Finance Industry Update July 2010
Who’s watching who? The new face of financial regulation
In his recent Mansion House address, the text of which was published by HM Treasury on 16 June 2010, George Osborne set out the government’s proposals to reform the regulatory structure of UK financial services. The main thrust was that the government proposes to remove the existing tripartite system resulting in the FSA, in its current form at least, ceasing to exist.
The first of the new bodies, and the one tasked generally with regulating the conduct of consumer financial services, will be the Consumer Protection and Markets Agency (CPMA). The main objective of the CPMA will be promoting confidence in financial services and markets – the government wants the CPMA to be a "strong consumer champion" engaging in firm and proactive regulatory conduct.
The CPMA will inherit current FSA responsibility for the Financial Ombudsman Service, the Consumer Financial Education Body and the Financial Services Compensation Scheme, however it’s not clear whether the CPMA remit will extend to other FSA responsibilities including general enforcement and indeed its role as the UK Listing Authority.
The Prudential Regulation Authority (PRA) will be a subsidiary of the Bank of England and its responsibilities will include the regulation of financial firms including banks, investment banks, building societies and insurance companies. It has been indicated that the PRA will set institution specific capital requirements and that there will be changes to the current legislation and rules in relation to capital and liquidity ratios, to enable some discretion on a tailored basis.
The Financial Policy Committee (FPC) will be a committee of the Bank, responsible for considering large-scale issues concerning the economy and financial stability, and for taking any necessary action as a result. The FPC would look at those aspects of any particular bank that make it look unsafe in comparison with other institutions, and would also focus on any common features that threaten financial stability.
Finally, the Serious Economic Crime Agency will, as the name suggests, take on serious economic crime, inheriting functions that are currently dealt with by various government departments and agencies including the Serious Fraud Office, the FSA and the Office of Fair Trading.
The existing tripartite system has been heavily criticised for failing to anticipate the damage to the economy suffered during the financial crisis and for failing to provide clear, decisive leadership. The new government is of the opinion that only central banks have the broad macroeconomic and market know-how as well as the authority and knowledge required to make macro-prudential decisions.
It believes that because they are the lenders of last resort, the financial crisis was evidence that they need to be familiar with all aspects of the institutions they may have to support and therefore should be brought further into the regulatory fold.
The market has however expressed concern that the removal of the FSA could result in regulatory confusion and there have been questions as to whether it is in many ways change for change’s sake.
Concerns have also been expressed as to the lack of detail in the proposals, and in particular the interface of the new regulatory structures with Europe, given that policy making in the area of financial services regulation is now almost exclusively determined at that level. There is a concern that the UK’s already weakened position due to a perceived failure of its regulatory approach could be weakened further by a prolonged period of inward looking stasis.
In any case, this will be a drawn out process and there are those who question whether the end result will actually be worth the cost of that process and achieve a real change in regulatory attitudes. The government intends to publish a consultation document on its proposals before the end of this month and we will update in future bulletins as this process continues.
Funding the future – The Eco Bank
In its report published last month entitled ‘Unlocking investment to deliver Britain’s low carbon future’, the Green Investment Bank Commission set out the challenges facing the UK’s transition to a low carbon economy, the market failures and barriers to investment and the case for intervention to address them.
It proposes the establishment of the Green Investment Bank (GIB) to tackle the country’s low carbon investment needs, working within overall government policy and incorporating a number of existing government-backed bodies. It is noted that billions of pounds are being spent by disparate bodies with a lack of common direction and the proposal is therefore that funding should instead be directed into the GIB as a kind of central eco-bank.
The Commission has identified three bodies with an annual budget of £185 million which could be folded into a GIB – the Carbon Trust, the Energy Technologies Institute, and the low carbon wing of the Technology Strategy Board. They also have their eye on six government funds with a total budget of £2 billion.
The last government proposed setting up a similar scheme with initial capitalisation of £2 billion, a fraction of what the Commission suggest is needed. The present government has also pledged to create an eco-bank, but it’s not expected that detailed plans will be announced until after the comprehensive spending review due to be published on 20 October. This is later than many would wish and analysts have warned that this uncertainty over the government's plans might actually be hindering the flow of funding, with potential investors holding back until the situation becomes clearer.
The Commission is convinced that the private banking sector alone cannot provide the financial weight needed to meet the country’s carbon reduction targets. Under the proposals therefore, a GIB would be made up of two parts – a banking division to encourage private investment, and a funding arm which would allocate grants, loans and subsidies to low carbon schemes. Together, they would help generate and spend the £50 billion a year needed to fund clean energy projects, from building new wind farms to making the nation's homes and offices energy efficient.
Operationally, the GIB would work under strict principles to ensure it does not exclude the private sector, with the private sector leading and executing deals wherever possible and the GIB operating only where its actions achieve a result that would not otherwise have been possible and then preferably in partnership with the private sector.
