Depositor Compensation Scheme - Report - 19 October 2009

Economic Affairs

Scrutiny Panel

Depositor Compensation Scheme

Presented to the States on 19th October 2009

S.R.10/2009

1. PANEL MEMBERSHIP AND TERMS OF REFERENCE....................................3
2. EXECUTIVE SUMMARY....................................................................................5 FINDINGS AND RECOMMENDATIONS...........................................................................7

1. Findings..................................................................................................7
2. Recommendations .................................................................................9

4. INTRODUCTION..............................................................................................11

4.1 The Jersey Banking Sector and Business Model.................................11

5. KEY ISSUES AND OBSERVATIONS EXPLORED..........................................20

5.1 Safety of, and risk of, Jersey-based Banks.......................................20

6. OPENNESS, HONESTY AND CO-OPERATION .............................................33

2. Economic Development Department and Chief Ministers Department.33

6.2.2 Oxera Report and background information....................................33

6.2.8 Blanket Confidentiality...................................................................34

6.2.15 Lack of file notes, minutes and working papers.........................36

6.2.17 Evidence......................................................................................37

6.2.21 The integrity of the process..........................................................39

6.2.23 Caps by Stealth ...........................................................................40

3. Oxera Report........................................................................................42

6.3.1 Was Oxera's report written to order?...........................................42

4. Jersey Banker's Association.................................................................45

6.4.1 Lack of Cooperation from Jersey Bankers Association Executive Officers...................................................................................................46

5. The Wider Financial Industry................................................................46

6.5.1 Examples.......................................................................................47

7. CONSULTATION..............................................................................................48

2. Finance Industry...................................................................................50
   3. Jersey Bankers Association...........................................................50

7.2.17 Jersey Financial Services Commission........................................58

7.2.21 Jersey Finance Limited................................................................59

3. Public ...................................................................................................60

4. Small Businesses.................................................................................60
5. External................................................................................................63

6. Other....................................................................................................63

8. COVERAGE .....................................................................................................65

1. What is proposed for Jersey?...............................................................65
2. International Practice............................................................................65
3. Coverage: Key Issues Explored...........................................................66

8.3.1 Included: Retail (Jersey and International):....................................66

8.3.13 Included: Charities.......................................................................69

8.3.17 Excluded: Small Businesses........................................................70

9. FUNDING .........................................................................................................73

1. What is proposed for Jersey?...............................................................73
2. International Practice............................................................................73
3. Funding: Key Issues Explored..............................................................80

9.3.1 Too big to fail – a credible assumption?.........................................80

9.3.7 Who Pays? Government v Industry...............................................83

9.3.14 No scheme - loss of banking customers?....................................86

9.3.20 No scheme - loss of banking business?.......................................89

9.3.27 The £100 Million and 5 Year Caps...............................................91

9.3.38 Ex-Post v Ex Ante........................................................................97

10. STRUCTURE.................................................................................................. 103

1. What is proposed for Jersey?...........................................................103
2. International Practice........................................................................103
3. Structure: Key Issues Explored........................................................105

10.3.1 Is an Ex-post, Reactionary Board Appropriate?.........................105

10.3.14 Independence of the Board.....................................................109

11. MECHANICS.................................................................................................. 115

1. What is proposed for Jersey?...........................................................115
2. Mechanics: Key Issues Explored......................................................116

11.2.1 Seven Day Payouts...................................................................116

11.2.9 Cross Border Asset Recovery....................................................121

12. APPENDIX 1 – EVIDENCE CONSIDERED.................................................... 127
13. APPENDIX 2 – ADVISER SUBMISSIONS..................................................... 131

1. PANEL MEMBERSHIP AND TERMS OF REFERENCE

1. The Economic Affairs Scrutiny Panel is comprised of the following members:

Deputy M.R. Higgins, Chairman

Deputy C.F. Labey , Vice-Chairman

Deputy S. Pitman

Deputy D.J.A. Wimberley

Deputy J.M. Maçon

The Panel agreed to co-opt Deputy G.P. Southern for the purpose of assisting this Review.

2. The following Terms of Reference were established for the Review:

1. To examine the reasons for the adoption of a Depositor Compensation Scheme.
2. To establish whether the proposed Depositor Compensation Scheme is appropriate for Jersey and constitutes the best method of achieving the objectives of the scheme. To include examination of the following:

1. Principles;
2. Structure;
3. Development;
4. Coverage;
5. Liability and risk;
6. Funding; and
7. How the proposals compare with similar measures in other jurisdictions.

3. To examine any further issues relating to the topic that may arise in the course of the Scrutiny Review and which the Panel considers relevant.

Glossary

BBA - British Bankers Association

CDIC - Canada Deposit Insurance Corporation

CDO - Centralised Debt Obligation

CIS - Collective Investment Schemes

DCS  - Depositor Compensation Scheme

DGS - Deposit Guarantee Scheme

EC - European Commission

Ecofin - Ecofin is an investment firm which specialises in the global

utility and infrastructure sectors

EDD - Economic Development Department

EU - European Union

FDIC - Federal Deposit Insurance Corporation

FSA - Financial Services Authority

FSSA - Financial System Stability Assessment

FOS - Financial Ombudsman Service

FRC - Financial Reporting Council

FSCS - Financial Services Compensation Scheme

FSI  - Financial Soundness Indicators

GDP - Gross Domestic Product

HMT - Her Majesty's Treasury

IADI  - International Association of Deposit Insurers

IMF - International Monetary Fund

IOM  - Isle of Man

JBA  - Jersey Bankers Association

JDCS - Jersey Depositor Compensation Scheme

JF - Jersey Finance

JFSC - Jersey Financial Services Commission

SME - Small and Medium Enterprises

2. EXECUTIVE SUMMARY

1. The Economic Affairs Panel recognises the importance to depositors in Jersey's banks, as in other jurisdictions, of the protection afforded by a credible depositor compensation scheme. We acknowledge that the proposed scheme in Jersey has been developed in some haste, with pressure from the States, depositors and banks. However, the Panel is concerned that because of the speed of its development, the consultation carried out has been too narrow, with too much focus on the industry and too little on taxpayers and depositors, particularly the general public and small business depositors.
2. With the Department's focus on the banking sector, and the pressure applied by it, the Panel has found that the drive to keep down costs for the commercial benefit of the banks has dominated the development of the scheme, to the detriment of the principle of protecting depositors. An example of this is the 5 year cap, which is unique to the Guernsey scheme and to that proposed in Jersey. It is designed in tandem with the capping of banks' liability to £65 million to minimise the costs to the banks, particularly in the case of multiple or large failures. This drive, along with the questionable continued belief by the majority of stakeholders that a Jersey bank failure is a virtually non-existent prospect, also accounts for the ex-post funding structure and lack of a permanent Board, the absence of which brings into serious question the credibility and effectiveness of Jersey's proposed scheme. The Panel considers that a real Board funded from the outset by ex-ante or hybrid funding is the minimum requirement for the scheme to be credible.
3. Discussion of how the elements of the proposed scheme came about revealed to the Panel that the main driver was competition; to ensure that in the eyes of a depositor the scheme matched or bettered that primarily in Guernsey and the Isle of Man. This concerns the Panel deeply because depositor compensation schemes should not be used as competitive tools. The Panel believes that Jersey should have consulted with the Isle of Man and Guernsey with a view to co-operation on developing standard approaches to the protection afforded to depositors, the core of any credible scheme.
4. Assessing the coverage afforded by the scheme, the Panel is in agreement with the £50,000 level of payout per eligible depositor per bank is comparable with European jurisdictions. Furthermore, the coverage of Jersey resident and international retail depositors is appropriate and consistent with international standards. Whilst it is appropriate that charities and children's trusts are covered by the scheme, the Panel can not concur with the decision to omit small businesses. It is not satisfactory that such a crucial sector of the Jersey economy was given such limited consideration, indeed to even undertake basic research to see if this would be achievable. Small businesses appear to

have been simply disregarded in the initial stages simply on the grounds of minimising the cost of the scheme.

