UK: A Review Of Financial Regulations And Tax Issues For FSA-Regulated Businesses

Last Updated: 14 February 2011
Article by Natasha Lee


By Natasha Lee

We discuss the pertinent results of our 13th annual financial services survey, which collects the opinions and expectations of financial services businesses in the City of London.

In line with overall sentiment within the industry our survey results reflect a cautious mood among respondents, despite stable or improved results on 12 months ago, reflecting the uncertainty surrounding ongoing regulation and the impact of changes in tax legislation.

Generally there is greater confidence in the UK economy, with 81% believing the UK economy to be either stable or improved on 12 months ago, which compares to only 62% last year. The majority of respondents do not consider political factors such as the Coalition Government's Spending Review and subsequent cuts to be a major impact on their business, with 69% expecting their business to be unaffected. Conversely, regulation and changes in tax legislation are expected to have a significant impact, which is a continuation of industry fears a year ago.

Business confidence

Business has notably improved on 12 months ago, with 80% of respondents expecting business prospects to either improve or stabilise over the coming 12 months; this is supported by 87% of respondents expecting turnover to either improve or stabilise in the coming year. This confidence is built on solid financial performance during the last year with 64% of respondents reporting turnover and profit margins to be either stable or improved.

However, caution comes through in various guises. For example, 48% of respondents believe London's reputation as a major financial centre has declined in the last year, although for the previous two years approximately two thirds of respondents held this view. As expected, New York continues to be considered the biggest threat to London, with Frankfurt, Shanghai, Geneva and Zurich the other favourites, respondents no doubt swayed by their more appealing tax and/or regulatory regimes.

Unsurprisingly, despite the solid results reported for the previous 12 months plus the optimistic outlook for next year, 65% of respondents believe regulatory requirements are likely to restrict the development and growth of their business over the next 12 months; a view which is consistent with 63% of respondents expecting expenditure on regulatory compliance to increase over the same period. Though this may not please firms, the FSA is unlikely to be displeased by these expectations given their belief that firms are growing too quickly with under resourced compliance functions.

Overall, headcount is expected to remain stable or increase (93% of respondents), which is not dissimilar to the previous year (86% of respondents reported the same result for the previous 12 months). However, the balance of personnel within firms is expected to alter, with more requirements placed on back office staff.


Despite changes in the remuneration code and tax legislation, 73% of respondents reported that they are not expecting to change the way they incentivise employees. It will be interesting to see if firms are granted their wish.

In addition to regulatory compliance, firms believe tax legislation is also having a negative impact, with 40% of respondents reporting that changes in tax legislation will hinder the development and growth of their business. This sentiment is supported by 40% of respondents believing recent changes in tax legislation will actually decrease their firm's performance.

The survey asked respondents to select factors they believe will most affect business growth over the next 12 months. Of the ten responses available, all bar two received 23% or more of the vote, reflecting diverse views among respondents, which is consistent with the prior year, although the impact of regulatory compliance does dominate this year's response.


By Marco Bragazzi

The revised remuneration code came into effect on 1 January 2011. Marco and Nick consider how this affects those firms in tiers three and four.

In our last newsletter we commented on Consultation Paper 10/19 (CP10/19), issued in July 2010, about revising the remuneration code. On 17 December 2010 a policy statement was issued following the responses to CP10/19. This article comments on the key themes arising from the revised remuneration code and how it applies to 'smaller firms' as defined by the code. The revised remuneration code will apply to more than 2,500 firms that were not previously under the scope of the original remuneration code.

Policy statement

The revised code came into force from 1 January 2011 and will be applied from that date. For firms applying the code for the first time, transitional provisions apply in respect of Principle 12 and firms must comply with this Principle, where applicable, by 1 July 2011.

Approach to proportionality

Given the range of firms now coming into the scope of the code, i.e. all BIPRU investments firms, the FSA recognises the importance of following a proportionate approach to adopting the code. The policy statement introduces four 'proportionality tiers', based around capital resources and, for non-UK BIPRU firms only, total assets thresholds.

In this article, we focus on the relevant tiers for smaller firms and our typical client base: proportionality tiers three and four.

Proportionality tier three firms include:

  • any bank and building society with capital resources of less than £50m
  • any full scope firm with capital resources of less than £100m
  • third-country BIPRU firms with total assets (for the branch) less than £2bn.

Proportionality tier four firms include:

  • all limited licence and limited activity firms, irrespective of size, including third BIPRU firms within equivalent permissions.