It has been suggested that over time the GIB could develop a range of products including early stage grants, equity co-investment, wholesale capital, mezzanine debt, offering to buy completed renewables assets, purchase and securitisation of project finance loans, insurance products and long-term carbon price underwriting. All of that said, it’s anticipated that only some of the funding would come from existing bodies, while the rest could come from the sale of bonds to leading investors such as pension funds to finance long-term projects such as wind farms.
In its initial phase, the GIB would focus on supporting the areas where maximum impact and speed to implementation can be achieved. For example, increasing investment in proven energy efficiency projects that can lower the overall development need of renewable energy sources.
The Commission's report received broad backing from the City and environmental groups, but it remains to be seen to what extent the government will actually look to implement the proposals. This should become clearer in the Autumn, but according to some that will already be too late.
For more on funding in this area, in our April e-bulletin we looked at the creation of a new Environmental Investment Innovation Fund.
Breaking the Silence – Confidentiality Agreements
In light of the need for secrecy in many commercial transactions, it is standard practice to enter into a confidentiality agreement, or detailed confidentiality obligations in a contract, when sensitive information is being passed between two parties.
In most cases the parties comply with their obligations but what happens when one steps out of line and acts in breach and what recourse is available to the aggrieved party? These questions are looked at in the decision of the High Court in England in Vercoe & Others v Rutland Fund Management Limited.
Briefly, the facts are that the defenders breached certain confidentiality undertakings and proceeded with an acquisition without involving the claimants, who argued that they were entitled to the profits made by the defenders as a result of entering into the acquisition.
The High Court, whilst agreeing there had been a breach of the terms of the confidentiality agreement between the parties, did not accept the quantum of the claim, stating instead that damages should be based on the cost of buying a release from the claimants' rights under the confidentiality agreement.
The aggrieved party was not entitled to choose the remedy and may be confined to an award of damages.
The Court decided the test was whether the aggrieved party’s interest in the obligation made it just and equitable that the defendant should retain no benefit as a result of breaching his obligation – the remedy awarded should not be oppressive but proportionate to the wrong which has been done.
The Court also observed that given the wide array of facts and circumstances which could apply in a breach of confidentiality situation then the appropriate remedy (or set of remedies) may require other areas of laws to be looked at.
For instance, certain confidentiality obligations might be considered to be similar to a fiduciary duty (effectively a duty to act in the best interests of the other party), in which case remedies relating to breach of fiduciary duty would be appropriate. In other instances, it may be that the obligation is purely contractual so that breach would amount simply to breach of contract leading to contractual remedies, or it may be that the law of tort / delict is more appropriate.
In Vercoe, as stated above, the judge said that it was not appropriate to look at the profits made by the breaching party. As the relationship was entered into on a contractual basis and there was no fiduciary relationship, the judge decided that the confidentiality provision was similar to a restrictive covenant and therefore it was appropriate for the remedies to be based on a "notional, reasonable transaction to buy release from the claimants' rights".
The main lesson to learn from this case is that when agreeing confidentiality obligations, the parties should consider what remedy or compensation they would expect to receive in the event of a breach and take legal advice on how to provide for this.
If it is difficult to quantify the loss (e.g. where details of sale negotiations are leaked) then there may be little scope to seek any financial remedy. Therefore, confidentiality clauses should be carefully drafted to properly protect the parties, perhaps resulting in an increase in the use of deposits so that there is a clearly ascertainable remedy for breaching obligations which are vital to commercial transactions.
Review of the Lending Code
On 18 June 2010, the Lending Standards Board (LSB) announced a review of the relatively new Lending Code, which was introduced only last November to coincide with the date on which the Financial Services Authority assumed responsibility for retail banking conduct of business regulation. The review is open until 10 September 2010.
The Lending Code (which incorporates standards previously covered by the Business Banking Code) covers conduct of business standards for banks and others providing credit products, including overdrafts, unsecured loans and credit cards, to individual customers and small businesses in the UK, requiring subscribers to be fair and reasonable in all their customer dealings by meeting commitments and standards set by the Code.
Examples of those standards and key commitments include:
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giving customers clear information about accounts and services, including how they work, their terms and conditions and applicable interest rates;
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informing customers about variations of interest rates, charges or terms and conditions; and
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treating personal information as private and confidential, and providing secure and reliable banking and payment procedures.
The LSB is charged with monitoring compliance with the Code, although adherence is voluntary. Financial institutions that subscribe to the Code also assume the responsibility of ensuring that any third party or agent acting on their behalf complies and so it is a potentially onerous standard.
