THE LAW AND PRACTICE OF INTERNATIONAL BANKING

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1 THE LAW AND PRACTICE OF INTERNATIONAL BANKING CHARLES PROCTOR LLD (B'HAM) Solicitor of the Supreme Court England and Wales Partner, Bird & Bird LLP, London Honorary Professor of Law, University of Birmingham Visiting Professorial Fellow Centre for Commercial Law Studies Queen Mary College, University of London OXFORD UNIVERSITY PRESS

2 CONTENTS SUMMARY Table of Cases Tables of Legislation List of Abbreviations xxxv lxvii lxxix A REGULATORY MATTERS 1. The Regulation of Deposit-Taking Business 3 2. EU Banking Law The Conduct of Retail Banking and Investment Business The Regulation of Lending Business The Regulation of Payment Services Capital Adequacy, Liquidity, and Large Exposures Money Laundering Legislation The Market Regulators 173 B MERGER, REORGANIZATION, AND INSOLVENCY OF BANKS 9. UK Bank Mergers and Business Transfers Foreign Bank Mergers Bank Rescues and Financial Stability in the United Kingdom Cross-Border Reorganization and Winding Up of Banks Deposit Protection Schemes The Liability of the Regulator 281 C THE BANKER-CUSTOMER RELATIONSHIP 15. The Banker-Customer Contract Cheques Duties of the Paying Bank Duties of the Collecting Bank Electronic Funds Transfers 349 D THE BANK AS SERVICE PROVIDER 20. The Bank as a Lender Syndicated Loans 387 IX

3 Summary 22. Trading Loan Assets Swaps and Derivatives Bank Guarantees, Performance Bonds, and Documentary Credits Sources of Bank Liability 471 E GUARANTEES AND SECURITY 26. Guarantees Security Characterization, Formalities, and Registration Types of Security Charges Over Shares and Other Securities Charges Over Receivables Charges Over Bank Balances Charges Over Real Estate Charges Over Aircraft Charges Over Ships Financial Collateral Arrangements Lien and Set-off Vitiating Factors 'Financial Assistance' \ Transactions Between Companies and their Directors Avoidance of Security in Insolvency 627 F SELECTED CROSS-BORDER ISSUES 40. The Banker-Customer Contract in Private International Law Cross-Border Financial Services, Consumer Protection, and Unfair Contract Terms The Banker's Duty of Confidentiality Freezing Injunctions and International Banks Execution Proceedings and Foreign Deposits Liability for Branch Deposits and the Impact of Foreign Law Economic Sanctions Customer Obligations and Foreign Law 761

4 Summary G ISLAMIC FINANCE 48. Islamic Finance Principles and Structures Islamic Finance Transactions in the Courts Corporate and Regulatory Issues Harmonization and the Development of the International Islamic Financial Markets 813 Index 821 XI

5 CONTENTS Table of Cases Tables of Legislation List of Abbreviations xxxv lxvii lxxix A REGULATORY MATTERS 1. The Regulation of Deposit-Taking Business 1.01 The History of Banking Regulation in the United Kingdom 1.04 Deposit-Taking as a Regulated Activity Acceptance of Deposits 1.10 Deposits 1.13, Accepting Deposits 1.14 Carrying on a Business 1.15 In the United Kingdom 1.16 Exempt Persons 1.19 Consequences of Contravention 1.20 The Authorization Procedure 1.22 Powers of the FSA 1.26 EEA Firms 1.27 : EU Banking Law Background to the EU Banking Directives 2.02 The Deposit-Taking Prohibition 2.09 The Authorization Process ' 2.11 The Treaty Freedoms General Considerations 2.13 The Right to Establish a Branch 2.16 The Right to Provide Services 2.17 Provision of Services from within the Home State 2.18 Free Movement of Capital and Banking Services 2.22 The Commission Interpretative Communication 2.25 Conclusions 2.29./ xiii

