UK: Banking And Capital Markets Insight, February 2010

Last Updated: 25 February 2010
Article by Deloitte Financial Services Group

Most Read Contributor in UK, August 2017

Welcome to the February 2010 edition of Banking and Capital Markets Insight, which focuses on technical issues currently coming out of the banking, capital markets, securities and fund management arenas. Our focus for this edition is on the significant, and now much more imminent, proposals for regulatory change in respect of banks and investment firms, and the equally significant developments in the treatment of bank payroll taxes and the code of practice for bank taxation.

Our five pieces cover the following areas:

  • Clifford Smout on the Bank of England discussion paper issued at the end of 2009 on "The role of macroprudential policy" which considers the tools which policy makers have available to avoid procyclicality and the "too big to fail" concerns around a number of institutions, such as moving to an expected loss model for provisioning and capital surcharges for size and interconnectedness;
  • Eric Wooding on the FSA's proposed changes to the large exposures rules for investment firms, which will on the one hand remove Limited Licence and Limited Activity firms from the LE regime, but which proposes the introduction of a much more restrictive treatment of large exposures for Full Scope firms from 1 January 2011;
  • Debbie Masterton on the basics of the Bank Payroll Tax, introduced by HMRC in December 2009, which employees it applies to, how it is calculated, and which specific elements of relevant remuneration it captures;
  • Mike Williams on the current issues arising for investment firms from the FSA reports and discussion papers on client money and the basis for calculation of the ICAAP, and the challenges that they pose at board as well as operational levels; and
  • Tim Sharp/Mark Kennedy on the revised Code of Practice on Taxation for Banks, which was issued in December 2009 and amends the basis on which banks should approach HMRC to discuss individual transactions, and emphasises the need for "reasonable belief" that remuneration packages are not contrary to the intentions of Parliament.

We look forward to your comments on the current edition.

Macroprudential requirements: What are they and what might this mean in practice?

There is currently no shortage of proposals on what must be done to reform the banking system. In broad terms these can be classified under three headings:

  • Changing banking structures (e.g. limiting links between commercial and investment banking; reducing bank size; greater use of central counterparty clearing). The intention is that in future firms will not be too "big" (or too interconnected) to fail, and that depositors will not be exposed to supposedly "risky" activities.
  • Making individual firms more resilient (e.g. raising capital and liquidity requirements; improving risk management; re-examining remuneration structures). These amendments to the regulatory framework are intended to reduce the probability of failure.
  • Improving the way in which failing firms are dealt with (e.g. by requiring them to draw up recovery and resolution plans). The intention is that when firms fail they do so in a way that does not impose undue costs on others.

As part of the proposed changes to the regulatory framework, policymakers are also focusing on the system as a whole, and the interaction between firms: the so-called macroprudential perspective. As part of this debate, at the end of 2009 the Bank of England published a discussion paper on The role of macroprudential policy.

Financial stability and systemic risk

Although the FSA has responsibility for the prudential supervision of individual firms, the Bank of England has a statutory objective of financial stability. In order to make this concept operational, there needs to be a clear definition of what "financial stability" is, and a workable set of tools to help deliver it.

The paper suggests that the goal of financial stability policies should be "the stable provision of financial intermediation services to the wider economy", avoiding the sort of boom and bust in the supply of credit and liquidity experienced recently, although not necessarily preventing asset price bubbles as such. Importantly, this means that in a downswing, steps should be taken to sustain lending, whereas a microprudential supervisor might advocate a more conservative approach.

The paper notes that systemic risk has two components:

  • The first is a tendency of firms to become collectively overexposed to risk in an upswing and to over-react in a downswing, perhaps as a result of herding.
  • The second is a failure to take account of the spillover effects from their actions on others.

Both represent forms of market failure, which may reflect incentive problems, information frictions (including "disaster myopia" where the possibility of bad outcomes are eventually ignored) or co-ordination issues, where individually rational decisions (such as an attempt to sell assets) may result in a worse outcome for all.

Macroprudential tools: countercyclical requirements

What tools might make the financial system less cyclical? How can firms be encouraged to build up buffers of capital in good times, to be used when the going gets tough?