FINDINGS AND RECOMMENDATIONS

1. Findings

1. The Jersey authorities and other key stakeholders believe that a depositor compensation scheme is not necessary, in the sense that it will never need to be used, due to the rigour of the bank licensing policy in Jersey and the Jersey Bank Business Model. (5.2.28)
2. The world has changed since the onset of the world financial crisis and global recession. The political climate has changed markedly. Different approaches to bank failure are now under consideration, leading to an increased likelihood that a bank or banks could fail. (5.2.29)
3. The Jersey Banking Business Model is not without risk, as has been identified by the International Monetary Fund. A depositor compensation scheme is required to protect retail depositors. (5.2.30)
4. The final Oxera Report appears to have been tailored to bolster the preferred scheme of the Economic Development Department. (6.3.6)
5. The development of the scheme has been carried out in a less than transparent manner. (6.3.7)
6. There has been a lack of co-operation with the Panel during its evidence gathering from a number of key stakeholders. (6.6.3)
7. Although consultation took place with one of the main stakeholders, the Jersey Bankers Association, and with amongst others the Jersey Financial Service Commission, the Law Officers and Viscount's Department on technical issues, there was no consultation with the small business community, who were left out of the scheme, or with the General Public. (7.6.5)
8. The £50,000 payout per eligible depositor per bank is consistent with comparable jurisdictions and is a credible level of compensation. (8.2.5)

9. The coverage of Jersey resident and international retail depositors is appropriate and consistent with international standards. (8.3.12)
10. It is appropriate that charities and children's trusts are covered by the scheme. (8.3.16)
11. The scheme does not cover small businesses and insufficient consideration was given to establish if this would be achievable. (8.3.27)
12. The proposed scheme is not world class and does not comply with all of the IADI core principles. (9.2.22)
13. There is no evidence of a risk management strategy for the States' liability in the scheme. (9.3.13)
14. The drive to keep down the costs for the commercial benefit of the banks has dominated the development of the scheme to the detriment of the principles of protecting depositors and limiting the exposure of taxpayers . (9.3.25)
15. Depositor Compensation schemes should not be used as competitive tools. Jersey should have consulted with the Isle of Man and Guernsey with a view to co-operation on developing standard approaches to the protection afforded to depositors. (9.3.26)
16. The 5 year cap is unique to the Guernsey scheme and to that proposed in Jersey. It is designed to minimise the costs to the banks but this is to the potential detriment of depositor protection. (9.3.37)
17. An ex-post funded scheme lacks credibility. (9.3.44)
18. Hybrid funded schemes are becoming increasingly common. (9.3.45)
19. A permanent Board would be able to react more effectively to a bank failure than a Board established post failure. (10.3.9)

20. Public awareness of the scheme will be an important element of its credibility. It is not clear who will be responsible for promoting Public Awareness of the scheme. (10.3.10)
21. A permanent Board would be more credible to depositors and would be well placed to undertake roles including promoting Public Awareness of the scheme. (10.3.11)
22. The Board as proposed is not sufficiently independent. (10.3.21)
23. The proposed aim for a seven day payout is currently unrealistic and undermines the credibility of the scheme. (11.2.8)
24. There are significant cross border asset recovery concerns. (11.2.21)
25. There is no separate insolvency law for banks in Jersey despite the likely complexity of the liquidation of a failed bank. (11.2.22)
26. Claims of high recovery levels from of a failed Jersey bank's parent company are untested and not guaranteed. (11.2.23)

2. Recommendations

1. The Minister for Economic Development should make provision for coverage to be extended to small local businesses. (8.3.28)
2. A hybrid funding structure should be adopted. (9.3.46)
3. In order to raise the credibility of the scheme for depositors a real, permanent Board should be established. (10.3.12)

4. A permanent Board should be funded in advance outside of failure periods by an administration fund collected from bank levies. (10.3.13)
5. There should be a permanent Board funded by the banks and more demonstrably independent of the States and industry practitioners. Its remit should include public awareness, monitoring of international standards in depositor protection and the administration of the scheme. (10.3.22)
6. A separate insolvency law for banks should be established. (11.2.24)

4. INTRODUCTION

4.1 The Jersey Banking Sector and Business Model

1. Banking Sector
2. The finance sector dominates the Jersey economy. The main activities are banking, fund management and fiduciary services. In December 2008 the Jersey Banking Sector comprised 47 licensed institutions, with assets of £319,090 million. The Finance sector employed 13,400 people in December 2008, of which 6,040 were employed in banking.
3. The Jersey Financial Service Commission's (JFSC) licensing policy requires, inter alia, that:

• an applicant bank be a member of "a group of stature" (ie. one ranked in the top 500 by Tier 1 capital);
• systemically important in its "home" jurisdiction; and
• that the standard of consolidated supervision applied to the group by its primary regulator is judged to be of the international standard by the JFSC .

4. The 47 licensed institutions comprised 23 joint stock banks, 21 bank branches and 3 other types. Of the 23 joint stock banks, 7 were subsidiaries of UK banks and 10 were subsidiaries of other EU banks. Their combined assets amounted to £103,608 million. Of the 21 bank branches, 7 were branches of UK banks and 4 were branches of other EU banks. Their combined assets amounted to £215,481 million.
5. Among the total of 47 banks that have a licence to operate in Jersey, 31 hold deposits of natural persons. The other banks specialise in corporate deposits, serve wholesale clients only or concentrate on own-group requirements. Retail deposits represent around 18% of total banks' liabilities.

6. Number of accounts and balances of natural persons:

7. The Island is among the larger Offshore Financial Centres in the banking sector.

1

8. The ratio of bank deposits to GDP is significantly higher in Jersey than in other jurisdictions. In  Jersey,  bank  liabilities  are  equal  to  53  times  GDP,  which  is significantly  higher  than  in  other  jurisdictions  listed,  including  countries  that  are known for hosting sizable financial centres, such as Luxembourg (where liabilities are less than 16 times GDP) and Switzerland (where liabilities are 3.4 times GDP).

1 Michael Foot Interim Report April 2009

9. Banking Business Model
10. The banks' principal business is the collection of retail deposits from overseas (eg. from British expatriates or non-domiciled expatriates in the UK), and from corporate and the trusts that are managed in the Island. These funds are mainly placed with banks and in particular parent banks (ie. upstreamed).
11. Structure of total deposits by region (September 2008)

2

12. Structure of deposits, by size and residence (end of October 2008)

3

2 JFSC, as contained in IMF Report on Jersey September 2009

3 JFSC and IMF Staff Estimates, as contained in IMF Report on Jersey September 2009

13. Nature of Lending
14. Bank deposits are mainly placed with other banks and in particular with the banks' parent banks (ie. upstreamed to head office).
15. Loans to banks at the end of 2008:

4

16. Non-interbank lending is mainly to individuals, property companies, and some non- bank financial institutions.
17. Loans and advances at the end of 2008:

5

4 JFSC and IMF Staff Estimates, as contained in IMF Report on Jersey September 2009

5 JFSC and IMF Staff Estimates, as contained in IMF Report on Jersey September 2009.

18. Structure of Non-Interbank Loans by type (end of June 2008):

6

19. Many banking groups have licences to perform other financial services, such as fiduciary services, that are ancillary to the wealth management services provided to their clients.
20. History and development of Depositor Compensation Schemes in Jersey
21. The 1998 Edwards Review of financial regulations in the Crown Dependencies recommended that there should be a depositor protection scheme in Jersey.
22. In 1999 the States formed an action group, undertaking in due course to ensure that depositor protection was in place. A draft scheme was prepared in 2002/3, but ultimately this scheme was never placed before the States for debate, the political and industry will for such a scheme being insufficient at the time.

