UK: Banking Industry Regulatory Update, September 2012


International regulatory bodies, working alongside their regional and national counterparts, have spent over four years attempting to mend the global financial system by strengthening its stability and resilience. In 2012, the stream of regulations does not appear to be slowing, as governments and regulators continue to address the issues arising from the financial crisis.

This banking industry regulatory update, the seventh in the series, sets out the key banking industry reforms, and proposals for reform, in the international, European and UK spheres. This update sets out the position as at September 2012. It should be noted that, as this is an ever changing regulatory landscape, care should be taken when reading the update as it will become out of date relatively quickly.


In its October 2010 Report to the G20, the Basel Committee on Banking Supervision (the "BCBS") announced its plan to review the Core Principles for Effective Banking Supervision (the "Core Principles"), which were last updated in 2006. On 20 December 2011, the BCBS published a consultation document (BCBS213) on the review.

The Core Principles are a framework of universally applicable minimum standards for sound prudential regulation and supervision of banks and banking systems. They are used by countries as a benchmark for assessing the quality of their supervisory systems, and by the International Monetary Fund ("IMF") and World Bank in the context of the Financial Sector Assessment Programme.

Following the consultation (BCBS213) in December 2011, the BCBS has published a revised Core Principles. The new principles combine the 2006 versions into a single comprehensive document.

The key changes to the Core Principles include the following:

  • a new Core Principle on corporate governance has been added by bringing together existing corporate governance criteria in the assessment methodology and giving greater emphasis to sound corporate governance practices. The BCBS has also expanded an existing core principle into two new ones relating to public disclosure and transparency, and enhanced financial reporting and external audit;
  • the number of Core Principles has increased from 25 to 29;
  • There are 39 new assessment criteria, comprising 34 new essential criteria and 5 new additional criteria; and
  • 34 additional criteria from the existing assessment methodology have been upgraded to essential criteria that represent minimum baseline requirements for all countries.

The BCBS has reorganised the principles to highlight the difference between what supervisors do and what they expect banks to do:

  • principles 1 - 13 address supervisory powers, responsibilities and functions, focusing on effective risk-based supervision and the need for early intervention and timely supervisory actions; and
  • principles 14 - 29 cover supervisory expectations on banks, emphasising the importance of good corporate governance and risk management, as well as compliance with supervisory standards.


(a) International - BCBS

On the international stage, there has been a continued emphasis on effective governance. This focus stems from the view that corporate governance is so fundamental to both individual banking organisations and to the international financial system as a whole, it merits targeted supervisory guidance. The BCBS published a set of 14 principles (the "Principles") for enhancing sound corporate governance practices in October 2010, following its consultation on those principles in March 2010.

As outlined in our previous updates, the focus of the Principles is primarily on attributing responsibility for corporate governance, risk management/strategy and corporate values to the board and senior management (rather than to regulatory supervisors). Emphasis is also placed on the need for the board to ensure effective communication laterally and vertically (in order for risk and other issues to be adequately dealt with) and for each board member to properly know and understand the institution's structure. The sentiment that a board must establish and promote corporate values that discourage excessive risk taking pervades the Principles.

Specifically, the Principles include the following requirements:

  • appropriate practices, committees and roles must be set up to manage risk, remuneration, conflicts and auditing. Such practices must keep pace with the bank's sophistication and risk profile;
  • the board of a parent company must take responsibility for overseeing corporate governance across the group;
  • the board must properly understand the bank's corporate structure and the nature and purpose of any offshore or unregulated entities;
  • communication lines must be adequate to effectively report risk issues and exposures to the board;
  • compensation must be aligned with prudent risk taking;
  • a bank's code of conduct must outline acceptable and unacceptable risk taking behaviour and that the board should take the lead in establishing the correct €Ütone at the top'.

The BCBS advises supervisors to establish guidance or rules in accordance with the Principles. The BCBS notes that banks' compliance with the Principles (as implemented by the bank's home country) should be proportionate to the size, complexity, structure, economic significance and risk profile of a bank, and the corporate group it belongs to (if relevant).

In June 2011, the BCBS updated a framework of principles concerning operational risk management for banks and their supervisors published in 2003 called Sound Practices for the Management and Supervision of Operational Risk (Sound Practices), to reflect current industry practice. The framework of principles incorporates governance as an over-arching theme and, in line with the BCBS's 14 Principles, places emphasis on the role of the board of directors in assessing operational risk and overseeing the implementation of appropriate policies and procedures.

