Banking Crisis: The impact of the failure of the Icelandic banks - Treasury Contents


5  Protecting British citizens

Individuals who lost

84. As we have seen, on 9 October 2008 HM Treasury announced that "The Chancellor has put in place arrangements to ensure that all retail depositors in the Icelandic banks of Landsbanki (including their "Icesave" products), Heritable, and Kaupthing Singer and Friedlander (including their "Edge products") will receive their money in full".[155] Most of these onshore UK customers saw their accounts moved to ING direct.[156] These measures protected all individuals who held accounts onshore in the United Kingdom with the branches and subsidiaries of the Icelandic banks. These announcements did not, however, cover those individuals who had money at risk in the subsidiaries of the Icelandic banks in the Isle of Man and Guernsey.

85. Information provided by the depositors' groups provides some evidence on the make-up of these individuals. Mr Sieczko, the London coordinator for the Kaupthing Singer & Friedlander Isle of Man Action Group, suggested that "between 55% and 60%" of KSF (IOM) depositors were British expatriates.[157] A straw poll conducted by the Landsbanki Guernsey Depositors' Action Group, suggested that 35% of depositors were British citizens from Guernsey or Jersey. Another 49% were British expatriates living elsewhere and a further 12% were British expatriates [now] living in the UK.[158] Some 60% of those savers polled had savings between £10,000 and £100,000.[159]

The provision of assistance

86. Many of those who have lost out in the failure of the offshore subsidiaries of the Icelandic banks were British citizens, and many have requested the assistance of the UK Government in seeking the return of their deposits. We have heard several arguments both for and against the provision of assistance to these depositors by the UK Government, and we consider them in turn, before providing an overall conclusion on the appropriateness of the provision of assistance by the UK Government to those depositors.

AN OVERARCHING PRINCIPLE

87. The UK Government has been acting on the principle that it cannot be responsible for the losses of UK citizens where they invest money in jurisdictions outside the control of the United Kingdom. The Chancellor explained that:

Mr Tony Brown MHK, Chief Minister, Isle of Man, also accepted this position, telling us that "As far as the situation for the Isle of Man is concerned, we are accepting our responsibilities and endeavouring to rectify the situation".[161] When pushed on whether the UK Government should seek to provide redress to savers in the Isle of Man, Mr Brown replied "I do not think the UK Government is responsible for the financial affairs of the Isle of Man".[162]

88. We agree that the overarching principle should be that the UK Government cannot provide cover for deposits held by British citizens in jurisdictions outside the direct control of the United Kingdom.

THE ROLE OF THE UK FINANCIAL SERVICES AUTHORITY

89. Questions have been raised with us in respect of the extent of the FSA's involvement in the transfer of funds from the Icelandic parent company, Kaupthing, to its UK subsidiary, KSF(UK). By March 2008, the Financial Services Commission (FSC)[163] of the Isle of Man had become concerned by the Icelandic situation. As such, they approached the KSF IOM) board, which in turn offered to reduce its exposure to Iceland, by replacing its deposits in Iceland, with ones in KSF(UK).[164] Before allowing this transaction, the Isle of Man FSC raised certain questions with the FSA about the UK's liquidity regime for KSF (UK), which were responded to via an exchange of letters.[165] From this exchange, the FSC felt that it had satisfied itself that, should the transfer be made:

  • the exposure to the parent bank would be eliminated (save for the fact that a line of liquidity was available to draw upon from the parent if needed, which netted off in the event of insolvency);
  • the 60% of total assets of KSF(IOM) that were represented by claims on Kaupthing Group in October 2008 (after netting off the liquidity exposure to Kaupthing Bank hf) were due from KSF(UK), a UK bank where all related party exposures were limited to 25% of Large Exposure Capital Base and where there was no net exposure to Kaupthing Bank hf; and,
  • KSF (UK) would have liquid assets to meet all maturing liabilities out to eight days and were only permitted to have a maximum mismatch of 5% out to one month.[166]

Mr John Aspden, Chief Executive of the Isle of Man Financial Supervision Commission (FSC), told us that if those understandings had been adhered to, he "would not have thought that the London bank [KSF(UK)] would be in quite the predicament that it appears to be".[167]

90. As was discussed in Chapter 3, when KSF (UK) went into insolvency, the deposit held on behalf of KSF(IOM) became part of the assets available to the Administrator, while KSF(IOM) became one of the many creditors. When it was suggested to Mr Sants that the FSA had put pressure on KSF(IOM) to invest in KSF(UK), he flatly rejected this suggestion.[168] Lord Turner in turn noted that the decisions made by the Isle of Man FSC were based on correct information provided by the FSA:

