial stability, might facilitate consistent policy-making and accountability.

9. The JFSC enjoys considerable independence, and is subject to suitable accountability provisions. The foundation of this independence is the clear statement in law of the JFSC’s responsibilities. Moreover, commissioners cannot be dismissed without good cause; the JFSC approves (and if need be terminates) the appointment of a Director General. However, the government may give the JFSC “guidance” or “general direction.” A memorandum of understanding (MOU) between the JFSC and the responsible minister has clarified that the minister would exercise this power to guide or direct only in exceptional circumstances where it believed that the well-being of the island is at stake, and with respect to general policy, not individual cases. Any “direction” would have to be explained to the States and the public. The minister has never exercised this power. Hence, this legal possibility does not seem to limit independence in practice. Accountability provisions include a requirement to publish annual reports, regular meetings with the government and the States and a practice of consulting widely when formulating policy.

10. The JFSC now sets the detailed regulatory framework for the financial sector largely through codes of practice. The JFSC has wide scope to obtain information, especially from supervised entities, and arrangements are in place to share that information with other domestic and overseas authorities, subject to assurances on the maintenance of confidentiality.

11. Concerning enforcement, the JFSC has numerous and effective powers, although the scope for imposing fines is limited. The JFSC can issue binding directions, publish warnings and advice, appoint managers or co-signatories when management has been demonstrably inadequate, revoke licenses, or request that a court start bankruptcy or winding-up proceedings. Fines can be imposed by the JFSC mostly for administrative matters, such as late submission of supervisory returns; and the court may impose fines on regulated firms that commit a criminal offence such as providing misleading information. While the JFSC can and does use other means to enforce compliant behavior, the restricted availability of fines as a sanction mechanism limits possible responses to misconduct. It may be useful to have in addition a fining power to ensure that breach of JFSC regulations is damaging not only to a regulated firm’s reputation, but also to the profitability of the activities in question. The JFSC and its staff enjoy legal protection.

12. The authorities cooperate pro-actively with the home supervisors of foreign institutions. Numerous MOUs with supervisors abroad have been signed to address both ongoing supervision and information exchange. Relevant information is in fact exchanged, and regular visits to and from home supervisors are undertaken, including for on-site supervision. In the current financial turmoil, the authorities have found themselves able to communicate effectively with relevant home authorities, although the initiative generally has come from Jersey.

13. The JFSC appears to be adequately resourced, although some technical skills are limited. It is funded by fees payable by the industry, which it adjusts periodically such that fees from a particular sector substantively cover the costs of regulating that sector plus a share of the JFSC’s overheads. Fee levels appear reasonable and have allowed the JFSC to build a reserve to deal with contingencies, such as exceptional legal fees. The JFSC currently has over 100 staff, representing an increase of about 40 over the last five years. Most work in regulatory and supervisory functions. However, it can be difficult to retain good staff, and expertise in some areas (such as the assessment of risk models) is in short supply. Representatives from the regulated sector generally felt that the JFSC functions with rigor and expertise; it consults with the industry but is viewed as not beholden to it.

14. The JFSC will be challenged to react to the changes in supervisory standards coming out of the global financial turmoil, and implement them proportionately to the risks on the island. Especially relevant may be changes to standards on bank liquidity management and capitalization requirements, and an expansion of the regulatory perimeter, which may affect the CIS and companies registry sectors.

B. Banking Sector

15. The BCP assessment undertaken by the mission confirms the high standard of prudential regulation and supervision described in the 2003 assessment, and issues identified at that time have largely been addressed. Most importantly, the JFSC now conducts a large program of on-site supervision, supported by off-site analysis. The JFSC follows up on visits with detailed recommendations. In addition, a framework of minimum prudential standards is provided by the Banking Business (Jersey) Law 1991 and other legislation.

16. Pillars 1 and 2 of the Basel II capital requirements were introduced in 2008. Most banks adopt the standardized approaches. The JFSC has set a minimum risk-weighted capital adequacy requirement (CAR) of 10 percent, and in some cases banks have additional capital requirements under Pillar 2. Moreover, if a bank’s capital approaches the minimum, consultations on remedial action are triggered. The JFSC has reviewed banks’ Internal Capital Adequacy Assessment Processes (ICAAP). Since banks’ internal models are complex and evolving rapidly, the JFSC will need to take care to ensure that it maintains up-to-date expertise in this area.

17. The authorities complement regulation and supervision by an express policy of limiting entry to banks with strong parents. Only groups that are among the global top 500 in terms of Tier I capital and meet certain other requirements are permitted to open on the island. These banks are presumed able and willing to provide their Jersey affiliates with support in case of local difficulties, and are likely to be viewed as too big to fail in their home jurisdictions. Furthermore, these banks tend to have centralized risk management and internal controls procedures, which are imposed on their Jersey affiliates, as well as central treasury, trading and risk modeling functions, so Jersey operations are relatively straightforward.

18. Banks’ intra-group claims on their parents represent the major risk to the system (see below). However, The JFSC exempts these claims from limits on exposures to related parties and large exposures. Specifically, inter-group exposures with a maturity of one year or less are exempted from risk concentration provisions. Jersey banks are highly vulnerable to concentration risk with respect to their groups. Recent experience has demonstrated that even the largest banks can come under extreme stress, in which eventuality a Jersey affiliate could lose access to almost all of its assets, at least temporarily. If a parent is suspected to be in difficulties, the JFSC may attempt to require the Jersey subsidiary to move assets elsewhere, as would be consistent with the duties of the subsidiary’s management, but such action may be damaging to the parent, to the home country authorities, and ultimately to Jersey banks’ business model.3 While some flexibility is required for banks to fulfill their business model of “upstreaming” deposits, a permanent and blanket exemption from single counterparty limits is inconsistent with the BCP, which requires setting a prudent limit.

19. While this conundrum cannot be fully resolved, it is recommended that the authorities make the exemptions less automatic. The JFSC could confirm on a regular basis that the parent continues to have the will and capacity to support its subsidiary, and try to ensure that local banks develop more autonomous risk management capacity. In addition, the JFSC could seek more frequent updates from home supervisors of their assessment of group soundness.4 This approach would recognize that the full development of local treasury and risk management capacity would be uneconomic and bring with it other risks, such as operational risk.

