UK: Financial Services And Markets Group Bulletin

Last Updated: 23 July 2009
Article by Natasha Lee


On 18 March 2009, Lord Turner published his review, alongside the accompanying Financial Services Authority (FSA) discussion paper, of the regulation of banks and bank-like institutions in response to the financial crisis which has besieged the global economy. In truth, the review was less radical than had been feared as the majority of its recommendations had already been made public.

We address some of the high-level issues raised by the Turner Review including the potential wider impact on regulated firms which do not fall under the banking umbrella.

Capital adequacy

As expected, Lord Turner recommends that the quantity and quality of capital maintained by banks should be increased. However, given the current financial pressures experienced by the banking sector, the recommendation will not be implemented in the short-term.

The main aim of this proposal is for banks to hold counter-cyclical capital in order to avoid the peaks and troughs experienced in recent years. Taking a steer from the existing regime operating in the Spanish banking market, banks will be required to maintain counter-cyclical capital buffers which increase in the good times to be used in the bad times.

To help implement this system, Lord Turner proposes transparency within the banks' published financial statements, whereby such a buffer is separately accounted for and disclosed, favouring a capital reserve over a smoothing provision. Whichever accounting method is favoured, the International Accounting Standards Board will need to agree to this.

The most challenging aspect of implementing a counter-cyclical capital buffer will be judging the level of the buffer depending on the state of the economy at any given time. Each bank's judgement will undoubtedly be subtly different, potentially resulting in significant variances in the level of buffers. Lord Turner recognises this, and proposes that the banks make their assessments transparent in order for any outliers to be identified and corrected. He also acknowledges that such a proposal will need international buy-in for it to be effective, otherwise the majority of banking activities will merely converge to lesser regulated jurisdictions.

As a supplementary measure, he has proposed that firms monitor their gross leverage ratio, set against a predetermined benchmark, in order to identify and help prevent excessive balance sheet growth.

The days of Value at Risk (VaR) models appear to be numbered. An increase in capital requirements against banks' trading books and assessing the validity of VaR models, as they appear not to have stood the test of time, have been proposed. Firms that use such models should now be seriously considering viable alternatives.


Lord Turner considers liquidity to carry equal weighting with capital adequacy. The majority of the proposals have already been considered through the FSA's consultation paper (08/22) and we previously discussed this in the May edition of this newsletter.

The key point from the FSA's perspective is that such proposals can be implemented nationally, unlike those proposed for capital adequacy, and implementation is scheduled to commence from quarter four of this calendar year. BIPRU firms would be well-advised to ensure these requirements have already been addressed.

Lord Turner also invites consideration of a 'core funding ratio' as either a rule or as an indicator of potential concerns. In essence, this will drive firms to adopt stable forms of funding.

Credit rating agencies

Credit rating agencies (CRA) have not survived Lord Turner's wrath. He believes the credit rating based system played an important part in the origins of the financial crisis, in particular due to its lack of rigour in assessing the risks of securitised and structured credit and the potential conflict of interests it has with its commercial objectives.

To counteract these issues, the Turner Review proposes that CRAs are regulated going forward, but acknowledges the need for change in legislation in order to achieve this. However, Lord Turner expects this to be achieved by quarter two of 2010.


Clearly an emotive topic, particularly bearing in mind the constant press coverage, Lord Turner acknowledges the conflict of interests certain remuneration structures encouraged in respect of profit versus risk. However, despite this, he clearly states that areas such as capital and liquidity were the key drivers behind the financial crisis.

Proposed changes in remuneration are discussed in the FSA's consultation paper (CP 09/10) and principally surround the need to break the link between bonuses and short-term profit making.

FSA supervisory approach

Ever since the publication of the Turner Review, the FSA has been at pains to make it clear that its approach will now be a more intrusive one – firms are already experiencing this through an increase in ARROW visits and notification of Skilled Person Reports (s166). Going forward, this will also involve the FSA placing a greater emphasis on understanding firms' balance sheets and related accounting judgments.

Firm risk management and governance

Continuing the theme of an intrusive approach, the FSA believes a significant improvement in risk management and governance is required by banks, including the quality of senior management. The FSA will now play an active role in assessing the technical competence of senior management, which will include interviews with the FSA before any recruitment decision can be confirmed. In addition to this, the FSA requires improved skill level and time commitment of non-executive directors. These issues are expected to be addressed in detail by the Walker Review, with final results due to be published in the last quarter of 2009.

Cross-border banks

The review highlights the need to impose more local/national regulation on individual cross-border firms affecting domestic markets. This would involve branch entities of banks not currently regulated where they reside. The FSA is clearly reacting to the consequences suffered through the Icelandic bank failures and requests the European framework is revised accordingly.

Impact on other sectors

The underlying FSA discussion paper highlights the wide impact the proposed changes made by Lord Turner have on other regulated firms.

  • Intrusive supervision – this will affect all firms as the change in culture of the FSA will be felt industry wide. Risk management and governance of all firms will be assessed.
  • Quality and quantity of capital – key criteria which matter to all firms. How much this is passed on to non-banking firms will in part depend on their ability to enter into an orderly wind-off, as documented within a firm's Internal Capital Adequacy Assessment Process.
  • Group regulation – the FSA intends to widen its scope of group reporting and this will therefore affect all regulated firms that are part of a group (particularly those that currently do not report to the FSA on a group basis).
  • Macro-prudential approach – the FSA will need to be alert to macroprudential risks arising from other sectors within the financial services industry.
  • CRAs – these are not only used by banks, and therefore the regulation of CRAs will have an indirect impact on the regulatory capital required to be held by firms.
  • European Union passporting – potential changes in passporting arrangements may be applied to other sectors in addition to banks, which will undoubtedly affect a firm's commercial activities.