6 JFSC and IMF Staff Estimates, as contained in IMF Report on Jersey September 2009.

23. On 23rd September 2008 in a Statement to the States Assembly, the then Minister for Economic Development, Senator P.F.C. Ozouf , advised Members of a change of approach to the requirement for a Depositor Compensation Scheme in Jersey. It was outlined that, in light of the unfolding international financial market and banking crisis and to further strengthen public confidence in the Island's banking industry, a review of the arrangements for depositor protection in Jersey would be undertaken.[7]
24. In October 2008, OXERA Consulting Ltd was engaged to undertake the review entitled Deposit Guarantee Arrangements for the States of Jersey: A Review and Evaluation of Options'. The subsequent report was released at the beginning of June 2009, in conjunction with the lodging of the Depositor Compensation Regulations on 2nd June 2009.
25. Following the banking crisis in October 2008, the then Chief Minister Senator Frank Walker , Treasury Minister Terry Le Sueur and Economic Development Minister Philip Ozouf gave a political guarantee to take a deposit compensation scheme to the States to give 100% compensation to all Jersey residents with retail deposits in Jersey banks in the extremely unlikely event that a bank licensed in Jersey should fail.
26. On 3rd December 2008 the States voted unanimously in support of a proposition (P150/2008) lodged by Deputy P.V.F. Le Claire:

to request the Minister for Economic Development to present proposals prior to July 2009, for a Financial Compensation Scheme for Jersey, with aims and objectives along the lines of, or similar to, the U.K. Scheme known as, the Financial Services Compensation Scheme (FSCS).'

27. On 15th July 2009 the States Assembly voted unanimously for the introduction of a depositor compensation scheme when it passed the principles of proposition P86/2009. Also on 15th July 2009 the Economic Affairs Scrutiny Panel used its powers under Standing Order 72 of the States of Jersey to call the proposition in for detailed scrutiny, giving an undertaking to the States that it would report back to members prior to the main debate on the proposition's articles on 20th October 2009.

28. Draft Depositor Compensation Scheme – P86/2009
29. In broad terms, the lodged Regulations propose a permanent, standalone depositor compensation scheme to be activated in the event that a Jersey bank failed i.e. ex post. The overall liability of the scheme including administration costs will be capped at £100 million over each 5 year period and levies on industry will also be capped with the States making up any shortfall. This shortfall funding may be repaid to the States depending on the rate of recovery in the bank liquidation. It is envisaged that short-term liquidity will be provided by the States through a loan to the scheme.
30. The scheme would provide full protection for private individuals up to a maximum of £50,000 per person, per Jersey banking group, whether or not the depositor is resident in Jersey. Up to the first £5,000 of a valid claim would be paid within 7 working days, with the balance being paid within 3 months.
    31. These Regulations would establish a scheme that would ensure that most individuals and charities with money deposited with a bank in Jersey (an eligible deposit) would receive some compensation if the bank becomes bankrupt. The compensation would be the lesser of an amount equal to the eligible deposit or £50,000. Although in extreme cases the sum paid to each individual may have to be reduced to keep within the £100 million cap.
31. In response to a failure, a Board would be established to administer the compensation scheme and to pay the compensation. The scheme envisages that the Board would raise all the necessary funds to do so by imposing a levy on the banks in Jersey that held eligible deposits at the time the bank in default became bankrupt.
32. However, the amount each bank may be required to pay by way of levy in any period of 5 years is limited. So too is the amount of compensation that the Board may be required to pay by way of compensation during the same period. Where, in the case of the bankruptcy of certain banks, the amount of the levy the other banks would be required to pay would be insufficient to pay compensation, the States is required to pay the shortfall to the Board up to the overall £100 million cap.

34. Economic Affairs Scrutiny Panel
35. The Panel, including Deputy G.P. Southern who the Panel co-opted in order to draw upon his experience working in Scrutiny, has continued to work during the summer recess to carry out this review. The Panel has held a total of 7 public hearings with stakeholders, including with the Minister for Economic Development and his Officers, the Jersey Financial Services Commission and interested members of the public. The Chairman and Deputy Southern also travelled to the Isle of Man, the U.K. and Guernsey to speak to representatives of the schemes that are in place in those jurisdictions.
36. The Panel has been invaluably assisted by the advisory services of a leading international consultant on the development of depositor compensation schemes, Mr Ray Labrosse of Patterson and Labrosse Financial Consultants, Canada, a founding Member of the International Association of Deposit Insurers (IADI).

5. KEY ISSUES AND OBSERVATIONS EXPLORED

5.1 Safety of, and risk of, Jersey-based Banks

1. The proposed Depositor Compensation Scheme appears to the Panel to be built on one central premise, and that is that it is almost certain that no banks in Jersey will fail and that therefore it is highly unlikely that the scheme will ever be activated.
2. This was a recurring theme in presentations to the Panel by the Minister and his Officers and various stakeholders from within the Financial Services Industry:

. We still do not believe fundamentally that a depositor compensation scheme is needed'[8]

3. In testimony that the proposed depositor compensation scheme was the least worst solution:

Nobody wants a deposit scheme, it is something that happens in a bad set circumstances. The preference is that it does not happen and we, by means of history and regulation, have a better environment in banking terms than any jurisdiction in the world. There is no jurisdiction in the world that is in a better position in terms of the quality of the banks and the nature those risks that they undertake.' [9]

4. The principal evidence offered by these witnesses in support of this assumption was the composition of Jersey's banking community, which had been shaped by the Island's long standing Top 500 policy and because of the Jersey banking business model, which is followed by the vast majority of banks in the Island.
5. The Top 500 licensing policy laid down by the Authorities and pursued by the Jersey Financial Services Commission requires that an applicant bank:

1. be a member of "a group of stature" (ie. One ranked in the top 500 by Tier 1 capital);
2. be systemically important in its home" jurisdiction; and

3. that the standard of consolidated supervision applied to the group by its primary regulator is judged by the JFSC as meeting international standards.

6. The banking model operated by most banks in the Island is the collection of retail deposits from overseas (eg. from British expatriates or non-domiciled expatriates in the UK) and from corporate and the trusts that are managed in the Island and placing these funds with banks, particularly with their parent banks (ie. a process known as upstreaming).
7. The assumption thus appears to be based on the view that the banks in Jersey are too big, to complex, too interrelated and too systemically important to their home states and financial systems that they will never be allowed to fail.
8. Evidence'

. . . we, the government, the regulator in terms looking at our community of banks in Jersey, are confident that the likelihood of a bank failure is extremely remote indeed because of the portfolio of banks.'[10]

9. In an explanation of why other jurisdictions had had bank failures and why Jersey is different:

The simple answer is that we are different and if you look at the portfolio of banks and the business model both locally and of their parents that they are different

Iceland had a series of banks that were (a) massively leveraged and (b) leveraged to the point that the jurisdiction was at risk of not being able to fund the problem. We do not have any such bank here in Jersey.'[11]

10. When discussing the political guarantee to Island residents made in October 2008 by the then Chief Minister, Treasury Minister and Economic Development Minister, which offered unlimited protection to all retail deposits:

Our assessment is to the extent that we have even the remotest risk, it is outside the population of banks which are systemic in nature. So we have reviewed the banking population and the first twelve, thirteen banks are manifestly systemic. They have all either had or their governments have already evidenced their support for their banking community to prevent them . . . [failing?].

The assessment of giving the political guarantee was to say, well, assuming that is the case, what is the slightly higher risk for a couple of reasons. One is that a couple of the banks in that population that have not had evidence that they are systemic in nature are actually financially much stronger, and others are not in the same sort of business. They have a slightly different business model where they are not basically retail deposit takers.'[12]

Mr Martin De Forest Brown, Director of International Finance

11. But are such assumptions – that Banks are too big to fail and the Jersey banking model has little of no risk - really credible in light of the recent and current global financial events?
12. In response to a statement that it is no longer valid to say that banks are too big to fail and that they may be broken up by the authorities, the following was said;

I struggle with that, to be honest, because I think banks are different. They are intrinsic to the economic system of any given country and, you know, it is not necessarily the case that you get better financial stability by parcelling up your banks into smaller and smaller entities.

Maybe governments have been forced to recognise that the utility of having large banking groups with the wherewithal to do the things they do in order to oil the wheels of the economy comes with this implicit recognition, now explicit recognition, that governments are going to have to be prepared to step in.

I do not think that debate is finalised at all. Lord Turner has made it clear, for example, in his review that he does not buy the argument that banks need to split up. That is perfectly acceptable to have large banking groups which operate both the retail side of the business and also the wholesale side of the business.

What he basically said is they just need to be better supervised and their business model needs to be tested more regularly.

