Including updates on FATCA, bank recapitalisation and deposit insurance systems


FATCA takes shape

On 8 February 2012, the US Department of Treasury (Treasury) and Internal Revenue Service (IRS) issued its Proposed Regulations providing guidance for foreign financial institutions (FFIs), non-financial foreign entities, and US withholding agents to implement various provisions under the Foreign Account Tax Compliance Act (FATCA) of 2009.

The Treasury and IRS have taken on board commentators concerns, seeking to reduce FATCA’s overall burden on the financial industry and extending the implementation timelines for FATCA.

Some of the key changes to the proposed regime include:
  • Grandfathering: eligibility criteria expanded to include obligations outstanding as of 1 January 2013 (previously 18 March 2012) and obligations such as debt instruments, revolver credit facilities, lines of credit and certain life insurance contracts.
  • Passthru payments: FATCA withholding on foreign passthru payments begins 1 January 2017 (previously 1 January 2015). However, FFIs must report the aggregate amount of certain payments to each non-participating FFI in the interim, to prevent non-participating FFIs using participating FFIs to block the application of the FATCA rules.
  • Reporting requirements: transition period on the scope of information reporting by FFIs extended. From 2014 and 2015, all FFIs must begin reporting the name, address, TIN, and account number of US account holders. FFIs are required to report income associated with US accounts (for calendar year 2015) from 2016 onwards. From 2017, FFIs must begin reporting gross proceeds from securities transactions.
  • Transition rule: new two-year transition rule applies until 1 January 2016 for certain members of expanded affiliated groups to become a participating FFI or a deemed- compliant FFI. This grace period only applies to FFIs located in countries that prohibit the tax withholding or reporting required under FATCA. The rule does not prevent other FFIs within the same expanded affiliated group from entering into a FFI agreement.
  • Additional categories of deemed-compliant FFIs: expansion of the categories of deemed-compliant financial institutions to eliminate or reduce burden on certain entities.
  • Changes in due diligence procedures for identifying accounts: increase in thresholds amounts associated with reviewing records of pre-existing accounts to determine U.S. status.
  • Verifying compliance: the responsible officer of a FFI will now be expected to certify that the FFI complied with the terms of the FFI agreement.
  • Definition of ‘financial account’: includes traditional bank, brokerage, money market accounts, and equity interests in investment vehicles and excludes most debt and equity securities issued by banks and brokerage firms.
Clearly, FATCA will be more burdensome and invasive than comparable tax regimes and will require significant investment by major European FFIs. It will extensively increase the amount of data that must be analysed by financial institutions, the types of payments that could be subject to US withholding tax and the number of entities that could become liable for US tax on such payments. It will also require more stringent management of legal entities and greater clarity of not just ‘who customers are’ but ‘what they are’.

We are likely to see other countries adopting corresponding regimes. In a press statement accompanying the Proposed Regulation, the Treasury expressed a willingness to ‘reciprocate in collecting and exchanging basis information on accounts held in US financial institutions by residents of France, Germany, Italy, Spain and the UK’. Those countries announced that they are exploring arrangements for domestic reporting and reciprocal automatic information exchange. Legislative requirements in those countries will probably overlap with FATCA timescales as well as the other European specific regulations such as EMIR, MiFID II and CRD IV, placing additional burdens on European FFIs as they try to get to grips with their requirements across different territories.

The Proposed Regulations are open for comment until 30 April 2012. After that, the Treasury and IRS will issue additional FATCA guidance on issues not covered by the Proposed Regulations (e.g. on the administration of foreign passthru payment withholding). They plan to publish a draft model FFI agreement in early 2012 for comment, and a final model FFI agreement in the fall of 2012.

Further information and insights on the Proposed Regulations can be found in our Global IRW Newsbrief.


EBA: recapitalisation plans on track?

EU banks are planning to raise 98 billion euros by the end of June 2012-- which represents an additional capital buffer 26% higher than the shortfalls identified by the European Banking Authority (EBA) in December 2011.