Though not wholly unexpected, the Turner Review and underlying discussion paper make some thought-provoking suggestions, some of which may have a long lead time before seeing the light of day, given the international cooperation required. However, notwithstanding this, firms should already be starting to address recommendations made where this is practical. Ultimately, fundamental changes to the regulation of the financial services industry, and consequently its business activities, will be made and sufficient time needs to be afforded to firms in order to move with these changes. Thankfully, this is something the FSA has acknowledged.

Comments were required to be submitted to the FSA by 18 June 2009, and these should be published by the last quarter of 2009. Once published, we will provide our readers with an insight into the next stage of what will be a long running saga.


Reduce the impact of the proposed increases in income tax and NIC.

From 6 April 2010, the income tax rate for individuals earning over £150,000 per annum (p.a.) is currently planned to be 50%; the highest rate for 20 years. Personal allowances will also be restricted for individuals earning more than £100,000p.a. The effective rate of tax for earnings between £100,000 and £112,950 in the year from 6 April 2010 will be 60%.

From 6 April, 2011 all national insurance contribution (NIC) rates are planned to increase by 0.5%. The new rates will be:

  • 13.3% for employers' NIC
  • 11.5% for employees' NIC up to the earnings limit
  • 8.5% for Class 4 NIC for self employed persons
  • 1.5% additional rate for all earned and self employed income.

New rules are also proposed to limit tax relief for certain pension contributions against the 50% income tax band.

Minimising the impact

The possibilities available to UK taxpayers to limit the impact of the changes will depend on the status of the taxpayer, i.e. employee or self employed, for example, a partner in a partnership or a member of a limited liability partnership (LLP).

Pensions remain tax-efficient saving mechanisms for most taxpayers and businesses, up to certain limits. Salary sacrifice schemes can still reduce NIC.

Alternatively, approved or unapproved share or share option schemes can result in employees receiving amounts taxed as capital gains, at 10% or 18%, rather than income, with a potential tax deduction for the employer. Enterprise Management Incentives (EMI) and Company Share Option Plans (CSOP) are popular approved share schemes and can be tax efficient for employer and employee. The limits on the value that can be granted are £120,000 for EMI and £30,000 for CSOP. It is worth considering whether these are relevant for your company.

Unapproved share schemes are flexible, not being subject to HM Revenue & Customs (HMRC) imposed conditions. If structured correctly, they can offer significant tax benefits. Smith & Williamson has developed several share scheme ideas, offering tax benefits to both employee and employer, while also being an incentive scheme for the employee. We have implemented these for a number of clients, helping save tax and NIC.

Using employee benefit trusts can also offer tax and NIC benefits.

For partnerships and LLPs, we have developed an incentive scheme for employees which mirrors a company share scheme and also offers tax advantages.

Otherwise, partnerships and LLPs could reduce the impact of the increasing taxes by:

  • changing their accounting date
  • using rules involving partner cessation and commencement
  • introducing new partners (including companies), or retiring partners
  • using a service company.

These measures would need to be introduced carefully to ensure unintended consequences are avoided.

Businesses should not forget routine tax planning, for example, ensuring that profits are taxed in the correct period and tax deductions are maximised for expenses/ provisions and capital allowance claims.

Tax planning can reduce the impact of the proposed increases in income tax and NIC and businesses should take action as soon as possible to ensure they do not lose the opportunity to reduce their tax burden.


Avoid self-inflicted VAT costs through mishandling supplies of staff.

Most financial sector businesses are partly exempt and recover only part, or none, of the VAT on their costs. Such businesses are often careful to pay no more VAT than necessary, but many incur self-inflicted VAT costs by mishandling supplies of staff. This is because, while salaries are VAT-free, a supply of staff (or directors) from one business to another is generally subject to VAT.

Temporary staff

Since 1 April 2009, businesses which hire temporary staff from an agency have been paying more VAT than before. Previously, the agencies were able, by concession, to restrict the VAT charge to their own fee and not the salary element. The removal of the concession was widely publicised, but in the recession businesses have been employing fewer temps and the full impact has probably not yet been felt.

The concession also benefited outsourcing businesses, which typically take over part of their client's workforce and supply their services back to the client. With VAT chargeable on the full amount, achieving savings by outsourcing may now be more difficult.

Corporate groups

Businesses which have service companies, or share personnel between companies (often for tax, national insurance or transfer pricing reasons) can end up paying VAT on the full salary costs of the people concerned. The problem can be exacerbated if charges are applied retrospectively (e.g. at the year-end), when it may be too late to consider alternatives.

The same issue can arise if staff costs are spread around the group by means of a management charge – not forgetting that management charges paid to an overseas parent company can also attract VAT as a 'reverse charge'. It may seem odd, but yes, you could end up with a UK VAT bill on recharged US salaries.

Possible solutions

Sometimes the VAT costs can be removed by simply forming a VAT group, but remember that not all companies are eligible to be grouped – and HMRC will not allow grouping to be backdated. Alternatively, you could consider 'paymaster' or joint employment arrangements.

It is also worth looking in more detail at what, exactly, is being supplied. A charge calculated by reference to salaries is not necessarily a supply of staff: it could be a supply of whatever the staff do, which in the financial sector could well be exempt.

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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