THE COMMISSION

STEP Jersey – 11th International Trust Conference

Speech by David Carse OBE
Director General, Jersey Financial Services Commission

19 November 2004

“The Year Past and the Year Ahead”

Ladies and Gentlemen:

Introduction

I am pleased to have the opportunity to address the 11th International Trust Conference hosted by the Jersey branch of STEP.

The Commission attaches great importance to maintaining links with organisations such as STEP. One of our key objectives is to work in partnership with the industry. This does not mean compromising our regulatory principles; nor does it mean that the Commission and the industry will always see eye to eye. But what it does mean is that we should be pulling together in the same broad direction in the best economic interests of the Island. This involves a joint commitment to the pursuit of excellence and to high regulatory and professional standards.

It is bodies such as STEP that deliver the training, education and qualifications that underpin high professional standards. Jersey is a mature financial centre and its continued success cannot depend on secrecy and on being a tax haven. We certainly cannot hope to compete with emerging centres on price. Competitiveness depends on the skills of all the various professionals that make up the finance industry and the other professionals – the lawyers, accountants etc – that back them up. To retain our advantage it is important that each business makes a continuing investment in highly trained and qualified staff, and this is what STEP helps to provide.

We are now getting to the time of the year when we are all putting the final touches to business plans and budgets for next year. The Commission is no exception to this. I thought therefore that I would use the opportunity of this speech to say something about the major issues that have preoccupied the Commission in 2004 and our priorities for 2005, focussing particularly on those topics that are most relevant to the trust company sector. But I will begin by making some observations about where things stand on the regulation of trust companies in both the domestic and international context.

The regulation of trust companies

This month coincides with the first anniversary of my arrival in Jersey. This first year has certainly been busier and has gone faster than I expected. Perhaps this partly reflects the fact that this has been an active year for the finance industry in Jersey. While it may not be universal, many firms tell me that business is booming in areas such as corporate trust work, personal wealth management and funds. The latter has been demonstrated by the 30 Jersey expert funds that we have authorised since the new regime was introduced in February of this year, by the migration of property funds from the UK due to the change in the stamp duty rules there and by the setting up of new recognized funds, disproving the view that this part of the business is moribund.

I suppose the thing that has struck me most since I came to Jersey is the importance of the trust company sector. In a speech to one of the industry seminars that we held last week, Debbie Sebire, our new Director of Trust Company Business, described the sector as the “seed bed” of the financial services industry in Jersey – a view which I share. The marketing efforts of the trust companies bring in business not only for themselves, but for the banks, fund and investment managers, law firms and accountants. Your business is pivotal to the economy and reputation of the Island.

It was for this reason that the Island took the view that trust companies should be regulated. This month also sees the fourth anniversary of the amendment to the Financial Services Jersey Law which extended the definition of financial service business to include the trust sector.

The trust companies have come a long way since then. The licensing process has seen a number of companies merge or leave the industry. Some have migrated to other centres where the regulatory regime is either non-existent or perhaps more lax, a point I shall return to later. But the vast majority have remained, including many small and medium size companies, and I think that it fair to say that they have generally benefited from the raising of standards that regulation has brought with it.

Support for this view comes from STEP itself in the shape of its just published survey of offshore trust business. This suggests that 80% of the respondents in Jersey think that the degree and style of regulation in their jurisdiction has been good for the industry. This is despite the fact that around the same percentage thought that the regulation had significantly increased operating costs, and a sizeable minority of 39% thought that the regulation was too robust.

All surveys need to be viewed with a sceptical eye, and their results are not always internally consistent. But the overall picture I take from the survey is that most trust practitioners think that the price of regulation has been worth paying, and that a majority (albeit a somewhat smaller one) consider that we have got the balance about right.

This should not come as too much of a surprise. After all, if you look at the principles and practices on which our regulation is based, these are what a well-run firm should be doing for itself, without being told.

The problem is that not all firms are managed to the same high standard as the quality firms. So the task of the Commission is to make sure that clear minimum standards are laid down, supplemented by guidance on best practice, and that everybody follows these standards.

Another problem is that not all countries follow the same standards. Jersey, along with a few others, has been a pioneer in the regulation of trust company business. It is not always comfortable being out in front, and Jersey has probably lost some business to unregulated jurisdictions. Equally, some business has probably been gained because of our regulation. Whatever the net result, we would prefer to have a more level playing field.

