[Senate Hearing 112-6]
[From the U.S. Government Publishing Office]
S. Hrg. 112-6
OVERSIGHT OF DODD-FRANK IMPLEMENTATION: A PROGRESS REPORT BY THE
REGULATORS AT THE HALF-YEAR MARK
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED TWELFTH CONGRESS
FIRST SESSION
ON
CONTINUING THE OVERSIGHT OF THE DODD-FRANK WALL STREET REFORM ACT
__________
FEBRUARY 17, 2011
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
Available at: http: //www.fdsys.gov /
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
TIM JOHNSON, South Dakota, Chairman
JACK REED, Rhode Island RICHARD C. SHELBY, Alabama
CHARLES E. SCHUMER, New York MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii JIM DeMINT, South Carolina
SHERROD BROWN, Ohio DAVID VITTER, Louisiana
JON TESTER, Montana MIKE JOHANNS, Nebraska
HERB KOHL, Wisconsin PATRICK J. TOOMEY, Pennsylvania
MARK R. WARNER, Virginia MARK KIRK, Illinois
JEFF MERKLEY, Oregon JERRY MORAN, Kansas
MICHAEL F. BENNET, Colorado ROGER F. WICKER, Mississippi
KAY HAGAN, North Carolina
Dwight Fettig, Staff Director
William D. Duhnke, Republican Staff Director
Dean Shahinian, Senior Counsel
Laura Swanson, Professional Staff Member
Andrew J. Olmem, Jr., Republican Chief Counsel
Dawn Ratliff, Chief Clerk
Brett Hewitt, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
(ii)
?
C O N T E N T S
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THURSDAY, FEBRUARY 17, 2011
Page
Opening statement of Chairman Johnson............................ 1
Opening statements, comments, or prepared statements of:
Senator Shelby............................................... 2
WITNESSES
Ben S. Bernanke, Chairman, Board of Governors of the Federal
Reserve System................................................. 4
Prepared statement........................................... 40
Responses to written questions of:
Chairman Johnson......................................... 75
Senator Shelby........................................... 76
Senator Reed............................................. 84
Senator Menendez......................................... 87
Senator Brown............................................ 88
Senator Tester........................................... 90
Senator Warner........................................... 91
Senator Merkley.......................................... 92
Senator Crapo............................................ 94
Senator Corker........................................... 95
Senator Vitter........................................... 97
Sheila C. Bair, Chairman, Federal Deposit Insurance Corporation.. 8
Prepared statement........................................... 42
Responses to written questions of:
Chairman Johnson......................................... 99
Senator Shelby........................................... 102
Senator Brown............................................ 111
Senator Warner........................................... 116
Senator Merkley.......................................... 119
Senator Crapo............................................ 124
Senator Vitter........................................... 125
Senator Wicker........................................... 129
Mary L. Schapiro, Chairman, Securities and Exchange Commission... 10
Prepared statement........................................... 50
Responses to written questions of:
Chairman Johnson......................................... 130
Senator Shelby........................................... 136
Senator Reed............................................. 155
Senator Menendez......................................... 157
Senator Tester........................................... 158
Senator Warner........................................... 159
Senator Merkley.......................................... 160
Senator Crapo............................................ 164
Senator Vitter........................................... 166
(iii)
Gary Gensler, Chairman, Commodity Futures Trading Commission..... 11
Prepared statement........................................... 59
Responses to written questions of:
Chairman Johnson......................................... 167
Senator Shelby........................................... 168
Senator Reed............................................. 180
Senator Menendez......................................... 182
Senator Warner........................................... 182
Senator Merkley.......................................... 183
Senator Crapo............................................ 185
Senator Vitter........................................... 187
John Walsh, Acting Comptroller of the Currency, Office of the
Comptroller of the Currency.................................... 13
Prepared statement........................................... 63
Responses to written questions of:
Chairman Johnson......................................... 191
Senator Shelby........................................... 193
Senator Reed............................................. 201
Senator Menendez......................................... 201
Senator Brown............................................ 203
Senator Warner........................................... 208
Senator Merkley.......................................... 209
Senator Crapo............................................ 214
OVERSIGHT OF DODD-FRANK IMPLEMENTATION: A PROGRESS REPORT BY THE
REGULATORS AT THE HALF-YEAR MARK
----------
THURSDAY, FEBRUARY 17, 2011
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee convened at 10:03 a.m., in room SD-538,
Dirksen Senate Office Building, Hon. Tim Johnson, Chairman of
the Committee, presiding.
OPENING STATEMENT OF CHAIRMAN TIM JOHNSON
Chairman Johnson. I would like to call to order the first
Banking Committee meeting of the 112th Congress.
The last several years have been a historic time for this
Committee. I have big shoes to fill, following in the footsteps
of my recent predecessors, Chairman Sarbanes, Chairman Shelby,
and Chairman Dodd. I am thankful and humbled by this
opportunity and I look forward to working with all of my
colleagues on this Committee to make this a productive session
of Congress.
We have five new Members joining our Committee and I would
like to welcome Senators Hagan, Toomey, Kirk, Moran, and
Wicker. I look forward to working with all of you.
There is important work ahead of us. I am committed to an
agenda that will bolster our economic recovery, make our
financial regulations world class, and ensure that consumers
and investors have the protections they deserve.
Two vital parts of this agenda are overseeing the
implementation of the Dodd-Frank Wall Street Reform Act and
beginning the process of housing finance reform. We have
compiled a further list of issues the Committee may consider
which will be posted on the Committee's Web site today.
This morning, we hold the first in a series of many
oversight hearings on the Dodd-Frank implementation. There are
certainly no shortage of topics for us to discuss with the
regulators today, and in the coming weeks and months, we will
take a closer look at many issues important to myself and the
Members of this Committee. The Committee's oversight will seek
to ensure that the letter and the spirit of the new law are
being implemented by the regulatory agencies, public comment on
proposed rules is being appropriately solicited and considered
and that the new law is being enforced, legitimate concerns are
recognized and addressed, and that the regulators have the
resources they need. The regulators have been hard at work and
I look forward to learning more about their progress
implementing the Dodd-Frank Act.
I want to be clear. The Dodd-Frank Act has brought
significant and much-needed reform to our financial system. It
improves consumer and investor protection, fills regulatory
gaps by bringing oversight to the over-the-counter derivatives
market, and helps prevent another financial crisis. The
effective and timely implementation of the Dodd-Frank Act will
help strengthen the economy by creating certainty for the
business community, consumers, and investors. In turn, that
certainty will bring market participants back to the table and
restore consumer and investor confidence.
A task of this complexity with such a global impact must be
done with great care to avoid unintended consequences that
could impair economic growth or send good-paying jobs overseas.
Our oversight agenda will make sure we stay on the right track.
I commend the hard work of all of the regulators. I look
forward to working closely with all of you to be sure we get
this right and I thank you for being here today in an
incredibly busy week, with both the release of the budget and
hearings in the House. Because of the busy schedules of our
regulators, we will limit opening statements today to myself
and Ranking Member Shelby and I ask the other Members of the
Committee to please submit their opening statements for the
record.
With that, I turn to Senator Shelby.
STATEMENT OF SENATOR RICHARD C. SHELBY
Senator Shelby. Thank you, Mr. Chairman.
Last year, Congress passed the Dodd-Frank Financial Reform
Act, as the Chairman has mentioned. The President and the
majority proclaimed the Act a historic legislative
accomplishment. At the signing ceremony, the President declared
that the Act would provide certainty to our markets and lift
our economy to a more prosperous future.
Eight months later, the sober realities of what Dodd-Frank
will mean for our economy, I believe, are now setting in. Our
unemployment rate still stands at record levels. While the
political forces that drove the passage of Dodd-Frank have
waned, the huge costs of the Act are now becoming very clear.
The Dodd-Frank party, I believe, is over. Unfortunately, our
economy is now preparing to pay the tab.
Our financial regulators have begun to implement Dodd-Frank
and the decisions they make over the new few months will impact
every American. Regulators will determine if Americans can buy
a home or a car and if they can get loans to start businesses.
They will also determine what financial products are available
and to whom they may be sold.
In Dodd-Frank, the majority party delegated an
unprecedented amount of authority and discretion to the
bureaucracy. Accordingly, our financial regulators now have
more than 200 rulemakings to complete, many by July. The work
required to implement these rules is staggering. For lobbyists,
lawyers, and Government bureaucrats, Dodd-Frank is providing to
be a gold mine. For the rest of us, however, it means more red
tape, more governance, fewer choices, and higher fees.
Today, I hope to learn more about how our regulators plan
to manage this unprecedented workload. Already, concerns have
been raised about the quality and the fairness of the
rulemaking process. In the rush to comply with the unrealistic
deadlines set in Dodd-Frank, the regulators have had to focus
on speed rather than deliberation. And while our regulators
will do their best to comply with the deadlines, Congress, I
believe, should seriously examine whether the speed of the
process is undermining its integrity. There are early
indications that it is.
One of the hallmarks of our regulatory process is openness.
Yet with so many rulemakings being considered simultaneously,
public participation could be stifled. It may be practically
impossible for parties to provide thorough comments on so many
rules and for regulators to fully consider every comment in
such a short timeframe. And although the regulators will
receive an enormous quantity of comments, what really matters
is the quality of the interaction between the commentators and
the regulators. With that in mind, I believe we should begin
considering whether the final rules would be better if our
regulators had more time to hear from the public.
Another consequence of the hasty rulemaking process is that
our regulators may not be properly conducting economic analysis
of proposed rules. Any thorough consideration of a proposed
rule obviously should include an understanding of its cost.
Unfortunately, there are serious questions regarding the
willingness and the ability of our regulators to conduct such
analysis. At the SEC, the position of Chief Economist has been
vacant for 10 months. At the CFTC, the position of the Chief
Economist was vacant for 11 months before finally being filled
this past December.
I believe the failure to promptly fill these key positions
suggests that economic analysis is not a high priority for our
regulators. In light of the fact that the cost imposed by these
rules may cause some Americans to lose their jobs, our
regulatory agencies should, at the very least, make themselves
aware of the economic impact of proposed rules before adopting
them.
And while improvements in the rulemaking process can smooth
the implementation of Dodd-Frank, I am under no illusions that
it can dramatically alter its long-term consequences. Absent
legislative action, Dodd-Frank is going to be very, very
expensive. Dodd-Frank may not raise taxes directly, but
consumers will soon feel its cost when they pay higher
regulatory fees, higher compliance costs, and higher prices for
financial services.
Just this past week, the President's budget calls for the
CFTC to impose $117 million in new taxes in the form of user
fees to pay for the cost of Dodd-Frank. Over the coming months,
the hidden costs of Dodd-Frank will grow as our regulators
steadily impose new rules and regulations. I hope that the
Committee will focus at least as much attention on the cost as
it does the rules over the next few months.
