SCENESETTER FOR SEPTEMBER 3-7 VISIT OF CODEL KANJORSKI TO

UNCLAS SECTION 01 OF 03 LONDON 001999

H For CODEL KANJORSKI

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: OTRA OVIP ECON UK
SUBJECT: SCENESETTER FOR SEPTEMBER 3-7 VISIT OF CODEL KANJORSKI TO
THE UNITED KINGDOM


1. (SBU) The UK government is eager to share viewpoints on
financial services reform, and to ensure that U.S. and UK
regulations complement each other with the goal of ensuring a vital
and thriving financial services industry - critical to both our
countries' economic recovery and growth. (Post has separately sent
the schedule, along with biographies to military aide and to the
chief of staff to Representative Kanjorski.)


2. (SBU) UK government officials are concerned about economic
recovery and are questioning whether recent positive signs in the
U.S. and Europe indicate that the worst is over. The Labour and
Conservative Parties have recently released white papers outlining
their vision for UK regulatory architecture. Labour would give the
Financial Services Authority (FSA) a formal, statutory objective for
financial stability. The Conservatives plan to abolish the FSA and
centralize bank banking regulation authorities in the Bank of
England while creating a separate Consumer Protection Agency.


3. (SBU) The Financial Services Authority, the Treasury Select
Committee and the bankers are concerned about actions in Brussels.
The UK is concerned that regulations originating in Brussels would,
perhaps as an unintended consequence, most adversely affect the UK.
They point to the draft hedge fund directive; the bankers are also
concerned about moves to regulate pay and bonuses. Internationally,
the UK is pushing for an agreed mechanism for resolving failed
multinational banks.

Overview of UK Economy
--------------


4. (U) The UK officially entered recession in the third quarter of
2008 and has suffered a cumulative contraction of 5.7 percent over
the last five quarters. In July, the IMF forecasted contraction of
4.2 percent in 2009 and growth of 0.2 percent in 2010. The OECD
projected UK output would decline by 4.3 percent in 2009 and would
see zero growth in 2010. HM Treasury expects a contraction of 3.5
percent in 2009 and growth of 1.25 percent in 2010. Unemployment
stands at 7.8 percent, its highest since 1995, and is expected to
climb to more than 10 percent in early 2010. Unemployment is
particularly acute among 18-to-24 year olds at 17 percent. The
economic downturn is taking a heavy toll on trade. According to U.S
Commerce Department and US International Trade Commission monthly
trade statistics, U.S. goods exports to the UK declined by 21.7
percent from Jan. to June 2009, compared to the same period in 2008,
and UK exports to the US declined by 25.6 percent.


5. (U) Credit conditions are easing. The Bank of England's latest
Credit Conditions Survey found lending to the corporate sector
increased during the second quarter of this year, as did the
availability of secured credit to households. Small businesses and
homeowners, however, still find it difficult to find financing at
reasonable rates. Chancellor of the Exchequer Alistair Darling
called together CEOs of major banks on August 8 to criticize them
for not passing on the lower rates to customers and not increasing
their lending.


6. (U) Public debt stands at GBP 800 billion, at 56.8 percent of
GDP, its highest level since records began in 1974, up from 56.6
percent last month. However, UK debt as a percentage of GDP is
still lower than the same percentage in the other G7 countries. CPI
inflation was stronger than expected in July, remaining at 1.8
percent. Consumer confidence is up one point since June and up 11
points since July 2008.

UK Government Actions to Address the Crisis
--------------


7. (U) The UK Government (HMG) has responded to the financial
crisis with a three-step plan: bank recapitalization, monetary and
fiscal stimulus, and credit stimulus.


8. (U) Bank Capitalization: In October 2008, Chancellor Darling
provided a GBP 50 billion capital injection into 8 UK banks and the
largest building society (Abbey, Barclays, HBOS, HSBC, Lloyds,
Nationwide Building Society, Royal Bank of Scotland -RBS - and
Standard Chartered). HMG also invested GBP 34 billion in RBS,
Lloyds and HBOS. In January, HMG converted its equity stake in RBS
from preferred to ordinary shares, increasing its stake in the bank
to 70 percent. In recent weeks, HSBC PLC, Lloyds Banking Group
PLC, Royal Bank of Scotland PLC and Barclays PLC all reported
profits in their retail divisions for the first six months of 2009.
Since October 2008, the Bank of England's (BOE's) Monetary Policy
Committee has cut the UK's benchmark interest rate 450 basis points
from 5 percent to 0.5 percent, the lowest in its 315-year history.