Building on the 14 Principles, the BCBS issued supervisory guidance on the internal audit function in banks (BCBS223) on 28 June 2012. The guidance revises the previous supervisory guidance issued in August 2001 whilst taking account lessons learnt from the financial crisis and evolutions in the sector. The guidance consists of 20 principles relating to:

  • supervisory expectations relevant to the internal audit function;
  • the relationship between supervisors and the internal audit function; and
  • supervisory assessment of banks' internal audit function.

The BCBS expects to publish a consultative version of its external audit guidance in late 2012. This was announced in the press release that was published with BCBS210 in December 2011. This new guidance will be additional to the previous BCBS guidance (BCBS87 and BCBS146)

(b) Europe

At European level, the European Commission (the "EC") published a Green Paper on corporate governance in June 2010, which discussed the links between corporate governance and the financial crisis; and suggested options for reform along similar lines to the Principles. On 12 November 2010, the EC published a feedback statement on responses to its green paper which had been given by interested parties such as the FSA. While the feedback statement demonstrates the broad support of the industry to the EC's proposals (particularly in relation to the clarification of responsibility), it also noted that many respondents see corporate governance failures as due to a lack of effective implementation of existing rules rather than deficiencies in the regulatory regime. The European Parliament adopted a resolution in response to the Green Paper on 11 May 2011, in which it:

  • emphasised the need for financial institutions to establish effective governance systems, with adequate risk management, compliance, internal audit functions, strategies, policies, processes and procedures;
  • called for the establishment of mandatory risk committees or equivalent arrangements at board level for all economically significant financial institutions;
  • called for the establishment of "fit and proper persons" criteria to be implemented by national regulators;
  • called on the EC to develop legislation requiring large financial institutions to submit their boards to regular external evaluation;
  • encouraged institutional shareholders to take a more active role in holding the board to account with a view to encouraging a culture of greater responsibility.

On 5 April 2011, the EC published another Green Paper as part of a public consultation focused on improving the corporate governance of European companies. The Green Paper was intended to prompt debate in three key areas: the functioning of boards of directors; how to enhance shareholder involvement and how to improve the effectiveness of the existing national corporate governance codes. The EC published a feedback statement on the responses to the Green Paper on 15 November 2011.

In addition, the European Banking Authority (the "EBA") published a set of Guidelines on Internal Governance (the "Guidelines") on 27 September 2011, following a consultation on a draft version of the Guidelines in October 2010. The Guidelines seek to improve the implementation of internal governance arrangements in credit institutions and apply on a "comply or explain" basis. The Guidelines update and consolidate the former Committee of European Banking Supervisors (the "CEBS") guidelines, including the CEBS High Level Principles on Remuneration and on Risk Management. They contain new guidance on:

  • the transparency of corporate structures, with the introduction of the "know-your-structure" principle;
  • the composition, appointment and succession and qualifications of the management body;
  • the responsibilities of the management body regarding outsourcing and setting the remunerations policy;
  • the role of the Chief Compliance Officer and the risk management function; and
  • information and communication systems and business continuity management.

National authorities must implement the guidelines by 31 March 2012. They were required to notify the EBA as to whether they comply or intend to comply with the Guidelines (or their reasons for noncompliance) by 28 November 2011.

CEBS was replaced by the new, more powerful EBA as of 1 January 2011 which exercises a wider role than its predecessor. For example, the EBA is able to issue binding technical standards on member states and has indicated that it is keen to press for a single EU rule book. The EBA was also responsible for EU-wide bank stress testing in 2011.

(c) United Kingdom

In the UK, the government and the Financial Services Authority (the "FSA") have been responsible for a number of initiatives to strengthen corporate governance in financial services companies. These include the implementation of the Walker Review of 2009 (which set out 39 recommendations which are intended to improve the governance of UK banks and other financial institutions), through revised governance and remuneration codes, a new stewardship code, and increased supervision of individuals performing significant influence functions in regulated firms.