Thank you, Mr. Chairman.
Chairman Johnson. The Committee will now turn to Executive
Session.
[Whereupon, at 10:13 a.m., the Committee moved to Executive
Session, and reconvened at 10:19 a.m.]
Chairman Johnson. Before I begin the introductions of our
witnesses today, I want to remind my colleagues that the record
will be open for the next 7 days for any materials you would
like to submit.
The Honorable Ben S. Bernanke is Chairman of the Board of
Governors of the Federal Reserve System. He is currently
serving his second term as Chairman, which began on February 1
of last year. Prior to becoming Chairman, Dr. Bernanke was
Chairman of the President's Council of Economic Advisors from
2005 to 2006. Also, he served the Federal Reserve System in a
variety of roles in addition to serving as Professor of
Economics at Princeton University.
The Honorable Sheila Bair is Chairman of the Federal
Deposit Insurance Corporation. Prior to her appointment in
2006, Ms. Bair was a Dean's Professor of financial regulatory
policy for the Isenberg School of Management at the University
of Massachusetts at Amherst. She was also Assistant Secretary
for Financial Institutions at the U.S. Department of the
Treasury from 2001 to 2002.
The Honorable Mary Schapiro is Chairman of the U.S.
Securities and Exchange Commission. She is the first woman to
serve as permanent Chairman of the SEC and was appointed by
President Obama in January of 2009. Previously, she was CEO of
the Financial Industry Regulatory Authority, or FINRA. Chairman
Schapiro also served as Commissioner of the SEC from 1988 to
1994 and Chairman of the Commodities Futures Trading Commission
from 1994 to 1996.
The Honorable Gary Gensler is Chairman of the Commodities
Futures Trading Commission, which oversees the commodity
futures and options markets in the U.S. Chairman Gensler
recently served in the Treasury Department as Under Secretary
of Domestic Finance and Assistant Secretary of Financial
Markets. In addition, he served as Senior Advisor to Paul
Sarbanes on the Senate Banking Committee.
Mr. John Walsh is Acting Comptroller of the Currency of the
Office of the Comptroller of the Currency. Mr. Walsh assumed
the position last August. He previously served as Chief of
Staff and Public Affairs. He has been with the OCC since 2005
and prior to that was the Executive Director of the Group of
Thirty. Mr. Walsh also served with the Senate Banking Committee
from 1986 to 1992.
I thank all of you for being here today. I regret that I
had my surgery on my voice box recently, but I hope it will
clear up.
Chairman Bernanke, you may begin your testimony.
STATEMENT OF BEN S. BERNANKE, CHAIRMAN, BOARD OF GOVERNORS OF
THE FEDERAL RESERVE SYSTEM
Mr. Bernanke. Thank you. Chairman Johnson and Ranking
Member Shelby and other Members of the Committee, thank you for
the opportunity to testify about the Federal Reserve's
implementation of the Dodd-Frank Act.
The Dodd-Frank Act addresses critical gaps and weaknesses
in the U.S. regulatory framework, many of which were revealed
by the recent financial crisis. The Federal Reserve is
committed to working with the other U.S. financial regulatory
agencies to implement the Act effectively and expeditiously. We
are also cooperating with our international counterparts to
further strengthen financial regulation, to ensure a level
playing field across countries, and to enhance international
supervisory cooperation. And we have revamped the supervisory
function at the Federal Reserve to allow us to better meet the
objectives of the Act.
The Act gives the Federal Reserve important
responsibilities both to make rules to implement the law and to
apply the new rules. In particular, the Act requires the
Federal Reserve to complete more than 50 rulemakings and sets
the formal guidelines as well as the number of studies and
reports. We have also been assigned formal responsibility to
consult and collaborate with other agencies on a substantial
number of additional rules, provisions, and studies.
So that we meet our obligations on time, we are drawing on
expertise and resources from across the Federal Reserve system
in banking supervision, economic research, financial markets,
consumer protection, payments, and legal analysis. In all, more
than 300 members of the Federal Reserve staff are working on
Dodd-Frank implementation projects. We have created a senior
staff position to coordinate our efforts and have developed
project reporting and tracking tools to facilitate management
and oversight of all of our implementation responsibilities.
We have made considerable progress in carrying out our
assigned responsibilities. We have been providing significant
support to the Financial Stability Oversight Council, of which
the Federal Reserve is a member. We are assisting the Council
in designing its systemic risk monitoring and evaluation
process and in developing its analytical framework and
procedures for identifying systemically important nonbank firms
and financial market utilities.
We also are helping the new Office of Financial Research at
the Treasury Department develop potential data reporting
standards to support the Council's systemic risk, monitoring,
and evaluation duties.
We contributed significantly to the Council's recent
studies, one on the Volcker Rule's restrictions on banking
entities' proprietary trading and private fund activities, and
a second one on the Act's financial sector concentration limit,
and we are now developing for public comment the necessary
rules to implement these important restrictions and limits.
Last week, the Board adopted a final rule to ensure that
activities prohibited by the Volcker Rule are divested or
terminated in the time period required by the Act.
We also have been moving forward rapidly in other areas.
Last fall, we issued a study on the potential effect of the
Act's credit risk retention requirements on securitization
markets as well as an Advanced Notice of Proposed Rulemaking on
the use of credit ratings in the regulations of Federal banking
agencies.
In addition, in December, the Board and the other Federal
banking agencies requested comment on a proposed rule that
would implement the capital floors required by the Collins
Amendment. In December, we also requested comment on proposed
rules that would establish standards for debit card interchange
fees and implement the Act's prohibition on network exclusivity
arrangements and routing restrictions.
In January, the Board, together with the OCC, FDIC, and
OTS, provided the Congress a comprehensive report on the
agency's progress and plans relating to the transfer of the
supervisory authority of the OTS for thrifts and thrift holding
companies. In addition, as provided by the Act, we in the
Federal Reserve Banks each established offices to consolidate
and build on our existing equal opportunity programs to promote
diversity in management employment and business activities.
We continue to work closely and cooperatively with other
agencies to develop joint rules to implement the credit risk
retention requirements for securitizations, resolution plans or
living wills for large bank holding companies and counsel-
designated nonbank firms, and capital and margin requirements
for swap dealers and major swap participants. We are consulting
with the SEC and the CFTC on a variety of rules to enhance the
safety and efficiency of the derivatives markets, including
rules that would require most standardized derivatives to be
centrally traded and cleared, require the registration and
prudential regulation of swap dealers and major swap
participants, and improve the transparency and reporting of
derivatives transactions.
We also are coordinating with the SEC and the CFTC on the
agencies' respective rulemakings on risk management standards
for financial market utilities, and we are working with market
regulators and central banks in other countries to update the
international standards for these types of utilities.
The transfer of the Federal Reserve's consumer protection
responsibilities specified in the Act to the new Bureau of
Consumer Financial Protection is well underway. A team at the
Board headed by Governor Duke is working closely with the staff
at the CFPB and at the Treasury to facilitate the transition.
We have provided technical assistance as well as staff members
to the CFPB to assist it in setting up its functions. We have
finalized funding agreements and provided initial funding to
the CFPB. Moreover, we have made substantial progress toward a
framework for transferring Federal Reserve staff members to the
CFPB and integrating CFPB employees into the relevant Federal
Reserve's benefit programs.
One of the Federal Reserve's most important Dodd-Frank
implementation projects is to develop more stringent prudential
standards for all large banking organizations and for nonbank
firms designated by the Council. Besides capital, liquidity,
and resolution plans, these standards will include Federal
Reserve and firm conducted stress tests, new counterparty
credit limits, and risk management requirements. We are working
to produce a well-integrated set of rules that will
significantly strengthen the prudential framework for large,
complex financial firms and the financial system.
Complementing these efforts under Dodd-Frank, the Federal
Reserve has been working for some time with other regulatory
agencies and central banks around the world to design and
implement a stronger set of prudential requirements for
internationally active banking firms. These efforts resulted in
the adoption in the summer of 2009 of more stringent regulatory
capital standards for trading activities and securitization
exposures.
And, of course, it also includes the agreements reached in
the past couple of months on the major elements of the new
Basel III prudential framework for globally active banks. Basel
III should make the financial system more stable and reduce the
likelihood of future financial crises by requiring these banks
to hold more and better quality capital and more robust
liquidity buffers.
We are committed to adopting the Basel III framework in a
timely manner. In December 2010, we requested comment with the
other U.S. banking agencies on proposed rules that would
implement the 2009 trading book reforms, and we are already
working to incorporate other aspects of the Basel III framework
into U.S. regulations.
To be effective, regulation must be supported by strong
supervision. The Act expands the supervisory responsibilities
of the Federal Reserve to include thrift holding companies and
nonbank financial firms that the Council designates as
systemically important, along with certain payment, clearing,
and settlement utilities that are similarly designated.
Reflecting the expansion of our supervisory
responsibilities, we are working to ensure that we have the
necessary resources and expertise to oversee a broader range of
financial firms and business models. The Act also requires
supervisors to take a macroprudential approach. That is, the
Federal Reserve and other financial regulatory agencies are
expected to supervise financial institutions and critical
infrastructures with an eye toward not only the safety and
soundness of each individual firm, but also taking into account
risks to overall financial stability.
We believe that a successful macroprudential approach to
supervision requires both a multidisciplinary and a wide-
ranging perspective. Our experience in 2009 with the
Supervisory Capital Assessment Program, popularly known as the
bank stress test, demonstrated the feasibility and benefits of
employing such a perspective. Building on that experience and
other lessons learned from the recent financial crisis, we have
reoriented our supervision of the largest, most complex banking
firms to include greater use of horizontal or cross-firm
evaluations of the practices and portfolios of firms, improved
quantitative surveillance mechanisms, and better use of the
broad range of skills of the Federal Reserve staff. And we have
created a new Office of Financial Stability within the Federal
Reserve which will monitor financial developments across a
range of markets and firms and coordinate with the Council and
with other agencies to strengthen systemic oversight.
The Federal Reserve is committed to its longstanding
practice of ensuring that all of its rulemakings are conducted
in a fair, open, and transparent manner. Accordingly, we are
disclosing on our public Web site summaries of all
communications with members of the public, including banks,
trade associations, consumer groups, and academics, regarding
matters subject to a proposed or potential future rulemaking
under the Act.
We have also implemented measures within the Act to enhance
the Federal Reserve's transparency. In December, we publicly
released detailed information regarding individual transactions
conducted between December 1, 2007, and July 20, 2010, across a
wide range of Federal Reserve credit and liquidity programs and
we are developing the necessary processes to disclose
information concerning transactions conducted after July 20,
2010, on a delayed basis as provided in the Act.
To conclude, Mr. Chairman, the Dodd-Frank Act is a major
step forward for financial regulation in the United States. The
Federal Reserve will work closely with our fellow regulators,
the Congress, and the Administration to ensure that the law is
implemented expeditiously and in a manner that best protects
the stability of our financial system and our economy.
