The Guernsey Financial Services Commission has published the final draft of new Capital Adequacy Rules, mandatory for all entities licensed under the Protection of Investors (Bailiwick of Guernsey) Law 1987. The release of the Rules in the their final form is culmination of a November 2009 consultation.

The Capital Adequacy Rules will become effective on April 16, 2010, but contain transitional rules that allow licensees until June 30, 2010, to meet the requirements.

The Guernsey FSC has released details on the following rule changes:

Capital Adequacy Requirements for Designated Managers administered by another firm

Several respondents asked whether, for designated managers administered by another licensee, the Capital Adequacy Rules should be relaxed. The respondents were concerned about barriers to entry. The Commission no longer has the power, or the duty, under section 4 of the Law to consider economic benefit for licence applicants.

The Commission, in arriving at these Capital Adequacy Rules, has considered the general risks that it considers licensees are exposed to. The risk for such licensees is in being a designated manager; the Commission does not recognise a distinction between an administered designated manager and one with its own staff and premises.

Use of Carry Value for adjustments at Rule 5

The Commission has been made aware that the concept of carry value is more appropriate than market value. This is because, under certain GAAP provisions, some assets are carried at cost in the balance sheet. The Commission does not wish to force companies to apply market value or fair value where they are not required to under GAAP. Therefore the Commission has accepted this point.

Inter-Company Group Loans

The Commission received significant feedback about the disallowing of inter-company group loan debtors. Some respondents suggested to the FSC that this might be appropriate in cases where capital is then placed outside the Bailiwick of Guernsey but should not apply where the debtor is another company domiciled in Guernsey. The FSC considers that this is not an appropriate principle on which to negotiate. It has been regulators’ experience that such arrangements lead to a recycling of capital that disguises, maybe unintentionally, insufficient cover to the group as a whole, the FSC said.

Counterparty Risk

The absence of a definition of counterparty risk provided a major problem for respondents. Whilst the Capital Adequacy Rules have been designed to protect licensees from an over-exposure to any single counterparty they were not designed to capture balances with counterparties for every outstanding bargain or trade. Consequently, the Capital Adequacy Rules now exclude outstanding trades unsettled for 15 days or less from the Counterparty Risk computation.

In addition, respondents were concerned that cash held at bank would also be captured under counterparty risk. The Commission has accepted this concern: any cash held at bank with a term of less than 90 days should be excluded from the Counterparty Risk computation, the new rules state.

Matching of Fees Payable and Receivable

Lastly, respondents expressed concern at the inclusion of fees payable (which were directly attributable to fees receivable) in expenditure for the purposes of calculating the Financial Resources Requirement. The Commission has accepted this inclusion did not reflect the behaviour of such businesses and therefore the risks of undercapitalisation.

Such fees payable are now excluded from the Financial Resources Requirement (and Liquidity Requirement) calculation.

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