    That was the liquidity regime that was in place, which I have to say was more onerous than our normal liquidity regime that we put in place in 2005 in response to some of our concerns earlier. We confirmed that regime was in place. Whether that provided sufficient assurance to the regulator on the Isle of Man was for them to decide. We are another, as it were, host regulator and our job under our [Memorandum of Understanding] with them is to provide them with information; it is not for us to make judgments on that information. We accurately answered their question and that regime was indeed in place with the bank.[169]

91. The failure of Kaupthing Singer and Friedlander (UK), given the deposits held by it on behalf of Kaupthing Singer and Friedlander (IOM), was extremely detrimental to the ability of Kaupthing Singer and Friedlander (IOM) to maintain its operations. However, we can find no evidence that the FSA pressured the Isle of Man authorities to authorise or encourage the placement of such a significant deposit with Kaupthing Singer and Friedlander (UK).

92. Both the Guernsey and Isle of Man authorities also expressed concern over the level of the FSA's communication with them during the crisis with the FSA. Mr Aspden told us that he felt "disappointed" and "severely let down" by the communication with the FSA as the Icelandic subsidiaries failed.[170] The Guernsey authorities had also been in close contact with the FSA over the crisis period, especially around the time of the crisis around Northern Rock.[171] Mr Peter Neville, Director General of the Guernsey Financial Services Commission, had concerns that the FSA believed that "it could not and should not have passed us more information than it did in terms of the changed liquidity situation, the dependence on the parent and on the action it was planning to take".[172] The concern for Mr Neville was therefore that "there was limited information given to us … and they did not tell us they were limiting information".[173]

93. It is of critical important that regulators in different jurisdictions can communicate effectively at times of financial crisis. We note with concern the suggestion that the paucity of information provided by the Financial Services Authority may have impeded the ability of the regulators in the Crown dependencies to safeguard their own financial systems. This is a particular concern given the close working relationship that appears to have existed between the Financial Services Authority and the Financial Services Commission of the Isle of Man in relation to previous situations such as that surrounding the failure of Bradford & Bingley just days earlier. We recommend that the Financial Services Authority review its existing powers and strategy for dealing with other jurisdictions, and reports on its efforts in this respect.

TAX HAVENS

94. One of the reasons cited by the Chancellor in refusing assistance to the depositors in the offshore centres affected by the failure of the Icelandic banks was the low-tax environment in these jurisdictions. Using the example of the Isle of Man, he explained that:

However, representatives of the depositor groups affected reacted strongly to this accusation. Mr Dickens stated that "We are not tax dodging millionaires".[175] Mr Sieczko pointed out that "If you are a UK resident you will pay standard rate withholding tax and [that] will be remitted back to the Treasury, the same Treasury that is now refusing to back us and refusing to help us out at all".[176] He went on to say that "It is a diabolical accusation to accuse these people of being tax dodgers or going to the Isle of Man for a tax haven".[177] Tony Brown MHK, Chief Minister, Isle of Man was also keen to defend the Isle of Man against the Chancellor's accusation:

    it is not a statement that carries any weight. If you look at the basis of how the Isle of Man is structured, the Isle of Man is a well-regulated country, it has a diverse economy. It applies international standards to the highest level and has a full system of direct and indirect taxation, including a full national insurance system. If you look at all the components of how the Isle of Man operates, it reflects very much how the United Kingdom operates, so that statement was unfortunate and does not reflect the status of the Isle of Man.[178]

95. HMRC describes the EU Savings Tax Directive (came into effect on 1 July 2005) as being designed "to counter cross border tax evasion by collecting and exchanging information about foreign resident individuals receiving savings income outside their resident state".[179] Until such a time as that exchange of information occurs between all the signatory nations, both the Isle of Man and Guernsey have decided to implement a withholding or retention tax, though the option of information exchange will be available for some customers.[180] Such taxes are levied on the savings held in these jurisdictions, and then 75% is remitted to the EU member state where the beneficial owner of the interest resides.[181] Table 2 shows the receipts to HMRC from the withholding tax element of the EU Savings Tax Directive from Guernsey and the Isle of Man.
Table 2: Amounts of withholding tax paid to HMRC
Jurisdiction Period (as at January 2009)
Amount of withholding tax
 
 
£
$
Swiss Frs
Guernsey UK tax year 2005-06 2,330,160 27,547 184,145 18,646
  UK tax year 2006-07 7,164,129 880,057 463,166 53,364
  UK tax year 2007-08 7,471,670 800,818 289,958 59,220
Isle of Man UK tax year 2005-06 6,393,424
  UK tax year 2006-07 9,765,119
  UK tax year 2007-08 10,699,869
Data source: HC Deb, 12 February 2009, cols 2146-2148W

96. It should also be noted that "HM Treasury considers the standard of the money laundering systems in the Crown Dependencies and Gibraltar to be equivalent to European Union standards, as embodied in the Third Money Laundering Directive".[182]

97. Whatever the potential limitations of Government support for these individuals, we think it is important to note that the majority of those affected are not sophisticated, investors of high net worth who are somehow insulated from the losses they have incurred.

