Article

China

In an effort to curb skyrocketing inflation and overheating investment in China, the central bank, the People's Bank of China, ordered all Chinese banks as of 12 May 2008 to raise their RMB reserve requirement ratio by 0.5 percentage points. As a consequence of accelerating inflation, this is the fourth time this year the central bank has ordered an increase, approaching the most rapid pace since 1996.

In April, consumer prices were up 8.5 per cent from a year earlier, driven by food costs. Banks must now place a record 16.5 per cent of deposits with the central bank, up from 16 per cent a short time ago. The central bank is likely to raise the bank reserve ratio to 19 per cent by year's end. We view this as move to ensure that the Chinese banks will remain in sound condition.

The increase will freeze about 208 billion yuan (USD 30 billion) in the banking system, helping to cool the world's fastest-growing major economy by restraining lending. The 7.5 percentage point increase in the reserve requirement since the beginning of last year has failed to stop the lending growth that has helped Chinese banks to record profits.

China's economy expanded 10.6 per cent in the first quarter from a year earlier. This is modestly down from an 11.9 per cent pace for all of 2007, as exports cooled. Nonetheless, China's 12 publicly traded lenders posted an average 118 per cent jump in profits.

In April, inflation, as measured by the consumer price index, was up 8.5 per cent year-on-year. The figure compared with 8.3 per cent increase in March and a nearly 12-year high of 8.7 per cent in February. Another key inflation indicator, the producer price index, which measures the cost of goods when they leave the factory, surged 8.1 per cent in April. Despite these increases, the central bank this year has kept the benchmark oneyear lending rate unchanged at a nineyear high of 7.47 per cent. This follows six rate increases in 2007. Since April, the government has also slowed the pace of the yuan's gains against other currencies.

The primary sector (farming, fishing, forestry and the like) continued to show the most rapid growth among the economic sectors, expanding 71.6 per cent during the first four months of 2008. For the whole of last year, these sectors grew at a rate of 31.1 per cent. Investment in secondary and tertiary sectors rose 25.9 per cent and 24.9 per cent, respectively.

We view this 71 per cent surge in primary sector investment as a positive sign, since it demonstrates that the government's move to shore up agricultural development has been effective.

The government is clearly concerned that lending rates higher than in the US, along with the strengthening yuan, are attracting overseas money to an economy already awash in trade cash which, in turn, threatens to further fuel inflation. For example, urban fixed-asset investment rose 25.7 per cent yearon- year to 2.841 trillion yuan (USD 406 billion) in the first four months of this year. Investment in China's booming real estate sector grew 32.1 per cent to 695.2 billion yuan. Foreign direct investment climbed by USD 35 billion in the first four months, up an impressive 59 per cent from the previous year.

In light of these developments, we believe that domestic companies are still relying too heavily on bank loans, reflecting weakness in the corporate direct financing market. As a result, financial risks are concentrated in the banking system. Moreover, China's property and stock prices have seen major fluctuations, all of which affect financial stability.

Having said all of this, we believe that if the yuan is floated on global financial markets in the near future, this, along with other tighter monetary policies, could reduce the global imbalance of payments and keep Chinese inflation under control.

Simon Jian
Chief Executive Officer and President
rd Trading LLC
jian@edwardtrading.com

Sweden

There is a discrepancy that makes applicants irrelevant and puts L/C issuing banks in an awkward situation. The problem begins when second beneficiaries under transferred letters of credit send their documents through their own bank directly to the issuing bank, bypassing the transferring bank. In doing so, they create an incurable discrepancy, even if other terms and conditions of the credit are met. This is because they are in violation of subarticle 38 (k) of UCP 600, which clearly stipulates that "Presentation of documents by or on behalf of a second beneficiary must be made to the transferring bank."

When this rule is not respected, all of the parties involved will suffer one way or another. The issuing bank cannot release the documents to the applicant because they are discrepant. The bank then should inform the presenter as per article 16 and either hold the documents until further notice or return them to the applicant and risk making him very unhappy. On the other hand, if the bank does release the documents to the applicant and pays the second beneficiary's claim, it may be sued by the first beneficiary/ transferring bank for its wrongful action.

The applicant, whose views are not controlling on this subject, has no recourse but to wait for the documents to be released by the issuing bank. The first beneficiary may lose his profit margin, because he has had no chance to replace the second beneficiary's invoice with that of his own. Finally, the initiator of this mess, namely the second beneficiary, must wait a very long time for payment.

In order to get out of this situation, it is imperative for the issuing bank to seek the authorization of the transferring (first beneficiary's) bank to release the documents. Indeed, the only party who has the upper hand and need not worry is the transferring bank. Experience shows that the transferring banks are usually aware of the business arrangements that first beneficiaries have with their suppliers (second beneficiaries), which allow the latter to send their documents to issuing banks directly, and therefore to finalize the deal and collect transferring and other commissions. Therefore, the transferring bank may not give a high priority to responding to the issuing bank's request. All of the other parties can only wait.