20. The supervision of credit other than to parent groups is adequate but should not be neglected. Such credits form a small portion of most banks’ assets, but the exposure is significant in percent of GVA, and in current circumstances vulnerabilities might be emerge suddenly. The JFSC relies largely on banks’ internal controls and auditors to ensure adequate loan classification and provisioning, but it does not engage in intensive dialogue with auditors on individual banks. More frequent discussions between supervisors and auditors on individual banks would give the JFSC access to an important information source.

21. The JFSC should develop more capacity to assess overall financial sector stability and banks’ risk models. The JFSC could engage in more discussions with banks’ risk managers and modelers, and foreign supervisors, if it had more ability to quantify risks and simulate scenarios, including scenarios that allow for comparisons of vulnerability across banks. In this connection, the JFSC should consider publishing more statistics on banks and other financial institutions, such as aggregate balance sheets and the mean and distribution of FSIs. Publishing these indicators would further contribute to Jersey’s reputation for stability and transparency, and facilitate peer group comparisons. In addition, the authorities could usefully gather more comprehensive information on the overall indebtedness of Jersey households and the corporate sector by accounting for credit from abroad and from local non-bank lenders. This will help banks and the authorities better assess borrowers’ ability to absorb shocks, and the possible spillover effects to the rest of the economy in the event of a credit crunch.

22. Jersey could benefit from an enhanced framework for macroprudential analysis and decision taking. With no central bank, there is no authority with an explicit mandate to maintain overall financial stability. Creating a more formal framework for addressing macroprudential issues could enhance the authorities’ ability to identify potential problems and take appropriate action. Issues which could be considered include information gaps, for example on the total indebtedness of the domestic economy, stress testing, and contingency planning.

C. Investment Business

23. The JFSC has significantly reformed the regulation of funds and funds services business, mainly to make Jersey funds more attractive to institutional investors. Since the 2003 OFC assessment, Jersey has been developing the funds regulatory framework to make it more accommodating to funds aimed at institutional and larger private investors; the authorities consider these to be outside the scope of IOSCO principles relating to CISs. The “expert funds”, for investors with $1 million in net worth or making a minimum $100,000 investment, have proved particularly popular. Regulation of such funds is light. This is also the case for funds that are offered to fewer than 50 investors, which are not regulated under the Collective Investment Funds (Jersey) Law 1988 (CIF Law) but instead under the Control of Borrowing (Jersey) Law 1947 (this simply requires the JFSC’s consent). Specialist funds are generally permitted unlimited leverage, subject to disclosure of their approach in offer documents and to the approval of the JFSC where leverage in excess of 200 percent of net asset value (NAV) is proposed. Since February 2008, legislation has been further amended, at the request of the industry, to allow for “Unregulated Funds” which require only notification to the JFSC. They have a minimum initial investment (except where exchange listed) of $1 million, and a risk warning waiver is required from each investor to ensure that the product is restricted to its target market. Twenty nine had been registered at the time of the FSAP discussions.5

24. Parallel to this reform of funds, the JFSC has reformed the regulation of fund services providers. Until November 2007, managers, administrators, advisers, custodians, and registrars had to be authorized by the JFSC separately for each fund. Now, they can seek a general authorization, under the Financial Services (Jersey) Law 1998 rather than under the CIF Law, to provide services to any fund—including the new unregulated funds (but excluding funds eligible for sale in the UK, where the previous approach remains). Fund service business can also be done through a managed entity, that is, a company whose business in Jersey is managed by another registered fund service provider. All these reforms were aimed at reducing the regulatory burden on fund service providers when creating a CIS, thereby allowing the JFSC to divert resources to supervision of those fund service providers.

25. The JFSC has significantly strengthened the supervision of fund service providers. Codes of Practice for Fund Services Business have been introduced setting out the JFSC’s expectations in respect of issues such as corporate governance and financial resources. Fund services businesses are now subject to the JFSC’s risk assessment model and to on-site visits. The JFSC has put particular emphasis in this sector on “themed” visits—for example, a 2007 program looking at compliance with the requirements for expert funds. One effect has been to align funds services regulation more closely to that of other investment services business, which is often undertaken by the same companies or groups. As the authorities recognize, continued strict supervision of service providers is necessary to offset the potential reputational risks attached to the light regulation of certain categories of funds.

26. Jersey has continued to maintain a cooperative relationship with regulatory authorities for investment business overseas. Jersey was an early signatory of the IOSCO Multilateral MOU. It exchanges information regularly with other regulators over the regulatory status of the owners of fund services business in Jersey. It responds to requests for cooperation (including on average 10 enforcement-related requests a year, across all its responsibilities, most from European and U.S. regulators) where an overseas regulator is undertaking an investigation or has other reasons to require information about a Jersey fund or fund services business.

27. The JFSC has substantially implemented the recommendations of the 2003 OFC assessment of the IOSCO Objectives and Principles of Securities Regulation. Most significantly, Codes of Practice for Fund Service Business have been completed—and Codes of Practice for Certified Funds themselves are in preparation, which will help with transparency issues, for example, by reducing deadlines for filing financial statements. Suitability of advice issues have been addressed through supervisory work and “mystery shopping” exercises. Advertising requirements have been strengthened. While compliance with IOSCO Principles was not assessed as part of the FSAP Update, it is evident that the regulation of investment business, particularly funds business, has been significantly strengthened since 2003. Going beyond the IOSCO Principles, it would be useful to gather information on the gross balance sheet size and leverage of funds (and other investment vehicles).

D. Insurance Sector

28. Insurance regulation has been strengthened since the 2003 assessment. While the sector has been contracting in this period, the JFSC has expanded supervisory resources, applied its general risk assessment model, and undertaken on-site visits to all insurers. To maximize resources, some thematic work is outsourced, typically to international audit firms. Extensive codes of practice have been introduced. One effect has been to align insurance regulation more closely to that of other sectors.

29. A key challenge going forward is to maintain effective and proportionate regulation of a small sector with limited insurance risk. With some companies scheduled to close or relocate, and with other centers now likely to attract new international business, the outlook is for further contraction in Jersey. The costs of developing a modern regulatory regime may be disproportionate to the benefits. A better approach, which the JFSC is already adopting with success, is to tailor requirements to the risk profile of each remaining insurance business. It now needs to take the approach further in some areas such as the regulation of closed life insurance funds.