There has been much attention recently on moving from an "incurred" to "expected" loss model for provisioning, and also on eliminating procyclicality from risk measures. But the Bank notes that these merely reduce procyclicality. By contrast, some of the macroprudential tools it describes are countercyclical by design.

This could be done either by adjusting capital requirements across-the-board, or by doing so at a more disaggregated level, which would be more complex but potentially also more precise.

One difference between these alternatives, not explored in the paper, is that since capital requirements are the product of risk-weighted assets (which would alter in the disaggregated approach) and the capital ratio, a significant change in capital could occur even with an unchanged ratio. By contrast, in the aggregate approach the capital ratio would vary – which might be received negatively in a downswing, when the market would be nervous about apparently lower ratios. It would be simple, however, to recast the across-the-board approach into an overall levy or discount on all risk weights instead, if this were felt necessary to address the problem.

The paper also considers the role that judgment should play in making these adjustments. One approach would be to use a formula instead, based on asset prices or credit expansion, though there is no perfect early warning indicator: rapid credit growth for instance might reflect a structural change in the economy. Alternatively, policy might be set judgmentally, via a Committee that could take the full range of data into account, but which might be subject to lobbying from bankers and others reluctant to accept the case for more stringent requirements when the economy seemed to be in good shape. The Bank of England appears to prefer the latter approach, but accepts that it would require robust mechanisms to ensure accountability, transparency and predictability.

Capital surcharges for size and interconnectedness

Systemic risk can result not only from aggregate factors – i.e. the tendency of the sector to move together – but also from network risk: problems at one firm spilling over to others, or to the economy as a whole. These potential externalities are greater the larger the firm, the more connections it has to others and the less "substitutable" its products are. If a firm is "too big to fail" then the beneficiaries from the "rescue" are typically not shareholders or management, but wholesale counterparties and funders, who in effect benefit from a guarantee for which they have not (as yet) paid.

The Bank supports the FSA proposal to set a capital surcharge to address these issues. This would not only lower the probability of those firms failing, but also potentially encourage restructuring (e.g. to make the firm less interdependent on others) and the preparation of "living wills".

Making the regime operational

While there is no perfect early warning indicator for exuberance in credit markets, the Bank of England sets out a list of variables that might be considered by those setting variable capital requirements. Not all of this information currently exists – and some would require extensive data from individual firms to build up an aggregate picture.

The paper also sets out the various steps that would be needed to set countercyclical capital surcharges, with some illustrative diagrams on how this process might have worked over the past ten years. A similar process is described for institution-specific surcharges, reflecting both the size and interconnectedness of the firm.

The paper also examines a number of other issues, including the vexed question of institutional coverage, and the international dimension.

The Bank concludes that "to be wholly effective, a macroprudential regime might require significant international co-ordination. But, even in its absence, appropriate macroprudential instruments might still be able to strengthen the resilience of the domestic banking sector".

This may underplay the importance of the issue. If introduced unilaterally in an upswing, banks will argue that higher capital requirements will hamper their business: as evidenced by past furores over "goldplating" of EU directives. If introduced when times are bad, it will be difficult for one country to reduce capital requirements significantly, both because of the market reaction to such a move, and the existence of internationally agreed minimum standards.

Conclusion

The paper is very much intended to generate discussion; it "does not reach definitive answers and does not seek to advocate a particular operational regime". But there is plenty within it that provides food for thought, and which hints at some of the difficulties that might be encountered in journeying from concept to operational reality.

Major changes to large exposures rules: how will they affect investment firms?

For most BIPRU investment firms – virtually all but the large securities dealers/investment banks – the proposals on large exposures are likely to be the most relevant section of the FSA's recent Consultation Paper "Strengthening Capital Standards 3" (CP 09/29), which addresses the UK implementation of recent changes to the EU Capital Requirements Directive (CRD).

The impact of the changes in the large exposures rules differs markedly for different categories of BIPRU investment firm ("firm" in the remainder of this article). While limited licence and limited activity firms will be exempt from large exposures rules from 1 January 2011, full scope firms will be subject to tighter large exposures restrictions from that date.

Which type of BIPRU investment firm are you?

Limited licence firms either do not have permission to deal in investments as principal or the permission is subject to a standard limitation that requires any principal positions to arise only as a result of the firm's failure to match investors' orders precisely and restricts the total market value of all such positions to 15% of capital.