So, for my money, looking at it from where I sit at the moment as a supervisor linked into the system, I think that that argument is by no means finalised and I would be surprised if we do indeed end up going down the road of a forced separation of investment and non investment banking arms.' [13]

13. The following response was given to a request to provide evidence to the claim that big banks cannot fail because there was clear evidence on the record of big banks have failed and been allowed to fail. The following was stated;

We are making an assessment of the current position, which is the banks that we have here have either already been supported or are the nature of banks that will receive . . support as a systemic bank by their government.

So we are not saying that big banks cannot fail, but what we have been through is the worst . . . arguably one of the worst banking crises ever, and what has happened in that is the banks that did fail are not retail banks.

What has become clear is all governments have realised that politically they cannot allow retail banks to fail, They will step in, which is why suddenly in the UK you have half a trillion of government support for the banking system. So, you cannot say they will not.

All the evidence is that governments have learnt politically that you cannot have your . . . a significant proportion of your population suddenly being made bankrupt. So they have realised, and they have also learnt from experience that the cost of supporting a bank and maintaining it and keeping it going is going always turns out to be significantly less than allowing it to fail.

The hindsight now is very much that even the banks that they did let fail, the ones that were not retail, was that that was a mistake and it cost more ultimately to clear up the mess.'[14]

14. Counter view
15. Even if banks were considered to be too big to fail in the past the same is not true for the future. The global financial crisis that began in September 2007 has cost governments and taxpayers dearly. It has damaged world trade and the real economy in many nations putting millions of people out of work. The role of the banks in generating the financial crisis and global recession will not be forgotten or forgiven, especially by the taxpayers who for years to come will be paying the price of the bank bailouts as governments try to cut public debt which has ballooned and restore public finances by reducing services and raising taxes.[15]
16. According to the Panel's adviser, it is a risky assumption to make;

While implicitly, many of the European schemes may have been constructed with the idea that the authorities might never have to deal with a bank failure, the States of Jersey Scheme is quite explicit on that point as its aim is "to provide depositors with compensation quickly in the unlikely event of a bank failure".

But, banks do fail and they fail in periods even when there is not a financial crisis. We have seen bank failures all around the world and even in those jurisdictions that have strict licensing regimes and structured early intervention frameworks. Some of the failures in the US recently can be attributed to the financial crisis (sub-prime loans), but others were attributed to bad management, poor risk management practices, etc.

We know that the root of the problems surrounding Northern Rock plc was its dependence on wholesale markets for the large majority of its funding and that was what most distinguished Northern Rock from other UK banks (and a fortiori from all UK building societies). Retail deposits (and other classes of retail funds) did grow, but not nearly as rapidly as did wholesale funds. Retail funds fell as a proportion of the total liabilities and equity of Northern Rock from 62.7% at end 1997 to 22.4% at end 2006. It remained, however, a predominantly UK-based institution, with the great bulk of its business done in that country.

It is the case that Northern Rock's securitisation programme supported rapid balance sheet growth for several years. Much of that funding was short term. About half of their wholesale borrowing was at a maturity of less than one year. Even more important to their subsequent problems, the size of the Northern Rock securitisation programme meant that a large amount of mortgage-backed securities needed to be refinanced every year. It was this need to replace the funding obtained from short-term wholesale and securitisation markets, markets which were effectively closed from the summer of 2007 that forced Northern Rock to turn to the Bank of England for liquidity support.

The States of Jersey has historically only licensed banks that are in the Top 500. Thus, there is an assumption that all such banks are "too big to fail" in their home jurisdiction and therefore the operations in the States of Jersey will not fail. Globalisation of financial institutions and markets has had important spin-off benefits but it appears that that thrust has led to more financial institutions being "too big to fail", "too complicated to regulate", "too difficult to manage" and in some cases "too interconnected too fail" as a opposed to a more desirable outcome of having institutions being "too good to fail".

We also note that recent experience has shown that the capital levels that are generated to meet minimum regulatory standards are simply not enough. Indeed, Sheila Bair, the Chairman of the US Federal Deposit Insurance Corporation: "[a] strong case can be made for creating incentives that reduce the size and complexity of financial institutions as being bigger is not necessarily better. A financial system characterised by a handful of giant institutions with global reach and a single regulator is making a huge bet that those few banks and their regulator over a long period of time will always make the right decisions at the right time." She added that "unless there are clear benefits to the financial system that offset the risks created by systemically important institutions, taxpayers have a right to question how extensive their exposure should be to such entities."

Thus, it may no longer be the case that banks are "too big to fail" because governments are running out of financial capacity to allow big banks to continually expose their fiscal arrangements. The suggestion from Lord

Turner that even the largest banks should develop "living wills" is a very profound statement and may represent the new reality. [16]

17. International Monetary Fund
18. The International Monetary Fund's recent Financial System Stability Assessment Update on Jersey published on 1st September 2009 states in its main findings that:

1. The financial crisis has highlighted the vulnerability of Jersey's banks to events in major financial centres.

19. In the body of the report it states:

The current global financial crisis highlights the vulnerability of Jersey institutions to events in major financial centres.

Most banks in Jersey are branches or subsidiaries of large international groups, to which they provide financing. This close relationship reduces risk in normal times, given the group's ability to support their Jersey operations. However, it is also a powerful risk transmittal mechanism in case the health of the group deteriorates. In the event of extreme stress, a large share of Jersey's banks' balance sheets could be at risk, as well as their core business model.

Banks' intra-group claims on their parents represent the major risk to the system. However the JFSC exempts these claims from limits on exposures to related parties and large exposures. Specifically, inter-group exposures with a maturity of one year or less are exempted from risk concentration provisions.

Jersey banks are highly vulnerable to concentration risk with respect to their groups. Recent experience has demonstrated that even the largest banks can come under extreme stress, in which eventuality a Jersey affiliate could lose access to almost of its assets, at least temporarily.

If a parent is suspected to be in difficulties, the JFSC may attempt to require the Jersey subsidiary to move assets elsewhere, as would be consistent with the duties of the subsidiary's management, but such action may be damaging to the parent, to the home country's authorities, and ultimately to Jersey banks' business model.

While some flexibility is required for banks to fulfil their business model of "upstreaming" deposits a permanent and blanket exemption from single counterparty limits is inconsistent with the Basel Banking Core Principals, which requires setting a prudent limit.

The JFSC thus faces a conundrum. It cannot feasibly analyze in depth the soundness of major international banking groups, but it should be able to detect and react to intensified spill-over risks. The JFSC also needs to further develop its capacity to look at the strength of the banking system as a whole, for example, by performing stress tests.

While Jersey supervisors cannot feasibly analyze in depth the soundness of the financial groups to which their Jersey operations provide extensive funding, it should be able to detect and react to intensified risks stemming from parent institutions.

2. Jersey has experienced some effects from the global crisis, but financial soundness indicators (FSI's) for institutions licensed on the Island have been satisfactory, and stress tests confirm that the system is resilient to a range of shocks. However, there is high concentration risk and spill-over risk from parent banks.

20. In the body of the report it states:

Jersey has felt some effects from the turmoil in global financial markets, There have been some outflows from banks and CISs (Collective Investment Schemes), and profitability is expected to decline. No bank has failed, but the crisis should reinforce awareness that even the largest parent groups are not immune to major disruption. Available FSIs for institutions licensed on the island are satisfactory. Stress tests confirm that, while the system is resilient to a range of shocks, concentration risk and spillovers from parent banks are the main potential areas of concern, and that credit risk is of significance for the local economy.

2. The Authorities are making contingency plans, a key element of which will be cooperation with home supervisors. Experience elsewhere suggests the usefulness of a dedicated bank insolvency regime (Panel's emphasis).

20. In the body of the report it states:

The authorities rightly recognize the need to plan for contingencies, and preparations have begun. An essential element will be cooperation for home supervisors – and with the domestic authorities. Experience elsewhere suggests that it is useful to have a dedicated bank insolvency regime.

4.  The IMF Assessment Team found Jersey only largely compliant with Principles 10 and 11 of the Basel Core Principles, which relate to Large Exposure Limits and Exposures to Related Parties and recommended amongst other things that the general exemption given by the JFSC to inter- bank loans or placements, certificates of deposit or similar instruments issued by banks with a maturity of one year or less from concentration risk regulations should be considered.