The Walker Review was considered by the Financial Reporting Council (the "FRC") in early 2010. The primary conclusions drawn by the FRC can be summarised that; more attention should be paid to following the spirit of the existing Combined Code on Corporate Governance 2008 (the "Combined Code") as well as its letter and that the impact of shareholders in monitoring the Combined Code could be enhanced by better interaction between the boards and their shareholders. The FRC review thus led to the Combined Code being replaced by:

  • the UK Corporate Governance Code 2010 (the "Code") which applies to listed companies (including financial institutions) for reporting periods beginning on or after 29 June 2010; and
  • the UK Stewardship Code 2010 (the "Stewardship Code") which sits alongside and is complimentary to the Code, and which will apply to fund managers and other institutions authorised to manage assets on a discretionary basis for "professional clients" (including collective investment schemes, insurance companies and pension funds).

Both codes apply (as the Combined Code did) on a ۆcomply or explain' basis.

In December 2011, the FRC announced that it would consult on changes to both the Code and the Stewardship Code. Subsequently, in April 2012, the FRC published a consultation in relation to proposed changes to the Code. The changes include:-

  • FTSE 350 companies put the external audit contract out to tender at least every ten years.
  • Boards to explain why they believe that their annual reports are fair and balanced.
  • More meaningful reporting by audit committees.
  • When failing to comply with the Code, a company should provide greater explanations to shareholders.

The deadline for responding was the 13 July 2012 and, subject to the outcome, the proposed changes will enter into force for financial years commencing on or after 1 October 2012.

In relation to the Stewardship Code, the FRC also published a consultation in April 2012. The proposed changes relate to the meaning of "stewardship", the respective roles and responsibilities of asset owners and asset managers, disclosure of the investors policy on stock lending (and whether the lent stock is recalled for voting purposes) and updates reflecting current market practice. The deadline for responding was 13 July 2012 and, subject to the outcome, the proposed changes will enter into force for financial years commencing on or after 1 October 2012.

(i) The Code

The Code consists of main and supporting principles spanning the five areas of leadership, effectiveness, accountability, remuneration and relations with shareholders. However, the Code differs in tone from the Combined Code in that it places more importance on the main principles which should guide board behaviour and which should be continually considered and reported on by the board. These are now listed separately at the front of the Code (in addition to later on together with the supporting principles). The primary differences between the Code and the Combined Code include:

  • increased emphasis on the roles and responsibilities of the Chairman, the senior independent director and non executive directors (the "NEDs");
  • requirement that any search for board candidates should have regard to diversity, including gender diversity;
  • requirement for directors of FTSE 350 companies to be subject to annual re-election;
  • requirement that external board evaluation reviews be conducted every 3 years by FTSE 350 companies;
  • emphasis on directors' time commitments;
  • emphasis on consideration and management of risk; and
  • amendments to provisions related to performance related remuneration.

(ii) The Stewardship Code

Broadly, the Stewardship Code sets out good practice for institutional investors when engaging with UK listed companies. The seven principles of the Stewardship Code cover the establishment and, where required, disclosure of practices relating to collective action with other investors, monitoring investee companies, voting policy and disclosure, enhancing shareholder value and the management of conflicts of interest. Adherence to the Stewardship Code is not compulsory (it applies on a "comply or explain" basis), however, the FSA rule in COBS 2.2 makes disclosure of a regulated firm's commitment to the code (or lack of) mandatory. The alternative to compliance is to explain why the firm's alternative business model makes compliance inappropriate. While certain of the requirements will already be part of a firms' practice, the net effect of compliance with the Stewardship Code is that a regulated firm must make public arrangements and policies that previously remained confidential.

The British Bankers' Association ("BBA") published a response to the Department for Business, Innovation and Skills' ("BIS") call for evidence "A Long-Term Focus for Corporate Britain" in January 2011, which states that it views the Stewardship Code as a step in the right direction and is supportive of the FRC in its endeavours to promote it. The call for evidence, published on 25 October 2010, was the first stage of a review into corporate governance and economic/board ۆshort-termism' in capital markets. BIS published the outcome of the consultation on 28 March 2011. Shortly afterwards, on 22 June 2011, the BIS announced that Professor John Kay was to carry out an independent review into investment in UK equity markets and its impact of the long-term competitive performance and governance of UK quoted companies (further discussed below).

