Memorandum from the Financial Services
This memorandum responds to the Committee's
requests at the evidence session on 9 October 2007.
1. Granite (Qq 231-240)
Decisions on the structure for any securitisation
will rest with the originating bank. As part of our overall supervision
work, we monitor the range of securitisation programmes used by
UK banks, including the Granite securitisation used by Northern
Rock. We have extensive discussions with the firms involved and
access to all relevant documentation which they hold.
The structure of the Granite securitisation
meets industry norms and there is nothing to suggest that the
Granite structure is not functioning as intended. The Committee
should note that there is also an extensive body of public literature
that explain the details of all types of securitisation activity.
Securitisation is a well-established management
tool and has been used in the UK for 15-20 years. It has been
an efficient and low-cost form of funding for the UK and global
mortgage markets as the buyers of a mortgage securitisation are
able to look for repayment purely from cash generated by the mortgage
assets that have been securitised, as opposed to the bank itself
For many transactions these buyers will include other banks, insurance
companies and pension funds.
An integral part of securitisation is that the
assets must be removed from a potential insolvency of the bank
that has made the loans. In the UK, an effective way for this
separation to take place is via a trust structure. Each securitisation
will include many "special purpose vehicles" (SPVs)
that each has a role to play; for example one vehicle will hold
the assets while another will issue bonds. The arrangements are
overseen by independent trustees who ensure proceedings are undertaken
in line with strict documentation during the transaction; overseas,
many civil law jurisdictions have set up specific securitisation
legislation in order to replicate the features of securitisation
that can be achieved via trusts in common law jurisdictions such
as the UK. It is not unusual for some of the SPVs to be based
in off-shore jurisdictions, such as the Channel Islands, where
the laws are well-suited to the purpose. Tax considerations may
also be a factor in decisions on where to domicile such entities.
The SPVs are typically legally owned by a holding
company. To reinforce the separation from the bank, the shares
in this holding company are held by a third party. In many cases,
including Granite, they are held under the terms of a trust for
the benefit of charitable institutions. The company used to facilitate
this process in Granite is the Law Debenture Corporation. It should
be noted that any payments to charity in this sort of structure
are unlikely as the trustees ensure that payments are allocated
in line with the strict payment schedule.
In our response to your question we were not
clear if it concerned the Northern Rock foundation or the Granite
SPV. I would like to make it quite clear that the Granite SPV
is entirely separate from the charitable body, Northern Rock Foundation,
which was established by Northern Rock and which receives contributions
by way of profit share.
2. The FSA's communications with Northern
Rock's auditors (Q 241)
We met Northern Rock's external auditors as
part of the last full ARROW assessment in December 2005. There
were no material audit or control issues arising. Aside from formal
communication with the external auditors, we checked the firm's
external audit status with senior management on an continuing
basis, as part of our close and continuous relationship. No material
issues have arisen during this period and this has been confirmed
by the firm's external auditors.
As a result of the bank's current difficulties
we received a letter from Northern Rock's auditors on 11 September
and had a meeting with them on 20 September 2007. In this letter
the auditors expressed concern that the firm might cease to be
a going concern if a liquidity facility could not be arranged.
3. The regulatory relationship between the
FSA and Northern Rock prior to August 2007 and how that relationship
compared with other businesses in the same markets
Our framework for assessing the risks to our
objectives posed by individual firms is called "ARROW".
Full ARROW risk assessments are an integral part of this supervisory
process; they are intensive stocktakes of individual firms and
are supplemented by a number of other monitoring techniques. We
have designated Northern Rock and more than a hundred comparable
businesses as high- impact firms.
In addition to these full ARROW risk assessments,
we subject firms which we designate as high-impact to "close
and continuous" supervision. This is characterised by very
regular dialogue with the firm on the full range of supervisory
issues, through ad hoc meetings and regular telephone conversations
and email traffic. Our workstreams in supervising Northern Rock
over the last two years have included: reviewing strategic and
business developments through discussions with the firm; attendance
at results presentations; monitoring the market; assessing the
ongoing validity of our risk assessment; monitoring financial
data, supervisory returns and management information; reacting
to specific requests from the firmsuch as the Capital Requirements
Directive (CRD) waiver request which was a major workstream during
this period; and undertaking the formal review process which sets
the capital requirements of the firm on the basis of the risks
identified by the firm and the FSA. We also carry out thematic
reviewsprojects to review practices in a range of firms
in a specific area of their business. Northern Rock was subject
to thematic reviews in the same way as other similar firms.
In implementing our ARROW framework, we form
ajudgement on how frequently we should carry out a full risk-assessment
of each high-impact firm. In making that decision we take into
account a range of factors including impact, probability, complexity,
and the potential for the risk profile of the firm to change.
Currently the mean period between full risk assessments for high
impact firms is 26.4 months; this is longer than usual because
of the work we are carrying out reviewing capital requirements
under the CRD.
Our first ARROW assessment of Northern Rock
was completed in Q4 2002. Following this, we set the next regulatory
period to run from December 2002 to December 2003. Following the
assessment in December 2003, taking account of our close and continuous
relationship with the firm, we set the next regulatory period
to run for 24 months, from December 2003 to December 2005. After
completing the most recent ARROW assessment in Q4 2005, we set
the third (and current) regulatory period, to run from January
2006 to January 2009.