21. They pointed out that even short term lending to banks could provide for considerable losses as experiences eg. from the failure of Bankhaus Herstatt in 1974 (ie. the so-called "Herstatt risk") or the recent market turmoil and losses connected therewith clearly show. They also pointed out that these exposures constitute the dominant vulnerability of Jersey as a Finance Centre.
22. The IMF Main Recommendations gave a high priority to the following:

• Continuing to develop contingency plans, including through a clear allocation of roles between the JFSC, the Treasury, and other institutions.
• Seeking to develop mechanisms to receive early information on financial strains, including from home supervisors.
• Replace the general exemption for inter-bank exposures from risk concentration provisions by a defined and transparent procedure under which the JFSC renews such permissions on a regular basis following a review of risks and risk mitigants.

• Develop the capacity to assess overall financial system soundness, including through stress testing.

23. It also gave a medium priority to the study of a possible depositor compensation scheme based on explicit objectives and recognizing constraints.[17]
24. Bank of England
25. Recent speeches by the Governor and Deputy Governor of the Bank of England have addressed: the financial crisis; whether banks are too big or too systemically important to fail; whether the retail and investment activities of large banks should be segregated or broken up; the concept of the "living will": the 2009 Banking Act which grants the Bank wide ranging special resolution powers to deal with failing banks; and state aid for failing banks:

As far as individual banks are concerned, we face some uncomfortable choices about the structure and regulation of our banking sector.

If some banks are thought to be too big to fail, then, in the words of a distinguished American economist, they are too big. It is not sensible to allow large banks to combine high street retail banking with risky investment banking or funding strategies, and then provide an explicit state guarantee against failure. Something must give. Either those guarantees to retail depositors should be limited to banks that make a narrower range of investments, or banks which pose greater risks to taxpayers and the economy in the event of failure should face higher capital requirements, or we must develop resolution powers such that large and complex financial institutions can be wound down in an orderly manner. Or perhaps an element of all three.

Privately-owned and managed institutions that are too big to fail sit oddly with a market economy. One important practical step would be to require any regulated bank itself to produce a plan for an orderly wind down of its activities. That would provide the information to the authorities the absence of which made past decisions about the future of institutions difficult. Making such a will should be as much a part of good housekeeping for banks as it is for the rest of us. And it would be sensible for the various authorities to work across national boundaries to identify detailed plans for how each large cross- border financial institution could be wound up.'[18]

25. The Governor of the Bank of England:

Whatever the ultimate shape of the structure and regulation of the banking system . . . change will be necessary.

The cost of this crisis are not to be measured simply in terms of its impact on public finances, the destruction of wealth, and the number of jobs lost. They are also to be seen in the lost trust in the financial sector among other parts of our economy.

For a generation or more, businesses and families up and down the country were told, not least by the City, that disciplines of the market economy were essential, even if painful in the short run, for the greater prosperity in the longer term. That belief in the merits of a market economy was embraced and for many years was not misplaced. But out of the blue – in this case the financial sector – came a crisis that did not stem from weaknesses in the real economy. It has wreaked havoc on those same businesses and families. Unemployment, as we saw in today's figure, is rising sharply.

And yet it is the banking system that has received financial support on an almost unimaginable scale. We who work in the financial sector have much to do to regain the trust of those who work outside it. "My word is my bond" are old worlds, but they were important. "My world is my CDO-squared" will never catch on.

There is no support in this country, and no case, for excessively bureaucratic regulation. But change to the structure, regulation and indeed culture of our banking system is necessary. Blaming individuals is not substitute for acknowledging the failure of a system, of a certain type of banking. We have a real opportunity now to put that right, and regain the trust that has been lost.'[19]

26. The Deputy Governor of the Bank of England:

Some banks and building societies have not looked distress in the eye over the past year and in earlier years endeavored to run their business safely, foregoing some of the profits of the boom. But I would urge even them to recognise that their relatively calm passage through the crisis to date owes a lot to government standing behind their peers. That support cannot go on forever, which underlines why the Social Contract for banks must be redrawn.

It must be redrawn to reflect the lessons from the crisis. And also to mark a credible shift in regime so that, as an industry, you can re-establish trust and stand on your own feet.'[20]

27. In addition to the speeches made by the Governor and Deputy Governor of the Bank of England the UK Parliament has enacted the Banking Act 2009 which gives the Bank, working with the FSA and HMT, special resolution power, among many other things, to split up a bank or building society into a number of pieces: deposits going to one buyer; some assets possibly to another; parts going into administration.

6. OPENNESS, HONESTY AND CO-OPERATION

1. The Panel has been concerned since February 2008 at the level of co-operation it has received from a number of parties, both from the public and private sectors, and the degree to which Scrutiny has been engaged in the process of bringing such a vital scheme into being.
2. The Panel has also been concerned as to whether the process itself has been carried out in an open, transparent and co-operative manner.

2. Economic Development Department and Chief Ministers Department

1. Whilst the Panel is clear that it would not be within its role to actively seek to develop the scheme and Regulations, it should have been entirely apparent to the Minister from correspondence and meetings with him and his officers that it was seeking background material from the Department in order to be able to review the scheme as expeditiously as possible once they had formulated and published the scheme details and draft regulations.
2. Oxera Report and background information
3. The Panel's requests for information began in February 2009 when it decided to undertake a review of the topic.
4. Key to the Panel's understanding of depositor compensation schemes and the issues and options that could be pursued was the Oxera Report, which had been commissioned by the then Economic Development Minister in October 2008. Although the current Minister received a draft Oxera report in February 2009, which was shared for comment with the Jersey Bankers Association, the Panel was not notified that the draft had been received even though it had specifically requested a copy at its quarterly meeting with the Department in February and was advised that it had not yet been received by the Department.
   5. Despite repeated requests to obtain a copy of the report the Panel did not receive a draft until the 1st June 2009, when it was provided with the final version of the report, together with a copy of the final Regulations, which were being lodged the following day for debate on 14th July 2009.

7. The Panel did receive copies of two early drafts of the Regulations. One was received in March from a member of the Jersey Bankers Association who the Chairman met in the street and said that he would be commenting on the draft proposals. This was the first that the Chairman or any member of the Panel knew of the consultation process and the fact that draft Regulations were being circulated for comment. It was at this point that the Panel became aware that an Oxera Report was in existence which had not been supplied to the Panel despite numerous requests. Another draft of the Regulations was received from Mr. J. Mews, the Finance Industry Development Manager, Chief Minister's Department on 15 May 2009. Neither drafts were considered in detail by the Panel as they were considered work in progress by the Department and meaningless without sight of the underlying information contained in the Oxera Report and other supporting documents. The Panel was also heavily engaged in reviewing another topic at the time.
8. This left the Panel with just 6 weeks before the States debate to undertake a Review of such a significant topic and the draft Regulations which had been tabled, which was not reasonable or realistic.
9. Blanket Confidentiality
10. The Panel was not provided with the background papers it had also requested and needed to effectively scrutinize the draft Regulations until 30th June, when it received four large lever arch files containing law drafts, emails and three Oxera Reports dated February, March and May and assorted papers. These papers were released to the Panel on condition that the Panel signed a confidentiality agreement, which effectively would have hampered its ability to effectively scrutinize the proposals.
11. Although the Chairman signed the agreement, in a personal capacity, to evaluate whether the information contained in the files really warranted such a restriction the rest of the Panel refused to do so as it was felt by all members that it was designed to prevent the Panel from effectively carrying out its function. The Chairman determined that with the exception of some banking data that had been provided on

a confidential basis by the banks to the JFSC, and anonymied and utilized by Oxera to scope the scheme, there was nothing else that should not be in the public domain.

11. A request was therefore made to the Department to review the files and classify only genuinely confidentially documents. This request was repeated to the Minister at the Panel's first hearing with the Minister and the officers from the Chief Minister's Department on 2nd July 2009:

Deputy M.R Higgins

The second thing I would like to say is, blanket confidentiality. Now, what we have is a situation where the 4 volumes came the other day. I signed it for myself, not for the committee, and the committee have not had sight or copies of the volumes or anything else, and I do believe a lot of the material that is in those files should be confidential and they should be allowed to have [them] anyway.