30. There are also some gaps in the regulatory framework, which should be filled as opportunities arise. Exemptions to the Insurance Business (Jersey) Law 1996 should be narrowed to bring under the JFSC’s regulation, one significant domestic insurer currently subject to a separate statute. New requirements should be introduced in relation to controllers of insurers, risk management (especially operational risk), and groups (though the JFSC has no insurance group responsibilities at present, additional powers to gather information from group companies and a group solvency test could prove valuable in future). The JFSC would benefit from a review of the regime for companies incorporated abroad. This has served Jersey-based insurance consumers well. But the JFSC should ensure that it has a framework for assessing where home state regulation is equivalent to its own approach and should ensure that it is applying appropriate regulation to the small number of companies operating as branches in Jersey rather than merely offering cross-border services.

E. Trust and Company Service Providers

31. The trust and company service business sector enjoys a comprehensive regulatory and supervisory framework. Already in the 2003 OFC assessment, Jersey’s regulatory and supervisory framework for such business was found to be consistent with all of the practices set out in the Offshore Group of Banking Supervisors (OGBS) Statement of Best Practices. Since then, the States have amended the Trust (Jersey) Law 1984 in October 2006, and the JFSC refined the Codes of Practices for Trust Company Business, most recently in January 2008, in line with the recommendations of the assessment, to further enhance implementation of international standards. In particular, the JFSC completed the transitional licensing process following the introduction of the regulatory regime in 2000, extended regulatory sanctions and powers to all key persons of registered persons, beyond “principal persons,” and introduced explicit record keeping requirements.6

32. The JFSC supervises the trust and company business (TCB) sector on an ongoing basis, with regular follow-ups. The JFSC conducted over 70 on-site examinations in 2007 and has completed over 50 at end-October 2008. Examinations vary in scope (they can be focused, themed, or narrow) and in coverage (i.e., they can review aspects of AML/CFT, conduct of business, liquidity, corporate governance, risk management processes). Typically, businesses are reviewed under a three-year cycle, although the JFSC will determine a risk-based priority list. Shortcomings found during on-site inspections related mostly to corporate governance issues and, to a more limited extent, liquidity requirements.

33. The implementation of the regulatory regime has been a catalyst for sectoral consolidation over the last five years. There has also been a trend toward outsourcing back-office functions to cheaper centers. The new Foundations (Jersey) Law allows trust companies to expand their range of services.

F. Others

34. The SPVs registered on the island are normally organized as companies established by trusts. SPVs are registered as public companies, and are therefore subject to relevant regulation (for example, on disclosing financial results) under the Companies (Jersey) Law 1991 (Companies Law), but not supervision. Institutions associated with the SPVs, such as trust service providers, are subject to oversight. The JFSC has sought to ensure that only reputable institutions sponsor the establishment of SPVs. However, little information on their activities is compiled. In recent years only a few score SPVs have been established annually, and only a handful have been used for securitization purposes or to finance relatively risky investments. Of the latter, several are being closed by investors and one is being liquidated following heavy losses. In current circumstances, the JFSC should survey SPVs and SIVs associated with the island in order to achieve a more detailed understanding of their activities.

35. Arrangements are being made to strengthen the oversight of audit work on the island. There is no official oversight of the quality of the audit work of Jersey companies, although auditors are subject to reviews by their relevant professional body such as the practice assurance review scheme operated by the Institute of Chartered Accountants in England and Wales. However, legislation to amend the Companies Law is being drafted that, in respect of companies whose shares are admitted to trading on a regulated market, will result in one or more professional bodies monitoring the quality of audit work and will enable action to be taken against auditors that breach rules on audits work carried out for those companies.

G. AML/CFT

36. The authorities have put in place a comprehensive and robust AML/CFT legal framework that incorporates almost all aspects of the FATF Recommendations. The key elements of this framework have been kept up-to-date, most substantially in the last two years in response to the 2003 revision of the FATF Recommendations and in parallel with moves by EU member states to implement the EU Third AML Directive. Substantial resources have been devoted to developing the latest AML/CFT laws and regulations, to consultations between public and private sector regarding implementation issues, and to testing industry compliance. This is evident across the financial institutions and particularly so with regard to trust company business.

37. Both money laundering (ML) and financing of terrorism (FT) are criminalized largely in line with the international standard and Jersey has implemented the provisions effectively. The JFCU receives a satisfactory flow of suspicious activity reports and carries out its role of a financial intelligence unit effectively.

38. The assessment confirms a high level of compliance by Jersey with the FATF Recommendations on preventive measures, with most deficiencies noted being technical in nature. The application of formal AML/CFT requirements to some categories of Designated Non-Financial Businesses and Professions (DNFBPs) had only recently taken effect at the time of the on-site visit—notably in the case of certain business of accountants and lawyers—and it was, therefore, not feasible to assess the effectiveness of the measures in place. One more material issue relates to the extent and manner of the concessions allowed to financial institutions and certain DNFBPs to rely on intermediaries and introducers to have conducted customer due diligence measures, which the assessment concludes does not comply fully with the international standard; the authorities have indicated that they do not agree with this finding.

39. Jersey has adopted a risk-based approach to AML/CFT at all levels, in determining the scope of the requirements, in designing implementation measures, and in supervision. AML/CFT policy is coordinated by an AML/CFT Strategy Group, comprising all relevant authorities, which focuses on identifying and responding to areas of vulnerability.

40. The Jersey authorities engage actively in international cooperation and are in a position to share information with counterparts, subject to appropriate safeguards. The legal framework for mutual legal assistance is in place and effective.

III. Stability Issues

A. Vulnerabilities of the Financial System

41. Overall, banks have a low risk profile, under the crucial provision that the health of their parent banks remains sound. Banks tend to have a simple balance sheet structure, and their primary role is to collect deposits and provide a stable source of liquidity to the group. Were the health of a group to deteriorate, local banks’ large intra-group exposures could destabilize the financial system. The authorities have made an explicit choice to admit only subsidiaries and branches of major banking groups from large jurisdictions. However, the global financial turmoil has shown that even these groups can suffer severe difficulties, and indeed their complexity and size can create little-understood risks and uncertainties. Furthermore, a group that is admitted because of its size and sophistication may change its characteristics. The authorities recognize this vulnerability.