98. While the Isle of Man and Guernsey obviously have different systems of tax to that in the UK, the EU Savings Directive ensures some tax in respect of UK residents banking offshore is recouped by HMRC, via the retention tax operating on the islands. If the Chancellor feels that there has been an element of tax evasion, then HMRC should investigate and prosecute those involved. Furthermore, whilst the Chancellor appears to deprecate the use of offshore banks by British citizens, we note that the FCO carries advice on its website for those retiring abroad that "you may want to … consider the benefits of offshore banking before you retire abroad. An offshore bank account can play an important role in helping to minimise your tax liabilities".[183]

EXPATRIATES

99. Some of those depositors involved in the failure of KSF(IOM) and Landsbanki Guernsey complained to us that, as expatriate British citizens, they had limited access to the UK financial system. The Landsbanki Guernsey Depositors' Action Group highlighted research undertaken in November 2008 that showed that out of 58 firms, only two small building societies would accept expatriate account holders, and that "Without exception, the reason given for refusal was the Anti-Money Laundering 'Know Your Customer' guidelines which, although expatriates are not barred by law from opening or maintaining an existing UK account, have effectively prohibited them from doing so in practice".[184] Mr Dickens expressed the belief that "if you have a British passport—and, of course, that includes the people in Jersey and Guernsey and the Isle of Man—you should have the right to open a bank account in the United Kingdom because the only thing that is stopping one from having an account in the UK is an address".[185] Given the lack of choice in the UK market, British expatriates had instead deposited their sterling reserves in bank accounts in either the Isle of Man or Guernsey.

100. Mr Ian Pearson MP, Economic Secretary to the Treasury, stated on 6 November 2008 that:

    There is no legal bar under UK financial services regulation that would prevent a non-UK resident from opening a new bank account here. When an account is opened remotely, more onerous anti-money laundering checks are, quite properly, required because of the increased risks involved. This might well be a factor in the willingness of some UK banks to offer new accounts to non-residents. However, this would not be a burden for customers who move offshore but wish to retain existing accounts.[186]

In its response, the FSA reiterated that neither the Treasury's Money Laundering regulations, nor the FSA's handbook, prohibited expatriates opening accounts in the United Kingdom:

    The Treasury's Money Laundering Regulations require firms to know their customer. … Guidance sets out how firms should identify their customer and which aspects of their identity they should verify. There is a section in the Guidance on customers who are non-resident, not physically present in the UK, wishing to open a bank account. This section explains what firms should consider when dealing with such applications: for example, it states that a firm should apply enhanced due diligence where the customer is not met personally or where other high risk factors come into play. It does not, as noted above, suggest that firms should refrain from entering into a business relationship with a UK citizen not residing in the UK.[187]

101. We accept that there is no specific regulation or law preventing the provision of bank accounts to expatriate British citizens, but in practice the supply appears to have been extremely limited. As such, many expatriates have been forced to deposit their money offshore, outside the protection of the Financial Services Authority, and the Financial Services Compensation Scheme, as a direct result of the way in which Financial Services Authority regulations were interpreted in the UK. We therefore recommend that the Financial Services Authority liaise with both the Building Societies Association and the British Bankers' Association, to identify why provision is so poor, and report back to us on steps to be taken to ensure better provision in the future, whether by new products, or greater access to existing products.