Limited activity firms have permission to deal in investments as principal but that permission is subject to a standard limitation that restricts principal dealing to fulfilling or executing a client order or gaining entrance to a clearing system/ exchange while dealing as agent or executing a client order. There is no restriction on the size of positions that may result from activities that fall within the standard limitation.

Full scope firms have permission to deal as principal but do not have either of the standard limitations referred to above. Firms that engage in proprietary trading, market-making or underwriting will be full scope.

The remainder of this article focuses on the proposals that are relevant to full scope firms.

Two key proposals for full scope firms are:

  • removal of the "inter-bank" exemption; and
  • application of the 25% of capital large exposures limit to third party trading book exposures.

In addition, while they will not have such a widespread effect as the above, the proposed changes in respect of intra-group exposures may affect a number of full scope firms to some degree.

Removal of the "inter-bank" exemption

Under the current large exposure regime, exposures to a third-party "institution", that is, a bank, building society or CAD investment firm, are exempt from the limit of 25% of capital provided the exposures have a residual maturity of one year or less. The amount of cash a firm can place with one bank is therefore currently not restricted.

This will no longer be the case from 1 January 2011. The limit of 25% of capital will apply to exposures to a third party bank but relief is proposed for smaller firms (i.e. those with regulatory capital less than €400m). The proposed relief is that such a smaller firm's total exposure to a third party bank (or building society or CAD investment firm) may exceed 25% of capital provided it is not more than the lower of €100m (about £87m at the exchange rate ruling at the time of writing) and 100% of the firm's capital resources. Thus, provided that it is satisfied that such an exposure is reasonable, a firm with regulatory capital of say €300m will be able to place up to €100m with a single third party bank, not just €75m as would be required by the normal limit of 25% of capital.

It will be apparent that for very small firms (i.e. those with regulatory capital below €100m) the binding constraint under the above exemption would be 100% of regulatory capital rather than €100m. However, the FSA proposes to allow such firms to apply for a waiver from the 100% limit but not from the ceiling of €100m.

Thus a full scope firm with a capital base of say €80m may be able to obtain a waiver which allows it place between up to €100m with one bank. To be successful, the waiver application will have to explain why the firm needs to have exposures to a bank in excess of its capital base.

The proposals are summarised in the table below.

It should be noted that the exemption limit of €100m proposed by the FSA is lower than the ceiling of €150m contained in the directive. The FSA does not give any precise reason why it proposes gold plating the directive in this respect.

Application of the 25% limit to third party trading book exposures

Currently, the FSA adopts a national discretion which allows UK firms to have trading book exposures to a third party in excess of 25% of capital (and indeed up to 5 times capital). An additional capital requirement – the concentration risk capital requirement – is levied on the excess. Although the amendment of the CRD does not remove this national discretion, the FSA does not propose to continue using it. Rather it proposes that from 1 January 2011 trading book exposures to a third party should be subject to the 25% limit. (However, the existing regime for intra-group trading book exposures is to continue "for the time being" while the FSA continues work in this area.)

The FSA's reasons for tightening up on concentrations of exposure in the trading book appear to originate in lessons learned in the crisis such as that trading book exposures may be difficult to trade out of without incurring significant loss and rapidly deteriorating counterparty creditworthiness may be difficult to monitor and deal with in times of extreme stress. The FSA's conclusion is that the large exposure limit for trading book exposures to third parties should be the same as that for non-trading book exposures i.e. 25% of capital.

This change may be of particular relevance to full scope firms which are active in proprietary trading or underwriting or which may have large trading book counterparty risk exposures. Changes to the treatment of intra-group exposures

There are three key proposed changes regarding intra-group exposures within the UK:

  • a firm that wishes to exempt such exposures will have to apply for a formal waiver in order to establish a "core UK group", rather than give notice as at present;
  • all the entities in the core UK group must be fully owned (i.e. no minority interests) and fully consolidated within the same UK consolidation group; and
  • the members of the core UK group that are not FSA regulated firms must enter into a legally binding agreement to support the regulated members, should they need additional capital to meet regulatory requirements.

As regards intra-group exposures outside of the core UK group, the FSA proposes to replace the current Wider Integrated Group regime with a basic limit which may be 100% of the capital of the core UK group if the counterparty satisfies certain conditions, including conditions relating to common risk management and consolidated supervision.