42. Threats to Jersey’s reputation for probity and safety represent another significant potential vulnerability. As the authorities recognize, a major instance of malfeasance or mis-management, even in one of the smaller institutions such as a CIS or SPV, could provoke a sudden withdrawal of deposits. In such circumstances, banks would generally be able to meet claims by running down deposits with parent banks, but this could threaten the banks’ business model and impose a longer-term cost on the island.

43. Credit risk toward third parties is less important for banks, but should not be ignored since domestic resources are small.7 Almost 85 percent of banks’ non-interbank loans are to non-residents, and one quarter are mortgage-related, creating marked exposure to a global recession or further fall in housing prices. So far, the local economy has displayed stability, supported by a low level of domestic bank indebtedness by industrial country standards (domestic non-financial bank loans amounted to 95 percent of GVA at end-June 2008) and moderate domestic bank credit growth (13 percent on average for 2004-2007; Table 6).8

Table 6.

Jersey: Bank Credit Growth, 2004-08

(GBP millions unless indicated otherwise)

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Sources: JFSC, and staff estimates.

44. Other risk factors are less important for systemic soundness. The insurance and pension sectors are small. Risks in CISs are largely borne by investors who presumably acquired them willingly. There are some risks from mis-selling (though in international business, advice and distribution is mostly handled overseas) and particularly mismanagement—for example, operational risks for fund services providers and other fund managers, which tend to crystallize more often in falling markets when customers also have more cause to make complaints or even to bring legal action. Fund service providers are to an extent protected by capital requirements and professional indemnity insurance. The assets of trust and company service businesses are held off-balance sheet, and losses in this sector would not threaten the financial soundness of the Jersey financial system. It appears that SPVs on Jersey currently pose no direct risk to the financial system as a whole because risks are borne by investors or the sponsoring institutions, which are non-resident. However, if a highly leveraged SPV or fund were to fail, there may be a reputational effect.

45. Were these risks to materialize and result in major losses, there would be an adverse effect on the local economy. The financial sector is such an important component of the local economy that a downturn would have a major effect on employment and government revenue, with knock-on effects on other sectors. Moreover, a deterioration in the financial health of parent institutions could lead to a domestic credit squeeze, which would hurt the development of the local economy. There may also be feedback via the nonbank lending companies that operate on the island and foreign indebtedness (e.g., UK-based credit card debt) not captured in domestic statistics.

46. Strains in the financial sector would not in itself produce significant cross-border spillover effects, but Jersey may transmit international shocks. Any Jersey-specific shock would likely result in the rapid transfer of business to another international center, so the global effect on parent banks could be minimal. However, deposits in one Jersey bank currently fill 10 percent or more of the parent bank’s funding gap.9 Hence, worries about the parent could provoke a withdrawal of deposits from Jersey that would put further pressure on the parent’s liquidity position. Furthermore, negative shocks are likely to be correlated: a recession may strain the parent, making it less able to support its subsidiary at the same time as the subsidiary’s loan book deteriorates. Jersey may also be involved in the transmission of shocks through highly leveraged specialist investment funds and SPVs.

B. Performance and Stability Indicators

47. Banks enjoy high asset quality, profitability, and capitalization, but leverage is also high (Table 7). Asset quality and especially the quality of loans to the local economy has been satisfactory. Risk-weighted CARs are elevated in international comparison, driven largely by banks’ low risk-weighted assets, and the tendency to retain profits in a low tax jurisdiction. In contrast, the overall capital to asset ratio is about 2 percent; excluding branches, the ratio is 5.6 percent. Profitability has been comfortable, although this partly reflects transfer pricing arrangements with parent institutions.10

Table 7.

Jersey: Financial Soundness Indicators for the Banking Sector

(in percent)

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Source: Jersey Financial Services Commission.

Net interest income to interest bearing assets.

48. The banking sector as a whole exhibits ample liquidity given that claims on groups are mostly short term. Banks typically match the maturities (and currencies) of their deposits with those of their claims on parents.

49. The global financial turmoil has had some impact on Jersey’s financial institutions. Most banks have no significant exposure to the most affected asset classes, and the deposit-based nature of much of their funding has ensured stability. While some banks have enjoyed flight-to-quality deposit flows, the system as a whole lost 6 percent of its deposits by value in the year to March 2009 (principally during 2008Q2); certain individual banks suffered quite large deposit outflows. One bank, moreover, suffered significant losses on its investment portfolio. The CIS sector has seen moderate losses and outflows; while currency and other market price movements complicate the interpretation of aggregates, the total NAV of CIS declined by about 11 percent from December 2008 through March 2009, and the number of funds declined by about 2½ percent. Insurance companies are financially strong. Limited data are available on the financial soundness of other nonbank financial institutions (NBFIs) or the nonfinancial sector.

C. Stress Test Results

50. Stress tests highlight that, while the close linkages to large parent banks are a source of strength in the case of mild stress, they could create disastrous consequences in the event of extreme stress. Stress tests were performed to assess the resilience of banks to a variety of shocks. The methodologies and shocks were chosen in consultation between the JFSC and the FSAP team (Appendix III). The most material risk is counterparty risk with the parent (Table 8). A 10 percent loss on claims on parent banks would lead 14 banks to become insolvent. However, concentration risk and spillovers from parent banks are difficult to capture quantitatively. In reality, the banks’ sensitivity is more nuanced as the likelihood that a parent bank of a Jersey affiliate fails is small, as reflected in recent events.

Table 8.

Jersey: Stress Test Results: Market Risk and Credit Risk 1/

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Sources: Jersey Financial Services Commission and staff estimates.

Unweighted average across banks in sample.

Including Citibank, Standard Chartered, HSBC ME, all of which report in USD.

Asset valuation effect.

Instantaneous loss fully absorbed by capital (no impact on risk-weighted assets)

Excludes HSBC Middle East and Standard Chartered.

51. Credit risk remains a significant risk factor, although the tests confirmed banks’ overall resilience. For example, based on prudential data, a macroeconomic shock (such as a decline in GDP or higher interest rates) that leads to the default of 10 percent of banks’ (nonfinancial) credit outside of Jersey could reduce the system-wide CAR by 340 basis points (bps) to 12 percent. The default of banks’ three largest (nonparent) exposures would have an even larger impact, although this test does not capture the ample cash collateral and parental guarantees that cover such exposures.