Chairman Johnson. Thank you, Chairman Bernanke.
Ms. Bair.
STATEMENT OF SHEILA C. BAIR, CHAIRMAN, FEDERAL DEPOSIT
INSURANCE CORPORATION
Ms. Bair. Chairman Johnson, Ranking Member Shelby, and
Members of the Committee, thank you for the opportunity to
testify today on the FDIC's progress in implementing the Dodd-
Frank Act.
First, I would like to congratulate Senator Johnson on
becoming Chairman, and it is a real honor to be called to
testify at your first hearing as Chairman. We have appreciated
your efforts in the past on issues like deposit insurance
reform and we look forward to your leadership as we address
future challenges in the financial industry.
The recent financial crisis exposed grave shortcomings in
private sector risk management and our framework for financial
regulation. When the crisis hit, policy makers were faced with
a choice of propping up large failing institutions or risking
disruptive bankruptcies, as we saw with the Lehman failure. The
landmark Dodd-Frank Act, enacted last year, created a
comprehensive new regulatory and resolution regime to protect
the American people from the severe economic consequences of
financial instability. It gives regulators tools to curb
excessive risk taking, enhance supervision, and facilitate the
orderly liquidation of large banks and nonbank financial
companies in the event of failure.
The Act requires or authorizes the FDIC to implement some
44 regulations, including 18 independent and 26 joint
rulemakings, which we are doing as expeditiously and as
transparently as possible. Many of the FDIC's rulemakings stem
from the mandate to end ``too big to fail.'' First, in
implementing our new orderly resolution authority, we are
making clear that there will be no more bailouts of large
financial institutions. Our goal is that market expectations
and financial institution credit ratings should, over time,
fully reflect this reality.
Consistent with the Dodd-Frank mandate, our recent interim
rule requires that creditors and shareholders, not taxpayers,
bear the losses of a financial company failure and makes clear
that the FDIC's resolution powers will not be used to bail out
another institution. To make most effective use of these new
resolution authorities, it is essential that we have access to
the information we need to monitor the health of systemic
entities and conduct advance planning to wind them down without
disruption to the broader system.
To this end, the FDIC and the Federal Reserve are working
to establish requirements for these firms to maintain credible,
actionable resolution plans that would facilitate their orderly
resolution. If these entities are unable to demonstrate that
they are, quote, ``resolvable,'' we should be prepared to
require structural changes so that they can be wound down, and
if they cannot make needed structural changes, we should
require divestiture. The FDIC is working closely with its FSOC
counterparts to develop criteria for designating systemically
important institutions that will be subject to enhanced
supervision and the need to maintain resolution plans.
The FDIC Board has also implemented its authority under
Dodd-Frank to strengthen and reform the Deposit Insurance Fund.
The Act will enable us to maintain a positive fund balance
during crisis periods while also maintaining steady and
predictable assessment rates over time. We have expanded the
assessment base used for Deposit Insurance assessments and we
have removed reliance on credit ratings while also making large
bank assessments more sensitive to risk.
Also, under the Collins Amendment, capital requirements for
bank holding companies and nonbanks will be made as strong as
those applied to community banks. The Federal banking agencies
are in the early stages of rulemaking to implement this
provision and are also taking steps to implement Basel III
proposals for strengthening capital and liquidity standards, as
Chairman Bernanke mentioned.
The Dodd-Frank Act addresses misaligned incentives in
securitization by requiring the FSOC agencies to develop risk
retention standards for loan securitizations and to define
standards for qualifying residential mortgages that would not
be subject to risk retention. As this interagency process moves
forward, we believe the standards must include incentives to
appropriately service securitized loans. Research and recent
experience show the importance of servicing to mortgage
performance and risk, but most securitizations currently do not
provide the proper resources or incentives for servicers to
effectively engage in loss mitigation.
As implementation moves forward, the industry should
understand that Dodd-Frank reforms are in no way intended to
impede the ability of small and midsized institutions to
compete in the marketplace. Instead, they should do much to
restore competitive balance by subjecting systemically
important institutions to greater market discipline and
regulatory oversight.
History reminds us that financial markets cannot function
in an efficient and stable manner without strong, clear
regulatory guidelines. Millions of Americans have lost their
jobs, their homes, or both, even as so many of our largest
financial institutions received Government assistance that
enabled them to survive and recover. We have a clear obligation
to members of the public who have suffered the greatest losses
as a result of the crisis to prevent such a severe episode from
ever recurring.
Thank you very much.
Chairman Johnson. Thank you, Chairman Bair.
Ms. Schapiro.
STATEMENT OF MARY L. SCHAPIRO, CHAIRMAN, SECURITIES AND
EXCHANGE COMMISSION
Ms. Schapiro. Chairman Johnson, Ranking Member Shelby, and
Members of the Committee, thank you for the opportunity to
testify today on behalf of the Securities and Exchange
Commission regarding the implementation of the Dodd-Frank Wall
Street Reform and Consumer Protection Act. The Act is intended
to fill a number of significant regulatory gaps, bring greater
public transparency and market accountability to the financial
system, and give the SEC important tools with which to better
protect investors. It also assigns the SEC new authority for
over-the-counter derivatives, hedge funds, and credit rating
agencies, among others.
To respond, we have brought together experts from across
the agency, creating cross-disciplinary teams to draft rules
and conduct the required studies. We put in place measures to
ensure maximum input from the public and a highly transparent
process. And we continue to consult frequently with our fellow
regulators domestically and internationally.
We have made significant progress to date. The Commission
has issued 25 proposed rule releases, seven final rule
releases, and two interim final rules. We have reviewed
thousands of public comments, completed five studies, and
hosted a number of public roundtables jointly with the CFTC.
While my written testimony contains a detailed discussion
of our work, I would like to highlight just a few areas of
particular interest.
A key portion of the Act seeks to reduce a source of
financial instability by improving transparency in the
derivatives markets and facilitating the centralized clearing
of swaps. The SEC has proposed rules regarding swaps which
together provide a clear blueprint for a more stable and
transparent derivatives market. These include proposals that,
to mention just a few, would lay out the reporting requirements
for market participants and obligations of swap data
repositories, seek to mitigate potential conflicts of interest
to clearing agencies, and establish the duties and core
principles of swap execution facilities. We are also working
with the Federal Reserve, the CFTC, and the Financial Stability
Oversight Council to develop a framework for supervising market
utilities that are designated as systemically important.
In addition to derivatives, the Dodd-Frank Act provides the
agency with authority over hedge funds and private equity funds
with assets under management in the U.S. of over $150 million.
Here, we have proposed rules that would facilitate the
registration of private fund advisors, and together with the
CFTC, we have proposed rules to require advisors to hedge funds
and other private funds to report information for use by the
FSOC in monitoring systemic risk.
The SEC also is acting to give investors more information
about asset-backed securities, another focus of the
legislation. In this area, we have adopted rules requiring ABS
issuers to disclose the history of asset repurchase requests
received and repurchases made, and we have also adopted rules
requiring issuers to review the assets underlying the ABS, to
disclose the nature of the reviews, and to provide reasonable
assurances that the prospectus disclosures are accurate.
The Dodd-Frank Act also includes provisions related to
executive compensation. In furtherance of these provisions,
last month, the Commission adopted rules requiring companies to
allow shareholders to cast an advisory say-on-pay vote at least
once every 3 years and requiring a separate advisory vote on
the frequency of say-on-pay votes at least every 6 years.
Additionally, the legislation substantially expands the
agency's authority to compensate whistleblowers. In November,
we proposed a rule mapping out a procedure for would-be
whistleblowers to provide useful information to the agency. The
rule makes it clear that whistleblowers play a critical role in
protecting investors. At the same time, it is designed to
complement, not circumvent, existing compliance regimes that
companies operate.
In recent weeks, the SEC also released two studies which
examine ways of improving the investment advisor and broker-
dealer regulatory frameworks. First, the Commission published a
staff study describing potential approaches for Congress to
consider to increase examinations of investment advisors. And
second, we issued a staff study looking at the differing
standards of conduct required of investment advisors and
broker-dealers. Most importantly, that study recommended that
the Commission implement a uniform fiduciary standard of
conduct for broker-dealers and investment advisors when they
are providing personalized investment advice about securities
to retail investors.
In short, the Commission has moved steadily and responsibly
to implement the Dodd-Frank Act. As we continue to make
progress, we look forward to working closely with Congress, our
fellow regulators, the financial community, and investors to
craft rules that will strengthen the financial markets.
Thank you for inviting me here today and I look forward to
answering your questions.
Chairman Johnson. Thank you, Chairman Schapiro.
Chairman Gensler.
STATEMENT OF GARY GENSLER, CHAIRMAN, COMMODITY FUTURES TRADING
COMMISSION
Mr. Gensler. Good morning. Thank you, Chairman Johnson,
Ranking Member Shelby, Members of the Committee, and
congratulations on assuming the Chair. Congratulations to the
five new Members of the Committee, as well. I guess I am a
little partial, having once staffed a chair of this Committee.
I thank you for inviting me here today to testify on behalf
of the Commodities Futures Trading Commission. I want to thank
my fellow Commissioners and the staff for such hard work at the
CFTC in fulfilling their statutory mission. I am also pleased
to testify alongside the fellow regulators here today.
In 2008, the financial system failed the American public,
and the regulatory system, as well, failed the American public.
The effects of that crisis have reverberated throughout America
and the global economies. In the U.S., hundreds of billions of
taxpayer money were used to bail out the financial system that
was at the brink of failure, and millions of jobs have been
lost and have yet to fully come back.
The CFTC is working very closely with the SEC, the Federal
Reserve, the FDIC, the Office of the Comptroller of the
Currency, Treasury, and other regulators to implement the Dodd-
Frank Act and we are coordinating and consulting closely with
international regulators to harmonize oversight of the swaps
market and ensure that there is a level field. We have received
thousands of comments from the public and had hundreds of
meetings, which we all post on our Web site. For the vast
majority of the proposed rulemakings, we have solicited public
comments for a period of 60 days.
One area where the CFTC is seeking input from the public
relates to the timing and implementation of various
requirements under the rules. Public comments will help inform
the Commission as to what requirements can be met sooner and
which can be phased and can be implemented later.
We are also under the Act to propose rules, along with the
other regulators here, with regard to margin requirements. The
Congress recognized that there are different levels of risk
posed by transactions between financial entities and those
involving nonfinancial entities. This was the so-called end-
user exception from clearing. Consistent with this, proposed
rules on margin requirements from the CFTC, we believe, should
focus only on the transactions between financial entities
rather than those transactions that involve nonfinancial end-
users, consistent with how Congress did the clearing
requirement.
