International Banking - Law and Practice - Assignment Example

?INTERNATIONAL BANKING-LAW AND PRACTICE Task Questions Regulation of Banks 2. Security for secured syndicated loans in an international context NAME OF STUDENT STUDENT NUMBER LAW M591 INSTRUCTOR’S NAME 22ND DECEMBER 2011. Table of Contents Table of Contents 1 1.0REGULATION OF BANKS 2 1.1 Introduction 2 1.2 Banking Regulation Policy Highlights 2 1.3 Main objectives of bank regulation 3 1.4 Disadvantages to the regulation of these businesses because of the behaviours they encourage in the regulated entities and their customers. 8 2.0SECURITY FOR SECURED SYNDICATED LOANS IN AN INTERNATIONAL CONTEXT 10 2.1 Introduction 10 2.2 Overview of Common law and civil law jurisdiction with regard to secure syndicated loans 11 2.3 Different mechanisms used in the transfer of secured syndicated debts 11 2.4 Forms of transfer 14 1.0 REGULATION OF BANKS 1.1 Introduction The globalization of banking markets has led to vital issues pertaining to corporate governance regulation for banking institutions, as a way of enhancing business activities, and safeguarding the customers’ interests. Bank regulation incorporates detailed regulations and guiding principles overriding the operations, activities and acquisitions of the banking organisations.1 The regulation of the banking business activities has seen a number of policies under implementation. This section aims at analysing the different objectives of the regulation in regards to the deposits and investment related business. Further, the disadvantages in the regulation of the businesses due to the behaviours they encourage in the regulated entities of their customers analysed critically. 1.2 Banking Regulation Policy Highlights Financial regulations’ role in influencing the growth of banking business principles has become a key policy issue. The regulation of corporate governance in the financial sector has initially been regarded as a special area with standards, and rules to achieve the objectives of financial regulation involving the safety and soundness of the financial system and consumer, as well as investor protection.2 With banking regulation, the traditional principle-agent model used to analyse the relationship between shareholders, directors and the managerial team has given way to broader policy concerns aimed at maintaining financial stability, while ensuring that banks operate in a way that promotes broader financial growth as well as enhancing investor worth.3 The main reason why banking regulation is of much essence is due to systemic risks.4 These are risks whereby, economic problems at one or more banks spill over to a great number of other banks or financial systems as a whole. Regulation whether created at initial stages or after new models are fully operational, ought to obey two principles, which are proportionality and effectiveness. Poorly designed or timed regulation can obstruct responsible providers from entering and competing profitably on a level playing field. Thus, a well equaled approach incorporates recognizing the tradeoffs between protecting customers and fostering financial access.5 The laws pertaining to banking regulation appear complex and confusing, but in the real sense, with understanding of the objectives, it brings out a clear understanding of the intended application and projected achievements. 1.3 Main objectives of bank regulation Prudential: involves reducing the level of risk exposure to the bank creditors considerably. Therefore, the regulation aims at protecting the depositors. The concept of prudence is integral to bank regulation and supervision as it connotes the notion that, regulation requires banking activities be undertaken with reasonable care.6 Systemic risk reduction: This aims at reducing the peril of distraction resulting from unpleasant trading circumstances for banks, that in turn cause numerous or prime bank failures. This can also be referred to as ensuring monetary stability. Banks play a pivotal role in controlling the volume of money circulating in the economy of any given state. This in turn, provides a stable base for the payment systems availed.7 In order to provide stability, regulation in the banking sector fosters the development of strong banks with adequate liquidity. It also discourages any banking practices that may be detrimental to the depositors and harm the payment systems. Mainly, the goal of monetary stability is depositor protection. This alleviates probable financial crisis and unintended fluctuations in the supply of money.8 The result is an increased confidence in the banks and an ensured safety of deposits. Bank regulation has a substantial obligation of facilitating risk taking.9 This is because; risk taking drives the market and the economy progressively. A number of tools used by bank supervisors in the regulation of banks include capital adequacy, consolidated supervision, expansive exposure rules and deposit insurance.10 The requirements of reserve, capital and liquidity designed to ensure that the providers of financial services are able to honor its liabilities