The FSA proposes to allow firms to continue with the existing BIPRU 10 rules on intra-group large exposures until 31 December 2012 provided they notify the FSA.

Conclusion

The list of areas in which limited licence and limited activity firms enjoy a lighter regulatory burden than their full scope cousins is growing. When the CRD came into force in 2007, a key such area was consolidated supervision, where limited licence and limited activity, but not full scope, firms were permitted to seek a waiver from consolidated supervision. More recently, the FSA applied the new quantitative liquidity rules to all but the smallest full scope firms but exempted those which are limited licence or limited activity. The new large exposures regime, with its tighter restrictions for full scope firms but complete exemption for those which are limited licence or limited activity is the latest addition to the list.

Bank Payroll Tax

Given all of the column inches given over to the effect of Bank Payroll Tax ("BPT") which was introduced in December 2009, we thought it would be useful to provide a summary reminder of the basis of calculation, the application and the effect of the tax on both relevant individuals and institutions.

What is the basis?

In brief, the bank (not the employee) pays a one-off tax charge of 50% in relation to discretionary payments which arise between 9 December 2009 and 5 April 2010 (the "chargeable period"). The rules might be extended until the point the Financial Services Bill becomes law. However, discretionary bonuses or benefits up to £25,000 do not attract the charge.

Affected companies must complete a return and make a payment on account of the tax by 31 August 2010.

Which approach to take?

The affected banks and building societies have faced one fundamental choice: whether to postpone the bonus review or go ahead regardless and incur the BPT.

In the majority of cases, it seems that employers will proceed with bonuses as planned (due to the fear of losing valued staff and the ongoing uncertainty that the new rules may be extended), meaning that these employers will absorb 100% of the cost of the BPT as a business cost.

However, we are aware of a few other affected entities which have decided to pass the cost of the BPT on to employees (both wholly and partly) by reducing the overall bonus pool.

Who does it apply to?

Assuming HM Revenue & Customs ("HMRC") incorporate their recent guidance into the legislation, then BPT applies to banks, building societies and banking groups, including investment firms that trade their own capital. Additionally, institutions that are full scope BIPRU 730K investment firms, or would be if their head office were in the UK (and whose activities consist wholly or mainly of "relevant regulated activities") will remain within the scope of BPT. It does not apply to other non-banking companies outside of banking groups (e.g. independent insurance companies, asset managers, stockbrokers etc).

The employees of affected institutions are only included if they are "relevant banking employees". However HMRC guidance clarifies that all employees, including back office and support staff, are relevant banking employees if they are involved in "relevant regulated activity" or the lending of money. "Relevant regulated activity" is defined by reference to specified articles of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 and includes, inter alia, accepting deposits and arranging or dealing in investments.

What does it apply to?

BPT applies to earnings or employment related benefits ("Relevant Remuneration") awarded during the chargeable period, including stock awards and deferred arrangements, regardless of whether that remuneration is subject to tax in the hands of the employee.

Further, contractual obligations or any "arrangements" to pay such Relevant Remuneration in the future that arise, or are entered into, in the chargeable period are also caught. "Arrangements" will include any agreements, promises or looser understandings.

There is some uncertainty over whether pension contributions are caught within the rules. HMRC have stated that pension contributions are caught, however there is a case to say that neither the initial contribution nor the subsequent provision of pension income is caught as arguably no benefit is derived on contribution and the pension income is distributed by reason of retirement, not employment.

Certain other types of remuneration are more clearly excluded. "Regular" salary or benefits are explicitly excluded and, in this context, it is interesting to note that regular means that the amount of the award cannot vary according to performance of the business or the employee concerned, rather than the frequency of the payment.

In addition, contractual amounts paid in the chargeable period where the obligation arose prior to 9 December will not be subject to BPT. When determining what is a contractual amount, regard can be given to rights the employer feels obligated to regard as contractual, even where they are not in the employment contract. However, the approach should be consistent e.g. it should not be argued that a bonus was contractual if it was regarded as discretionary in the past or will be in future. Individual bonuses, and indeed whole bonus pools, which are determined or capable of being determined without discretion are deemed contractual for this purpose even where the allocation of the overall pool amongst participating employees is discretionary.