6 3. The Conduct of Retail Banking and Investment Business 3.01 Scope of BCOBS 3.04 Application 3.04 Communications with Customers 3.09 Distance Marketing 3.11 Information Requirements 3.17 Post Sale Requirements 3.22 Cancellation 3.23 Investment Services Scope of MiFID 3.28 MiFID Overview 3.30 Client's Best Interests 3.34 Client Categorization 3.36 Information Requirements 3.38 Client Agreements 3.39 Client Money 3.41 Suitability 3.43 Appropriateness 3.46 Conflicts of Interest 3.47 Best Execution The Regulation of Lending Business 4.01 Consumer Credit Regulated Agreements 4.05 Types of Consumer Credit Agreement 4.07 Exempt Agreements 4.09 The Effect of Regulation 4.13 The Licensing Requirement 4.15 Advertising 4.23 Contents of Agreements and Formalities 4.25 Matters arising during the Currency of the Contract 4.30 Court's Powers of Intervention 4.38 Recent Reforms The Consumer Credit Directive 4.40 Mortgage Regulation The Scope of Regulation 4.44 The Nature of the Regulation 4.52 The Lending Code 4.55

7 5. The Regulation of Payment Services Contents 5.01 Implementation of the Payment Services Directive 5.04 Payment Services 5.07 The Definition 5.07 Exclusions 5.11 Territoriality 5.14 The Authorization Requirement 5.17 Authorized Payment Institutions v _ Capital Requirements for Payment Institutions 5.24 Small Payment Institutions 5.26 Ancillary Business 5.28 Passporting 5.29 Conduct of Business Requirements 5.34 Segregation Requirements Information Requirements 5.40 Scope of Requirements 5.42 Single Payment Service Contracts 5.46 Framework Contracts 5.48 Common Provisions 5.53 Rights and Obligations of Providers and Users 5.54 Scope 5.55 ChargesforTransactions 5.56 Authorization of Payment Transactions 5.57 Limits and Use of Payment Instruments 5.61 Misuse of Payment Instruments 5.65 Time Limits 5.67 Evidence and Liability for Unauthorized Transactions 5.68 Execution of Payment Transactions 5.76 Execution Time and Value Date 5.82 Liability \ 5.86 Access to Payment Systems 5.87 Powers of the FSA 5.89 The Single Euro Payments Area The Aims and Objectives of SEPA 5.93 The Role of the EPC 5.96 The Benefits of SEPA 5.97 Progress with SEPA 5.98 Charges for Cross-Border Payments Information on the Payer 5.104

8 6. Capital Adequacy, Liquidity, and Large Exposures 6.01 Capital Adequacy The Broad Framework 6.05 The Basel Standards 6.08 The Basel Committee on Banking Supervision 6.08 Basel II Pillar One Eligible Capital 6.23 Risk-Weighted Assets " The Standardized Approach 6.29 The Internal Ratings-Based Approach 6.33 Credit Risk Mitigation Common Principles 6.42 Funded Credit Protection 6.44 Unfunded Credit Mitigation 6.47 Market Risk 6.50 Operational Risk 6.52 PillarTwo Supervisory Review 6.55 Pillar Three Market Discipline 6.56 Reform of Basel II 6.57 Liquidity 6.60 Large Exposures 6.63 Conclusions Money Laundering Legislation 7.01 International Background 7.06 International Law 7.06 Community Law 7.08 Overview of the United Kingdom Regime 7.10 Legislation 7.10 Role of the Financial Services Authority 7.13 Role of Market Associations 7.15 The Money Laundering Regulations Customer Due Diligence 7.18 Record Keeping 7.21 Policies and Procedures 7.23 Internal Training Procedures 7.25