In the absence of the response from the transferring bank, however, the only choice for the issuing bank is to release the documents to the applicant against a letter of indemnity. But the consequences of this, which fall outside the UCP, can be unpleasant.

Perhaps the only way to discourage second beneficiaries from bypassing the transferring bank is to make them pay a heavy penalty, in addition to the discrepancy fee, for the troubles they cause. The story would be different, of course, if there were a 100 per cent transfer and no substitution of documents. (For further information, refer to the ICC Banking Commission Opinion TA 632rev).

Hossein Moezzi
Certified Documentary Credit Specialist
Nordea Bank AB (publ), Gothenburg
E-mail: hossein.moezzifard@nordea.com

United States

A recent study by the Deloitte Center for Banking Solutions surveyed 20 of the top 50 largest US bank and thrift institutions. The respondents reported that compliance costs have increased 159 per cent since 2002 and now represent 3.69 per cent of net income. Sixty per cent of that cost represented staff compensation.

The institutions surveyed were asked to suggest any regulatory, legal, industry or internal changes they believed would be most important to allow their institutions to improve the efficiency of compliance while maintaining their level of oversight. Some of the suggestions offered were: (i) provide more clarity and consistency in interpreting regulatory requirements, since currently a number of gray areas exist in regulations such at those concerning anti-money laundering; (ii) require more consistency among regulators and reduce the frequency of different regulators' examining the same issue; (iii) focus on principle-based regulations rather than a statutory/transaction approach; and (iv) increase collaboration among regulators and between regulators and industry.

While Deloitte surveyed only US financial institutions, I believe their findings are applicable globally. For financial institutions operating in multiple jurisdictions, the challenges can significantly increase compliance risks and costs. Of the suggestions made by the respondents, there are two that I believe to be particularly important for institutions worldwide.

The first of these is no. (i) above. When respondents complain of a lack of clarity and consistency in regulatory requirements, this is a global problem. Regulations are often different in different jurisdictions and require financial institutions operating globally to meet different compliance obligations in every jurisdiction in which they operate. On the one hand, while the policy aims are often different, there is an increasing trend toward regulatory consistency through the direction and guidance provided by organizations such as the Financial Action Task Force ("FATF") headquartered in the OECD in Paris, which provides specific anti-money laundering guidelines, meant to be implemented in all countries. But while this is an admirable initiative and guidance as a result is more consistent, there are often significant differences in implementation among individual jurisdictions. One recent example is the Guidance contained in the FATF Special Recommendation VII ("SRVII"), which deals with preventing terrorists and other criminals from having unfettered access to wire transfers. For financial institutions, SRVII aims to set standards for identifying and reporting suspicious transactions.

According to the latest count, regulations or legislation to comply with the policy aims of SRVII have been implemented in 24 countries plus the European Union, but with major differences from country to country. These differences have caused significant disruptions to payment flows on a global basis. An increase in clarity and consistency, particularly in implementation, would yield far better compliance on a global basis.

The second suggestion from Deloitte respondents that has global implications is no. (iv) above, to increase collaboration among regulators and with the industry. While regulators generally have a good idea of what they want to accomplish through regulation, the end result often lacks a practical sense of what financial institutions can do. Collaboration with the industry is critical to producing regulations that are practical, that can be accomplished by the industry. If regulations take account of what industry is able to carry out, in the end this increases compliance.

Unfortunately, compliance requirements are often difficult or impractical for financial institutions to implement, simply because they do not reflect the reality of what a financial institution can actually accomplish in a processing environment. Cases where there has been significant collaboration with industry have yielded better results. There has to be a balance between the policy aims of the regulatory authorities and the realities of what can actually be performed by the financial institution to assist in achieving those policy aims.

A former Speaker of the US House of Representatives, Thomas "Tip" O'Neill, said: "All politics is local", and in fact when dealing with the financial regulatory environment this is still largely the case. Yet today we can see the beginnings of an increasingly positive trend toward more global consistency and cooperation in regulation and implementation.

Taking account of this trend, is there a role the ICC Banking Commission can play in advocating a more global approach to regulatory compliance in the financial services industry? Can it build a consensus that is truly representative of the industry it represents? Can it step out of its traditional operational role and learn to look at regulatory issues from a broader global perspective? I believe it can, but not without significant work and a change from considering every regulatory issue to be unique to an individual jurisdiction and instead to consider the broader benefits of regulatory standardization on a global basis.

In November 2007, the Banking Commission created an anti-money laundering (AML) Task Force. Its first task was to respond to a request from FATF for comments on their "Guidance regarding the Implementation of Activity-based Financial Prohibitions". This was accomplished, and the Task Force is continuing to work on other issues arising from the FATF guidelines. Let us hope that through cooperation with global regulatory authorities, future regulatory and compliance obligations will become less costly, easier to implement and to comply with and, above all, more practically based.

Dan Taylor
President, International Financial Services Association Vice Chairman, ICC Banking Commission
New Jersey, US
E-mail: dan.taylor@intlbanking.org