How much is it?

Where Relevant Remuneration is in the form of money or money's worth, it is, as you would expect, the amount when awarded, although the draft legislation requires any restrictions attaching to the award to be ignored when determining the amount. However, when calculating money's worth, it may be possible, for certain awards at least, to take into account discounts for lack of liquidity or a minority stake.

Where Relevant Remuneration is awarded, or is deemed to be awarded, under an arrangement and there is uncertainty as to how much will be paid in the future, the amount that should be brought into account is so much as it is "reasonable" to assume will be paid in the future. As no guidance has currently been issued regarding how to determine what is "reasonable" for this purpose there is clearly some scope for interpretation. For example, where the award amount is dependent on performance conditions or continued employment, consideration should be given as to what it would be "reasonable" to assume will vest given those uncertainties.

Conclusion

As noted above, there are a number of areas relating to BPT which remain open to some degree of interpretation. In due course, HMRC may of course issue further guidance and clarification to aid employers further in making the necessary decisions. In the meantime, however, our suggestion is to take a reasonably robust and commercial approach to any analysis of what, and how much, is subject to BPT. That approach should be documented and justifiable, and reflect appropriate advice.

Current client money and ICAAP issues for investment firms

Two documents have appeared from the FSA in January 2010 which are likely to have a significant practical impact for investment firms over the coming 12 months. The first is the Client Money & Asset report, and accompanying "Dear CEO" letter of 19 January. This follows up on the "Dear Compliance Officer" letter which was issued in March 2009, and which highlighted a number of straightforward areas for attention in terms of management oversight, record-keeping, acknowledgement of trust arrangements, due diligence on, and diversification of, client money banks, reconciliations and the basics of segregation. The 2010 Client Money and Assets report widens the agenda to include title transfer arrangements, unallocated excess cash held in segregated accounts, improved reporting and the resolution regime for investment banks which the FSA and the Treasury have jointly worked on.

Key conclusions from the report are as follows in respect of the visits already performed:

  • The visits made to investment and insurance broking firms (the latter area we have not focussed on here) in 2009, which led to a number of skilled persons reports and two Enforcement referrals so far, will continue to be a regulatory priority in 2010 with visits currently being undertaken to custodians. The FSA anticipates increasing the level of enforcement resources devoted to client asset cases, and will consider the individual conduct of Significant Influence Function holders as well as firms themselves in pursuing enforcement cases.
  • Insufficient senior management oversight and control, with insufficiently robust governance arrangements and detailed management information, is often the underlying cause of more serious Client Assets Sourcebook ("CASS") breaches. In addition, the risk of non-compliance was higher during periods of change, for example, following internal restructurings or acquisitions, where a firm transferred to a new reporting and reconciliation system, or where it merged different systems.
  • Basic breaches are occurring at investment firms in respect of absence of receipt of trust letters from banks, insufficient due diligence on banks and strategy for diversification of client money assets on a regular basis, errors in segregation of client from firm money and in appropriate registration and recording of legal title to customer assets, insufficient adequacy and frequency of reconciliation of client money and custody assets, inappropriate use of title transfer arrangements to remove client monies from segregation, and insufficient oversight of third party administrators. There are a separate set of issues in respect of insurance brokers which we have not considered here.

In terms of future CASS areas of focus, the report discusses the following:

  • The FSA is working with the Institute of Chartered Accountants in England and Wales to improve the quality and consistency of CASS audit reports received from auditing firms.
  • There is some concern that the level of usage of title transfer arrangements for retail clients is much more extensive than the FSA originally envisaged and could potentially be being used to try to avoid giving client money protection to retail clients. As a result, the FSA will clarify the title transfer rules in a quarterly Consultation Paper to bring firms' practices into line with their expectations.
  • Firms need to have appropriately detailed calculations and to be able to fully reconcile their client money holdings in order to be in compliance with CASS. Firms may, however, hold a specific money amount of client money in a buffer to protect client assets, for example, in order to protect unallocated client money under the "alternative approach". The rationale for the buffer should be discussed and signed off at board level. FSA will engage with firms on this issue in the first half of 2010.
  • FSA intends to re-establish routine client money reporting, which previously existed for firms, on a monthly or quarterly basis, with an interim version being piloted in 2010 and the full system in 2011.
  • The Treasury is consulting on the Resolution Regime for Investment Banks and the FSA is looking to publish a Consultation Paper on the proposed amendments to the CASS rules in quarter one of 2010. This is likely to address the current concerns around the effectiveness of the alternative approach following the judgement by Justice Briggs in the Lehman Brothers High Court decision in December 2009.