Aside from proposing rulemakings to implement Dodd-Frank,
the CFTC is also supporting the work of the Financial Stability
Oversight Council, providing both data and expertise relating
to a variety of systemic risks. We also have had the
opportunity to coordinate with Treasury and the Council and the
Office of Financial Research on the studies and proposed rules
by the FSOC.
To adequately fulfill our statutory mandate, the CFTC does
require additional resources. The U.S. futures market which we
currently oversee is about $40 trillion in size. The U.S. swaps
market that we will jointly oversee with the SEC is about $300
trillion in size, or roughly seven times the size of the U.S.
Futures markets. We do not need seven times the people, but we
do need more people and we need more technology.
On Monday, the President submitted a fiscal year budget of
$308 million for the Commission. This is essential for
fulfilling our mission. In 1992, we had 634 staff at the CFTC.
We are currently between 670 and 680. We actually shrank about
23 percent in the prior decade, and with this Committee and
Congress' help, we grew back to where we were in the 1990s. But
only last year did we get back to where we were in the 1990s.
Furthermore, the CFTC's funding, if it were returned to
fiscal year 2008 levels, the agency would not be able to
fulfill our statutory mission. Every program would be affected.
We would be unable to pursue fraud and Ponzi schemes, market
manipulations. Though it did take, Senator Shelby, time to fill
the Office of Chief Economist, we would not even be able to
fill any jobs. We would have to go the other way and have to
unfortunately let people go. I do not think that is what the
American people need us to do at this time after the crisis of
2008.
The CFTC fundamentally is a good investment. The mission is
to promote transparent, open, and competitive markets so end-
users, hedgers, and investors can get the benefit of the
markets and the transparency in those markets and the
competition in those markets. The CFTC is also a cop on the
beat to ensure against fraud and manipulation and other abuses.
I thank you and I would be happy to answer any questions.
Chairman Johnson. Thank you, Chairman Gensler.
Mr. Walsh.
STATEMENT OF JOHN WALSH, ACTING COMPTROLLER OF THE CURRENCY,
OFFICE OF THE COMPTROLLER OF THE CURRENCY
Mr. Walsh. Thank you, Chairman Johnson, Senator Shelby, and
Members of the Committee. I appreciate the opportunity today to
describe the activities the OCC has undertaken to implement the
Dodd-Frank Act. Let me begin, as others have done, by saying
what a pleasure it is to appear before Chairman Johnson for the
first time and by expressing our hope for a continuing
productive working relationship with my old committee,
including with its five new Members.
I am pleased to report that much has been accomplished
during the past 6 months on implementation of the Dodd-Frank
Act. Progress in a number of areas is discussed in my written
statement. Our single largest task is integration of the
employees and functions of OTS into our supervisory mission,
and we are on track to complete all transfers by the target
date of July 21. We firmly believe that the talent and
experience of OTS staff will be essential for effective
supervision of Federal savings associations going forward and
we are fostering an environment that will maximize career
opportunities while ensuring they enjoy the full protections
afforded employees by the Dodd-Frank Act.
We are also engaged in extensive outreach to the thrift
industry, addressing concerns and clarifying expectations. We
anticipate an orderly transfer of authority that will ensure
the combined agency can continue to provide effective
supervision of both national banks and Federal savings
associations.
In the area of rule writing, we are making progress on the
many projects assigned to us, but a few present particular
challenges. An issue I raised in testimony last September is
the prohibition on use of credit ratings. We recognize that the
misuse of credit ratings, especially in structured finance,
contributed importantly to the financial crisis, but this was
not true of corporate and municipal ratings, and after
significant study and comment, we have found no practical
alternative for such ratings that could be used across the
banking sector. We have heard concerns from regional and
community banks that attempting to replace ratings with
internal assessments of creditworthiness would be prohibitively
costly and complex for them. Although we certainly do not
advocate a return to total reliance on credit ratings, their
use within defined limits is essential for implementation of
capital rules, including the Basel III capital framework, and
we urge Congress to modify this prohibition.
A more general concern is the need to coordinate
implementation of Dodd-Frank requirements for capital and
liquidity with Basel III. While the two share many common
objectives, it is essential to implement these reforms in a
coordinated, mutually reinforcing manner that enhances safety
and soundness without damaging U.S. competitiveness or
restricting access to credit. My testimony describes our
efforts to enhance the capital and liquidity standards of U.S.
financial companies with this coordination challenge in mind.
Finally, I would like to update the Committee on steps the
OCC has taken in response to the foreclosure crisis since I
last testified on this issue. The Federal banking agencies have
concluded examinations of foreclosure processing at the 14
largest federally regulated mortgage servicers. The
examinations, which we undertook in late 2010 with the Federal
Reserve, the FDIC, and the OTS, found critical deficiencies and
shortcomings that resulted in violations of State and local
foreclosure laws, regulations, or rules. Despite these clear
deficiencies, we found that loans subject to foreclosure were,
in fact, seriously delinquent and that servicers had
documentation and legal standing to foreclose.
In addition, case reviews showed that servicers were in
contact with troubled borrowers and had considered loss
mitigation alternatives, including loan modifications. That
said, our work identified a small number of foreclosure sales
that should not have proceeded because of an intervening event
or condition. We are now finalizing remedial requirements and
sanctions appropriate to remedy comprehensively the problems
identified. Our actions will address identified deficiencies
and will hold servicers to standards that require effective and
proactive risk management and appropriate remedies for
customers who have been financially harmed.
We are also discussing our supervisory actions with other
Federal agencies and State Attorneys General with a view toward
resolving comprehensively and finally the full range of legal
claims arising from the mortgage crisis. Equally important, we
are drawing on lessons from these examinations to develop
mortgage servicing standards for the entire industry. The OCC
developed a framework of standards that we shared with other
agencies and we are now participating in an interagency process
to establish nationwide requirements that are comprehensive,
apply to all servicers, provide the same safeguards for all
consumers, and are directly enforceable by the agencies. While
we are still in a relatively early stage, we share the common
objective to achieve significant reform in mortgage servicing
practices.
Thank you for the opportunity to testify. I would be happy
to answer your questions.
Chairman Johnson. Thank you, Mr. Walsh. Thank you for your
testimony.
I will remind my colleagues that we will keep the record
open for statements, questions, and any other material you
would like to submit. As we begin questioning of the witnesses,
I will put 5 minutes on the clock for each Member's questions.
Chairman Schapiro and Chairman Gensler, with the arrival of
the President's budget to Congress this week and the failure
yet to appropriate the funds authorized by the Dodd-Frank Act,
please describe how you are addressing funding constraints in
your respective agencies as you continue to implement the Dodd-
Frank Act.
Ms. Schapiro. I am happy to go first with that, Mr.
Chairman. For the purposes of conducting the studies and
writing the rules that are required under Dodd-Frank, we are
using cross-agency teams of employees who are already on board
and have been long-time employees in many instances, and we are
not really feeling the pressure of the Continuing Resolution
with respect to that. In order to operationalize any of the
rules that we are writing, we will require additional resources
that are laid out in the President's budget request because we
do not have the capacity now to, for example, take on the
examination of hedge funds, the examination of municipal
advisors which is required under the legislation, the
registration and supervision of the new entities that are part
of the over-the-counter swaps market.
With respect to our current core functions, we are feeling
the pressure of operating under a Continuing Resolution. We are
making some difficult choices. We are restricting hiring across
the agency and selectively hiring only very special positions.
We have cut travel, and to me most importantly, we have delayed
very significant technology programs that would help bring the
SEC's technology up into at least this century, if not this
year. That is having an impact on our ability, I believe, to
achieve our core mission as effectively as we could, and quite
frankly, at the level at which the American people have a right
to respect.
Chairman Johnson. Mr. Gensler, please elaborate.
Mr. Gensler. Our agency just this past year, with the help
of Congress, got back to our staffing levels of the 1990s,
having been shrunk, unfortunately, in the prior decade. But
today's staff is not enough to take on the implementation. We
can write the rules and have the meetings. About a quarter of
our staff right now is working in one way or another on the
rule writing.
This year under the Continuing Resolution have had to make
hard choices. Our technology budget, only $31 million last
year. This year, under the Continuing Resolution, we will
probably have to cut it about 45 percent. We are cutting travel
and all the other things to be efficient. But technology is the
key to move forward.
We are also working hand-in-glove with the self-regulatory
organization, the NFA, to see what can they pick up, can they
pick up registration and examination functions and so forth. To
take on the task of overseeing a market that is about seven
times the size of our current agency, it is a new task to take
on something that large. This small agency needs to be larger.
The President has asked for $308 million for next year. I know
this Nation of ours has a great budget deficit that we all have
to come together and understand better and grapple with, so I
feel a little bit--it is daunting to ask for more money for
this agency at this time, but I really do think this is a good
investment for the American public to avoid crises like in
2008.
Chairman Johnson. Chairman Bernanke, Chairman Bair, and
Comptroller Walsh, community banks and credit unions are the
backbone of our economy, which is why we have worked hard to
protect their viability in drafting the Dodd-Frank Act. As the
regulators of depository institutions holding under $10 billion
in assets, could you please speak to the impact of the Dodd-
Frank implementation on these small institutions, including the
impact of the debt interchange rule and the qualified
residential mortgage, QRM, rulemaking, to ensure that there are
no unintended consequences moving forward.
Mr. Bernanke. Chairman Johnson, we fully agree with you
that community banks and small regional banks, play a very
important role in our banking system and it is very important
to minimize the excess regulatory burden on these institutions.
We have tried to institutionalize that effort within the
Federal Reserve. We have created a special committee that looks
only at smaller banks and tries to ensure that rules that are
written for the banking system broadly are not excessively
burdensome on the smallest institutions. We have also created a
Community Bank Council that meets three times a year with the
Board of Governors to give us their views. And so we are trying
to reach out and understand particular problems.
Our rulemaking activities are focused primarily, given the
nature of the crisis and the fact that most of the problems
were with large institutions, on the largest institutions. We
are currently developing, as Dodd-Frank requires, a new set of
regulatory, capital, liquidity, risk management, and other
rules that would apply primarily to those banks of $50 billion
or larger, and even those banks, the rules are tighter the
larger the bank. So we are very sensitive to this issue and are
trying to do our best to minimize the impact on small banks.
I will speak to the interchange rule. Perhaps Chairman Bair
would like to say something about QRMs. The interchange
provision has an exemption for banks, smaller banks, which we
will put in the rule. I think this is something we are trying
to better understand through the comments and through our
outreach; we are not certain how effective that exemption will
be. It is possible that because merchants will reject more
expensive cards from smaller institutions or because networks
will not be willing to differentiate the interchange fee for
issuers of different sizes, it is possible that that exemption
will not be effective in the marketplace. It is allowable, not
a requirement. And so there is some risk that that exemption
will not be effective and that the interchange fees available
to smaller institutions will be reduced to the same extent that
we would see for larger banks.