The only thing that I could see - and correct me if I am wrong - the only thing that I would consider confidential is the tables, the breakdowns, showing the individual groups. Although the banks are anonymised, and you have all got a number and they have got the various deposits against them and so on, but where you have a group you can pretty well guess which the group might

So, what I am going to ask you to do is review this thing about the confidentiality, about what people have to sign up to, I think. So, I am going to ask you to consider that and liaise with Tim on that over the coming week, if you will.

Senator A.J.H. Maclean:

... I think it is fair to say that quite an amount of the information that you were sent probably is not confidential However, to go through all of it individually and identify what is and what is not I think, in itself, would provide some difficulty.

Mr. M. De Forrest-Brown:

We would have to provide some generic words that agree, so if we could say something like any bank numbers, or something like that, but we can discuss that, explore that.

Deputy M.R. Higgins:

As I say, from what I read of what I saw, I think they were the only things that I would consider confidential and, as I say, there is no intention on the part of anybody here to impact on the banks or the Island in any way to jeopardise the position.

Senator A.J.H. Maclean:

No, that is fine and more than happy to look at that and see if we can work out, as Martin was saying, some wording that would hopefully cover that up.'

21

12. The confidentiality matter was never resolved and in the end the remaining Panel members agreed to be bound by the confidentiality restrictions in order to proceed with the review.
13. The  net  result  of  this  lack  of  openness  and  cooperation  from  the  Economic Development and Chief Minister's Departments was that the Panel could not review the proposals and Regulations sufficiently in time before the matter was debated in the States Assembly on 15th July 2009. This resulted in the Panel calling in the Regulations for  Review  under  the  States  of  Jersey  Standing  Orders  relating  to scrutiny of proposed legislation after first voting for the adoption of the principle of adopting a depositor compensation scheme.
14. This in turn led to the incredible situation where the Panel was faced with a vote of no confidence simply undertaking standard scrutiny practice. The proposition was lodged by three Assistant Ministers: Deputies Jeune , Dupré and Noel and one other member, Deputy Fox, none of whom had any experience of being part of Scrutiny,
    15. Lack of file notes, minutes and working papers

21 Public Hearing, Minister for Economic Development and Officers, 2nd July 2009

16. Except for the verbal evidence and assurances given by officers during the hearings it conducted the Panel had no means of verifying much of what it was being told by the Economic Development Department of the consultation process with the Jersey Bankers Association and others and how important aspects of the scheme were designed or were arrived at. The Panel found this situation to be unacceptable and felt that it called into question the openness, transparency and co-operation of the whole process. Although the Panel did later obtain copies of minutes of some of the meetings and discussions that took place with the Jersey Bankers Association from the Jersey Bankers Association itself on 16th September 2009 it still felt that the situation was less than satisfactory.
17. Evidence
18. When asked to be provided with the minutes or notes taken from meetings held with the J.B.A., the Panel was informed by the Director, International Finance that that no further records existed:

Deputy M.R. Higgins:

We have obviously been told there have been many meetings of the banking industry, JBA and so on.

We have not received any information about the level of consultation they did, any notes made on the meeting, whether they had any concerns with the consultation or any decisions made or any comments that have come back from banks with the exception of one or two emails. There must have been far more information than we have had.

Mr. M. De Forest-Brown:

Actually, no, there was not. We just had these open meetings where we kicked around all the issues and the usual debates and then we have had minutes at the JBA.

Deputy M.R. Higgins:

Can we have copies of the JBA minutes then?

Mr. M. De Forest-Brown:

I am not sure whether you can have copies of the JBA minutes. You might be able to have a copy of the relevant minutes and it will not tell you much.

Deputy M.R. Higgins:

I would not say all. I would like to see what you have actually discussed on the scheme.

The Deputy of St. Mary :

Would there not be notes of those discussions, formal notes, nothing written down?

Mr. M. De Forest-Brown:

No, not on a formal record. Individuals may have taken their own.

Deputy M.R. Higgins:

This sounds a strange consultation exercise, I must say.

Mr. M. De Forest-Brown:

Well, it is not a formal consultation exercise. I think that is clear. We have always said that. We have gone in to debate the issues with the bankers in open forum in the JBA. If they have wanted to make their comments they have generally made them orally at the meetings.

Deputy M.R. Higgins:

I must say actually I am surprised because, again, the normal consultation thing, you would have three months, you would have people giving back their responses --

Mr. M. De Forest-Brown:

Yes, I know, but these were different circumstances. We were under pressure to try to produce a scheme as quickly as possible.' [21]

19. Ms. A. McFadyen, Chief Executive of Standard Chartered Jersey and member of the J.B.A. elaborated on the J.B.A.'s role in the consultation process, explaining that

it was an issue on which all of the J.B.A. members were interested and had taken part in. She informed us of the nature of the consultation that had taken place:

.it was a sort of iterative process ... first of all it was we want a scheme and then Martin went away and James went away and they were working on what the possibles were. Then they had the benefit of the Oxera findings and they came back and presented what they felt would be the right scheme for comment to the banks. So how much it would cost the banks, what would be the coverage, who would be covered.

But from memory originally they needed some more information so they presented that as sort of that is the scheme but then they needed some more information from the banks which we then provided up through the J.F.S.C. (Jersey Financial Services Commission) so that we could give them some data to work with.

Then after that they came back with what they felt would be right and then we could all work on that: "How much would it cost if there was a big bank failure? How much would it cost the banks and what sort of coverage there would be.'

Deputy M.R. Higgins:

So were there many papers going back and forth, working papers?

Ms. A. McFadyen:

Working papers less. I think it was more of a dialogue and so they would present ... certainly the Oxera findings I think was in a presentation format but I think it was much more of the dialogue.' [22]

20. It should be noted here that the Panel eventually received the minutes from the JBA, in confidence, on 16th September 2009.
21. The integrity of the process
22. As part of its review of the depositor compensation scheme the Panel sought all background information relating to the scheme including all correspondence between

the parties. During its review of this correspondence the Panel came across two emails written by Mr James Mews, the Finance Industry Development Manager, and one of the two authors of the scheme, which cast doubt on the integrity of the development process and the reliance that could be placed on the Oxera Report.

23. Caps by Stealth

Deputy M.R.Higgins

In one email, I will not say who it was to or whatever, but it was from James:

"I am interested in asking my assistant who is a maths genius and who has an Oxbridge Double First in something like mathematics or quantum physics, the opportunity to come up with a complex formula that would impose a cap by stealth."

Mr. J. Mews:

Yes, I can explain that is very much the case. One of the things which we wondered was because when you look at the data, it seems fairly credible, to be perfectly honest. You can have a £40 million scheme that curves up to the top 5 banks in Jersey even though you have ...

The Deputy of St. Mary : For one failure.

Mr. J. Mews: Sorry?

The Deputy of St. Mary : For one failure.

Mr. J. Mews:

For one failure, yes.

The Deputy of St. Mary : Banks never fail two at a time.

Mr. J. Mews:

Yes, exactly. You look at the data which says a £200 billion on deposit and £40 million would cover all of those. Once you have caps in place in the scheme, it is blatantly apparent what your scheme can fund but the public will just equate £200 billion potentially with £40 million; they can do the maths, and for their mind it does not add up.

We have done the detailed research and it does add up. So one of the things I spoke to about, who is far brainier than most people I know - and certainly a lot brainier than myself - was to go away and look at this very issue and say: "Look, can we come up with something which does not (clarification; this should read does impose') impose a cap by stealth in order to make the scheme more palatable?"

Mr. M. De Forest-Brown:

I think the word "stealth" there is confusion in it. The idea was rather than say: "We do not care how things work, there is a flat cap of £100 million."

The question was: is there a formula that works to effectively achieve the same thing? We have fixed on the word "stealth" here as though there was some attempted trickery. The idea behind the request was just to come up with a formula, it might be a tapering formula, it might be a formula that works in a certain way that once it is applied this is the outcome, rather than having to say just flatly: "There is a cap."

I am not sure that generally in a whole range of examples or situations, caps or lines in the sand are ever a good idea. Cliff-edge events always seem to create some oddity.

I am sure Mr. LaBrosse would confirm that whenever you put lines in the sand in all sorts of circumstances, all you do is then have to spend hours and hours or time trying to define exactly which side of the line you are. It is much better if you have something that is graduated and therefore that was the nature of the request; it was to try and come up with some formulae with the means of achieving the same thing rather than just imposing the flat cap.