52. Stress tests confirmed that the banking system exhibits considerable resilience against a range of large market risk shocks. This resilience is due largely to banks’ small position-taking and various group transfer pricing and other maturity and currency matching arrangements.11 The largest impact would be a two-notch downgrade on all marketable securities, which would lead to a breach at one bank and lead to a 50 bps reduction of the system-wide CAR.

53. Banks also exhibit ample liquidity buffers. A 20 percent daily withdrawal of deposits with maturity up to one month would lead 9 banks (accounting for 6 percent of total assets) to become illiquid after five days, assuming banks have access only to assets with maturity up to one month (excluding liquid marketable instruments) to fund the deposit run (Table 9).

Table 9.

Jersey. Stress Test Results: Liquidity Risk

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Sources: Jersey Financial Services Commission and staff estimates.

Total assets of illiquid banks in percetn of total assets of all banks.

Funding 20 percent of daily run on deposits with maturity up to one month with one-month liquidity.

Same as L1 shock but assuming no access to liquid marketable assets.

D. Safety Nets and Contingency Planning

54. Even a well-supervised jurisdiction with normally sound banks needs to consider how it would deal with a crisis. The current global financial turmoil is a reminder of the size, speed, and unpredictability of financial sector shocks.

Safety nets

55. The authorities are considering the introduction of a bank DCS. This initiative followed the announcement of broadened deposit insurance, investment business, and bank guarantees by several countries affected by the global turmoil. Currently Jersey has provisions in laws covering the banking, insurance, and CIS sectors for the possibility of ad hoc compensation or a formal scheme, but no formal schemes have been established except for one covering “recognized” CISs (i.e., those eligible to be marketed to retail investors in the UK and certain other countries). Because Jersey is in a monetary union with the UK, there is no central bank to act as a lender of last resort (LOLR).

56. Jersey should study the benefits and potential costs of a DCS very carefully. The strongest case can be made for a transparent scheme that concentrates on a limited coverage for Jersey residents. Such a scheme could perhaps be funded largely from a levy on resident deposits. Offering wider coverage may not be credible given the size of the financial sector relative to Jersey’s own resources. Experience suggests that a DCS is most valuable when payouts can be made rapidly, which requires schemes to have considerable borrowing capacity and/or be substantially pre-funded. Furthermore, practical aspects of a DCS can be demanding.

57. In any case, all depositors and other claimants must receive clear information on who is responsible for safeguarding their claims and the DCS coverage, if any. The JFSC should ensure that banks provide prominent explanations that uninsured deposits are currently the sole liability of the respective institution, and neither Jersey nor a home jurisdiction offers any insurance.

58. Similar arguments apply to investor or policyholder compensation schemes. Discretionary or case-by-case schemes, as provided for at present (together with the possibility of ex gratia payments from government) could bias investors’ expectations, weaken market discipline, and put government funds at risk. The authorities should review policy on investor and insurance policyholder compensation in the light of the decision on a DCS. There may also be a case for establishing a financial sector ombudsman to deal with consumer protection issues.

Contingency planning

59. The authorities have rightly recognized the need to plan for contingencies in the financial sector, and preparations have begun.12 The starting point for contingency planning should be a clear understanding of priorities among objectives. Objectives may include: (i) safeguarding the savings of Jersey residents; (ii) maintaining the availability of financial services and financing for the local economy; (iii) preserving Jersey’s competitiveness as a financial center and in particular its reputation for safety and evenhandedness; and (iv) limiting fiscal and other costs. These objectives go beyond the responsibilities of the JFSC and require close collaboration among the Jersey authorities. Also, certain constraints need to be taken into account, such as:

  • (i) The large exposure of local institutions to their parent, and their operational dependence for key activities.

  • (ii) The high probability that, should a parent get into difficulties, it would attempt to extract liquidity and capital from its subsidiaries and branches.

  • (iii) The absence of a LOLR capacity and relatively small fiscal resources.

  • (iv) The high probability that, in a crisis, home authorities will look mainly to minimizing the costs to their own tax-payers.

  • (v) The limited ability of the authorities to track developments in real time, for example, because they cannot monitor the payments system.

Intervention powers and resolution procedures

60. The JFSC has broadly adequate powers to direct, intervene in, and close a troubled financial institution, but on its own may lack sufficient information to identify incipient problems. Because the banks are dependent on their parents, the JFSC has to rely on parent supervisors to inform them about rising tensions and possible interventions. The response to tension should include measures to increase local information in real time, for example, requiring frequent (even daily) reporting by affected institutions.13

61. The JFSC must seek to enhance its relationship with relevant home authorities to help ensure that Jersey’s interests are given timely consideration in any intervention. The authorities should review the June 2008 EU MOU on financial crisis management and consider what elements might be introduced into the MOUs with home country authorities. Jersey might offer in return to participate cooperatively in intervention and resolution procedures, help limit reputational risks, and even engage in equitable burden sharing.

62. Experience elsewhere suggests that it is useful to have a dedicated bank insolvency regime. Currently, bank insolvencies would be handled more or less like that of other companies.14 A bank insolvency regime would recognize the systemic nature of banking, which implies that the stakeholders include not only creditors but also, for example, borrowers and users of transaction services. Provision of, for example, “purchase and assumption” of a set of assets and deposit liabilities can be valuable in reducing disruption to the economy. However, it will be important to maintain compatibility with the UK (and EU) bank insolvency regime.

Annex—Observance of Financial Supervision Standards and Codes—Summary Assessments

This Annex contains the summary assessments of standards and codes in the financial sector. The assessment has helped to identify the extent to which the supervisory and regulatory framework is adequate to address the potential risks and vulnerabilities in the financial system.

The following detailed assessments were undertaken:

  • Basel Core Principles for Effective Banking Supervision—by Mr. Dreymann (BaFin, banking supervision expert), and Mr. Bell (banking supervision expert).

  • The IAIS Insurance Core Principles—by Mr. Tower (MCM)

  • The FATF 40+9 Recommendations for AML/CFT—by Mr. Donovan (IMF/LEG); Messrs. Abbott, Fennell, and Sutton and Ms. Dunker (consultants). The assessment was approved by Mr. Sean Hagan.

Jersey’s compliance with the international supervisory standards is generally high, and most of the issues raised in the 2003 assessment have been addressed.