THE ISLE OF MAN SUBSIDIARY OF THE DERBYSHIRE BUILDING SOCIETY

102. A very specific complaint was raised with us by depositors holding funds in the Isle of Man subsidiary of the Derbyshire Building Society, which had then been taken over by Kaupthing's Isle of Man subsidiary in 2008. These individuals had passed from having a parental guarantee from a British Building Society, to one from an Icelandic bank. Mr Sieczko suggested that the information provided to the Derbyshire's customers was not completely transparent:

103. The regulators, both in the Isle of Man, and in the UK, seemed relatively unconcerned about the takeover. Mr Aspden told us that, while not a regulatory requirement, the provision of the parental guarantee from Kaupthing Bank hf in Reykjavik in respect of the entire entity of KSF (IOM), not just Derbyshire had "offered an important overlay of comfort".[189] Mr Sants first reiterated that the transfers were not a matter for the FSA, pointing out that "A transfer of ownership to a company in the Isle of Man which is owned by an Icelandic company is obviously a matter for those regulators to approve those transfers".[190] However, he acknowledged that those with term deposits did not have the chance to opt out of the transfer should they have had concerns with the deal.[191]

104. In 2008, Kaupthing Singer and Friedlander (Isle of Man) took over the Isle of Man subsidiary of the Derbyshire Building Society. While those with non-term deposits could have moved their funds if not satisfied with the new parental guarantee offered by the Icelandic parent bank (rather than their old one from a UK building society), those with long-term bonds had no chance to remove their funds without penalty. Where a parental guarantee is given, the home regulator of the parent company should be aware of that guarantee, and when it is to be transferred, should work with all the host regulators to ensure that all depositors have a chance to switch their deposits if they are not satisfied with the new deal.

THE OVERALL CASE FOR ASSISTANCE

105. We have received thousands of letters and emails from individuals and families who are suffering as a result of the collapse of Kaupthing Singer and Friedlander (Isle of Man) and Landsbanki Guernsey. We acknowledge the severe distress shared by many individuals as a result of this banking failure.

106. A difficult judgment though has to be made in assessing the overall case for assistance. Those involved in the failure of the offshore subsidiaries of the Icelandic banks have suffered losses to date, and many of those affected are British citizens. On the other hand, we acknowledge the clear validity of the overarching principle that the UK Government cannot cover deposits held in institutions outside its direct regulatory control. However, we believe that the UK authorities should work with the Isle of Man and Guernsey authorities to resolve these issues, especially given the complexites arising from the take over of the Derbyshire building society.

107. We further recommend that the UK authorities should seek to work closely with other interested parties such as the Financial Services Commission of the Isle of Man to maximise the transparency of the administration of KSF(UK) in order to facilitate the best outcome for all depositors including those with funds in KSF(IOM).

Lessons learnt

ADVICE TO UK CITIZENS INVESTING OFFSHORE

108. During our inquiry, we also discussed the advice given to consumers about depositing offshore by Independent Financial Advisors (IFAs), as some of those who deposited their savings in the Crown dependencies did so after receiving advice from an IFA. Ms Davidson, Deputy Chair, Association of Independent Financial Advisers, noted that IFAs would not necessarily know what cash holdings a client may have:

Mr Cummings, Director General, Association of Independent Financial Advisers (AIFA), explained that for clients who wanted "very low risk", offshore investment was not appropriate.[193] However, for those clients prepared for more risk, he explained that "One of [the reasons to go offshore] is in a straightforward bank account those institutions were paying slightly higher rates of interest than could be got onshore".[194] He also stated that investing offshore could assist " tax management issues".[195] Mr Cummings outlined what a good financial advisor should have explained to their client before they deposited money offshore:

    We were absolutely aware of the notion of risk and we would have explained that to clients. We would have explained the protection that they get. We would also have explained the fact that if the client is unhappy with their independent financial advice, they are covered by the UK-based Financial Ombudsman Service, so they could have complained to the Ombudsman if they had not felt the advice was suitable. We would also have talked to them about the credit reference agency and the double or triple-A rating of the institutions. [196]

He went on to say that AIFA was ensuring that the lessons had been learnt from the present crisis, explaining that "Certainly we have issued notes to members, we have addressed these issues in our newsletters and communications with members to make sure that we are reinforcing the good practice that we see already exists".[197] Bearing in mind the heavy coverage in the financial press of Iceland's fragility we would have expected offshore savers using independent financial advisers to have been advised of the changing risk profile of their savings. We hope to explore further the role of advice to customers in our forthcoming inquiry into consumers and the banking crisis.

109. We draw attention to the information available to consumers on the FSA's 'money made clear' website which details what compensation a consumer is entitled to if a UK financial services firm is unable, or likely to be unable, to pay claims against it. We recommend that the FSA publishes on this website a list of all bank and building society accounts available in the UK and regulated in part by the FSA which would be covered by the Financial Services Compensation Scheme.