9 Proceeds of Crime Act 'Criminal Property' and 'Criminal Conduct' 7.30 Concealing Criminal Property 7.37 Acquisition, Use, and Possession of Criminal Property 7.40 Arrangements Relating to Criminal Property 7.42 The Regulated Sector Offence 7.47 The Disclosure Defence 7.52 The 'Reasonable Excuse' Defence 7.59 The Foreign Legality Defence 7.62 The'De Minimis'Defence 7.65 Offences by the MLRO v Tipping off Regulated Sector 7.70 Terrorist Financing 'Terrorism' and 'Terrorist Property' 7.76 The Offences 7.78 Civil Consequences of Money Laundering Legislation 7.83 Receipt of Funds 7.85 Suspicion Arising in Relation to Funds already Held 7.90 Dealings with the Customer in Relation to POCA The Market Regulators 8.01 The Financial Services Authority 8.04 History and Functions of the FSA 8.04 Rule-making and Other Powers 8.07 The FSA Handbook 8.08 The Bank of England 8.12 History and Functions of the Bank 8.12 Stability of the Financial System 8.18 Monetary Policy 8.24 The Treasury \ 8.29 History and Functions of the Treasury 8.29 Role of the Treasury 8.31 Current Reforms 8.34 The European Framework ' 8.38 European Systemic Risk Board 8.40 European System of Financial Supervisors 8.45 The EU Memorandum of Understanding 8.49 International Developments 8.51 Conclusions 8.55 xvn

10 B MERGER, REORGANIZATION, AND INSOLVENCY OF BANKS 9. UK Bank Mergers and Business Transfers 9.01 Effect of Part VII 9.04 Scope of Part VII 9.07 Procedure under Part VII 9.13 Effect of Court Sanction 9.18 'Property'and'Liabilities' 9.21 The Cross-Border Mergers Regulations Conclusions Foreign Bank Mergers Recognition of the Merger The Transferred Assets and Liabilities Consequences for the Transferor Consequences for Transaction Counterparties The Cross-Border Mergers Regulations Conclusions Bank Rescues and Financial Stability in the United Kingdom Collapse of Northern Rock Banking (Special Provisions) Act The S cheme of the Legislation Challenges to the Legislation Other Financial Crisis Events Banking Act Scope and Content of the Act General Considerations The Stabilization Options Transfer to a Private Sector Purchaser Transfer to a Bridge Bank Temporary Public Ownership Share Transfer Orders Property Transfer Instruments Partial Property Transfers xvill

11 The 'No Creditor Worse Off' Order Compensation for Transferors Continuing Obligations and Other Matters Bank Insolvency Bank Administration Investment Banks Interbank Payment Systems Emergency Liquidity Assistance The Nature of the Assistance v Recent Use of Emergency Liquidity Assistance Legal Aspects of Emergency Liquidity Assistance Other Forms of Assistance to the Financial Markets Conclusions 12. Cross-Border Reorganization and Winding Up of Banks Scope of the Directive Impact of the Directive on EEA Credit Institutions Reorganization Winding Up Common Provisions Regulatory Issues Third Country Institutions Court Assistance for Foreign Liquidators Cross-Border Insolvency Regulations 2006 Section 426 of the Insolvency Act 1986 General Powers of the Court Conclusions 13. Deposit Protection Schemes EU Law and Deposit Protection The Financial Services Compensation Scheme Part 4 of the Banking Act 2009 The Landsbanki Freezing Arrangements The Background The Legal Issues Action taken by Iceland The Legal Issues Action taken by the United Kingdom The Current Position The Wider Issues Conclusions

12 14. The Liability of the Regulator Immunity Provisions and Community Law Immunity Provisions and the European Convention on Human Rights The Effect of an Immunity Provision Regulatory Liability Conclusions C THE BANKER-CUSTOMER RELATIONSHIP 15. The Banker-Customer Contract The Banker and the Customer 'Banker', 'Customer' The Nature of the Relationship The Terms of the Banker-Customer Contract The Terms of the Contract The Customer's Duties to the Bank The Drawing of Cheques Duty to Disclose Known Forgery Other Duties Regulation of the Banker-Customer Contract Unfair Contract Terms Act Unfair Terms in Consumer Contracts Regulations FSA Guidance Cheques Definitions Bills of Exchange Cheques Impact of the Cheques Act Payment by Cheque Acceptance of a Cheque 16.19

