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Sunday, 14th April 2024
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Financial institutions need to be focussed on eventual impact of Basle Accord Back  
International developments in regulation, such as the Basle Accord, have a direct impact on Irish financial institutions and can affect their risk management strategies says Lorcan Tiernan.
Over the past 12 months or so, there have been some significant international legal developments which will in the not too distant future impact on the risk management policies of financial institutions established here. These cover areas as diverse as anti-moneylaundering procedures post-September 11th, to the preparation of a draft convention on the law applicable to securities held with an intermediary. On a practical level these developments are of crucial importance to the industry here.

New Basle Capital Accord - An update on progress
The proposed new Basle Capital Accord is a good example of an international body developing a set of rules, which could impact significantly on the financial services industry here. The Irish Association of Investment Managers response is also a good example of an industry representative body making its voice heard on behalf of its members (for further details on this response and updates on progress on the New Accord refer to www.bis.org/publ/bcbsca/htm).
Within 10 years of the introduction of 1988 Capital Accord, changes to the approach to risk management in the banking system prompted the Basle Committee to undertake a review of the Accord with a view to introducing a new version by December 2001. As widely predicted, this deadline has been recently extended not only to facilitate further consideration but to assist in expanding the New Accord’s original parameters. The new schedule has yet to be announced but it is unlikely that the New Accord will be implemented before 2005.
The 1988 Accord requires internationally active banks in G 10 countries to hold capital equal to at least 8 per cent of a basket of assets measured in different ways according to their riskiness, at least half of which should be held in Tier 1 form. While it is generally accepted that the 1988 Accord achieved its objectives of ensuring an adequate level of capital as well as levelling the playing field to ensure that banks could no longer build business volume without adequate capital backing, it became clear that the ‘one size fits all’ approach was not always appropriate, particularly in the context of the increased sophistication of internal measures of economic capital.
The New Accord’s stated objective is ‘to provide approaches which are both comprehensive and more sensitive to risks than the 1988 Accord, while maintaining the overall level of regulatory capital’. In attempting to achieve this, the New Accord will adopt three pillars:
• First pillar: minimum capital requirement;
• Second pillar: supervisory review process;
• Third pillar: market discipline
In brief, the first pillar maintains the minimum requirement of 8 per cent capital to risk related assets but it radically overhauls the 1998 Accord’s credit risk measurement methodologies, allowing for greater subtlety in its measure on a bank-by-bank basis. The new framework also proposes, for the first time, a measure for the operational risk of a bank.
The second pillar places increased emphasis on the supervisory review process. Regulators will be required to further increase their expertise in the area of risk management and on a practical level, significant resources will be required to assist in this regard. Time will tell whether the political appetite will be there to fund such a requirement.
The third pillar will seek to enhance the market discipline of participant banks by imposing enhanced disclosure requirements.
Of these three pillars, the first is the one most likely to have a significant practical impact on Irish financial institutions and although the New Accord’s eventual implementation has been further delayed, financial institutions should be focussed on its eventual impact.
Draft Convention on the Law applicable to certain rights in respect of securities held with an intermediary
There are many questions of cross-border enforcement, which effect banks on a day-to-day basis. As complex as these may be in the context of real property such as land or office buildings, significant legal difficulties arise in the context of securities, particularly (as is now most often the case) when those securities are held in de-materialised form. A hypothetical example demonstrates the difficulties:
• Irish investor holds interests in respect of Delaware Inc.’s securities (the ‘Delaware Securities’) through entries on the books of its financial intermediary, Dublin broker;
• Dublin broker, in turn, holds its interests in respect of the Delaware securities through the entries on the books of New York sub-custodian;
• New York sub-custodian, in turn, holds its securities in respect of the Delaware Securities through entries on the books of the principal central securities depository for corporate securities in the United States, Depository Trust Company (‘DTC’) in New York;
• A nominee of DTC is recorded as the owner of the Delaware Securities on Delaware Inc.’s share register located in New Jersey at New Jersey Registrar;
• The certificate representing the Delaware Securities is physically held at Ohio Depository, a depository for DTC in Ohio.

If Irish investor provides Dublin broker with a security interest over the Delaware Securities as collateral for a margin loan, and then at a later stage purports to grant further security over the same securities to third party, which law governs the proprietary aspects of the provision of such collateral, such as the creation, perfection and priority of the interests purportedly granted by Irish investor to Dublin broker and third party? In the event of insolvency of one of the parties in the chain, what law will govern the title to the Delaware Securities?
The draft Convention seeks to address vexed questions such as this. In general terms, there are two approaches to determining the location of de-materialised securities for legal purposes:-
• The securities are deemed located in the place where the register of securities holding system is located (known as the ‘look-through’ approach), ie. this could mean the location of the register (New Jersey), the place of incorporation of the issuer (Delaware) or the location of any securities certificates (Ohio);
• The securities are deemed located in the place where the securities intermediary who is first above the asset holder maintains the relevant securities account (known as the ‘place of the relevant intermediary’ approach or ‘PRIMA’) ie. the Dublin broker.

To date there has been no consensus, on which approach to adopt, leaving financial institutions, which are active in cross-border financing facing considerable legal risk, which arises from this uncertainty.
The draft Convention (which was adopted by a Special Commission of the Hague Conference on Private International Law on 17 January, 2002) proposes to adopt the PRIMA approach to this issue. The timetable for its introduction envisages the adoption of the Convention by September 2002 with its subsequent adoption by signatory states. It is predicted that due to the support which the Convention enjoys in the main financial centres that it will not spend too much time gathering dust and is likely to be speedily introduced by the UK, Germany and the U.S. If this is the case, Ireland is unlikely to be too far behind.

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