to the customers, displays a consumer protection and macro-prudential rationale towards safeguarding the system against systemic risk.11 In the real sense, the regulators in the banking business serve as a monitoring role on behalf of unrefined customers of reserved means. Avoid misuse of banks: To reduce the risk used by banks for clinical purposes like, laundering the proceeds of crime.12 Most banks regulation requires the individual banks to notify the government of the deposits over a certain dollar amounts or any suspicious activities in the banking business by the banks’ customers. Money forms a central means and route to many criminal activities like drug trafficking and international terrorism. By use of restriction measures to the freedom of criminal and terrorist organizations, the government aims at reducing the power and capacity of such crimes. The greatest importance or advantage of regulating the banking business is to ensure that, they do not knowingly or unknowingly help criminal gangs to hide or distribute their cash in one way or the other. To protect banking confidentiality: With depositors’ contribution in the growth of the banking sector, fostering confidence among them is a vital principle in the enhancement of financial growth.13 In the United States of America, one of the primary objectives of banks regulations enacted after the acclaimed depression ensured the confidence of depositors. The crucial importance of regulating the financial banking management by the government is to ensure depositor confidence, evade run on banks as well as encourage active participation in the national financial system.14 Credit allocation: To direct credit to favored sectors. Most of the regulations in the banking industry require or enhance extension of credit to definite industries or types of loans, deemed socially desirable.15 For example, a regulation in the banking business might provide incentives to encourage loans to the minority, small scale business people or students pursuing higher education. Likewise, tax codes promote social policy with preferential tax treatment of given activities; regulations in the banking business promote social policies that have exacting necessities, and incentives with respect to international banking. Banking regulation also aims at protecting consumer interest in various aspects of the banking relationship. The objectives discussed prior clearly identify the importance of protecting the consumer attached to banking regulation. Most notably is through the practice of safeguarding the deposits and enhancing completion in the provision of banking services.16 The protection of the consumer is ensured through a series of legislation acts passed over considerable time.17 Critically evaluating the legislation, various basics purposes can be deduced. First, it requires the financial institutions to provide customers with sensible disclosures of their credit and deposit terms. This gives the customer the freedom to compare and come up with informed choices concerning the various institutions and financial instruments. The disclosures also aim at serving to protect the borrowers from abusive practices and improve awareness of cost commitments in the financial contracts.18 The FSA has ensured a significant level of emphasis on consumer protection rather than on just the efficiency of financial markets.19 Customers get protected to a greater extent, and the FSA put measures to enhance this. The publishing of Treating Customers Fairly- Building on Progress in 2005 ensured that, customers get treated fairly and well catered for. Therefore, customers get protected from the faulty advice and inappropriate products that do not make their inherent risks clear and understandable.20 The second aim of consumer protection legislation; ensures the same treatment and access to credit options towards the financial customers.21 Equal treatment acts also seen as the economic industry’s equivalent to universal rights legislation that aims at ensuring equal treatment in areas like employment, education and housing. Lastly, consumer protection can be seen to promote financial privacy and at the same time, alleviate problems and abusive practices in the course of credit transactions, collection of debts and eventually report credit related histories.22 Financial stability is a central goal in financial regulation. Looking at the responsibility for financial stability in the United Kingdom; shared by the HM treasury, the Bank of England (BE), and the Financial Services Authority (FSA) and together, constitutes the “tripartite authorities”.23 Antitrust enforcement is the most common rule to oppose undue prices.24 Competition procedure aims at protecting consumers from monopolistic pricing. It also harnesses the market forces that improve the competence of the allocation within the fiscal sector and amid the financial quarter and the rest of the economy. The rules do not exist in commercial banking, apart from the banking code that only provides for a limited form of protection to the depositor.25 The separation of investment and deposits business activities together with the obligations they have to the investor and the depositor is crucially different. An outstanding example is whereby a bank has diminished or has no obligation at all to an investor and depositor to explain the rationale of its decisions regarding the deposit; whereas, in the investment business, the obligation to investors is continuous to enable them assess and judge the risks associated with the investment product bought. 