A. Basel Core Principles for Effective Banking Supervision

63. The regulatory system and prudential supervisory practice have been improved, building on the high standard found in the 2003 assessment. Laws and regulations have been amended to enhance compliance with international standards and keep pace with financial sector developments. The JFSC, which is responsible for financial sector regulation and oversight, has continued to strengthen supervisory practice, for example, by establishing a comprehensive, risk-based system of on-site visits. Cooperation with home supervisors has been enhanced, buttressed by numerous MOUs. The JFSC’s operational autonomy has been reinforced. The major supervisory challenge is how to deal with banks’ exposures to parent groups.

Introduction

64. This assessment of implementation of the BCPs was undertaken as part of an IMF FSAP Update for Jersey in 2008, and in particular was prepared during an IMF mission that visited Jersey during November 2008. This assessment follows-up on an earlier BCP assessment performed in the context of the 2002/2003 IMF OFC assessment of Jersey.

Information and methodology used for assessment

65. The assessment of compliance with the BCPs was made on the basis of a study of the legal and regulatory framework and detailed discussions with relevant authorities and stakeholders. The assessment was conducted in accordance with the Basel Committee’s revised Core Principles Methodology (October 2006). The assessment team is grateful for the very good cooperation received from the Jersey authorities. This included the comprehensive provision of documentation and extensive supplementary information, and the JFSC’s self-assessment of compliance with the BCPs.

Institutional and macroeconomic setting and market structure—overview

66. Jersey is a British Crown Dependencies. As such it is not part of the UK and has its own legislature (the States), legal and regulatory system, and tax regime. In December 2005, a system of ministerial government was established.

67. Jersey’s economy has performed satisfactorily over the last decade, but some slowdown is currently expected in the context of the global financial turmoil and the slowing of the British economy. Annual real GVA growth averaged 3.8 percent over 2003-07.15 Current strains in global financial markets and especially lower interest rates, combined with slower growth in the UK economy generally, are expected to slow growth in the coming period.

68. The basis of the economy is the financial sector. The main activities are banking, fund management, and fiduciary services. The combined financial services sector contributes over half of GVA, and total assets under management are a large multiple of GVA. The island is among the larger OFCs in the banking sector. Branches and subsidiaries from the UK, other EU countries, North America, and some other countries operate on the island. Banks’ principal business is the collection of retail deposits from overseas (e.g., from British expatriates or non-domiciled expatriates in the UK), and from corporates and the trusts that are managed on the island. These funds are mainly placed with parent banks. Many banking groups have licenses to perform other financial services, such as fiduciary services, that are ancillary to the wealth management services provided to their clients. Non-interbank lending is mainly to individuals, property companies, and some nonbank financial institutions. Banks have relatively little real estate exposure and most do not operate trading books or independent treasury functions.

69. Banks enjoy high asset quality, profitability, and capitalization, but leverage is also high. The banking sector as a whole exhibits ample liquidity given that claims on groups are mostly very short term. Recent global financial turmoil has had some impact on banks.

Preconditions for effective banking supervision

70. Jersey’s macroeconomic performance is generally satisfactory. Unemployment is low, and the trend growth rate and inflation have been satisfactory.

71. The legal system, which is broadly based on common law with French and Norman elements, is highly developed. The courts are well versed in financial matters, and reportedly are able to act quickly if needed. A full range of high-quality accountancy, audit, legal, and ancillary financial services are available on the island.

72. Jersey is not a member state of the EU or the wider European Economic Area. Consequently, Jersey has not been obliged to implement European directives on the regulation of financial services. Instead, it has voluntarily followed a policy of adopting wider international standards such as those of the Basel Committee. Furthermore, Jersey has introduced a system of information exchange and withholding tax on financial income in accordance with the EU Savings Directive.

73. The authorities have substantially adequate powers to direct, intervene in, and close a troubled financial institution. There is no depositor compensation or insurance scheme in place. No bank has failed in recent decades.

Main findings

74. The BCP assessment confirms the high standard of prudential regulation and supervision described in the 2003 assessment, and found that the issues identified at that time have largely been addressed. Most importantly, the JFSC now conducts a large program of on-site supervision, supported by off-site analysis. The JFSC follows up on on-site supervision visits with detailed recommendations. In addition, a framework of minimum prudential standards is provided by the Banking Business (Jersey) Law 1991, the Banking Business (General Provisions) (Jersey) Order 2002, and the Codes of Practice for Deposit-taking Business (Banking Codes), which is updated regularly.

75. The JFSC, as the integrated regulator, has as its main responsibility the supervision and development of financial services provided on the island. In exercising its functions the JFSC must have regard to reducing the risk to the public of financial loss due to the dishonesty, incompetence or malpractice by or the financial unsoundness of financial institutions; protecting and enhancing the island’s reputation and integrity; protecting the best economic interests of Jersey; and countering financial crime.

76. The JFSC enjoys considerable independence, and is subject to suitable accountability provisions. A MOU between the JFSC and the responsible minister has clarified that the latter would exercise the statutory power to give the JFSC “direction” only in exceptional circumstances where it is believed that the well-being of the island is at stake, and with respect to general policy, not individual cases. The minister has never exercised this power.

77. The JFSC has numerous and effective powers. The JFSC can request information, issue binding directives, publish warnings and advice, appoint managers or co-signatories, revoke licenses, or even request that a court start bankruptcy or winding-up proceedings. Fines can be imposed mostly for administrative matters, such as late submission of supervisory returns. The JFSC is adequately resourced.

78. The authorities cooperate with the home supervisors of institutions active on the island. Numerous MOUs with supervisors abroad have been signed to address both on-going supervision and information exchange. Information is in fact exchanged, and regular visits to and from the home supervisors are undertaken, including for the purpose of on-site supervision.

79. Three broad areas for further work have been identified:

  • (i) The authorities have exempted banks’ exposures to their parents from limits on exposures to related parties and large exposures, even though these exposures represent the major risk to the system. It is recommended that the authorities make the exemptions less automatic by requiring that the JFSC, on a regular basis, confirm that the parent company still has the will and capacity to support its subsidiary, and try to ensure that local banks develop more autonomous risk management capacity.

  • (ii) The authorities rely largely on banks’ internal controls to ensure adequate loan classification and provisioning. More attention should be paid to this risk factor, especially in the current environment.