THE WIDER ISSUE OF CROSS-BORDER REGULATION AND 'PASSPORTING'

110. As we have seen with the case of Landsbanki and Icesave, the FSA has a limited ability to regulate those firms that 'passport' into the UK financial system, as branches of EEA banks are regulated by their 'home' supervisor, which in the case of the Icelandic banks was the FME. As a result, UK savers may have thought that their savings were in an institution regulated by the FSA, and fully protected by FSCS. The consumer group Which? expressed concern at this, and made the following request:

Which? also believed that "collaboration between national regulators needs to be strengthened".[199] A similar point was made by the Financial Services Consumer Panel, who agreed that passporting arrangements made unrealistic assumptions about the nature of regulatory practice in Member States and "encouraged regulatory arbitrage". They noted the absence of a "consistent EU-wide infrastructure for the protection of consumers through access to ADR services and minimum levels of compensation."[200] In their view, the balance had turned too much in favour of companies rather than consumers, with EU initiatives concentrating on "a desire to make cross-border trade easier for firms with insufficient regard to the 'demand' side of the equation".[201] The Building Societies Association was also keen to raise its objections to the passporting arrangements as currently operated in the EU:

    The experience of the last three to four months has also placed a big question mark against 'passporting' by EEA banks into the UK—the activities and collapse of the Icelandic banks in particular left UK depositors troubled and panicky, and both the UK taxpayer, and all UK building societies and banks, severely out of pocket in paying for the depositor bailout. Wholesale depositors such as local authorities and charities, and some societies, have lost money. The whole episode has undermined financial stability.[202]

111. The FSA is already considering this issue. In its written evidence to us, it suggested that "Recent events, including the crisis in Icelandic retail bank branches, demonstrate that the EU single market rules need to be reconsidered".[203] They suggested two possible reforms. One was to restrict passporting, such as by enabling "Member States to require firms to undertake their retail operations in fully capitalised subsidiaries".[204] The other route was to encourage greater pan-European cooperation.[205] Lord Turner was adamant there was a need for change:

    We have tried to run a European single market in retail banking services as if retail banking is the same as retail or manufacturing, and that you can run a European single market without some category of European supervision of supervision or co-ordination of supervision which goes beyond what we do for retailers and manufacturers, but I do not think we can. I do not think we can run a European single market in retail banking without significant changes in the regime.[206]

112. Our Banking Crisis inquiry, and specifically the problem of the failure of the Icelandic banks, has raised issues surrounding the cross-border regulation of financial institutions. Considerable taxpayer support has been required to provide rapid compensation to onshore UK depositors in Icelandic banks that 'passported' into the UK. This area of European law requires further consideration, and we will return to this topic in our future inquiry onto the banking crisis within its international context, with specific reference to the regulation of subsidiaries and branches of cross-border financial institutions.



155   HM Treasury, Press release 103/08, Landsbanki, Heritable, and Kaupthing Singer and Friedlander, 9 October 2008,  Back

156   Ibid. Back

157   Q 1320 Back

158   Ev 422-423 Back

159   Ev 423 Back

160   Q 121 Back

161   Q 1449 Back

162   Q 1450 Back

163   The Isle of Man financial services regulator Back

164   Ev 304 Back

165   Ev 663 Back

166   Ev 304 Back

167   Q 1454 Back

168   Qq 2300-2301 Back

169   Q 1 Back

170   Q 1425 Back

171   Q 1426 Back

172   IbidBack

173   Q 1426 Back

174   Q 132 Back

175   Q 1322 Back

176   Q 1328 Back

177   Q 1328 Back

178   Q 1445 Back

179   European Union Savings Directive (Countering cross-border tax evasion by individuals), HM Revenue and Customs, www.hmrc.gov.uk Back

180   Isle of Man Government, Isle of Man: Guide To The European Savings Tax Directive; Commerce and Employment, a States of Guernsey Government Department, Guidance on the application of the agreements entered into between Guernsey and each EU Member State in support of the EU directive on the taxation of savings income Back

181   Commerce and Employment, a States of Guernsey Government Department, Guidance on the application of the agreements entered into between Guernsey and each EU Member State in support of the EU directive on the taxation of savings income, para 24 Back

182   HC Deb, 26 March 2009, col 630W Back

183   Ev 572 Back

184   Ev 139 Back

185   Q 1362 Back

186   HC Deb, 6 November 2008, col 470 Back

187   Ev 572  Back

188   Q 1353 Back

189   Q 1469 Back

190   Q 2305 Back

191   IbidBack

192   Q 1340 Back

193   Q 1336 Back

194   IbidBack

195   IbidBack

196   Q 1342 Back

197   Q 1343 Back

198   Ev 238 Back

199   Ev 238 Back

200   Ev 267 Back

201   IbidBack

202   Ev 275 Back

203   Ev 459 Back

204   IbidBack

205   Ev 459 Back

206   Q 2309 Back


 
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