1.4 Disadvantages to the regulation of these businesses because of the behaviours they encourage in the regulated entities and their customers. With regulation in the banking sector, particularly the forms of public regulation as entrenched in the business laws; some would suggest them to be detrimental and those that ought to be avoided. The skepticism referred here is mostly associated with free banking. School viewing the safety net leads to moral hazards and relaxes the discipline in the market for risk taking and is thus, best avoided in favour of a free market.26 Further, they state that the consequences of systemic risks get heightened, as runs tend to shift funds to larger banks and not into cash. Pressure to extend regulation may render conflicts of responsibility between retail and wholesale customers in the sense that; regulation may bring out complications of their different needs, and rules designed for the former and may inappropriately be applied to the latter.27 Some regulatory measures work at close purposes. An excellent example is the geographical restrictions on banking, which intends to protect access to credit of local firms and households.28 This may lead to heightened exposure to systemic risks by imminent diversification of regulated institutions and increase their susceptibility to a local shock. On the same note, fits and proper tests employed for security and reliability reasons may pose entry hindrances that get elevated to achieve the effectiveness gains from antagonism. In the US, non-bank lenders usually escape much of the federal and state regulation imposed on banks. The credit market crush of 2007 saw significant measures taken by leading economic governments.29 The federal government passed new lending standards and regulations minimizing the exposure banks could assume in making loans. The set of laws were not relevant to all lenders and thus, the non-banks escaped and are currently unregulated. There exists less range for unfinished coverage with selective institutions or business lines going down the regulatory and supervisory net because of lack of clarity. The regulation of banks process increases the cost in the sense that, many people get employed by regulators. The additional cost on investment regulation falls on the customers, who benefit from the regulation and who, therefore, have to pay more. Further, it can be argued that the regulation has penalized bank customers who have no convenient access to the range of products they demand. On the same note, these restrictions increase the prices beyond the ones obtained in a purely competitive market place. Regulation affects the competitive nature of any business venture. The regulated entities are safeguarded from competition thus forming a monopolisation. Though they may compete for customers, they tend not to compete on the price service. With regulation, rent-seeking welfare losses may arise, as the banks expend resources in order to achieve regimes aiming at serving the interests of a selective class. This in some ways promotes monopoly in an unintended way, though they are not explicit structural regulations. An outstanding example is the strict licensing rules or high capital sufficiency requirements that may tend to limit new entrants; liquidity policy tends to twist portfolio allocations, whereas, precincts on activities of banks limit the benefits derivable from economies of scope between activities. Capital regulations requiring the least ratio of shareholders funds to assets or liabilities, can be viewed as a means of shifting the risks that have been insured for the shareholders; thus, they become the first victims to bear losses in case of their occurrence.30 Lastly, low capital ratio in other terms referred to as high leverage, heightens the probability of bankruptcy and increases the agency costs for debt holders. 2.0 SECURITY FOR SECURED SYNDICATED LOANS IN AN INTERNATIONAL CONTEXT 2.1 Introduction Borrowing by way of a loan facility provides a one with a supple and proficient source of funding. Whenever a borrower requires an enormous or complicated facility or various types of facilities, it follows that this is commonly provided by a number of lenders referred to as a syndicate under a syndicated loan agreement.31 A syndicated loan accord is truly essential as it simplifies the borrowing process. This because the borrower utilizes only one agreement covering the collection of banks and diverse types of amenities instead of entering into a sequence of separate, joint loans, with each possessing different terms and conditions. In this context, different mechanisms used in