The Deputy of St. Mary :

But what happened was you ended up with a flat cap which is puzzling because you have this super-brain who has been asked to graduate ... your argument is very sound; cliff-edges are not nice.

Mr. J. Mews:

Notwithstanding the size of his brain; he could not come up with anything so ...' [23]

3. Oxera Report

1. Was Oxera's report written to order?
2. During a Panel hearing with the Minister and his Officers, the following was asked of the Department:

Deputy M.R. Higgins:

The second one I mentioned was in terms of Oxera: "In essence, we would like the report to tie in with our scheme just more. This could be done by covering off the following areas in more depth.

Firstly, explicitly providing that despite the fact that many schemes do not have State funding, if Jersey is to have a scheme that is competitive with other jurisdictions as Guernsey, State funding may be necessary to ensure the scheme is credible."

Then it also goes on to: "Secondly, thank you for removing all data we asked(?). However, we need to have a document that we can point to in public to justify the amount of the States contribution.

We also say, thirdly, the section on S.M.E.s (Small and Medium Enterprises) could be slightly more focused towards the benefits of leaving them out, as in fact our scheme provides. Issues include the fact that no data was analysed on the size of the community and the fact that we do not know whether it is affordable to include them plus the difficulties already highlighted."

In other words, Oxera were being asked to write the report to ...

The Deputy of St. Mary : To order.

Deputy M.R. Higgins: Yes, to order.

Mr. M. De Forest-Brown: I disagree.

I think that all of those are comments on the report that they can take on board. I know that you have had an in-depth session with Oxera and they will give you their responses on that.

I think all of those I am perfectly comfortable with as suggestions in terms of making the report as broad as possible or to avoid confusion.

I am happy to go back through each of those points and explain how we understood those comments and why we thought that they were appropriate.

The Deputy of St. Mary :

Fine, let us focus on the one I wrote down as it was the most startling for me: "Slightly more focused on the benefits of leaving them out." I mean that refers to small businesses in Jersey.

Mr. M. De Forest-Brown:

I totally agree that that sounds odd. I think a better wording would have been something like let us put the balance of arguments for having them in or out. There was no deliberate intent. I think it was just felt that the report did not include the benefits of having them out as well as having them in, simple as that.

Senator A.J.H. Maclean:

Shall we just also put into perspective that we are looking to introduce a scheme in a fair timeframe. I said earlier on in this hearing that we need more data with regard to small and medium size businesses. We are going to obtain that data and we will look at the issues in more depth.

Deputy S. Pitman:

Will that include consulting with the small businesses?

The Deputy of St. Mary : They have already said yes.' [24]

3. The Panel also sought clarification from Oxera as to why they had agreed to make these changes with its Director, Mr. F. Barnes, who explained the role of Oxera;

Oxera are economic advisers to the States. We are retained by the Government of Jersey on a permanent retainer basis, and have been for the last 10 years, and in that role we are asked to do lots of different things and in effect we were asked to look at the design of a world class deposit guarantee scheme..... We have essentially two tests for anything that Oxera does.

The first test is an independence test which we characterise internally as being something which says if you were under an obligation to the court would this piece of work, whatever the output is, satisfy the requirements of an expert witness going to a court. We apply that to everything we do.

We also have a quality test which again we internalise by saying essentially if this was going to the Competition Commission in the U.K. (United Kingdom) or a similar kind of body would you be prepared to send this as the author or the authors of this report. We apply that to everything we do, including everything we do for the States of Jersey.' [25]

4. He explained that any decisions taken on what would be included in the scheme were political decisions, and not at all the role of Oxera.

5. The Chairman sought to clarify the matter;

Deputy M.R.Higgins

Your first report, for example, was . . . setting out the options; that was very good. Later, obviously, decisions were made that the scheme is going to take this form and the last report reflected the fact this is it. But it was not necessarily your recommendation, was it? It was a decision that was made elsewhere; you just basically tailored the report to meet the reality of the scheme that was adopted.

Mr. F. Barnes:

We are tailoring it so that the information about how it is going to work is there.

Deputy M.R. Higgins:

Yes, but you did not make the decision. It was not your recommendation that it should be in the final form that is appears, is it?

Mr. F. Barnes:

No, and it would not be appropriate.' [26]

4. Jersey Bankers Association

1. Lack of Cooperation from Jersey Bankers Association Executive Officers
2. The Panel has been disappointed at the cooperation it has received from the President and Secretary of the Jersey Bankers Association with its review. Although they did supply the Panel with the minutes of their association's meetings when the depositor compensation scheme was discussed they declined to attend any hearings with the Panel.
3. Instead, the Panel received a response outlining the broad stance of the JBA but stated that the invited representatives [Mr Martin Fricker, President and Mr Martyn Scriven, Secretary] would not be able to appear due annual leave and work commitments, and explaining that August is a difficult month'. Consequently, further attempts to meet with the JBA were unsuccessful, but the Panel were informed by the JBA's Secretary:

I have spoken to the President who has made it clear to me that he really does not wish the JBA to take part in any Public Hearings. Recognising that no scheme is perfect he simply feels we now have something fit for purpose which should not be unduly delayed. Sorry we will therefore decline the invitation.' [27]

4. It was to the Panel's surprise therefore that, at its hearing with Jersey Finance Chief Executive Geoff Cook and Alison McFadyen, Chief Executive of Standard Chartered Jersey on 7th September 2009, we were advised that Ms McFadyen was attending as a representative of the JBA. Although Ms McFadyen was very helpful in the evidence she gave, the Panel had not been notified of her attendance in this capacity and therefore was not prepared to cover relevant JBA issues.
   5. The Wider Financial Industry

1. Examples
2. The  Panel  also  made other  unsuccessful  attempts  to  gather  evidence.   These included: a request to meet representatives from a high profile bank that had taken part  in  the  DCS  consultation  process  and  The  Society  of  Trust  and  Estate Practitioners, Jersey Branch.

7. CONSULTATION

1. Underpinning the development of the draft Regulations was the information received in the report from the consultants Oxera, engaged to advise the Minister on the options that might be considered in deciding key elements of the scheme.
2. In addition to the Oxera report, the Panel received two files of email correspondence with  stakeholders  that  had  taken  place  during  the  development  phase  of  the Regulations from the Department of Economic Development.
3. Additionally, the Panel was provided with an outline chronology of the consultation undertaken during the development of the draft Regulations:

DCS: Schedule of Consultation [28]

Consultee Email date Law Officers' Department 25 March 2009 3 April 2009

21 May 2009

28 May 2009 Comptroller & Auditor General 27 May 2009 Viscount's Department 21 May 2009 Jersey Financial Services Commission 26 May 2009

2 April 2009

27 March 2009

17 March 2009

Council of Ministers 6 May 2009 FSCS (UK) 22 May 2009 States insurers (Rossborough) 21 May 2009

Jersey Finance

JBA

19 May 2009

- HSBC

- Barclays Wealth

- Anglo Irish Bank

- ING Bank

BBA (UK) Meetings:

JBA

21 May 2009

BBA FSCS

27 March 2009 25 March 2009

27 May 2009 26 May 2009 1 April 2009

26 March 2009 25 March 2009

24 March 2009

18 March 2009

23 March 2009 30 April 2009

4. As context for the approach adopted to the development of the Regulations, it was stressed to the Panel by the lead Officers on the project that time was a foremost consideration, with particular reference to the decision of the States on 3rd December 2008 to agree that a scheme should be brought to the States as soon as possible, and certainly by July 2009.
5. The Finance Industry Development Executive told the Panel that:

we need to bear that in mind that the message we had very clearly from the States Chamber was that a scheme needed to be brought in as quickly as possible.'[29]

2. Finance Industry

1. It is apparent from the Panel's hearings with industry representatives and the Minister for Economic Development that particular attention was give to consultation with Finance Industry stakeholders in the drafting of the Regulations.
2. The summarised extent of this was outlined to us in the schedule of consultation provided to the Panel by the Finance Industry Development Executive and below we present in greater detail the information that was provided to the Panel in relation to Industry consultation.
3. Jersey Bankers Association
4. The Jersey Bankers Association, representing the banking industry, is a major stakeholder in the development of a depositor compensation scheme, and as such was approached for views by way of Officers' attendance at J.B.A. monthly meetings, two additional meetings, seven rounds of email correspondence and a large number of teleconferences.
5. The depth and content of that consultation was outlined to the Panel by the Finance Industry Development Executive;

well, the J.B.A. meets on a monthly basis, Martin and I or Martin or I have been to every single meeting since October so we have met with the J.B.A. on a monthly basis, we have either reported to them how the scheme is going or discuss certain particular issues which arise during that time, such as initially it was all to do with the getting the data which Oxera needed in order for the scheme to go ahead but then it moved on into other issues such as the fact that certain banks are here in Jersey for disaster recovery purposes, for example. So talking with them about how that works, finding out more about whether those should be included in the scheme. There were other questions put to the banks as well at various times through that process.'[30]

6. Whilst the Panel had been presented with the email correspondence that had taken place, it further requested to be provided with the minutes or notes taken from those meetings held with the J.B.A., in anticipation that the content of such consultation meetings would have been recorded in some format in order for it to be fed transparently into the scheme's development.