4. The discussions that took place between
the FSA and Northern Rock in August and September 2007 and who
Throughout August and September FSA management
(Chairman, CEO, relevant Directors and Heads of Department) had
frequent discussions with the Northern Rock senior management
team. In addition, there were many conversations with the Chairman
and Non-Executives of Northern Rock. and Hector Sants and I met
the Chairman and Company Secretary on 30 August. Discussions with
external parties on private sector solutions were primarily conducted
by Hector Sants.
In addition, a strengthened supervision team
had almost daily conversations with Northern Rock from Monday
13 August, which increased after 21 August to twice daily conversations.
In addition, they have visited Northern Rock three
times since the beginning of August. During this period we also
analysed the whole range of management and financial information
submitted by Northern Rock.
5. Briefing of journalists
You also asked us to provide further information
relating to "the suggestion that the FSA briefed against
the Bank of England in the media in September". We understand
that in making this suggestion the Committee had in mind two particular
newspaper articles. We have reviewed these in detail.
The FT story headlined "U-turn raises heat
on King" (p1: 20 September) purports to be, inter alia,
an account of a meeting between the major commercial banks, the
FSA and the Bank of England on 19 September. It accurately reports
that Hector Sants urged the banks (not the Bank of England) to
lend to each other in the interbank market. This approach had
been preagreed with the Tripartite Authorities, I do not believe
that this supports an inference that that article represents the
FSA briefing against the Bank of England. I would also observe
that this meeting was attended by numerous parties, any of whom
could have provided details to the press. For the record, on that
day, the FSA confirmed that the meeting had taken place but declined
to provide any information about the content. Indeed at the beginning
of the meeting Hector Sants asked all parties to maintain confidentiality
about the discussions. It should be clear that from the point
of adverse market impact the FSA considered that the contents
of this meeting should remain confidential and we were subsequently
concerned when reports of it appeared in the press.
The Daily Telegraph article from 20 September
headlined "Government forces King U-turn" contains comments
from various parties, about the Bank of England's announcement
of its new money market auctions. Its principal argument appears
to be that HMT applied pressure on the Bank to change its policy
and it quotes unnamed "political sources" to that effect.
None of that supports the allegation of FSA briefing. Towards
the end of that article there is the following paragraph:
"The Financial Services Authority was more
open to the idea of relaxing rules, though informed sources deny
reports the FSA took a strong stand. Relations between the FSA
and the Bank have now become poisonous".
As I made clear in my oral evidence, I entirely
reject this characterisation of relations between the two Authorities.
Insofar as the article is concerned, it could hardly be said to
represent the FSA in a good light in contradistinction to the
Bank. It is not evidence of what has been claimed to be FSA briefing.
I would suggest therefore that neither of the
two articles you have brought to our attention supports the contention
that FSA staff briefed against the Bank. Nonetheless, as you requested,
I have made inquiries and am happy to assure your Committee that
no FSA employees who are authorised to brief journalists on these
matters carried out any briefing of the kind suggested.
6. The FSA's Risk Committee
The Risk Committee is a committee of the Board,
made up of a number of non-executive directors. It is responsible
for the following, on which it reports to the Board:
review and oversight of the risks
to the FSA's statutory objectives;
the executive's appetite for such
the risk management and mitigation
strategies and systems used to control such risks.
The Committee met on the following dates in
2006-07: 23 February 2006, 25 May 2006, 26 July 2006, 25 October
2006 and 13 February 2007, 17 April 2007 and 17 July 2007. Sir
John Gieve sent his apologies for the meetings on 25 May 2006
and 13 February 2007.
7. Information from regulated firms on liquidity
In our supervision we rely to a significant
extent on analysing information which firms report to us, on prescribed
topics and with prescribed frequency. In this context, retail
firms report on their liquidity position regularly; for example,
building societies report monthly, mortgage lenders report quarterly,
and banks report at least quarterly, with large retail banks reporting
In the light of the market turbulence, from
9 August we intensified our monitoring of financial markets generally
and engaged more closely with those firms likely to be most affected
by market developments. From 10 August this involved individual
discussions with the large retail banks, which in some cases included
daily contact, asking for updates on their funding and liquidity
positions. We contacted smaller banks and building societies on
13 August asking for detailed information on their current liquidity.
From 9 August we also asked for more detail
in the data collected, and sought information on a prescribed
stress scenario from some banks and building societies. The frequency
with which we asked the larger firms to provide data using this
framework varied from daily to weekly reporting, depending on
their exposure to current market conditions. As part of this enhanced
monitoring programme, on 18 September we sent a questionnaire
to some smaller wholesale funded mortgage lenders and a further
questionnaire to building societies. This questionnaire was referred
to in the Financial Times on 27 September. This article
suggested that this questionnaire had been sent to the largest
banks. This was not the caseas noted above, work commenced
with those firms on 10 August.
As we have said to the Committee in our written
and oral evidence, we believe that there are lessons to be learned
from our supervision of Northern Rock in the period to August
2007, and we have begun a review, We will publish our conclusions.
I hope that this information will be helpful
to the Committee, including in the context of your hearing with
Northern Rock on 16 October.