Ms. Bair. Thank you. I welcome that question. I guess I
would like to note, first of all, that one of the things Dodd-
Frank did was change the assessment base for deposit insurance
premiums from one based on domestic deposits to one focused on
assets. We just recently finalized rules on that and it will be
effective in the third quarter, and that will reduce community
banks--in aggregate, reduce community banks' deposit insurance
premiums by about 30 percent. It tends to shift more of the
burden to entities that rely less on deposit insurance and
really hits those that rely on secured liabilities, which tend
to be the larger institutions. So I think that is going to have
a significant benefit for community banks.
On the QRM rule, I do not want to front-run the rulemaking
process, but that rule is close to being done and I think I can
assure the Committee the direction on the QRM rule, it will be
focused on issuers of securitizations, not small mortgage
originators. So I think the impact will not be burdensome for
community banks. I think we have all strived to realize
community banks were not the problem, that the curing rules are
trying to correct, and so I think that you will--if you are
concerned about that, you will be pleased when you see the rule
that goes out for public comment.
I would also, back to my opening statement about orderly
liquidation authority, I think robust implementation of Title 2
and orderly liquidation authority will help further level the
competitive playing field between small and large. I anticipate
that funding costs for many of the large institutions will go
up as that authority is implemented and that will also help the
community banking sector.
I would also share Chairman Bernanke's concerns about the
effectiveness of the interchange rules and statutory provisions
to truly protect community banks, particularly if networks are
not required to have a two-tiered pricing structure, so the
community banks can continue to charge the higher fees. So we
are in consultations with the Fed on this and reviewing what
the legal authorities might be there from a regulatory
standpoint. But I do think this is a real issue for community
banks.
Chairman Johnson. Mr. Walsh, my time has expired, but
please sum up quickly.
Mr. Walsh. Just to echo some others on QRM and interchange,
we are working with the other agencies there. I would just note
that our community banking population is going to go up by half
when we integrate the OTS, from 1,400 to 2,100 institutions. We
have a division devoted to community banking. We have examiners
around the country who are attentive to their concerns. We have
been doing quite a bit of outreach to community banks to try to
understand their concerns. As was noted, most of the
significant changes in Dodd-Frank are aimed at larger
institutions, but the smaller institutions do worry about the
increasing weight of regulation that the changes imply. And as
I noted, we have one concern with credit ratings, and if it
were simplified could be of benefit to community banks.
Chairman Johnson. Thank you, Mr. Walsh.
Senator Shelby.
Senator Shelby. Thank you, Mr. Chairman.
I will direct this question first to Chairman Bernanke and
then some others. In a recent Financial Times article,
Secretary Geithner talked about the difficulty of designating
nonbank financial institutions as systemic. He said, and I will
quote, ``it depends too much on the state of the world at the
time. You won't be able to make a judgment about what is
systemic and what is not until you know the nature of the
shock.''
I find the Secretary's comments interesting given his
strong support of Title 1 of Dodd-Frank when we went through
this. If it is impossible to know what firms are systemic until
a crisis occurs, the Financial Stability Oversight Council will
have a very difficult time objectively selecting systemic banks
and nonbanks for heightened regulation.
Mr. Chairman, as a member of the Council, what is your view
on whether firms can be designated as systemic without creating
some type of arbitrary process here?
Mr. Bernanke. Senator, it is a difficult problem.
Senator Shelby. I know it is.
Mr. Bernanke. You have different types of firms respond to
different types of shocks. It is also true that an individual
industry with small firms might be subject to a broad shock, as
we saw with the money market mutual funds, for example.
That being said, I think one of the sources of the crisis
in 2008 was that there were very substantial gaps in the
oversight of many large firms, like the AIG----
Senator Shelby. Sure.
Mr. Bernanke. ----which did not have strong consolidated
oversight. And I think our task is to do the best we can to try
to identify those firms which most likely pose a risk----
Senator Shelby. What does ``do the best we can'' mean to
us? What does that mean?
Mr. Bernanke. Well, we do not want to be arbitrary, as you
point out----
Senator Shelby. OK.
Mr. Bernanke. ----the FSOC, with the cooperation of all of
the folks at this table, has already put out a request for
input. But what we would like to do is provide relatively clear
guidelines about the criteria that we will use to try to
identify firms that are potentially systemic. Admittedly, those
will not be exact numerical guidelines but I do think it is
important that the fact that each agency at this table has a
certain specific set of institutions for which it is
responsible, that we do not allow that fact to create gaps
where there are important firms that have no serious
consolidated oversight. So I do think it is useful to do this,
but I acknowledge your concerns that it will never be a perfect
process.
Senator Shelby. Chairwoman Bair, do you have a comment
there?
Ms. Bair. Yes, thank you. I do. I think it is perhaps
easier to say what is not systemic. I think Congress said, at
least for bank holding companies, if you are below $50
billion----
Senator Shelby. Let us talk about banks, then.
Ms. Bair. Right. So----
Senator Shelby. And you are defending the fund, so to
speak.
Ms. Bair. We are defending the fund, and so I think our
concern about this is to make sure if we have to use our
resolution authority, that we are prepared and we have
resolution plans and have had information that we need for an
orderly wind-down.
So I think for me, Senator, the biggest--there are a number
of factors that our NPR identifies. For me, it is
interconnectedness more than anything. If you fail, what else
happens? Who else gets hurt? And it may be that we need to do a
type of a two-step process on some simple metrics based on size
and counterparty exposures, take it to a second level, and ask
those entities to do what is called a Credit Exposure Report in
Title 2 and basically do an analysis, do a scenario. If you
fail, what happens?
So I think in terms of systemic, that is the most important
factor to me. And there are some that will be obvious and that
is why we need to know who they are in advance, to have
prudential standards, to have them start reducing any
concentrations they might have that would have broader
collateral impact. There will be some gray areas. But at least
in terms of resolution planning, I would err on the side of
inclusiveness.
Senator Shelby. Mr. Chairman--Chairman Bernanke--all of you
are chairmen to a point. Do you believe that you are better
positioned now than you were 2 years ago to deal with the
failure of a large bank, for example, financial institution, or
would that come as a shock to you still? In other words, would
you be in a position to wind these institutions down?
Mr. Bernanke. Well, of course----
Senator Shelby. What about a manufacturing facility?
Mr. Bernanke. As Chairman Bair discussed, the resolution
regime and the other prudential requirements are aimed at
financial firms which have the risk of bringing down the
system. I think there is quite a bit more work to do to fully
implement all that Dodd-Frank has put on the table in terms of
living wills, resolution, prudential requirements, and so on.
I think we are better off today than we were 2 years ago,
but I would say that it will still be some time before we have
completely implemented not only all of the rules in the context
of Dodd-Frank, but I think, very importantly, and Chairman Bair
has taken leadership on this, we have to negotiate and
coordinate with international regulators because so many large
institutions are across borders. So we will need to work
together with other institutions.
So we have not gotten to the point where this set of tools
is fully implemented, but we are working very hard and it
certainly is a focus of the Fed and the FDIC to get the
resolution process up and running as effectively as possible.
Senator Shelby. Do you believe the Fed as a regulator today
is a lot more on top of things as to the capability of a bank
to stand a lot of shocks as opposed to 2 years ago? In other
words, are you more diligent than you were 2 years ago, the Fed
as a regulator?
Mr. Bernanke. Well, Senator, certainly we have all learned
lessons from the crisis in terms of----
Senator Shelby. What have you learned?
Mr. Bernanke. Well, the importance of being very aggressive
and not being willing to allow banks too much leeway when they
are inadequate in areas like risk management, where it turned
out to be such an important problem during the crisis. So we
have done a lot to try to strengthen and improve our
supervision from a day-to-day basis, but we have also done a
good bit----
Senator Shelby. It is important.
Mr. Bernanke. ----to restructure the internal process so
that we have a lot more interaction between the supervisors and
economists and financial market specialists who have different
skills they bring to the table to give us a broader perspective
on what the bank or other institution is doing.
Senator Shelby. How many banks today, just off the top of
your head, still owe a lot of money because of TARP?
Mr. Bernanke. Umm----
Senator Shelby. I know a lot of them, but if you----
Mr. Bernanke. Well, just a couple of larger banks. There
still might be a couple hundred small banks. But the great
majority of the money has been paid back, and in the end----
Senator Shelby. I am getting to the point, the ones that
have not paid back, is that a dangerous signal for you because
the economy has picked up a little bit, or are you not worried
about it?
Mr. Bernanke. I do not think so, Senator. The relatively
small banks have a relatively small number of smaller banks
have not paid their dividends. But as you know, we have had a
lot of failures of small institutions and a few of them had
TARP money. But the great majority have either paid back or are
on a track to pay back.
Senator Shelby. Are we going to continue to lose a lot of
banks, small banks, medium-sized banks, in this country? I see
the decline. You can see the trend line down.
Mr. Bernanke. Maybe Chairman Bair could take it.
Ms. Bair. So, Senator, I think we peaked last year at 157
failures. There will be an elevated number of failures, but it
will be lower, significantly lower, than 157.
Senator Shelby. How many are on the watch list now,
roughly?
Ms. Bair. I think we have got, oh, about 700, close to 800
on the----
Senator Shelby. Seven hundred banks on the watch list----
Ms. Bair. ----and so--well, the troubled bank list is--most
of those do not fail. Only about 23 percent ultimately fail,
and that is cyclical. The economy is improving and I think our
losses actually went down last year. It was about $22 billion
last year. It was around $34 billion in 2009. So losses were
down significantly last year. The banks that are failing are
much smaller banks, which is why the losses are lower. So
things are getting better. The banking sector is healing. At
the community banks, that is very true of the community banks,
as well.
Senator Shelby. My last question, if I could direct it to
Chairwoman Schapiro, on the importance of economic analysis.
You have repeatedly stated that economic analysis is important
to the SEC in its work, but it is my understanding that the SEC
has about 4,000 employees but only has 25 Ph.D. financial
economists. Considering the importance of economic analysis
that you placed on what you are doing, how did you determine
that 25 Ph.D. economists is the appropriate number, or have you
done that, or are you trying to grow it or what?
Ms. Schapiro. We are absolutely trying to grow it, Senator.
And if I could also speak to your earlier comments, I think you
know we are actively and aggressively recruiting for a Chief
Economist at the SEC. But I want to note that we would like
that person also to lead our Division of Risk, Strategy, and
Financial Innovation, and the person who is acting head of that
now is a Ph.D. economist. His Ph.D. is from the University of
Chicago, from where he also has an MBA. So we are not without
significant economic expertise within the agency. We have about
30 staff economists and they are fully engaged, as you can
imagine, on Dodd-Frank and other rules.
Senator Shelby. But you do not feel like it is adequate
yet, do you?
Ms. Schapiro. No, I sure do not.
Senator Shelby. OK.