  • (iii) The JFSC should develop more capacity to assess overall financial sector stability and banks’ risk models. At present, attention focuses on individual banks. In this connection, the JFSC should consider publishing more statistics on banks and other financial institutions, such as aggregate balance sheets and the mean and distribution of financial soundness indicators.

Table 10.

Summary Compliance with the Basel Core Principles

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Recommended action plan and authorities’ response
Recommended action plan
Table 11.

Recommended Action Plan to Improve Compliance with the Basel Core Principles16

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Authorities’ response to the assessment

80. The Commission acknowledges with gratitude all aspects of this assessment and is committed to fully considering the recommendations made.

B. Assessment of Observance of the Insurance Core Principles

81. Insurance regulation in Jersey broadly meets international standards. There is only a small number of locally incorporated, mostly specialist insurance companies, but many more companies incorporated abroad are licensed to sell insurance into Jersey on a cross-border basis or through branches. Insurance regulation has been strengthened since the 2003 IMF assessment. The JFSC has expanded its supervisory resources and undertaken on-site visits to most insurers. Extensive codes of practice have been introduced. There are some gaps in the regulatory framework, particularly in relation to controllers of insurers, risk management (especially operational risk), groups (though JFSC has no insurance group responsibilities at present) and disclosure requirements.

Introduction

82. This assessment of Jersey’s compliance with IAIS ICP was carried out as part of the 2008 FSAP Update Mission. It updates and replaces the assessment conducted in 2002 (published in 2003) in the context of the OFC assessment of the island.

Information and methodology used for the assessment

83. The assessment was made based on information available in November 2008 at the time of the FSAP Update mission. The authorities contributed a full self-assessment and further information in response to a pre-mission questionnaire. Full documentation, including all relevant laws and regulations, was supplied. The assessment took account of discussions with the JFSC in the course of the mission as well as meetings with government, insurance companies, managers of insurance companies, local representatives of the accountancy profession, and a representative of a major audit practice. The assessor is grateful for the full cooperation extended by all.

84. The assessment was based on the 2003 version of the IAIS ICP and Methodology. It took into account relevant IAIS standards and guidance in addition to the ICPs. The assessment of ICP 28 (AML/CFT) was informed by the parallel assessment of Jersey’s compliance with the FATF’s AML/CFT recommendations, using the 2004 Methodology (see below for the respective ROSC).

Institutional and market structure—overview

85. Jersey is one of the three British Crown Dependencies, the others being Guernsey and the IOM. It is not part of the UK and has its own parliament (the States), legal and regulatory system, and tax regime. However, its economy is highly oriented toward that of the UK and uses the pound Sterling as its currency. Jersey is in a customs union with the EU for trade in goods.

86. The Jersey economy has performed satisfactorily over the last decade, but some slowdown is currently expected in the context of the global financial turmoil and the slowing of the British economy. Annual economic growth averaged 3.8 percent over 2003-07 but has fluctuated considerably over the past decade because of variations in financial institutions’ net value added, which depends on global financial market conditions. Current strains in these markets and especially lower interest rates, combined with lower growth in the UK economy generally, is expected to slow growth in the coming year. However, the nonfinancial economy tends to be quite stable. Unemployment is negligible, in part because of immigration restrictions put in place to limit population density.

87. The basis of the economy is the financial sector. The main activities are banking, fund management, and fiduciary services. The island is among the larger OFCs in the banking sector. There has been some decline in the number of financial institutions on the island, in large part due to consolidation and shifts in business models, but the volume of assets rose fairly steadily at least through mid-2008.

88. The insurance sector in Jersey is underdeveloped, in relation to banking and investment businesses on the island and to the insurance sectors in Guernsey and the IOM. While the authorities have in the past sought to attract international insurance business (for example, captive insurers/managers and international life), other offshore centers developed their insurance sectors earlier and have achieved the critical mass and competitive position that Jersey lacks. A large number of insurers are licensed by the JFSC, but the majority (“Category A firms”) undertakes business on a cross-border basis using brokers to access the market and with no physical presence in Jersey. Some of the companies established on the island (“Category B firms”) are now closed to new business or in the course of relocation. There is no data for overall market size.

89. The JFSC is the sole regulator of insurance in Jersey. It is a statutory body corporate consisting of a chairman and at least six other commissioners appointed by the States on the nomination of the minister for economic development. By convention, members of the States are not appointed commissioners. The composition of the JFSC commissioners has to secure a balance between the interests of providers of financial services, the users of such services, and the interests of the public. The JFSC has 108 staff in total.

90. Jersey has its own companies legislation, but has no local accounting or actuarial standard setting bodies. It looks to other jurisdictions, especially the UK, for its framework of accounting, auditing, and actuarial standards. Auditors of Jersey companies must be members of a professional body in the UK or Ireland. Financial statements of insurance companies have to be prepared in accordance with International Financial Reporting Standards (IFRS) or the Generally Accepted Accounting Principles (GAAP) of the UK, the United States (US) or, with the prior approval of the JFSC, “the country or territory in which the beneficial owner of the permit holder resides or is incorporated.” Life insurers have to appoint as actuary either a Fellow of the Institute of Actuaries in England and Wales or a Fellow of the Faculty of Actuaries in Scotland or someone who can satisfy the JFSC that he has “such actuarial qualifications and experience as are appropriate.”

91. The impact of global credit and liquidity problems on Jersey insurers (Category B) has been limited, reflecting the nature and scale of their activities. There have been no significant losses. Impacts will be indirect, for example, through reduced interest in the use of Jersey registered insurers by fund managers that wish to establish special purpose vehicles holding investment instruments and which have an insurance element. All Category B firms maintain solvency cover well in excess of their minimum required margins.

Main findings

92. Insurance regulation has been strengthened since the 2003 assessment. While the sector (Category B firms) has been contracting in this period, the JFSC has expanded supervisory resources, applied its general risk assessment model, and undertaken on-site visits to all insurers. To maximize resources, some thematic work is outsourced, typically to large international audit firms. General insurance brokers were brought within regulation in 2005. Extensive Codes of Practice for Insurance Business (Insurance Codes) have been introduced, setting requirements for expectations of insurers in areas such as corporate governance and internal controls. One effect has been to align insurance regulation more closely to that of other regulated sectors including banking, although the legislative and regulatory frameworks remain distinct.