(iii) Review of the Code and the Stewardship Code

On 14 December 2011, the FRC published the first of what is intended to be an annual series of reports on the impact and implementation of the Code and the Stewardship Code. The report revealed that there had been a high level of compliance with the Code, with, for example, 80 per cent of FTSE 350 companies already adopting annual re-election of all directors. The report also reveals a positive response to the Stewardship Code, with over 230 asset managers, asset owners and service providers signing up since its introduction in June 2010. The FRC consulted on limited revisions to both the Code and the Stewardship Code during early 2012 and subsequently published the two aforementioned consultation documents (Revisions to the UK Stewardship Code and Revisions to the UK Corporate Governance Code and Guidance on Audit Committees).

As mentioned above, the deadline for responding was the 13 July 2012 and, subject to the outcome, the proposed changes will enter into force for financial years commencing on or after 1 October 2012. In addition, on 5 May 2011, the FRC published a consultation paper on Gender diversity on boards. In a feedback statement dated 11 October 2011, the FRC has announced, that as of 1 October 2012, companies governed by the Code will have to report annually on their boardroom diversity policy (including measurable objectives set to implement the policy and the progress made) and consider the diversity of the board when evaluating board effectiveness.

(iv) Kay Review

In 2011, BIS commissioned an independent review of the effect of UK equity markets on the competitiveness of UK businesses (the "Kay Review"). Professor John Kay, who chairs the review, launched a call for evidence on 15 September 2011. His speech emphasised that the subject of the review was corporate decision making and performance rather than corporate governance.

On 23 July 2012, Professor Kay published his final report on the review of UK equity markets and long-term decision making. The Kay Review concludes that, overall, short-termism is a problem in the UK equity markets. The recommendations are that there should be a shift in the culture of the stock market, relationships should be restored on trust and confidence, and incentives realigned across the investment chain.

(v) Approved Persons

The FSA confirmed in its Business Plan for 2011/12 that corporate governance remains a key area of focus in the coming months. The publication of the policy statement PS10/15 on effective corporate governance in September 2010 highlighted the extent of the work being done in relation to significant influence and controlled functions.

Under PS10/15 and the corresponding amendments to the FSA handbook:

  • a new framework of classification of controlled functions is being created including: parent entity SIF (CF00), chairman (CF2a), senior independent director (CF2b), chairman of risk committee (CF2c), chairman of audit committee (CF2d) and chairman of remuneration committee (CF2e);
  • three new systems and controls functions are being introduced: finance function (CF13), risk function (CF14) and internal audit function (CF15). The current systems and controls function (CF28) will be deleted; and
  • the scope and definition of the already existing director (CF1) and non-executive director (CF2) controlled functions are being reduced.

These amendments were due to come into force on 1 May 2011. However, in March 2011, the FSA announced that implementation would be postponed until a later date.

  • Guidance is provided on the role to be played and time commitments to be made by NEDs, while guidance on the limits of liability of NEDs in SYSC 2.1.2G and 4.4.4G is to be deleted.

This part of the new regime came into force on 1 May 2011.


(a) International

As mentioned in our February 2012 update, the Financial Stability Board ("FSB") completed its first peer review on compensation in March 2010, concluding that key issues were yet to be resolved and effective implementation was far from complete. A second peer review, the Thematic Review on Compensation, was published on 7 October 2011. In June 2012, the FSB published a further report on the progress made by member jurisdictions and firms implementing the FSB's compensation principles and implementation standards which covers the period from October 2011. The main findings of the report include the following:

  • almost all FSB member jurisdictions have now implemented the principles and standards;
  • notable progress has been made on the implementation of the Basel Committee on Banking Supervision's Pillar 3 disclosure requirements for remuneration, but more needs to be done to fully embed them in regulatory or supervisory guidance across all jurisdictions;
  • there continues to remain important differences across jurisdictions in terms of applying the principles and standards, particularly in the use of proportionality and the identification of firm's employees as material risk takers; and
  • supervisory attention to compensation issues continues to increase and is contributing to sounder compensation structures at firms. Supervisory co-operation in respect of crossborder financial institutions is also improving.

Further in July 2012, the FSB published a table setting out member jurisdictions' legal requirements on compensation.

(b) Europe

The European Commission has outlined its intention to replace and recast the Capital Requirements Directive (2006/48/EC and 2006/49/EC) ("CRD3") with the new Capital Requirements Directive ("CRD4") which is to come into force by 1 January 2013. With respect to remuneration, the bulk of the material in CRD3 will continue to apply to the CRD4 regime. However, the Commission has increased firms' disclosure requirements, and under the CRD4, firms are required to disclose "the number of individuals being remunerated EUR1 million or more per financial year, broken down into pay bands of EUR500 000".