In its primary review of EU-wide recapitalisation plans (which excludes Greek banks and three other banks currently restructuring), the EBA’s Board of Supervisors estimates that, in aggregate, direct capital measures will account for about 77% of the total amount of actions proposed. The majority of these measures are capital raising, retained earnings and conversion of hybrids instruments to common equity.

Measures impacting risk-weighted assets (RWAs) account for just 23% of the total amount of actions. This is not surprising; regulators prefer banks to improve the capital side of their capital ratio instead of adjusting risk measures in existing models, because it represents an increase in the capacity to absorb losses rather than refinement to the measurement of credit risk.

Not including other deleveraging plans already agreed, the EBA estimates that only 1% of the recapitalisation exercise will come from banks’ reducing assets or withdrawing lending to the real economy. Any deleveraging which does occur will have little or no impact on economic growth, according to the EBA.

Given current data, this claim is intriguing. According to the European Central Bank’s latest bank lending survey, credit conditions tightened significantly in the EU in the last quarter of 2011 (with further tightening expected for most of 2012). Eurostat reported on 15 February that economic output in the eurozone fell 0.3% during this period. While it is impossible to clarify the source of this decline (the first since 2009), the activities of banks and their lending patterns is likely to have had an impact.

However, the EBA’s analysis is preliminary. Its Board of Supervisors has not yet assessed the viability of the individual recapitalisation plans and it remains to be seen if they can be implemented successfully. The Board of Supervisors will ‘assess the credibility of measures’ such as forecasts of retained earnings, the effectiveness of the process for the approval of new advanced models and the reliability of assumptions underlying the planned disposal of assets and their geographical impact.

Notwithstanding ongoing concerns about the Greek economy, we envisage that banks will face significant hurdles in raising capital in the current environment (see 13 December 2011; 17 October 2011) and may have to resort to further deleveraging and support from their beleaguered governments.

The EBA indicates that banks will not be subjected to a pan-European stress test in 2012. The last two exercises have failed to quell market concerns. Many of the problems resulted from the parameters underpinning the EBA’s stress tests -- which were not necessarily the fault of the regulator itself. The 2011 exercise was marred by a failure to factor in sovereign debt restructuring, or even sovereign default, in prescribed stress test scenarios. EBA has had a difficult task in reconciling conflicting views amongst the Member States and EU institutions, while ensuring that the compromise reached is credible. In the future, we need to avoid stress scenarios becoming politicised, and ensure the EBA is given space to conduct stress exercises effectively.


FSB reviews deposit insurance systems

Deposit insurance systems across G20 members are broadly in line with international principles and standards for effective deposit insurance, according to a peer review by the Financial Stability Board (FSB).

Standards in G20 countries are particularly high in areas such as deposit insurance mandates, membership arrangements and the adequacy of coverage. Most countries agree that the appropriate design features of a deposit insurance system includes:
  • higher (and, in the case of EU Member States, more harmonised) coverage levels
  • the elimination of co-insurance
  • improvements in the payout process
  • greater depositor awareness
  • the adoption of ex-ante funding by more jurisdictions and
  • the strengthening of information sharing and coordination with other safety net participants.
Deposit insurers’ mandates are also evolving across the G20 countries, with more of them assuming responsibilities beyond a ‘paybox’ function to include involvement in the resolution process, which the FSB believes is appropriate.

The FSB’s peer review comes at a time when the EU is on the verge of changing requirements for deposit insurance schemes. The Irish government’s unilateral decision to guarantee all deposits in September 2008 left many other EU countries with little option but to introduce similar measures to protect their banking systems. The results were haphazard and uncoordinated. As a result, on 12 July 2010, the EC adopted a legislative proposal to overhaul the Directive on Deposit Guarantee Schemes. The Directive harmonises and simplifies the regime for protected deposits, calling for a faster payout, and improved financing arrangements. The EU Council and Parliament are currently negotiating the Directive and a consensus is relatively close. The Directive will dovetail with forthcoming proposals on a pan-European crisis management regime.


