The LMA has issued advice on negotiating the Increased Costs Clause in its recommended forms of facility agreement in light of the Basel III Accord. These pro-formas contain a footnote suggesting language for use where it is considered appropriate to exclude Basel II from the scope of the Increased Costs Clause. As Basel II has now been implemented (at least within the EU) and as the indemnification under the Increased Costs Clause relates to changes in law, it may be thought that this exclusion is now superfluous. However, there is still plenty of scope for changes in the way that Basel II legislation is interpreted or applied.

The LMA's advice arises from a concern that, by agreeing to the suggested Basel II exclusion, banks might inadvertently exclude from the scope of that clause any increased cost arising from the implementation of Basel III. This could happen when; Basel III is legislated for and it is consolidated with the existing Basel II legislation so that the definition of Basel II also captures the subsequent Accord.

Perhaps more fundamental is the question of the circumstances in which any bank will be able to recover its increased regulatory costs under current facility documentation. In due course banks will be able to factor the increased costs into their interest calculations, but can they recover these under existing documentation?

Banks and borrowers need to consider what circumstances might give rise to an increased lending cost as a consequence of the implementation of the Basel Accords and who should take the risk of that cost in each case. For example, the cost of maintaining a facility might be affected (amongst other things) by:

Whether any such cost could be claimed by a lender under a particular facility would depend on the exact drafting of the clause: it is not just a change in law but also a change in its interpretation or application which is covered. The lenders will also need to establish the amount of the increased cost and refer it back to the particular loan.

Further information on Basel III can be found on blog.

Johanna Chattle

In February 2011, the Association of Investment Companies (AIC) published a paper exploring the risks associated with third party custody of an investment company's assets. Investment companies rely on custodians to safeguard and process their assets. Services provided by custodians include trade settlement, income collection and processing and dealing with corporate actions, and safe custody normally involves the transfer of legal title from the investment company to the custodian. While the organising and monitoring of custody arrangements is often delegated by the board of an investment company to its manager, it is the board that is ultimately responsible for ensuring that its shareholders' assets are protected and kept safe. Although the AIC accepts that it is not possible to eliminate custody risk entirely (the risk that the assets held in custody are lost or access to them is compromised due to, for example, the custodian's insolvency, negligence, or fraud) in light of experiences such as the collapse of Lehman, the AIC believes investment company boards may wish to review their current custody arrangements to ensure that the most appropriate structure available is in place to protect the company's assets.

As a starting point, the AIC suggests that boards should review their existing custody arrangements. The paper includes a list of questions for boards to ask of both their custodian and investment manager if that manager arranges custodial services and, in carrying out their review, boards are advised to consider how their arrangements fit with current market practice. On completion of their review, if the arrangements are not felt to be satisfactory and the board feels that the security of the assets is compromised, the board will need to decide whether to renegotiate the existing custody agreement or consider using another custodian.

The paper also looks at how investment companies should report on their custody arrangements to shareholders. A description of the current arrangements, the scope and outcome of the board's review and the nature of ongoing monitoring could be included in the corporate governance statement in the annual report. The statement could also be included as part of the board's disclosures on internal risk and custody risk could be covered as part of the disclosures on principal risks and uncertainties in the business review.

The implementation of the Alternative Investment Fund Managers' Directive will replace the traditional custodian framework in due course with a broader, more regulated depositary function and the paper provides a general overview of this new framework and considers its implications for many investment companies.

In September last year, the European Commission published a proposal for a Regulation on short selling and credit default swaps (CDS). Whilst the Commission acknowledged the economic benefits of short selling, it also felt that the risks were worth creating legislation for so that a coherent European response could be implemented.

Whilst the Commission's proposal is going through the European Parliament, Council Member States have been busy updating their own national measures on short selling. For example:

However, notwithstanding European and national legislation it is important not to lose sight of the powers that now reside in the successor authority to CESR, the European Securities and Markets Authority (ESMA). For example, ESMA has an important role in coordinating action in exceptional situations. Regulators have to notify it of the measures they propose to take (or renew) in such a situation, not less than 24 hours before they come into force (this period may be shorter in exceptional circumstances). ESMA must then consider the information received and issue an opinion (within 24 hours) on whether the measure or proposed measure is appropriate and proportionate to address the threat, and whether measures by other national regulators are necessary. In addition, where certain conditions are satisfied ESMA may also take action itself.

The UK government has announced that the rate of bank levy payable during 2011 will be increased to 0.075% (from 0.05%) for short-term liabilities and 0.375% (from 0.05%) for long-term liabilities. It was always intended that bank levy would be charged at these rates from 2012.

The bank levy is not a tax on income, profit or gains. It applies to foreign banks that operate in the UK, as well as to UK entities. It is a charge on balance sheet liabilities and equity (after stripping out Tier 1 capital, insured retail deposits and certain other items) but only to the extent that they exceed £20 billion. Certain long-term liabilities are charged at half rate.

As the announcement was only made in February, the rate for January and February will remain at the previously announced 0.05% and the rate for March and April will be at higher (0.1%), in order to catch up. From 1 May 2011, the main rate of 0.075% will apply. This change means that a bank with a December year end will pay 50% more levy than previously expected for 2011.

A serious unresolved problem is the treatment of double taxation where levies are charged in different countries in respect of the same operations. Since the UK levy will apply to the consolidated balance sheet of a UK headquartered banking group, there is the prospect of double taxation where other countries impose bank levies on branch or subsidiary operations in their territory. The UK authorities are discussing this problem with foreign authorities but so far they have indicated that they hope to publish soon draft regulations detailing an agreement with France and that negotiations with Germany are advanced. One difficulty is that the bank levies being introduced differ in scope, base and rates. It is to be hoped that the necessary agreements will be finalised and published soon. Given that the start date for the UK levy was 1 January 2011, they will have to be introduced with retrospective effect.