13 Cheque Guarantee Scheme ' Cheque Clearing Duties of the Paying Bank The Duty to Pay The General Nature of the Obligation The Bank's Duty in Executing Payment Instructions Termination of the Bank's Authority to Pay Failure to Comply with Payment Instructions " Nature and Consequences of Unauthorized Payment Payment beyond the Scope of the Mandate Forged Signatures Misappropriation by an Authorized Signatory The Recovery of Payments Made Statutory Protection of the Paying Bank Payment in Due Course Material Alteration to the Cheque Incomplete Cheques Forged and Unauthorized Indorsements Section 80 of the Bills of Exchange Act Section 1 of the Cheques Act Liability to Third Parties Conversion Negligence 'Dishonest Assistance' Duties of the Collecting Bank * Collection of Cheques Role and Position of the Collecting Bank The Collection of Cheques ' Notice of Dishonour Statutory Protections Available to the Collecting Bank Liability of the Collecting Bank to Third Parties Conversion Monies Had and Received 'Knowing Receipt' Negligence 18.32

14 19. Electronic Funds Transfers Electronic Funds Transfer Systems BACS CHAPS TARGET Legal Nature of EFT Legal Consequences of an EFT Payment Agreement of Creditor Authorization of Payee's Bank The Nature of the Payment International Payments Liabilities to Third Parties D THE BANK AS SERVICE PROVIDER 20. The Bank as a Lender Overdraft Facilities Operation Cancellation Demand Interest Term Loans Nature and Operation The Facility/Purpose Conditions Precedent Utilization \ Currencies Repayment Prepayment Interest Fees/Expenses Tax Gross-up Increased Costs Indemnities Representations Information Undertakings Financial Undertakings General Undertakings 20.37

15 Events of Default/Acceleration Payment Mechanics Set-off Assignments and Transfers Governing Law Jurisdiction Conclusions Syndicated Loans v. The Arranger Duration and Nature of the Role Functions of the Arranger Liability of the Arranger The Agent Duration and Nature of the Role Functions of the Agent Liability of the Agent Gross Negligence and Wilful Misconduct Other Sources of Liability and Protections Relationship between Individual Banks and the Borrower Relationship between the Individual Banks Several Obligations Consents, Instructions, and Waivers; Majority Rule Pro Rata Sharing Liability and Regulatory Aspects Security Arrangements The Security Trust Structure Parallel Debt Clauses 22. Trading Loan Assets Restrictions on Assignments and Transfers Assignment Novation Participation Arrangements Funded Participations Risk Participations Credit Default Swaps XXlll

16 23. Swaps and Derivatives Interest Rate Swaps Currency Swaps Default and Termination Netting of Multiple Contracts Defences Conclusions Bank Guarantees, Performance Bonds, and Documentary Credits Bank Guarantees Performance Bonds Nature of a Performance Bond Types of Performance Bond Documentary Credits Definition Contracts, the Parties, and their Obligations Types of Commercial Credit Issuing Commercial Credits Application of Autonomy Principle Transfer and Assignment of Credits Documents Presented under a Commercial Credit Strict Compliance Transport Documents Insurance Documents Commercial Invoices Original Documents Presentation and Examination of Documents Presentation of Documents Examination of Documents Security under a Commercial Credit Pledge of Goods Trust Receipts Standby Credits Nature of the Standby Credit XXIV