common law jurisdictions and civil law jurisdictions to deal with the transfer of secured syndicated loans will be analysed. Further, the differences that arise between the two will be highlighted and discussed with context to international banking laws. 2.2 Overview of Common law and civil law jurisdiction with regard to secure syndicated loans In common law jurisdictions, security trustees act on behalf of the, enter into security documentation and eventually hold the security of entrust for the benefit of multiple lenders. Looking at the English law trust structure, the security is held by an independent trustee or a given lender who can be termed to as the security trustee.32 Countries following the common law system are the former British colonies or protectorates, with the addition of the USA. Civil law is practiced by countries that were former colonies or protectorates of French, Dutch, Spanish, and Portuguese. They mostly include the Central and South American countries.33 2.3 Different mechanisms used in the transfer of secured syndicated debts Under the English law, the trust structure security is preserved by an independent trustee or one lender who acts as the security trustee.34 The loan agreement contains the appointment of the security trustee. The function of the security trustee is to enforce security whenever directed by the excess of lenders also distribute the proceeds among the lenders as per their proportion in the participation of their loans. Taking security on the basis of a trust enables implementation of one of the basic principles of syndicated lending. In this case, risks are distributed among the lenders thus, no exposure to the credit risk of a security holder. Common law jurisdiction goals are achieved because a trust gives room to some allowances. The goals include providing; security to all lenders in relation to the same assets, a given mechanism for supervising and guiding the interests of various lenders on enforcement, and the earnings of enforcement to be held by the security trustees on units.35 All these ensure that the lenders are not exposed to the risk of the security trustee. A key advantage of using syndicated lending is the fact that lenders are able to share and offer loans with low interest rates. This is because the credit risk is shared across the syndicate unlike in the financing through debt capital markets instruments, where syndicated loans possess more flexible borrowing terms and a loan are more certain for renegotiation incase a borrower is faced by any financial difficulties. In jurisdictions that do not recognise trusts, agency concept is applied to hold security for the benefit of multiple lenders. The civil law is a codified system of law mostly taking its origin from the Roman law.36 The civil law system can be termed as more prescriptive than a common law system; however, a government still considers whether selective legislation in needed to limit the scope of a certain restriction so as to allow a successful infrastructure project, or to govern a sector. Syndication debt transfer occurs through the selling of ones partaking in a syndicated loan.37 The loan provider in a syndicated loan may end up selling its obligation in a facility for a number of reasons which include realizing capital, risk management, regulatory capital requirements and crystallizing a loss. A civilly syndicated loan requires that the agreement be made in writing, failure to which the agreement is termed as void.38 With international practice, the relationship of syndicate association is spelled out in mutual instruments. In civil syndicated loans, there are various types of loans identified. These include, jointly initiated syndicated loans, individually initiated syndicated loans and syndicated loans having no fortitude of the share. With jointly initiated syndicated loans, an aggregate of different loans, credits, as well as deposits are provided by lenders to one borrower. In this case, the conditions of the respective agreements for each such loan are between the borrower and the creditors that avail it. For the case of maturity dates with respect to the borrower’s obligations to the lenders, and the interest rates, are identical for all agreements.39 Every given lender commits to lending towards the borrower in the amount and under the conditions specified in the separate bilateral agreement. Further, every single lender has a given claim against the borrower under respective bilateral agreement and claims according to set rules and regulations against the borrower for repayment which are particular in nature. The lender holds each in the amount and subject to the conditions set as per the respective agreements. Looking at the loan disbursement and repayment, they are made through the lending institution serving as the agent, and which also may be the lender.40 Further, the agent bank to some extent, acts for the lenders under multilateral agreements prepared among the lenders. It is vital to highlight on the reasons that may cause a lender under a syndicated loan decide to sell the commitments accorded