Ms. Schapiro. I think it is important for us to have more
capacity in economic analysis. It is part of my view of how we
have to shift the entire focus of the agency. We will always
have lawyers. We are a law enforcement agency. That is
important. But we also need--and have been very successful in
recruiting--current market experience, new skill sets, new
kinds of talent to the agency, and I view economic analysis and
financial analysis to also be very key components of this. They
are also very important to the support of our enforcement
program, frankly, as well as our rule writing and the many
studies we have to do. So my goal would be to try to
significantly, if we have the resources, grow that area of our
operations.
Senator Shelby. Thank you, Mr. Chairman.
Chairman Johnson. Senator Bennet? Please abide by the 5-
minute rule.
Senator Bennet. Thank you, Mr. Chairman. I will and----
Chairman Johnson. Do, as they say, not as I do.
Senator Bennet. I will.
[Laughter.]
Senator Bennet. Congratulations on your first hearing as
Chairman. I also want to thank Senator Merkley for the
amendment that he raised and withdrew and say that if it is any
sign of things to come, we are delighted to have Senator
Isakson on this side.
[Laughter.]
Senator Bennet. It is working out perfectly and we are
enjoying it.
Chairman Bernanke, I wanted to just get some clarity from
you on the interchange issue, again, because there were, I
think, a lot of representations made when this vote came up and
when this bill was passed that institutions $10 million or
below would be exempt, and what I took you to say is that there
appears to be, or you are starting to hear feedback that there
may actually be a real--some practical problems with
implementing that.
Mr. Bernanke. Well, Senator, I should first say that our
rule is out for comment and we are still gathering information.
By the statute, the smaller institutions will be exempt from
these restrictions, but there is the possibility that either
because merchants would not accept the more expensive cards or
because networks would not be willing to have a two-tier
pricing system, it is possible that in practice they would not
be exempt from the lower interchange fee.
Senator Bennet. And what would the result of that be if, in
practice, they did not have the benefit of it?
Mr. Bernanke. Well, the statute limits the interchange fee
to the incremental cost associated with an individual
transaction, which does not cover the full cost if you include
some fixed costs associated with setting up a debit card
program, for example. So it is certainly possible that some of
those costs would get passed on to consumers in some way, for
example, a charge for a debit card or something like that, and
that would just mean that if the small banks do not have an
effective exemption, it would mean that whatever economic
forces are impinging on the larger banks would affect them as
well.
Senator Bennet. I wanted to follow up on some of the
questions the Ranking Member was asking about the FSOC, asking
it in a different way because it is both about the institutions
themselves, which are the ones that are systemically risky, and
it is also about the instruments, I would think. And I wonder
if any of you would like to talk a little bit about what the
priority setting looks like. How do you decide what the agenda
is going to be for the Council and over what period of time? Is
that something that the Treasury Secretary coordinates? How do
you detect where you ought to be looking versus where you are
not?
Mr. Bernanke. Senator, if I may take it----
Senator Bennet. And to the extent that you actually have
agenda items already, what those might be.
Mr. Bernanke. Senator, first, our agenda has two parts, in
a sense. As you know, FSOC has to write a financial stability
report once a year, and for that purpose, it makes sense that
there be an annual review of all the major financial sectors to
try to identify any emerging problems or developments in those
sectors, and so that is part of our process.
In addition, we want to remain flexible so that any ongoing
problem, say the developments in Europe and the implications
for U.S. banks or money markets, any developing event or
situation can be brought quickly to the Council.
The Council has set up committees of staff and deputies who
are covering different areas and who are presenting to the
Council short summaries of areas where they have identified
potential developments of interest and then the Council members
are giving feedback about what they would like to hear most in
the discussions.
Senator Bennet. Because I am under strict instructions from
our Chairman, I am going to ask you, because you mentioned
Europe, is our own domestic fiscal condition something that the
Council is going to be taking up, and are you aware of any
other systemic risks greater than our own debt and deficit?
Mr. Bernanke. Well, that is a difficult question because
obviously that falls somewhere between fiscal stability and
financial stability, and so the question is whether that is
more a Congressional responsibility or an FSOC responsibility.
I do not think we have discussed anything related to that so
far.
Senator Bennet. I would encourage it, just because I think
our financial stability is so closely linked to our fiscal
stability.
Thank you, Mr. Chairman. I have 3 seconds left. I yield
back the balance of my time.
[Laughter.]
Chairman Johnson. Thank you. Senator Corker, we have a vote
coming up at ten to 12 and I encourage you to abide by the 5-
minute rule.
Senator Corker. I have got it. Thank you. I appreciate it.
[Laughter.]
Senator Corker. So I welcome all of you and I thank you for
your service. We miss you. After Dodd-Frank, we have not heard
from you and the phones quit ringing. We are glad to have you
here today and appreciate the work each of you are doing. That
is a sincere statement.
I know there is a lot of talk about the budget issues.
There is no question that is going to probably get even
tighter, so there will be more of a limitation in funding. And
I know we did receive some calls during the CR period about
what you were going to be able to do, and I guess I would ask
this question. I am hearing that some of you are not being able
to invest in technology and there are some positions that are
open in other areas, examination and that kind of thing. Would
it make any sense--I know that you all have been really pushing
out rules and regulations and I know people have been concerned
at the rapidity of that. Would it make any sense for us to slow
you guys down a little bit so that you have time to both invest
in technology and hire people and actually be slightly more
thoughtful on the rulemaking? I will ask that to Chairman
Schapiro.
Ms. Schapiro. Thank you. I think, as I said earlier, the
real impacts of the Continuing Resolution on the SEC are on,
frankly, our core mission, our ability to hire examiners, to
travel for enforcement cases, and most particularly, to build
the technology we need to really do the job that is right in
front of us at this moment, putting Dodd-Frank aside.
If you think back to May 6 and the flash crash and how long
it took us after that to be able to generate the reports that
gave the public an understanding of what happened on that day,
that was largely because we lacked the technological capability
to take in the kind of data we needed to take in and analyze it
in a reasonable period of time. So for me, the budget impacts
are really as much or more right now to core mission, than they
are to Dodd-Frank implementation.
Once the rules are in effect--and we will be very careful
with how we sequence and implement the actual rules. We will,
as Chairman Gensler said, seek comment from the industry about
what is the right order--what do they need 6 months to be able
to do, because they have to build a system? What do we need
time to do, because we might need to build a system? And that
will require additional funding in order to both build those
systems and bring in the people needed to, for example, do
hedge fund examinations or examine swap dealers or major swap
participants or whatever. But I think getting the rules
written, it is a stress, for sure, and it is a challenge. It is
affecting all of our capacities to do other things. But I think
the real crunch comes after the rules are in place and we
actually have to operationalize them, and we lack the resources
to do that.
Senator Corker. OK. Thank you very much.
Chairman Bernanke, I know that there are a lot of things
that each of you sought and got, and then there were some
things you did not ask for and got. I know one of the things
you received was the interchange issue. I know you are being
diplomatic, but it seems to me that it is an impossibility that
if a rate is set for the larger institutions, it is not going
to impact the smaller institutions as it relates to interchange
rules. I mean, it does not seem to me to be a possibility.
I know, again, you did not ask for this. It was an
amendment that passed on the floor. But I was over the other
day with Senator Kirk and we were watching a Fed auction take
place at the Bureau of Debt. If you just looked at the cost of
that transaction, the electronic auction itself, it is
obviously very minimal. But there was a whole passel of folks
paying attention and making sure that ethical guidelines were
in place, and I am sure these--I know these institutions, these
banking institutions, have those same things.
So would you please--I mean, the fairness of us price
setting at some rate that only is a transmission cost seems to
me to be incredibly in error. We also are going to be forcing
people into credit cards over time. I mean, people that do not
have credit are going to be forced into credit cards, which is
a debt instrument, not something that is coming out of their
account. It just seems like, to me, the whole issue is very
perverse and something that was very short-sighted on our part
and sort of a populus move, and I wonder if you would
editorialize about that.
Mr. Bernanke. I do not know if I can editorialize about it.
As I said before, it is true that the statute requires us to
look only at the incremental costs and not necessarily the full
cost and that is going to have various implications. One would
be probably that some costs on the banking side will be passed
on to consumers or will affect product offerings and so on. On
the other side, merchants will be paying less, and depending on
the state of competition in that part of the market, they may
be passing those savings on to consumers. So there will be some
transfers on both sides and the issue really is what Congress
intended, what objects you had. Again, this process will
certainly lead to lower interchange fees which will benefit
some and impose costs on others.
Senator Corker. And Mr. Chairman, I know my time is up. I
thank you. But there is no question, our smaller institutions
are going to be impacted in a big way, and I think we all know
that and I hope that we will endeavor somehow to fix that here
in Congress. Thank you, and congratulations on chairing.
Chairman Johnson. Thank you.
Senator Menendez.
Senator Menendez. Thank you, Mr. Chairman. Congratulations
to your ascension to the Chairmanship. I look forward to
working with you.
Since I have 5 minutes, let me try to get succinct
questions and succinct answers. One is I marvel at people who 3
years after our financial crisis still do not have full
regulation of the Wall Street derivatives and other key issues.
I am always asked by New Jerseyans, why is it that no one has
gone to jail? And so I marvel now that I hear that your
response to the question of the funding ability to pursue what
Congress passed and that the American people wanted to see is
going to be sufficient to promote regulations but not
sufficient to enforce them. Is that a fair statement of what
you responded to the Chairman?
Ms. Schapiro. I think that we will have a lot of
responsibilities once the rules are written for examination and
enforcement, registration, taking in massive amounts of data,
particularly in the swaps area where we will not be able to
rely on a self-regulatory organization, and it will be very
difficult for us to do any of that without additional
resources. So it is broader than just enforcing the law.
Senator Menendez. A cop on the beat without any bullets?
Mr. Gensler. I----
Senator Menendez. Well, it is a concern that I have because
if we are going to promote regulations pursuant to the law but
not to be able to enforce them, then it is a hollow promise to
the American people of what we said we were going to do so that
they would never face the risk again of collectively assuming
risk for the decisions of others. And so I appreciate your
honest answer to that because I think that will dictate part of
the debate as to how we go forward in the budget process to at
least, largely derived from the industry, have the resources so
that you can do the enforcement that the American people want
to see. Otherwise, I would not be surprised if they send
everybody home.
Ms. Schapiro. I agree with that, Senator. I was just trying
to say that it is broader than just enforcement. It is market
analysis and market surveillance and all of those things, but--
--
Senator Menendez. The technology side, as well----
Ms. Schapiro. Yes, absolutely.
Senator Menendez. Absolutely. I am in agreement with you.
Second, I recently wrote to you, Madam Chair, about cyber
security and attacks that have taken place against hacking at
NASDAQ and what not. I hope you can give us some sense, because
obviously market integrity is important in a variety of ways.