7. However, the Panel was informed by the Director, International Finance that that no further records existed, apart from the J.B.A.'s own minutes (which the Panel did not receive until 16th September 2009);

Deputy M.R. Higgins:

Okay, there is one that I would like to see. We have obviously been told there have been many meetings of the banking industry, JBA and so on.

We have not received any information about the level of consultation they did, any notes made on the meeting, whether they had any concerns with the consultation or any decisions made or any comments that have come back from banks with the exception of one or two emails. There must have been far more information than we have had.

Mr. M. De Forest-Brown:

Actually, no, there was not. We just had these open meetings where we kicked around all the issues. We have had them yelling at us and the usual debates and then we have had minutes at the JBA.

Deputy M.R. Higgins:

Can we have copies of the JBA minutes then?

Mr. M. De Forest-Brown:

I am not sure whether you can have copies of the JBA minutes. You might be able to have a copy of the relevant minutes and it will not tell you much.

Deputy M.R. Higgins:

I would not say all. I would like to see what you have actually discussed on the scheme.

The Deputy of St. Mary :

Would there not be notes of those discussions, formal notes, nothing written down?

Mr. M. De Forest-Brown:

No, not on a formal record. Individuals may have taken their own.

Deputy M.R. Higgins:

This sounds a strange consultation exercise, I must say.

Mr. M. De Forest-Brown:

Well, it is not a formal consultation exercise. I think that is clear. We have always said that. We have gone in to debate the issues with the bankers in open forum in the JBA. If they have wanted to make their comments they have generally made them orally at the meetings.

Deputy M.R. Higgins:

I must say actually I am surprised because, again, the normal consultation thing, you would have three months, you would have people giving back their responses --

Mr. M. De Forest-Brown:

Yes, I know, but these were different circumstances. We were under pressure to try to produce a scheme as quickly as possible.'[31]

8. Ms. A. McFadyen, Chief Executive of Standard Chartered Jersey and member of the J.B.A. elaborated on the J.B.A.'s role in the consultation process, explaining that

it was an issue on which all of the J.B.A. members were interested and had taken part in. She informed the Panel of the nature of the consultation that had taken place;

.it was a sort of iterative process ... first of all it was we want a scheme and then Martin went away and James went away and they were working on what the possibles were.

Then they had the benefit of the Oxera findings and they came back and presented what they felt would be the right scheme for comment to the banks. So how much it would cost the banks, what would be the coverage, who would be covered.

But from memory originally they needed some more information so they presented that as sort of that is the scheme but then they needed some more information from the banks which we then provided up through the J.F.S.C. (Jersey Financial Services Commission) so that we could give them some data to work with.

Then after that they came back with what they felt would be right and then we could all work on that: "How much would it cost if there was a big bank failure? How much would it cost the banks and what sort of coverage there would be."

Deputy M.R. Higgins:

So were there many papers going back and forth, working papers?

Ms. A. McFadyen:

Working papers less. I think it was more of a dialogue and so they would present ... certainly the Oxera findings I think was in a presentation format but I think it was much more of the dialogue.'[32]

9. The Panel became concerned that the development of the scheme was somewhat rushed, and driven and shaped by pressure applied from the banking industry.
10. For instance, the Panel was made aware of the speed of change of the attitude of the banking industry regarding the need for a depositor compensation scheme and the reasoning behind that change.
11. Ms. A.  McFadyen advised the Panel that originally the J.B.A. did not want a depositor protection scheme, but this had changed towards the back end of 2008 when suddenly banks began to fail around the world and suddenly customers were asking for it. She explained;

The consultation process from memory started around November, but it could have been earlier. Certainly the J.B.A. meeting in November. At that stage I would say it was kind of seen as we do need to have a depositor protection scheme and at that stage people were starting to haemorrhage a bit of money, a lot of the small accounts were going and so the more clearing banks were starting to panic about that having a big impact.

The consultation, I think at that stage the J.B.A. said: "Yes, we think we should have one." That consultation followed through, I think there was a couple of special meetings, I certainly have got minutes from a J.B.A. in March but I think there were a couple of special meetings because the world was changing quite fast at that stage.

So I think first of all the J.B.A. said: "Get one in quickly" and then various members of the J.B.A. who were also involved in the Isle of Man and Guernsey were suddenly seeing massive bills coming in for Kaupthing and suddenly said: "Oh my God, do we really want a deposit protection scheme and if we get one in here we have got to be very careful about how it is written, how we account for it, because we need to be sure that any potential losses that come of it we understand and we can account for and understand on our balance sheet.''

I think certainly the March meeting concluded that things had died down, things were quieter, there was not the same haemorrhaging, it was more of a slow leakage now and certainly if there was another banking scare it would all escalate again.

So the message from J.B.A. was while not all banks think it is absolutely necessary it is seen as a hygiene factor now and without one we are just not playing on an even playing field. So it was I think we need one, and the message was if we are going to have one let us get one in quickly. But it was very balanced and we did change our views as time progressed.'[33]

12. The issue of bank deposits being lost, and possibly attributable to the lack of a Jersey depositor compensation scheme, was also covered in a question to Mr J. Cook, Chief Executive of Jersey Finance;

Deputy M.R. Higgins:

...we have been told that there is anecdotal evidence that there was withdrawal of funds from the Island during this period of time. Is that correct?

Mr. J. Cook:

Yes. We cannot quantify it because the problem is that some clients will tell you that they are withdrawing their funds and they will tell you that they are withdrawing it: "Because you do not have a depositor compensation scheme." A lot more will simply withdraw the funds. Where clients have disclosed it is that banks made attempts to try and persuade them to transfer the funds to alternate booking centres within the same group. So typically what would have happened is that Jersey-based depositors would have been encouraged to place their deposits in the Isle of Man or in Guernsey ... well essentially the Isle of Man, because of the presence of a longstanding scheme. Obviously history has proven that has not been quite as straightforward as perhaps people thought it might be but it certainly influenced behaviour at the time. The net consequence of that is that the international groups, that are multi- jurisdictional, have posted on their websites quite clear statements that their Jersey booking option does not have the support of a depositor compensation scheme.'[34]

13. Indeed the Minister for Economic Development also advised the Panel that;

...Banks are reacting on a commercial basis, they are realising that there is a very real probability that business can be lost and there are examples now from some banks that Jersey banks are losing deposits and indeed depositors are saying: "We are not going to place any larger sums locally because you do not have a depositor compensation scheme." So it is an insurance policy that is important. It is important for consumers, for their confidence, both local and international depositors that we have in the Island, but it is also important from the bank's point of view to protect their businesses.'[35]

14. However, the Oxera report, as late as May 2009, advises that there is no hard evidence that money is being lost to Jersey only anecdotal, if any. When challenged about this, the Minister responded;

Well, the information that we are getting from the banks themselves is suggesting that bank deposits are being lost and the increase ... not in any great sums but there is still a risk there. The banks themselves are now saying to us they are worried about their deposits and they think it is a concern. They were certainly very concerned when this particular scheme was not put in place.