9. (U) In November 2008, HMG announced a GBP 20 billion stimulus
package including a reduction in value-added tax (VAT) from 17.5

LONDON 00001999 002 OF 003


percent to 15 percent for one year, expected to put GBP 12.4 billion
into the economy. HMG also introduced a Homeowners Mortgage
Support Scheme and a GBP 200 million Mortgage Rescue Scheme. In
May, HMG introduced a scrappage scheme giving GBP 2,000 towards a
new vehicle if sellers trade in a car over 10 years old. The VAT
cut was criticized for having little effect on sales, the homeowner
schemes have helped few because of a lengthy qualification
processes, but the car scrappage scheme has been praised for
kick-starting the UK's automotive industry.


10. (U) In January, to improve access to wholesale funding markets,
HMG offered full or partial guarantees to eligible AAA-rated asset
backed securities. HMG also extended the drawdown window of its
existing credit guarantee scheme (a GBP 150 billion scheme to
provide banks with a guaranteed source of funding) from April 9 to
December 31. To increase the availability of corporate credit, the
Bank of England established an asset purchase scheme to buy high
quality assets financed by the issue of Treasury bills. To date,
the Bank has purchased GBP 129 billion of assets (primarily gilts)
as part of its quantitative easing program, and it is authorized to
buy up to GBP 175 billion. The Bank of England also extended its
Discount Window Facility, increasing the maximum length of time for
asset swaps from 30 days to one year.


11. (U) HMG announced an asset protection scheme February 26 to
remove uncertainty about the value of banks' past investments, to
clean up balance sheets and increase lending in the economy. The
scheme provides protection against future losses on banks' riskiest
assets, so that the healthier core of their commercial business can
continue to lend. Under the scheme, banks pay a fee to have part of
their riskier assets protected. If these risky assets result in a
loss to the bank, the bank suffers all losses up to a pre-determined
amount (called a "first loss"). If losses exceed this "first loss,"
HMG agrees to cover 90 percent of remaining losses, while the bank
is responsible for the balance. In this way, banks retain a portion
of the risky asset, but are not dragged down by risky toxic assets
of unknown value which may result in a significant, undetermined
loss. In return, banks are required to develop a sustainable,
long-term pay and bonus policy, consistent with the Financial
Services Authority's Code of Practice. To date, the Royal Bank of
Scotland (RBS) and Lloyds Banking Group have entered into deals with
HMG.

Financial Services Oversight - HM Treasury's Proposal
-------------- --------------


12. (U) HM Treasury (HMT) published its white paper on reforming
financial markets July 8. HMT plans to give the Financial Services
Authority (FSA) a formal, statutory objective for financial
stability. The shape of the UK's institutional regulatory framework
will remain unchanged but HMG will legislate to create a Council for
Financial Stability, to be chaired by the Chancellor of the
Exchequer.


13. (U) The white paper also recommends increasing the quality and
quantity of capital held by banks, increasing capital requirements
for riskier trading activities, introducing a backstop "leverage
ratio" that ensures minimum capital levels are maintained, and
increasing liquidity regulation. The FSA will increase the
intensity of its supervision of banks through its Supervisory
Enhancement Program (SEP),including increased regulatory resources
and greater focus on high impact firms. HMT supported the FSA's
work on reducing the incentives created for excessive risk-taking by
bank compensation structures. The FSA published a code of practice
designed to ensure boards implement a remuneration policy consistent
with good risk management. The FSA expects two-thirds of bonuses
for senior employees to be spread over three years and calls on
firms not to guarantee bonuses for individuals for more than one
year. Non-compliant firms could face enforcement action or be
forced to hold additional capital. Firms are expected to provide
the FSA with a pay policy statement by the end of October and the
code will take effect from January 2010.


14. (U) The white paper outlined a number of other regulatory
reforms. HMT will extend the powers of the FSA by providing it with
a formal, statutory objective for financial stability and giving it
legal authority to set rules to protect wider financial stability.
The FSA will be given extended powers to deal with individual
institutions through firm-specific interventions and will receive
enhanced enforcement powers to deal with market misconduct.

Conservative Party Proposals on Regulation
--------------


15. (U) Shadow Chancellor George Osborne on July 20 announced the
Conservative party proposals for changes to the UK's financial
regulatory system. A Conservative government would abolish the UK's

LONDON 00001999 003 OF 003


tripartite framework and replace it with a significantly more
powerful Bank of England (BOE) and a Consumer Protection Agency
(CPA). The BOE would be given responsibility for maintaining
financial stability, including the micro-prudential regulation of
all significant financial institutions. A new Financial Policy
Committee within the Bank would monitor systemic risks. The BOE
would be given powers to ensure capital and liquidity requirements
account for the riskiness of institutions and would oversee the
creation of "living wills" to assist with any wind-downs. The
Tories would merge the responsibilities for consumer protection of
the Financial Services Authority and the Office of Fair Trading to
form a new Consumer Protection Agency (CPA).


SUSMAN