One of the ways is that we are sure that we are not having
markets being affected by those that are hacking it, and I hope
you could give us some sense of where you are headed in that
regard.
And let me get my third question and you can answer it, to
both of them, and that is both for you, Chairlady Schapiro and
Mr. Gensler, with reference to Title 7 of Dodd-Frank requires
that all swaps, whether cleared or uncleared, are reported to a
swap data repository. I would like to know what your agencies
are doing to ensure that the information being reported to
multiple repositories is not so fragmented and ultimately
allows you an accurate and complete view of the market
activity. One of the provisions of Dodd-Frank allows the CFTC
to designate one repository to provide direct electronic access
to the Commission for all swap data repository information and
I am wondering if you considered that.
So if you can tell me what we are doing on cyber security
and tell me what you are doing on that.
Ms. Schapiro. Certainly. I do not want to comment
specifically on the NASDAQ matter, which is obviously under
scrutiny by regulators broadly. But let me just say that given
the highly electronic nature of our markets and their highly
fragmented nature, financial institutions broadly and exchanges
are, I think, increasingly having to face cyber security
threats.
We work very closely with the exchanges. We have something
called the Automated Review Program, where our examiners
evaluate with the exchanges the quality of their information
security that is in place and what vulnerabilities they might
have. We recently asked all of the exchanges to provide us with
an audit of their information security policies, practices, and
systems so that we can have a baseline understanding of where
the many different markets are with respect to that.
We are taking this extremely seriously. We are working
closely with the FBI, the Secret Service, and the Department of
Justice, to make sure that we are pursuing all of these threats
as aggressively as we can. I can tell you that the exchanges
are taking it extremely seriously, as well. This is their
franchise.
With respect to the securities swap data repositories, we
have asked questions in our proposing release on swap data
repositories and their responsibilities and obligations and
core principles about whether we should create some kind of a
consolidated audit trail, so to the extent that multiple
repositories are developed, we can link the data and have an
adequate audit trail.
Our vision is that, ultimately, this should be part of the
Consolidated Audit Trail System that we proposed last year and
hope to make final later this year that would have all of the
markets provide to a central repository all of the
transactional information in the life of an order, from
inception through execution, that would give us the ability to
reconstruct trading in markets and look for violations of
Federal securities laws.
Mr. Gensler. With regard to data, which is so critical to
regulators to get an aggregate picture, Congress did say that
we could have a direct electronic feed from the data
repositories, which we appreciate. We have put that in the
proposed rules. We are looking for public comment.
One of the challenges is aggregating if there is more than
one data repository in an asset class, more than one for
interest rate swaps, for instance. And that is part of the
reason why the CFTC, we believe, does need to be efficient and
use technology. In the President's 2012 budget, it actually
recommends doubling technology so we can be a more efficient
agency and then aggregate that data with those direct
electronic feeds that you referred to.
Senator Menendez. Thank you, Mr. Chairman.
Chairman Johnson. Senator Johanns.
Senator Johanns. Mr. Chairman, thank you.
Chairman Bernanke, let me start with you, and I want to
visit with you a little bit about the interchange rules that
you put out. Let me just start out and offer an observation. I
think you folks stunned everybody. I think you stunned the
retailers. I think you stunned the banks. I do not think anyone
ever expected something this dramatic, this Draconian.
Do you agree with me that 80 percent of the transactions,
interchange transactions, are actually done by about a percent
and a half of the merchants out there? Is that an accurate
statistic?
Mr. Bernanke. I know it is very concentrated. Obviously,
large national firms account for a lot of the transactions, but
I do not know the exact number.
Senator Johanns. I think that is the best available
information I can find. Not only national firms, but
multinational players are some of the biggest economic players
in the world. This is not Joe's Hardware somewhere in Nebraska.
Does it not occur to you that, really, what we have done there
is we have taken money from this sector of the economy through
Congressional price fixing and directed you to transfer that
money to this sector of the economy, impacting the biggest
players, really, in the world on this side of the equation?
Mr. Bernanke. Well, Senator, let me react first to your
comment about Draconian. We tried very hard to follow the
language of the statute, which is pretty clear----
Senator Johanns. Do not get me wrong. I am not beating up
the messenger. If it feels that way, I am sorry about that. You
are just trying to do what we told you to do. Now, not me. I
voted against it, and I wish more of my colleagues would have.
But the end result of this is that, really, what you are doing
is moving money from here to here and it is the big players
that are going to see the benefit of that, the big retailers.
Would you agree with that?
Mr. Bernanke. The retailers will benefit, as you say,
according to the fraction of the total debit transactions that
they have. A question is to what extent, those savings are
passed on to customers, which is part of the objective.
Senator Johanns. But there is the problem with price
fixing. We cannot guarantee that, can we? We cannot guarantee
that a single consumer will get any benefit from that
legislation. I mean, we hope we do. You might even be able to
make an economic argument that they will. But the reality is,
we do not know, do we?
Mr. Bernanke. No, Senator. There is no guarantee,
certainly.
Senator Johanns. Yes. Now, let me, if I might, just go a
step further, because this sounds so preposterous to me. We are
seeing commodity prices go up. There are a lot of complex
reasons for that, just like the interchange fees. There is
drought in China and et cetera, et cetera. But good economists
are now saying, you are going to pay more at the grocery store
for various products because the input costs are going up so
dramatically. It is hard to argue against that at the moment.
You would not suggest that it would be good economic policy
that we pass a law that the price of a porterhouse steak or the
price of a gallon of milk could only go high, would you?
Mr. Bernanke. No.
Senator Johanns. Yes. Mr. Gensler, let me go to you. You
know, I have an interest in this end-user deal issue. We all
do. One of the challenges I have, and I am guessing you
probably have it, too, is how do we define end-user? I have got
small community banks out there. They want to protect
themselves, so they are in the derivatives market to protect
themselves against the risks they are incurring. Are they end-
users or are they financial institutions that should be
regulated here?
Mr. Gensler. The statute says that they are financial
companies and so most of those community banks are not swap
dealers. In fact, I am not aware of any small community bank
that would be a swap dealer. They have not come knocking on the
door. I do not think any, probably, are swap dealers. So they
would not be regulated that way.
The question of the end-users is whether they are brought
into clearing, whether they benefit and are brought into that
clearinghouse, and Congress did give us authority to exempt
them from that. We have asked the public a series of questions
to help us on that. We are working with fellow regulators here,
looking at that, not only for those community banks but also
Farm Credit institutions and national credit unions, as well.
Senator Johanns. Mr. Chairman, thank you.
Chairman Johnson. Senator Reed.
Senator Reed. Thanks very much, Mr. Chairman. Thank you,
ladies and gentlemen.
Chairman Bair, there has been a great deal of work over the
last several months of trying to sort out the mortgage
foreclosure issues. The State Attorneys General, the FSOC,
everyone has been engaged. It seems from the reports that with
respect to robosignings, liabilities have been established but
penalties have not. Is that the crux of the debate at the
moment?
Ms. Bair. Well, I would defer to the Comptroller on this.
They have been leading most of this. We are not the primary
regulator of the large servicers. I think the way I envision
this unfolding, I think all the agencies have been working
hoping for some type of global settlement that would include
robust enforcement actions as well as more appropriate remedial
measures, including perhaps some type of very dramatically
streamlined modification, not only to help borrowers get a fair
shot at an affordable mortgage, but also to help clear the
market, because there is such an increasing backlog here. So I
would hope those would be key elements of any final package,
but I think John might have something to add on that.
Senator Reed. Mr. Walsh, what is your impression? Is this
an issue of--what is holding up this settlement? Attorney
General Miller was here months ago talking about how they were
working and they were almost at the cusp, so could you
elaborate briefly?
Mr. Walsh. We have been at work actually since the last
time we appeared here in the Committee on a series of
examinations--we, the Fed, the OTS, and with FDIC participating
to some extent in the exams to identify the problems and
develop both the facts on the ground and then also to develop
what the appropriate remedies were. Those remedies include both
remedial actions that the servicers will have to take to fix
what is broken, and there are clearly some things broken, as I
mentioned in my testimony. There is also the question of the
penalty phase, if you will, of that process.
We have finished the work. We are getting to the point now
where we will be delivering documents to the banks and talking
about civil money penalties. But the comprehensive settlement
that we are talking about is one that would also involve
violations that are under the purview of other agencies. They
are Department of Justice, the FTC, the State Attorneys
General. And our effort has been to achieve a kind of
comprehensive settlement that will put the problem to bed and
let us get on with remediation. But the specific supervisory
piece is kind of one piece of a broader effort.
Senator Reed. Well, the Wall Street Journal has reported
today that you are recommending rather modest fines in the
penalty phase. Again, from following these revelations in the
newspaper, it seems like there was some intentional activity
and, in fact, I think if they are agreeing to some sort of
penalty phase, there's some admission of something more than
just negligence. Are you measuring these fines in terms of the
overall impact on people who have lost their homes through this
process in terms of the benefits that banks have derived and
are deriving from, at least prior to detection, this type of
operation and will that factor into your consideration?
Mr. Walsh. Although one is amazed at what the Wall Street
Journal finds out, in this case, we have not made decisions
about the level of penalties. That is the next phase to come.
We will be discussing that with the Federal Reserve and there
will be penalties at the holding company and servicer levels.
So that is a process that is still underway. But in terms of
the sort of total penalties involved, they will include other
things than just those we are looking at.
Senator Reed. Well, I think you have to move with some
expedition, because, again, the last time we were all here
together visiting, we were talking about how much progress we
were making in this global settlement. You have got to come to
a conclusion very quickly, as Chairman Bair said, in terms of
trying to settle the market and move forward.
Just a quick question, because I have only a few seconds
left, Mr. Chairman. Dodd-Frank creates the position of a Vice
Chairman of Supervision, or Vice Chairwoman of Supervision, for
the Fed. How close are we to getting that person in place, and
in the interim, who is taking the lead in terms of what you now
have as extraordinarily more complicated and vast supervisory
responsibilities?
Mr. Bernanke. Well, the Administration has not yet
nominated anyone, so we are still nowhere in that respect. But
Governor Tarullo, in particular, who has headed our bank
supervision area and has testified before this Committee a
number of times is taking the lead on the supervisory and
relevant rule writing issues.
Senator Reed. Thank you. Thank you, Mr. Chairman.
Chairman Johnson. Welcome to the Committee, Senator Kirk.
Senator Kirk. Thank you, Mr. Chairman. Congratulations and
I look forward to working with you on the VA-Mil Con
Subcommittee.
Chairman Bernanke, I am an admirer of yours. I just
finished Liaquat Ahamed's book, Lords of Finance, which is a
very human story of what central bankers go through. A quick
question on Dodd-Frank Titles 1 and 7, which creates the
Oversight Council and talks about systemic risk, regulatory
gap, and a key phrase, regardless of legal charter. So it is a
broad authority to examine risk. You have now established this
Office of Financial Security to look at any potential dangers
out there. Would you be able to look at U.S. States as a source
of systemic risk?