him. The first reason is to realize capital; in case of a long term loan facility, the lender may decide to sell its share of the commitment upon it and realise capital or take available advantage of new lending opportunities. Secondly, there is case management, whereby, the lender may take the loan portfolio owned by it is weighted with too much emphasis pertaining to a borrower or loan and may opt to alter the yields dynamics of the loan portfolio.41 Placing the commitment for sale in the loan, lends somewhere else, therefore, diversifies the portfolio. The third reason concerns regulatory capital requirements; the ability of a bank to lend is subject to requirements that are both internal and external and keep a given percentage of its assets as envelop for its accessible loan requirements: known as Regulatory Capital Requirements.42 Lastly, it may be aiming at crystallizing a loss; this entails the case where the lender may decide to sell its commitments if the borrower runs into difficulties. In this regard, specialists dealing in distressed debts provide a market for such loans. However, prior to transfer, the lender ought to consider the implications of the method of transfer in place under the syndicated Loan Agreement. 2.4 Forms of transfer Novation: involves instance whereby, a lender can successfully ‘transfer’ all its rights and obligations under the Loan Accord. This process takes effect and cancels the existing lender’s obligations and rights under the loan while, at the same time, the new lender undertakes similar new privileges and obligations in their place. At this point, the contractual relationship between the transfer lender and the parties to the loan agreement diminishes as the new lender assumes a direct relationship with the borrower, the agent and the other lenders.43 Legal assignment: this involves the transfer of rights but not obligations. For legal assignment, section 36 of the Law of Property Act 192544 requires that the assignment must be: Absolute in the sense that the entire debt outstanding commences to exist to the lender; is done in writing and signed by existing lender; and notified in the form of writing to the borrower. If it happens that any element is left out, the assignment ceases and turns to be equitable. With syndicated loan in this context, a legal assignment will transfer all the existing lender’s rights under the loan agreement to the new lender. In this regard, the requirement of the on hand lender to provide funds to the borrower cannot be transferred by the assignment of legality, therefore, remains with the existing lender. Further, the new lender is obligated to pay the existing lender any funds that are due under the loan and the existing lender sends the funds to the agent, and in turn passes the resources on to the borrower.45 Equitable assignment: as stated above; whenever one or more of the provisions under section 136 of the Law of Property Act 192546 is not met, the equitable assignment, is created. In contrast to a legal assignment, the new lender termed as the equitable assignee, joins the existing lender, as an assignor in any action on the debt.47 Most significantly, the difference between a legal and equitable assignment exist in case of the borrower not, notified of the assignment. This leads to the new lender being subject to all equities arising linking the current lender and the borrower, even after the assignment of the loan.48 Funded participation; this refers to the new contractual rights existing between the lender and the participant; on the same terms as the contract that exist between the lender and the borrower.49 The role of the existing lender is acting as the intermediary between the borrower and the participant. The role of the participant is to put up funds which the existing lender, loans to the borrower and is only paid back by the existing lender after the borrowers have repaid the existing lender.50 Unlike in novation, there is no transfer of existing rights and the borrower is usually unaware of the contract between the existing lender and the participant. The last form of transfer is the risk participation which is a form of participation acting like a guarantee.51 The peril contributor does not instantly place any money with the lender at hand, but agrees for a fee, to put the existing lender funds in certain circumstances. Provision of the risk participation may be undertaken by the new lender as an interim measure prior to taking full transfer of a loan. REFERENCES Books Dalvinder, S., Banking Regulation of UK and US financial markets, (Hampshire, Ashgate publishing company, 2007).  Davis, EP, Problems of Banking Regulation-An EC Perspective, (Financial Marketing Group, An ERSC Research Centre, London School of Economics, December 1993) Rastra R. M. Central Banking and Banking Regulation, London, Financial Markets Group, (London school of economics 1996) pp 180 Sadikov, O., Soviet Civil Law (New York, M. E. Sharpe, Inc. 1988) Spong, K., Banking Regulation; Its purposes, Implementation and Effects, (5th Ed. 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