The positive news derived from the policy statement is that tier three and four firms may disapply a number of aspects of the code that have been commented on heavily during the consultation phase following the publication of CP10/19, assuming the firm considers it appropriate to do so in the context of the spirit of the code.

Areas that relevant firms may disapply include the principles around the deferral of variable pay, inclusion of retained and other instruments within variable remuneration and the performance adjustments around remuneration that can be found in Principle 12 of the code.

Although disapplied, the FSA has included a caveat that where code staff fall above the de-minimis limits for being applicable to the code, i.e. earning remuneration in excess of £500,000 and including at least 33% of the total as variable remuneration, then even tier four firms should consider whether from a risk perspective they should be applying Principle 12 in full.

Pillar 3 disclosures

By proportionality tier, there are now new disclosure requirements under Pillar 3 for the remuneration policy of BIPRU firms. The rule reference governing these new disclosures can be found in BIPRU 11.5.18 and the extent of disclosure required is again dependent upon what tier the firm is categorised as. The main requirements which are applicable for all tier firms include the following.

  • Information concerning the decisionmaking process used for determining the remuneration policy.
  • Information on the link between pay and performance.
  • Aggregate quantitative information on remuneration, broken down by business area.
  • Aggregate quantitative information on remuneration, broken down by senior management and members of staff whose actions have a material impact on the risk profile of the firm. For most firms this will equate to considering disclosure of directors' emoluments within the Pillar 3 disclosure.

The last two requirements would need to be considered in the context of materiality and confidentiality, which are two approaches to justify not making a disclosure under the Pillar 3 regime.

In addition, firms need to document their remuneration policy and maintain a list of people that fall within the definition of code staff. This can include those who are not employees of the firm but undertake a role which affects the risk of the firm, for example secondees.

Tier three and four firms do not have to have a remuneration committee, although the FSA considers it desirable, particular for large firms, to have one.


By Martin Sharratt

Financial services businesses will still be smarting from the increased cost of irrecoverable VAT, following the increase in the standard rate. Unfortunately, more VAT problems are in the pipeline.

We briefly discuss three VAT 'events' that could affect your business over the coming months: VAT grouping rules, the EU review of VAT in the sector and the Retail Distribution Review (RDR).

VAT grouping

Last year, the European Commission initiated infraction proceedings against the UK (along with several other member states) on the grounds that the UK's application of the VAT grouping rules is overly generous. It has all gone very quiet, but at some point in the next few months this will be debated before the European Court of Justice. The particular point at issue is the ability of UK VAT groups to include companies that are not 'taxable persons' in their own right, e.g. holding companies. However, the European Commission also asserts that a VAT group must be seen as a separate entity from any of its component companies, which (if upheld) could mean inter alia that the reverse charge would be imposed on charges from an overseas head office to a UK branch.

EU review of VAT in the financial services sector

This review has been making slow progress for some years, but it is now approaching the stage where the member states actually think about implementing changes. Some of the ideas on the table, such as a proposal to exempt the management of pension funds, would be welcome. Others, however, include a potential tightening of the rules around outsourcing, possibly going as far as imposing VAT on all outsourced services; the UK is resisting this, but the idea has not gone away. The UK could also be forced to accept a change from zero-rating to exemption for commodity futures, which could prove expensive (the difference being that with zero-rating the business can recover all of the VAT on related costs).

Retail Distribution Review

The RDR is an FSA initiative which, on the face of it, has nothing to do with VAT. The VAT rules will not change – but the RDR is set to change the way in which financial products are sold to retail customers and that in turn will generate significant VAT problems, both for IFAs (and other intermediaries) and for the product providers. Advice has always been subject to VAT, but IFAs typically waive any charge for their advice because they expect to be paid a commission by the product provider. So a large part of the income for a typical IFA currently consists of 'initial' or 'trail' commission on investment and insurance products bought by his/her clients. Many IFAs are not therefore registered for VAT, because their advisory fees fall below the VAT registration threshold (£70,000). Under RDR no such commission can be paid and IFAs will have to charge their clients directly, either for advice (plus VAT) or for arranging specific investments (generally – but not always – exempt.


By Natasha Lee

We briefly consider the FSA's policy statement on capital standards.

17 December 2010 was a busy day for the FSA. In addition to publishing its policy statement 'Revising the Remuneration Code', the FSA also published its policy statement 'Strengthening Capital Standards 3'.