Further, as outlined in the February 2012 update the current regime requires that an institution's policies include caps on cash bonuses, bonus deferrals and new bonus/salary ratios, the recurring aims being to better align remuneration with the long term interests of the institution. It is also intended that the amendments will bring down the disproportionate role played by bonuses in the financial sector. This has been implemented in the UK through amendments to the UK's remuneration code (see below). The CEBS Guidelines on Remuneration Policies and Practices, which address high-level remuneration policies and the day-to-day practice of making remuneration decisions, continue to be relevant.

In accordance with the proposals outlined in the EC's Green Paper on Corporate Governance in Financial Institutions and Remuneration Policies published on 2 June 2010, the recently adopted and published Alternative Investment Fund Managers Directive, amendments to the UCITS IV Directive (2009/65/EC) (UCITS IV) and the Solvency II Directive (2009/138/EC) contain provisions on the remuneration in the investment fund and insurance context.

(c) United Kingdom

As mentioned in the February 2012 update, the FSA revised its remuneration code in December 2010. The revised remuneration code (the "Remuneration Code") and disclosure requirements have been inserted into the FSA handbook by the Senior Management Arrangements, Systems and Controls (Remuneration Code) (No 2) Instrument 2010 and Prudential Sourcebook for Banks, Building Societies and Investment Firms (Remuneration Disclosures) Instrument 2010.

The rules on disclosure require a firm to disclose, on an annual basis, its remuneration policy and details in respect of senior management and members of staff whose actions have a material impact on the risk profile of the firm. The disclosure may form part of the firm's annual report and accounts provided the disclosure meets the relevant requirements. The FSA has recently published a consultation paper (CP12/18) on data collection regarding remuneration practices. The FSA has proposed two types of reports that relevant firms will be required to file:

(i) Remuneration Benchmarking Information Report - data on the remuneration of employees by significant firms (firms that either represent 60% or more of the total banking and investment services sector of the Member State concerned, or the 20 largest institutions in the banking and investment services sector of the Member State concerned) and their subsidiaries and branches; and

(ii) High Earners Report - data on firms employees with total annual remuneration of EUR1 million or more.

The changes will be incorporated by introducing new rules in SUP 16 in the FSA Handbook. With regards to both reports above, a firm that is within the scope of the report(s) on the date the rules come in to effect will be required to submit two reports by 31 December 2012 (one for each of the previous 2 completed financial years), and thereafter a report annually within two months after the firms accounting reference date.

The FSA is still currently in the consultation phase which is due to close on 30 September 2012. The FSA is hoping to publish a Policy Statement by the end of October 2012 with the Handbook rules coming in to effect by 1 November 2012.

(i) Proportionality

In September 2012 the FSA published finalised guidance on proportionality, specifically relating to the Remuneration Code (found in SYSC 19A) and Pillar 3 disclosures on remuneration (found in BIPRU 11). The FSA has replaced the current four-tier division of remuneration code firms, with three new levels based on total assets. The new approach is intended to allow the FSA to focus its resources on the most significant firms who pose risks to financial stability. The new structure is as follows:

  • proportionality level one - banks and building societies with regulatory capital exceeding £50bn and BIPRU 730k firms that are full scope BIPRU firms with capital resources exceeding £50bn;
  • proportionality level two - banks and building societies with regulatory capital exceeding £15bn but not £50bn and BIPRU 730k firms that are full scope BIPRU firms with capital resources exceeding £15bn but not £50bn; and
  • proportionality level three - Banks and building societies with regulatory capital not exceeding £15bn and any full scope BIPRU investment firm that does not fall within proportionality levels one or two, any BIPRU limited license firm and any BIPRU limited activity firm.

With regards to proportionality levels one and two, a remuneration committee is required. However with regards to proportionality level three the FSA has stated that although it is desirable a remuneration committee to be established, it accepts that it may be appropriate for the governing body of the firm to act as the remuneration committee.

Further if firms to which the Remuneration Code applies are part of a group, all firms within that group will fall into the highest proportionality level that any individual firm falls in to.

It is clear that the new approach will allow the FSA to focus its attention on firms which require closer supervision. However, as outlined in the February 2012 update, organisations will need to be prepared for a much closer relationship between their HR and compliance functions when it comes to pay, which will again, demand greater organisation.

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