The situation may be changing. The recent Transparency International (UK) report, “One Problem, Two Standards”, has drawn attention to the failure to supervise trust and company service providers in the UK, and the risks that this poses from a money laundering point of view. It contrasts this unfavourably with the situation in jurisdictions such as Jersey. The report has got it wrong in one respect by claiming that Jersey had to be forced by the UK to introduce regulation here. We did it, as I said earlier, because it was the right thing to do for Jersey. But the general thrust of the report is one that we support.

The interest of official bodies in trust and company service business has also been awakened by events such as Enron and Parmalat. The Financial Stability Forum following its meeting in September 2004 asked the international standard setters – FATF, Basel Committee, IOSCO, OECD – to address issues relating to this business. The European Commission also in September 2004 issued a communication on preventing and combating corporate and financial malpractice. Four lines of defence against this are identified – the internal controls and corporate governance within a company; independent third parties (such as auditors); supervision and oversight; and law enforcement.

Trust and company service providers have of course already been brought within the scope of the FATF’s Revised Forty Recommendations on Money Laundering.

So trust company business is on the international community’s radar screen. You may not feel totally comfortable with this prospect. But remember that this business is already regulated in Jersey, so it is a question of the rest of the world catching up; and if there is a more level playing field internationally, this should be to the benefit of Jersey-based firms.

There is of course the question of what international standards will be set for the regulation of trust and company service business. We are trying to get across the message to the international bodies that such standards already exist in the shape of the Statement of Practice issued by the Offshore Group of Banking Supervisors. Since Jersey played a major role in formulating these standards, we would be very happy to see them adopted as the international benchmark. This would be to the advantage of Jersey firms since they would already be meeting the standards, and the onus would be on the rest of the world to catch up.

Amendments to the Companies Law

It is reasonable for trust and company service providers in Jersey to expect to get some leverage from the fact that they are regulated, and that we will take this into account when considering changes to other aspects of the regulatory framework.

We have for example been reviewing during 2004 the way forward on the proposals set out in the Companies (Amendment) Law No. X. You may recall that this was intended to provide for the introduction of a register of directors in Jersey; for the ongoing disclosure to the Commission of changes in beneficial ownership; and for a register of foreign incorporated companies administered in Jersey. The latter two proposals were recommendations of the Edwards Report.

All three proposals are sensible in themselves, but they aroused concern in the industry about the administrative burden and about the possible increased disincentive to set up or administer companies in Jersey. We have therefore been rethinking how we proceed, and we are considering whether it would be reasonable to rely, in the case of beneficial ownership and foreign incorporated companies, on information held by regulated trust companies, which would be expected to supply the information to the Commission on demand.

We still feel that it would be useful to have a register of directors. But the administrative overhead of this, for both the industry and the Commission, would be greatly reduced if we were to allow corporate directors of Jersey companies. These have been frowned on in the past because corporate directors are considered to be less accountable than individual directors. But if the corporate director is provided by a regulated trust company, the necessary accountability should be there.

Final decisions on these issues have not yet been taken, but we aim to clarify the position during 2005. In deciding the way forward, we will continue to pay close attention to the need to comply with international standards, but we will also be careful to weigh the costs of the proposals against the likely benefits.

Internal issues

Turning to other issues, a large part of the Commission’s preoccupation during 2004 was internal. I mentioned earlier that Jersey must pursue excellence if it is to retain its position as a financial centre. This applies to the Commission as much as to the firms within the industry. We have therefore recently been reviewing our internal efficiency and we have also changed our structure to make it more industry focussed. This has lead to the appointment of new Directors, each dedicated to the various industry sectors, including trust company business. It will be the task of these new directors to provide leadership within the Commission for each of the sectors and to build up a close working relationship with those sectors.

Any restructuring is somewhat disruptive, and ours has coincided with an upturn in employment demand that has seen some of our staff depart for greener pastures. This has meant that our supervisory contacts with the trust company sector have been somewhat less than we would have liked this year. Perhaps this is not a view that the trust companies would share.

Ongoing supervision

We expect to have completed around 20 on-site visits to trust companies by the end of this year, which is not enough given the size and importance of the trust company sector in Jersey. A priority for next year therefore will be to increase the number of visits – which are the equivalent in the regulatory world of the policeman on the beat. We are planning therefore to conduct around 50 visits to trust companies in 2005.