This policy statement deals with feedback and final rules in respect of CP10/17 and CP10/22. In CP10/17, the FSA provides feedback on previous consultation papers relating to CRD 2, as well as consulting on CRD 3 aspects relating to core tier one capital, large exposures and operational risk. CP10/22 included consultation on parts of CRD 3, namely in relation to capital floors for firms using advanced approaches, residential mortgage losses given default (LGD) floors and covered bonds. Unlike the majority of CRD 3 amendments, which require implementation by 31 December 2011, these amendments were required to be implemented by 1 January 2011.


The policy statement provides final rules in respect of core tier one, operational risk and large exposures and is effective from 31 December 2010.

Amendments to core tier one capital

  • Core tier one instruments for joint stock companies are now restricted to ordinary shares.
  • Preferential right to a dividend is not a permitted characteristic of core tier one instruments.
  • Building societies are permitted to include an instrument which has a cap on distribution as long as the purpose of such a cap is to protect the building society's reserves. This exception does not extend to mutuals of jointstock model banking subsidiaries of institutions that adopt a mutual model.

GENPRU 2.2.83 R and 2.2.83A R detail the new definition of permanent share capital permitted as core tier one capital.

Operational risk

CRD 2 implements conditions for the use of insurance and other risk transfer mechanisms (ORTM) by firms using the advanced measurement approach (AMA) in calculating operational risk capital requirements. This will only impact a small number of firms and the guidance is included within BIPRU 6.5.26 R to 6.5.30A G.

Large exposures

BIPRU 10 includes guidance that references the Committee of European Banking Supervisors (CEBS) guidelines in respect of certain large exposures. The new rules refer to four embedded waivers for which firms can apply. Without a relevant waiver, the basic large exposures limit remains at 25% of a firm's capital resources.

All BIPRU limited licence and limited activity firms are exempt from BIPRU 10, and therefore the large exposures regime from 31 December 2010. A firm with a reporting end date of 31 December 2010 will not be required to make a FSA008 submission for that period end.


The policy statement provides final rules in respect of covered bonds and capital floors and they are effective from 1 January 2011.

Capital floors

To avoid discouraging firms from using advanced approaches to calculate part of their capital requirements, capital floors can be calculated on the basis of CRD, as opposed to Basel I, via a waiver, until the FSA implements an asset-based leverage ratio.

Residential mortgage LGD floors

Residential mortgage LGD floors are being extended for a further two years until 31 December 2012.


By Colin Aylott

The new FATCA rules will affect financial services organisations, and doing business with the US.

US legislation has been introduced to further combat perceived tax avoidance in the form of the Foreign Account Tax Compliance Act (FATCA). The rules have significant implications for financial services organisations in particular, including fund managers, as well as imposing a significant compliance burden on doing business with the US.

Withholding taxes

  • A 30% withholding tax would be imposed on 'witholdable payments' made after 31 December 2012 to non- US 'financial institutions' and other entities unless the non-US institution itself enters into an agreement with the IRS to disclose all US account holders and to report annually with detailed relevant information including account ownership, balances and transactions.
  • The definition of a 'financial institution' is broad and includes any entity that is engaged in 'the business of holding financial assets for the account of others, and any entity engaged primarily in the business of investing or trading in securities'. So, subject to exemptions, banks, insurers, private equity companies, hedge funds and asset managers are all likely to be caught by the rules.
  • A non-US entity that is not a financial institution is also subject to 30% withholding tax on witholdable payments unless it identifies its 'substantial United States owners' or certifies to the contrary.
  • Where a shareholder cannot be identified, the 30% withholding tax will be imposed on the portion of the witholdable payment relating to the unknown shareholder. This may be a significant issue for co-investment vehicles investing in the US.
  • The definition of 'witholdable payments' is broad and encompasses not only the ordinary categories of US source investment income, i.e. interest, dividends, annuities and premiums, but also gross proceeds from the sale or disposition of income-generating US property and also payments in respect of derivative contracts that are based on underlying US dividend payments (which will be re-characterised as US source dividends.)
  • The FATCA rules are intended to override reduced treaty rates unless an agreement to disclose to the IRS is entered into.

Other requirements

  • US individuals and entities will be required to report offshore accounts with values of USD 50,000 or more on their tax returns. These requirements are in addition to the current US Report of Foreign Bank and Financial Account Regime (FBAR).
  • The FATCA rules as enacted will represent a significant compliance burden requiring extensive customer due diligence for many UK financial institutions in order to comply, which may not be cost effective for many organisation.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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