17 The Fraud Exception Damages for Failure to Pay under a Credit Private International Law Issues English Buyer English Issuing Bank Issuing Bank Seller Confirming Bank Seller Issuing Bank Confirming Bank The Impact of the Applicable Law Sources of Bank Liability The Springwell Navigation Case Factual Background Claims in Contract and Tort Contractual Disclaimers Misrepresentation Breach of Fiduciary Duty Conclusions Other Cases Advisory and Management Arrangements Conclusions Guarantees E GUARANTEES AND SECURITY Purpose, Definition, and Characteristics Purpose * Definition Characteristics Formalities Offer and Acceptance Consideration Intention to Create Legal Relations Requirement of Writing Guarantees and Indemnities Distinction between Guarantees and Indemnities 26.24

18 Interpretation and Liability Interpretation The Guaranteed Liabilities Essential Validity Nature of the Guarantor's Liability Unfair Contract Terms Unfair Contract Terms Act 1977 Unfair Terms in Consumer Contracts Regulations 1999 Capacity to Guarantee Individuals Companies Other Entities Duties of the Bank to the Guarantor A Duty to Advise? A Duty of Good Faith? A Duty of Disclosure? A Duty to take Other Security? A Duty of Realization? Discharge of the Guarantor Discharge by Payment Discharge of the Guarantor Vitiating Factors Preference Transactions at an Undervalue Termination by the Guarantor ; Express and Implied Termination Rights Rights of the Guarantor following Payment Rights of the Guarantor Obligations of the Bank Conflict of Law Issues Security Characterization, Formalities, and Registration Contractual Nature of Security What is a Security Interest? The Scope and Extent of the Security Formalities

19 Part 25 of the Companies Act Foreign Assets Foreign Companies Summary of Registration Requirements Foreign Companies Types of Security Fixed Charges Floating Charges Definition " " "" Importance of the Characterization Crystallization Priorities Categories of Priority Claims Statutory Priorities The Prescribed Part Occupational Pension Schemes Employees Priority as against other Secured Creditors Priority as against Unsecured Creditors Rights of Set-off Liens Execution Creditors Distress for Rent Charges Over Shares and Other Securities Legal Charge Equitable Charge Foreign Shares ' Charges over Uncertificated Securities Registration Formalities Priorities Charges Over Receivables Essential Validity Foreign Receivables Registration Formalities Priorities XXVll

20 31. Charges Over Bank Balances Contents Features of the Security Registration Formalities Priorities Charges Over Real Estate Nature of the Asset ~ " ' Nature of the Security Extent of the Security Registtation of the Security Remedies of the Mortgagee Power of sale Appointment of Receiver Taking Possession Restrictions on the Exercise of the Mortgagee's Powers Consolidation Priorities Grounds of Challenge Security Over Foreign Land Charges Over Aircraft UKAircraft Priorities Foreign Aircraft International Issues Charges Over Ships English Ship Mortgages Priorities Foreign Ship Mortgages Enforcement of Ship Mortgages Financial Collateral Arrangements Settlement Finality Directive XXVlll

21 Structure of the Settlement Finality Regulations Private International Law Issues Financial Collateral Regulations Lien and Set-off Right of Lien Bank's Right of Set-off Other Rights of Set-off v. 37. Vitiating Factors 'Financial Assistance' Financial Assistance Scope of the Prohibition 'Financial Assistance' 'Larger Purpose' Exemption Other Exemptions Consequences of Breach Illustrative Transactions 38. Transactions Between Companies and their Directors Substantial Property Transactions Transactions involving Directors 39. Avoidance of Security in Insolvency Transactions at an Undervalue Preferences Extortionate Credit Transactions Avoidance of Floating Charges Transactions Defrauding Creditors F SELECTED CROSS-BORDER ISSUES 40. The Banker-Customer Contract in Private International Law The Governing: Law of the Relationship XXIX