The other important document for Limited Licence Investment Firms which appeared in January 2009 is the paper on ICAAP submissions, which was critical of the capital assessments undertaken by some smaller Limited Licence firms. Some key findings from the paper include the following:

  • While it may be sufficient for smaller Limited Licence firms to use the Pillar 1 Plus approach, which takes as its starting point the adequacy of Pillar 1 capital to determine whether it is necessary to hold any additional capital under Pillar 2 to cover the firm's risk exposures, the FSA prefers a bottom up assessment of risks under Pillar 2. Firms should also be clearer as to how the Pillar 1 market and credit risk capital requirements have been calculated, even when the Fixed Overhead Requirement ("FOR") is the determining factor in the firm's Pillar 1 capital resources requirement.
  • Firms are expected to hold the higher of the FOR and the wind-down cost of the business, whichever the Pillar 2 process indicates is the greater. The winddown analysis, which was often not sufficiently detailed in the ICAAPs reviewed, should include details of the period expected to wind down the business, the likely costs including costs of terminating contracts, realistic cash and funds in-flows and out-flows over the wind-down period when the firm is likely to be in distressed conditions, and additional losses or liabilities that could crystallise during the wind-down period.
  • The articulation of risk appetite requires quantitative measures (e.g. tolerable operational losses, stated say as a percentage of the last three years of earned income) alongside qualitative statements that the firm is risk-averse or the tolerance for risk is low. Firms should also be able to apportion risk appetite statements across business lines and risk types.
  • In terms of operational risk, the FSA noted that there was inadequate quantification of risk exposures in a number of cases and so it was difficult to assess the adequacy of capital allocated against individual types of operational risk exposure, and insufficient and inappropriate use was made of historical loss data, focussing on a limited sample of very recent loss events and of publicly available loss data where available.
  • Where firms were relying on professional indemnity insurance to mitigate against operational risks, while firms often had considered policy exemptions and coverage limits and the risk that the insurer would not be willing or able to pay out a large claim, it was not always clear from ICAAP submissions that firms had also demonstrated that they had sufficient liquidity to survive in the period between submitting a claim and having it settled.
  • Regarding stress and scenario testing, it was not always clear how relevant stress tests were to firms' businesses, and in some cases, base case capital forecasts used for stress and scenario testing were overly optimistic, either from being relatively historically based or being based on the revenue and funds under management targets in strategic and business plans as opposed to revenues that would be received under stressed economic conditions. The most appropriate stress tests drew on relevant data and focussed on the wind down of the firm. Some firms also considered the impact of several correlated events occurring concurrently. The FSA will continue to focus on senior management taking an active involvement in implementing an appropriate stress testing programme and incorporating its outputs into its decision-making. The FSA will also expect firms to incorporate reverse stress testing requirements going forward as part of their business and strategic planning process.
  • In terms of challenge and adoption of the ICAAP, the FSA is firmly looking to the board to approve and sign-off the ICAAP, and they will look in future ICAAP submissions for more demonstration of how the board's role works in practice and to see evidence that where there are significant events, such as market downturns, boards reassess their ICAAP assumptions in a timely manner.
  • In discussing group risk and aggregation principles, the FSA is clear that it is very conservative in the reliance it is willing to take from parental support as a mitigating tool or action, and that the onus is on the firm relying on the parental support to demonstrate, in the exceptional cases where the FSA does accept it, that it is legally enforceable and will be forthcoming in stressed scenarios.
  • Where groups have taken a top down approach to the ICAAP, many have apportioned capital to regulated entities based on contribution to group expenses rather than their relative risk exposures. As a result, particularly where management service structures exist, expenses have been underestimated and inadequate regulatory capital has been apportioned to entities.
  • Where groups have sought the benefit of diversification between different risk types in reducing the overall level of capital held, the FSA believes that it is difficult for Limited Licence firms to find appropriate quantitative evidence to support their assumptions, partly because future interactions may be different from historical ones and partly because there is not a sufficient history of extreme events for a proper analysis. The FSA has therefore not been able to conclude that the diversification benefit sought is prudent.