93. There are some gaps in the basic regulatory framework which should be filled as opportunities arise.

  • (i) Exemptions to the Insurance Business (Jersey) Law 1996 (IB(J)L) should be narrowed to bring under JFSC regulation one significant domestic insurer currently subject to a separate statute.

  • (ii) The IB(J)L should be amended to require potential shareholder controllers of insurance companies to seek the JFSC’s consent at the appropriate levels of control.

  • (iii) The Insurance Codes should be extended to include further provisions on risk management, including operational risk.

  • (iv) Requirements on insurance companies to disclose appropriate information to stakeholders should be introduced, taking into account the nature and scale of their insurance business.

94. The JFSC has no specific powers in relation to group supervision. Although the JFSC has no insurance group responsibilities at present, additional powers to gather information from group companies and a group solvency test could prove valuable in future.

95. The JFSC would benefit from a review of the Category A regime (companies incorporated abroad). Most Category A firms originate from the UK and other EU jurisdictions (97 percent) but there are also firms from South Africa and the US. The JFSC’s approach, both on licensing and subsequent supervision, relies heavily on the home state regulator. This regime has served Jersey-based insurance consumers well. Furthermore, the JFSC should establish a framework for assessing where home state regulation is equivalent to its own approach and should apply appropriate regulations to the small number of companies operating as branches in Jersey rather than merely offering cross-border services.

Table 12.

Summary Compliance with the Insurance Core Principles

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Recommended action plan and authorities’ response
Recommended action plan
Table 13.

Recommended Action Plan to Improve Observance of the Insurance Core Principles

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Authorities’ Response to the Assessment

96. The JFSC is pleased to note that the IMF assessment of Jersey’s compliance with the 28 IAIS Core Principles acknowledges that insurance regulation in Jersey has been strengthened since the 2003 assessment. That earlier assessment rated Jersey as “observed” or “broadly observed” with respect to the previous 17 IAIS Core Principles. The JFSC also appreciates the open and productive nature of the meetings held during the IMF assessment and of the subsequent dialogue held.

97. The JFSC has considered the IMF report and the recommendations made, with which it is in broad agreement. It has prepared an action plan to address each of the recommendations, albeit without losing sight of the very limited nature of the Jersey insurance market. For example, the recommendation (ICP 26) relating to disclosure requirements will be developed in the context of the specialized nature of the local market. In some instances the action plan involves amending legislation to incorporate explicit provisions that reflect the current practices of the JFSC.

98. The JFSC will continue to consider developments in international standards for insurance regulation and intends to continue with its approach of seeking to incorporate these in its regulatory requirements.

C. FATF Recommendations for Anti-Money Laundering and Combating the Financing of Terrorism

A. Introduction

99. This Report on the Observance of Standards and Codes (ROSC) for the FATF 40 Recommendations for Anti-Money Laundering (AML) and 9 Special Recommendations for Combating the Financing of Terrorism (CFT) was prepared by staff of the IMF. The report provides a summary of the AML/CFT measures in place in Jersey and of the level of compliance with the FATF Recommendations, and contains recommendations on how the system could be strengthened. The assessment was conducted using the 2004 Methodology and is based on the information available at the time it was completed on November 13, 2008, or shortly thereafter. The Detailed Assessment Report on which this ROSC is based has been agreed with the Jersey authorities. The views expressed in this document are those of the assessment team and do not necessarily reflect the views of the authorities of Jersey or the Executive Board of the IMF.

B. Key Findings

100. Financial services is a key sector of Jersey’s economy accounting for approximately half of the total economic activity and a quarter of the workforce (approximately 13,400 employed). The banking, fund administration, and trust company sectors dominate, supported by extensive legal and accountancy practices. Financial services expertise and international reputation have been significant in attracting business to Jersey, as has the close working relationship with the UK financial system and the availability of favorable tax arrangements in a developed, stable, and well-regulated jurisdiction.

101. A substantial proportion (believed to be around 90 percent in some sectors) of customer relationships is established with nonresidents. Arising from the nature of services provided and the typically nonresident, non-face-to-face nature of much of the client relationships, Jersey’s financial sector is inherently exposed to the risk of money laundering, particularly in the layering and integration phases. No particular vulnerability to terrorism financing (FT) was noted.

102. Jersey has put in place a comprehensive and robust AML/CFT legal framework with a high level of compliance with almost all aspects of the FATF Recommendations. The key elements were first introduced in the 1980s and have been kept updated, most substantially in the last two years to reflect the 2003 revision of the FATF Recommendations, in parallel with the implementation by EU member states of the EU Third AML Directive.

103. Both money laundering (ML) and financing of terrorism (FT) are criminalized largely in line with the international standard and Jersey has implemented the provisions effectively. With respect to both offences, however, some technical shortcomings have been identified that may limit somewhat the scope of criminal confiscation and the effectiveness of procedures for freezing of terrorist assets.

104. The Joint Financial Crime Unit (JFCU) carries out the role of a financial intelligence unit effectively and is benefiting from an increase in its resources. The JFCU receives a satisfactory flow of suspicious activity reports (SARs), mostly from banks and trust businesses (TCBs). Overall, there is scope to improve the timeliness of SAR submission and to increase the range of types of entities submitting SARs. Once the JFCU receives a SAR, it can consent or not to the financial activity that gave rise to the SAR. Nonconsent has the same effect as a freezing order.

105. Jersey has adopted a risk-based approach to AML/CFT at all levels–in determining the scope of AML/CFT requirements, in designing implementation measures, and in supervision. There is a high level of awareness of AML/CFT risks and requirements across the financial sector.

106. Jersey has a high level of compliance with the FATF Recommendations on preventive measures, with most deficiencies noted being technical in nature. CDD requirements for legal entities, trusts, and politically exposed persons (PEPs) largely comply with the international standard. One material issue relates to the extent of the concessions allowed to financial institutions and certain DNFBPs to rely on intermediaries and introducers in conducting CDD. While mostly valid in principle, the concessions do not comply fully with the international standard. The resultant increase in risk is partially mitigated by strong JFSC supervision.

107. AML/CFT requirements for DNFBPs are largely the same as those applied to financial institutions. With the exception of trust company businesses, for which regulatory controls were well established and robust, AML/CFT measures for some DNFBP business were too recent to permit a realistic assessment of the effectiveness of