It’s not entirely clear at this stage, however it’s assumed that responsibility for business regulation (and by extension the LSB) will fall to the proposed Consumer Protection and Markets Authority as successor to the FSA if the government’s current proposals for revised regulatory structures proceed as outlined by HM Treasury last month.
Details of the government’s proposals are outlined in this month’s article Who’s Watching Who? The New Face of Financial Regulation.
Misrepresented: Implication in Syndication
In the recent case of Raiffeisen Zentralbank Osterreich AG v Royal Bank of Scotland plc, the High Court dismissed a claim that implied misrepresentations were included in an information memorandum and other documents relating to a syndicated loan.
These included a confidentiality agreement and a facility agreement based on the Loan Market Association (LMA)'s standard terms. These are market standard documents which form the foundation for many of deals, and so it’s worth looking at the effect of this decision in terms of market practice on syndicated deals, but also in the wider context of misrepresentation in finance transactions generally.
In general, the decision should increase confidence that the established market use of the LMA’s standard terms in relation to syndicated loans is sufficient to allocate risk between arrangers and potential syndicate members. However there are some aspects of the judgement that require closer examination.
The basic facts of the case are that the Royal Bank of Scotland plc (RBS) syndicated a loan to invest in shares in an Enron entity, in which, Raiffeisen Zentralbank Osterreich AG (RZB) took a £10 million share. Enron became insolvent, the loan was not repaid and RZB claimed that there was an inducement to take part in the syndicated loan by way of implied misrepresentations on the part of RBS.
In a claim based on an implied representation, the court must consider "what a reasonable person would have inferred was being implicitly represented by the representor's words and conduct in their context". In other words, whether the contrast between what was represented and what was correct would have induced a reasonable person to enter into the contract. The court must also consider if the potential participant would not have entered into the contract "but for" the misrepresentation.
The Court held that none of the alleged implied representations had even been made. This conclusion meant that it was not necessary to decide other factors of the claim but it did so giving an indication of the criteria needed for a misrepresentation to have occurred.
In summary of the judgement, it was recognised that both parties were experienced members of the syndicated loans market and should have been aware that information memorandums regularly provide an overview of loan transactions to potential participants and contain what the arranger deems relevant.
A potential participant, therefore, cannot assume that it contains everything that anyone may deem relevant. For this reason, it is common practice for the arranger to include a disclaimer of any responsibility for the information provided by an information memorandum and for a confidentiality agreement to state that information is received without representation or warranty as to its accuracy or completeness.
It was also recognised that it was market practice for the legality of a transaction to be confirmed by separate legal opinions of lawyers and that in respect of compliance with other rules, this is confirmed by relevant experts in their relevant field. Therefore, an arranger would not regard itself as officially representing that a transaction was legal or that any other regulation to be adhered to was neither improper or unlawful.
The court noted that the sophisticated nature of the market in which bankers are working caused there to be an established understanding of the allocation of risk. However, it did warn that representations made by an arranger could amount to an inducement to enter into a contract despite a statement by the arranger that the representations are for information purposes only.
If the arranger intended what he said to be relied on by the potential participant in deciding whether to contract, the court must regard the arranger as having intended that the potential participant should rely on that statement.
The information memorandum, in this case, contained a statement that it was provided for information only and was not intended to provide the basis of any decision. However, for the reasons above, on this basis alone the Court would have found that RBS had the intention to induce the potential participant into the contract.
RBS, however, had also stated that the information memorandum was "believed to be true" but that no warranty or representation was being given as to its accuracy or completeness. So, only if an arranger does not in fact believe the information to be true will they be potentially liable.
Although dealing with misrepresentation in the context of the syndicated loan market, the issues discussed by the Court do have potentially wider application in terms of bank to bank dealings and burden sharing, as well as reminding us of the potential for the same issues in terms of bank to customer dealings.
A key point noted by the Court in this case is an assumption as to the sophistication of financial institutions working in particular in specialist markets and their understanding of risk in that context, an assumption which might be extended to borrowers working in those same markets.
That is probably the assumed default, but be aware that deal-specific sophistication and risk awareness can’t necessarily be assumed in every case and so that has to be allied to a recognition of the risks which exist in any provision of information or representation made.
Companies Take Heed – Natural Person Needed
Any company which has not yet appointed a natural director should take steps now to appoint at least one person before the impending deadline, or risk fines of up to £5,000. Corporate directors of a company in default will also be liable.
Further details on natural directors can be found in our briefing of 28 August 2008.
The matters covered in this ebulletin are intended as a general overview and discussion of the subjects dealt with. They are not intended, and should not be used, as a substitute for taking legal advice in any specific situation. Semple Fraser LLP will accept no responsibility for any actions taken or not taken on the basis of this publication.
FOR FURTHER INFORMATION PLEASE CONTACT: DOUGLAS GOURLAY