Between the challenges of increased scrutiny of both client money and capital requirements under the ICAAP, investment firms have a clear agenda for 2010, which relies in both instances in more detailed analysis of the underlying risks and mitigating operational procedures and controls of the business, to support more transparent and effective client money processes and the appropriate setting of the firm's overall regulatory capital requirement.

The revised Code of Practice on Taxation for Banks

Following a consultation period, HMRC has issued a revised Code of Practice on Taxation for Banks, along with a feedback on the consultation, supplementary guidance notes and an impact assessment. Whilst the underlying principles of the Code have not changed, amendments have been made to assist banks in applying the Code.

Implementation

The introduction of the Code was confirmed on 9 December 2009. HMRC expects those banks managed within the Large Business Service (LBS) to comply with all aspects of the Code and to communicate confirmation of their intentions to adopt as part of ongoing dialogue with their Customer Relationship Manager. The Government has now decided that banks not managed within the LBS will only be expected to comply with the summary requirements (Section 1) of the Code. HMRC has issued a written request to most of these banks that they provide confirmation of their intentions to adopt the voluntary Code by 29 January 2010.

Amendments to the Code In light of the comments received, HMRC has amended the Code to:

  • no longer demand that banks initiate dialogue with HMRC if there is doubt if a transaction is contrary to the "intentions of Parliament", but the bank may choose to do so; and
  • ensure that the test of 'reasonable belief' is explicit in deciding whether remuneration packages are structured such that proper amounts of tax are paid and that tax planning arrangements are not contrary to the "intentions of Parliament".

The supplementary guidance notes cover the practical application of the Code including how banks should approach HMRC regarding a proposed transaction and the processes HMRC will go through in making a decision under the Code.

Response on Consultation

In revising the Code, HMRC responded to comments sought from banks, their advisers and representative bodies such as The Chartered Institute of Taxation, The British Bankers Association and The Association of Foreign Banks. The following key areas were discussed:

Rule of law

Respondents raised concerns that HMRC should not become responsible for the interpretation of "spirit of the law" and "intentions of Parliament", indicating that legal interpretation should remain with the courts.

HMRC were in agreement that they should not become responsible for legal interpretation and that Banks will continue to be taxed in accordance with the law. HMRC emphasised that the Code is not law, but a statement of principle which provides a benchmark for corporate behaviour.

Discrimination

In announcing that the Code would apply solely to banks and banking activities, respondents claimed this would discriminate the financial sector against other industries.

HMRC rejected this view, citing historic planning activities involving banks and the recent economic situation, the latter resulting in an increased level of Government assistance.

Competition

Respondents indicated that UK banks would be at risk of losing business to foreign competitors who are not covered by the Code. In addition, UK banks will be in competition with one another if one adopts the Code and another does not.

HMRC replied that the Government's intention is that all banks and similar institutions operating in the UK should adopt the Code, promoting a level playing field across banking. The Government did not agree that adoption of the Code will place UK banks at a competitive disadvantage as the Code does not alter the fact that responsibility for the business decisions and transactions entered in to remain with the bank.

Definitions

Respondents felt it would be difficult, if not impossible to clearly define "spirit of the law" and decide if transactions are contrary to "intentions of Parliament", thus creating uncertainty for taxpayers when undertaking business transactions.

HMRC responded that the Code is not a legal document and the phrase should not be construed as if it were statutory provision/legislation. In a technical note drafted by HMRC in consultation with banks and advisers, they will suggest banks answer the question of whether the transaction is contrary to the "intentions of Parliament" in practice by asking whether the tax consequences are 'too good to be true' so that the tax consequences would be a 'surprise to HMRC'.

Conclusion

The tenets and policy rationale of the updated Code remain unchanged. To ensure compliance with both the letter and spirit of the law, HMRC have indicated banks apply the test of "reasonable belief" with regards tax planning and transactions entered. Whilst HMRC emphasise that the Code is not law and that the final business decision rests with the bank, the Code expects that banks will enter into open and transparent dialogue to promote best practice in relation to tax governance and relationships with HMRC.

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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Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.