It is arguable that this is still not enough. But we have to work within more or less our existing headcount. This means that we have to be focussed in what we do, and concentrate our attention, particularly though not exclusively, on those institutions that are higher risk. In this, we are guided by the risk model that we have developed that enables us to rate each regulated entity according to our perception of its risk. The rating encompasses two elements: an estimate of the probability of various types of risk materialising with respect to a regulated entity, and the impact on investors and the reputation of the Island if the risks do materialise.

One of our priorities for 2004 was to rate at least 75% of the trust companies using our risk model, and I am glad to say that we have met this objective. We will complete the rest in 2005, and use the results to guide our on-site visits,

This will be part of an ongoing effort to ensure that the standards set out in our Codes of Practice are applied evenly throughout the trust sector. Despite the improvements that have been made there is no doubt that some firms must increase their focus on corporate governance and span of control, on properly understanding the commercial rationale for the structures under their administration and on tightening their risk management. We also concerned that we see honest admission of fault when mistakes are made, and client complaints put right voluntarily.

Firms also need to ensure that they are operating with sufficient financial resources to meet their obligations and cover their risks. These resources must be real and not illusory; they must be properly accounted for along with the related assets and liabilities; and the regulatory requirements on ANLA and PII must be met on an ongoing basis.

Risk management is closely related to KYC. KYC is very important of course from an anti-money laundering point of view, but its significance goes well beyond that. It involves more than simply establishing the customer’s identity. The source of funds and the commercial rational for a structure are at the heart of KYC; and unless the firm has reliable information on these aspects of the client relationship, it runs the risk of being sucked into activities that may damage its reputation.

Anti-money laundering Handbook.

To draw attention to the broader aspects of KYC, is not to downplay its significance in the fight against money laundering and terrorist financing.

One of our key priorities in 2004 was to revise our anti-money laundering guidelines, and this effort will continue into 2005 when the exercise will be completed. We need to adhere to this deadline since the next external review of Jersey’s anti-money laundering framework is likely to take place in 2006. This will conducted by the Offshore Group of Banking Supervisors. To get a clean bill of health, we will need to have made the necessary changes to the anti-money laundering framework to comply with the revised FATF Recommendations by this time.

The first stage is to replace the current Anti-Money Laundering Guidance Notes with what we are now calling the Handbook for the Prevention of Money Laundering and the Financing of Terrorism. This will be accompanied by changes to the Money Laundering Order, which forms the statutory basis of the Handbook.

The Handbook will set out both statutory and regulatory requirements that regulated entities must follow. This is necessary to satisfy the FATF rule that its Recommendations must be implemented through legislation or some other enforceable means. The requirements will be supplemented by Guidance Notes that will not be mandatory, but will give examples of ways of complying with the requirements.

I will not go through the contents of the Handbook in detail other than to draw attention to two “hot topics” relating to the trust company sector that have emerged in our discussions with the industry Steering Group. The first is the extent to which a trust company should pass on information about the underlying principals of a trust when opening a bank account for the trust. The second is who are the underlying principals of a trust whose identity should be verified? The approach currently adopted in the Handbook is to focus not only on vested beneficiaries, but also on higher risk individuals likely to benefit from a trust. This is in keeping with the overall risk-based approach adopted in the Handbook, that allows concessions for low risk situations but requires enhanced due diligence for higher risk ones.

Both these proposals are somewhat controversial, but let me stress that they are not yet cast in tablets of stone. We are planning to conduct a full consultation on the contents of the Handbook, beginning at the end of this year or early in 2005. Rest assured that we will be taking the views of all the various parts of the industry fully into account, and we will try to move closely in step with the other Crown Dependencies. We will also be keeping in touch with developments in the UK and in the EU, where there is evidence emerging of a more pragmatic approach to the whole anti-money laundering issue, to ensure that Jersey does not find itself too much at the leading edge in terms of compliance with the FATF rules.

Conclusion

This is keeping with the overall approach of the Commission, one that is embodied in our business plan for 2005. It can be summed up in three words – partnership, prioritisation and pragmatism. The end result is intended to be an environment where commercial opportunities can be pursued while bad practices are avoided, and Jersey’s reputation – which we all agree is its most precious asset – is protected. We will continue to look for the cooperation of bodies such as STEP in delivering this objective, and I am sure that we can rely on you to provide this.

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