EC instigates wide-ranging review of Financial Conglomerates Directive

The European Commission (EC) is undertaking a ‘fundamental’ review of the Financial Conglomerates Directive (FICOD II) and is seeking stakeholder feedback on a host of issues related to the supervision of large and complex financial groups.

The review follows the implementation of ‘quick fix’ measures designed to address specific problems with the Financial Conglomerates Directive (Directive 2002/87/EC) which came to light following the 2008 financial crisis (FICOD I- Directive 2011/89/EU) which came into force on 9 December 2011.

In 2010, the Joint Committee of on Financial Conglomerates (JCFC) undertook a stocktake of supervisory practices which provided input to the EC’s August 2010 proposal for FICOD I. In April 2011, the EC requested additional support from the JCFC to extend its review of supervisory practices to include i) scope of application especially the inclusion of non-regulated entities (such as special purpose entities), ii) the internal governance requirements and sanctions, in particular with respect to obligations of the parent entity and ii) supervisory empowerment, in particular the necessary legislative provisions in case the parent entity is a (non-regulated) holding company. The EC noted that “the JCFC would add particular value if it could take the holistic group-wide view traditionally associated with conglomerate supervision instead of the more narrow approach of traditional sector supervision” and, in particular, provide key insights into how to ensure consistency in the prudential requirements introduced through the Capital Requirements Directive and Solvency II. It asked for input from the JCFC by July 2012: it is possible that the JCFC will consult on its draft advice in the spring.

The EC’s request came against the backdrop of ongoing work at the international level in the Joint Forum which published its Differentiated Nature and Scope of Regulation report in January 2010 which was subsequently endorsed by the Financial Stability Board. The Joint Forum issued a much- anticipated consultation paper on updating its Principles of Supplementary Supervision in December 2011: this consultation runs until 16 March 2012. The Joint Forum is looking to revise and supplement its Principles in areas such as supervisory powers and authority, supervisory responsibility, corporate governance and risk management.

In parallel with these ongoing exercises, the EC is now extending its net to capture the views of a wider range of stakeholders. The EC’s consultation will run until 19 April 2012. It is looking for feedback on the scope of the Directive for supplementary supervision, in particular its application to non-regulated entities such as special purpose vehicles. It is also consulting on:
  • the supplementary supervision of systemically relevant financial conglomerates (as per Financial Stability Board standards)
  • whether there should be mandatory stress testing for financial conglomerates
  • whether legal certainty and clarity in FICOD could be improved and
  • whether the FICOD supervisory framework could benefit from ‘legal tandem’ with any EU company law developments relating to governance.
The EC are keen on getting a “European perspective” on globally recognised Principles in this area. The EC are looking for stakeholders to address the following questions related to the Joint Forum’s principles:
  • should group supervision focus on the head entity of the financial conglomerate in its leading role and impose corrective measures on this entity, if it is not an authorized entity itself?
  • should there be discretion in the application of rules in the supervisory approach of cross-border and cross-sector groups?
  • whether explicit new or amended legal provisions are necessary to achieve sound group-wide governance systems in Europe, or whether sufficient legally clear provisions already exist to implement the suggested principles?
  • whether the European prudential framework should remain confined to enforceable capital- and liquidity-ratio's, or that additional provisions are necessary, as suggested by the Joint Forum, to ensure that a conglomerate's internal capital and liquidity policy is sufficient to meet the required standards at all times in all of its authorized entities?
Stakeholders are invited to give their views on the European implementation of more specific regulation of group risks of this kind and introducing relevant requirements at the level of the head of a financial conglomerate. The responses will help the EC to frame a review report on the fundamentals of the prudential supervision of financial groups due in Q3 2012. Legislative proposals may then follow in 2013.