22 The Effect of the Applicable Law Capacity and Authority Foreign Nationals/Individuals Resident Abroad Foreign Companies Situs of Deposit Obligations Conclusions Cross-Border Financial Services, Consumer Protection, and Unfair Contract Terms Choice of Law under Rome I Provisions Relating to Consumer Contracts Financial Instruments Multilateral Trading Systems Financial Instruments/Rights Issues/Takeover Offers Financial Instruments Terms and Conditions of Public Share Offers Public Takeover Offers Collective Investment Schemes Foreign Services The Banker-Customer Contract The Impact of Domestic Consumer Protection Laws 41 A3 Unfair Contract Terms Act Unfair Terms in Consumer Contracts Regulations Consumer Credit Act Conclusions The Bankers Duty of Confidentiality > The Applicable Law Nature and Scope of the Duty of Confidentiality Compulsion of Law Introductory Remarks Statutory Obligations of Disclosure Limitations on the 'Compulsion of Law' Exception Disclosure Orders made by an English Court in relation to Materials in England Disclosure Orders made by an English Court in relarion to Materials held Abroad Disclosure Orders made by a Foreign Court Interests of the Bank Public Interest Consent of Customer 42.56

23 Express Consent Implied Consent Liability to the Recipient Damages for Breach Data Protection Act The Wider Duty of Confidence Duties of Confidentiality to Third Parties Other Duties of Confidentiality Conclusions ' Freezing Injunctions and International Banks Nature and Effect of a Freezing Injunction Action to be taken by the Bank Necessity for Compliance Steps to be taken The Extent of Compliance Impact on Banker-Customer Relationship Set off Enforcement of Security Relationship between the Bank and the Applicant Obligations of the Bank Obligations of the Applicant Relationship between the Bank and Third Parties Territorial Issues Foreign Branches Assets held Abroad Conclusions \ \ AA. Execution Proceedings and Foreign Deposits Third Party Debt Orders Attitude of the English Courts in Extra-Territorial Cases The Case Law ' Special Cases Conclusions Liability for Branch Deposits and the Impact of Foreign Law The General Principles xxxi

24 Closure of a Branch Outbreak of War Foreign Customers of UK Banks UK Customers of Foreign Banks Expropriation Other Forms of Seizure Exchange Controls Moratoria Blocking Orders ' " ' Conclusions Economic Sanctions The Sources of Sanctions Legislation Effect of Sanctions Conclusions Customer Obligations and Foreign Law Moratoria Exchange Controls Conclusions G ISLAMIC FINANCE 48. Islamic Finance Principles and Structures The Foundations of Islamic Finance Riba Gharar Maisir Unjust Enrichment Rules Governing Islamic Finance Transactions Product Structures Customer Funding Murabaha Tawarruq Bai'Salam Bai' al 'ina Ijara xxxii

25 Istisna'a Musharaka Mudaraba Sukuk Attitude to Conventional and Ancillary Structures Product Structures Deposits Mudaraba Wakala Wadi'a Qard ; Islamic Finance Transactions in the Courts English Case Law Islamic Investment Company of the Gulf (Bahamas) Ltd v Symphony Gems NV Beximco Pharmaceuticals Ltd v Shamil Bank of Bahrain EC The Investment DAR Company KSCC v Blom Development Bank SAL English Case Law Conclusions Malaysian Case Law Earlier Cases Later Cases Malaysian Case Law Conclusions Corporate and Regulatory Issues Constitutional Structure of Islamic Banks Overview Constitutional Issues The Shariah Supervisory Board General Regulatory Issues Regulatory Standards and Guidelines Deposit-taking Collective Investment Schemes Islamic Home Finance Other Regulatory Issues Islamic'Windows' Harmonization and the Development of the International Islamic Financial Markets The Imperatives of Standardization The Tawarruq and the Sukuk Illustrations of the Difficulties xxxin

26 Enforcement Issues What Needs to be Harmonized? Documentation Shariah Rulings The Regulatory Framework Capital Adequacy Taxation Conclusions Index 821 XXXIV

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Bank Finance and Regulation Survey MALTA Ganado & Associates Malta is a member state of the European Union and the applicable European Union directives are the main reference points for the regulatory