Mr. Bernanke. Our Office of Financial Stability is a small
office, which is just trying to look at different risks that
might emerge. It does not have any examination authority.
The risks arising from States or the municipal market would
be something that the Federal Reserve would pay attention to,
but I think probably the appropriate venue for that would be
the FSOC, the Council, where we would discuss mutually any
complications or ramifications of the developments there.
Senator Kirk. I would just note that Illinois has the worst
State-funded pension in the country, at 54 percent, but a new
analysis could mean it is as low as 38. The Chicago Tribune
reported this morning that the State deficit is $160 billion.
And we have concerns about California. I would just note that a
young State Representative from New Salem, Illinois, wrestled
with this issue in 1840, named Abraham Lincoln. The Senate
passed a resolution in 1841 advising Treasury Secretary Webster
not to guarantee State debt to preserve the full credit of the
United States. So it would appear that this could be a source
of systemic risk and something that is fully within your
capability to examine.
One other question. The Wall Street Journal 2 days ago
reported that our largest foreign creditor, China, had sold
$11.2 billion in Treasuries in November and another $4 billion
in December. A $15.2 billion unwinding is about a 1.7 percent
reduction in their total holdings, now down to $892 billion. Do
you see this movement by America's largest creditor abroad as a
source of systemic risk?
Mr. Bernanke. The international imbalances, the current
account imbalances and reserve accumulations could in principle
be a systemic risk and I think they contributed to the crisis.
That being said, I would not make much of those data. First of
all, they are actually incomplete data. And second, in the
short run, the main determinant of Chinese accumulation of
dollars is their need to keep the Renminbi pegged at the level
that they choose, and so it is pretty much they take whatever
they need to take in order to keep their currency at the
desired level.
Senator Kirk. Thank you, Mr. Chairman. I have reached out
to Chairman Warner on one of our subcommittees hoping that we
will look at continued dangers in Spain and Portugal and the
adequacy and size of the IMF, which I think this Committee
really needs to work on.
Thank you, Mr. Chairman. I yield back.
Chairman Johnson. Senator Akaka.
Senator Akaka. Thank you very much, Mr. Chairman, and
congratulations on becoming Chairman.
Good morning to our witnesses. Your agencies have worked
tirelessly on implementing this law. Your efforts have, I would
say in large part, been prompt, thorough, and transparent, and
we do appreciate that. Before I begin, I would like to thank
each of you for your leadership and recognize your staffs for
their extraordinary efforts.
Chairman Schapiro, I was pleased with the Commission's
staff study on the obligations of broker-dealers and investment
advisors. I am also encouraged by its recommendations in favor
of a uniform fiduciary standard. I know this is an area that
you have been interested in, so I have two questions for you.
First is how can confusion on the varying obligations of
financial professionals harm investors seeking investment
advice? And then second is how can a uniform fiduciary standard
reduce investors' costs and improve portfolio performance?
Ms. Schapiro. Thank you, Senator, and I know you share my
great interest in financial literacy and investor protection
and I have always appreciated your support. I think one of the
things we learned, the SEC commissioned a study by the RAND
Corporation several years ago that looked at this issue of
whether investors understood the relationship that they had
with a broker versus their relationship with an investment
advisor and found that there was actually significant
confusion, and our current study references much of the work
that was done by RAND Corporation.
The issue goes to whether the interests of the customer
must be put ahead of the interests of the financial
professional; whether the customer must come first, or whether
the duty owed should be what is currently under the broker-
dealer regime--the duty to only provide suitable
recommendations, understanding the net worth, the investment
goals, the risk tolerance, and so forth of the investor. So it
currently is a suitability standard of care under broker-
dealers, and a fiduciary duty to put the investor's interests
first under the investment advisor regime.
We felt that it really was not fair to leave customers to
guess which standard of care they were receiving when they were
dealing with a financial professional. It is just not something
that is transparent to investors. And so the staff study does
recommend, and the Dodd-Frank Act authorizes the Commission to
study, that a uniform fiduciary standard of care no less
stringent than the one that applies to investment advisors be
applied across financial professionals when giving advice to
retail investors about securities.
I think that the standard will alleviate confusion for
investors because it will become uniform, and I think while the
costs are hard to quantify--the staff made attempts to do some
of that, and we have asked for data in that context--I think
the benefits to investors of having their interests put first
are also hard to quantify but will be very real over time.
And so our next step is for the Commission to consider the
report carefully and make a determination about whether to move
forward with specific rules that would create this fiduciary
standard of care.
Senator Akaka. Chairman Schapiro, through the Dodd-Frank
Act, we provided the Commission with the authority to require
meaningful disclosures prior to the purchase of an investment
product or services. More effective and timely disclosures can
greatly improve investor financial decision making. What is the
Commission's plan to implement this specific provision and to
promote more responsible investor behavior in general?
Ms. Schapiro. Well, this is an area of long-time interest
to me, that investors get decision-useful, accessible
information at the right moment in the process of making a
decision about whether or not to invest. And what we often see
is that they get information after they have made the decision
to invest. So it would be my hope that we could, when our
calendar is a little bit more open after getting through many
of the Dodd-Frank rule-writing provisions, turn our attention
back to a point of sale disclosure inquiry and see if the
Commission can do something that helps investors get really
useful information, not pages and pages and pages of
boilerplate, and get it at the time that will help them make
the right decisions. And so it would be my hope that at some
point later this year we will be able to turn our attention
back to those issues.
Senator Akaka. Thank you very much for your responses.
Thank you, Mr. Chairman.
Chairman Johnson. Welcome to the Committee, Senator Moran.
Senator Moran. Mr. Chairman, thank you very much and
congratulations to you. I want to be a good Member of this
Committee. This is my first hearing and I want to impress you.
I assume that is done by speaking less than 5 minutes.
[Laughter.]
Chairman Johnson. It would.
Senator Moran. I have read the audience.
I want to talk just a bit about a broad issue and then a
very specific one. We have had lots of conversations about
small community banks, credit unions, small financial
institutions. They certainly dominate the economy in Kansas and
communities across our State. And in all the responses to
questions that have been given and in your testimony, you
indicate an effort to treat differently, to recognize the
difference between a community bank. I would assume that you
would agree that they are not a cause of systemic risk to our
economy. And yet the constant conversation with community
bankers, with credit unions, is very much about the regulations
that are coming our way. This conversation predates Dodd-Frank,
but it is exacerbated by Dodd-Frank. And so while I hear the
regulators saying, we understand the problem, we treat them
differently, there does not seem to be a recognition on the
part of bankers that that is the case.
My question, in a general sense, are my bankers just
normally complaining types who have it wrong, or are my
regulators wrong in which they say, we are taking care of this
issue. We are not overly regulating community banks.
Mr. Shelby, in his question about the loss of small banks,
the immediate response, Ms. Bair, by you was about the number
of closures. That is a component, I suppose, of losing small
banks, but what I have noticed in our economy is that it is
happening by consolidation, and there are perhaps economic
reasons that consolidation should occur, but my impression is
that it is occurring because of the regulatory cost.
In fact, I had a conversation with one of our large
regional bankers who tells me, for the first time in their
bank's history, they are receiving calls from small community
bankers saying, are you interested in buying our bank, because
we no longer can afford the regulations. It is no longer fun to
be a banker. And the cost of being a small community bank now
exceeds our ability to generate the revenues necessary to get a
return on investment.
So my question is, while we talk about treating differently
community banks, the evidence, at least from my view, does not
seem to be there. What are we missing? What needs to take
place? I think there is great value in that community bank in
making decisions and I would issue the caveat, I am not
necessarily here advocating on behalf of the bankers, but I am
here advocating on behalf of their customers, their borrowers,
their clients who in a State like Kansas or like South Dakota,
it is a place in which our farmers, ranchers, small businessmen
and women have the opportunity to expand, and I think there is
a tremendous consequence to our economy, including job
creation, in the failure of our banks being comfortable in
making loans.
And finally, in that regard, particularly real estate
loans. I have had half-a-dozen bankers tell me, we no longer
make real estate loans. You cannot come to our bank and borrow
money to buy a house because of all the regulations and our
fear of the next examination that we have missed something that
is going to then get us written up. Making a real estate loan
is no longer worth it. That is a terrible circumstance in small
town Kansas, small town America, in which the local bank is now
fearful of making a real estate loan, a mortgage on a house.
Your response?
Ms. Bair. Well, I would say a couple of things. I think you
are right. There has been consolidation. There are still over
7,000 community banks out there, but there is consolidation.
That is always a byproduct of a financial crisis. The stronger
absorb the weak and that is what is happening here.
We are very concerned about making sure that we have a
vibrant community banking sector. It is not our job to serve
community banks. It is our job to serve the public. But I think
the public interest is served by having diversity in their
choice of banking institutions, and I think, and I have said
this repeatedly throughout the crisis, we saw the community
banks were doing a better job of lending than the larger
institutions and that is just a fact.
We have very proactively tried to protect community banks
from the brunt of the Dodd-Frank requirements, which I think
are overwhelmingly targeted at large financial institutions.
They, as I indicated earlier, are changing the assessment base.
It has now reduced by 30 percent in aggregate, the premiums
that community banks will be paying for their deposit
insurance. They are, by and large, exempt from the compensation
rules that we just put out. We have tried to insulate them from
these QRM rules on securitizations, as you will see when those
come out. So I think we have acted on a number of fronts to try
to insulate them and strengthen their competitive position, and
as I said, I think ending ``too big to fail'' and robust
implementation of orderly liquidation authority will increase
funding costs for many large institutions and provide better
competitive parity.
The interchange fee issue, I think, is a very real one. We
are very concerned. We will be writing a comment letter. I
think the likelihood of this hurting community banks and
requiring them to increase the fees they charge for accounts is
much greater than any tiny benefit retail customers may get for
that, any savings to be passed along. I think that is just
obvious to me.
So we are very much hopeful that--I do not know if this
could be dealt with by Congress, but what we are planning to do
is work within the regulatory framework to see if there is
greater discretion to provide better protection for community
banks against discrimination and particularly by networks. But
I do think this is a real issue and could have an adverse
impact in a way that was clearly not intended by Congress in
enacting Dodd-Frank.
Senator Moran. I have set a standard for myself and the red
light is on. I would like to follow up with you, Ms. Schapiro,
about financial advisors, about community banks and lending
to--or making perhaps advice to local units of Government.
There is a new rule issued January 6 that has created great
concern. And, Ms. Bair, I will be in your hometown a week from
tomorrow. Thank you very much. Thank you, Mr. Chairman.
Ms. Schapiro. I will make time to come and see you as soon
as possible.
Chairman Johnson. Senator Tester.
Senator Tester. Yes. Thank you, Mr. Chairman. I, too, want
to congratulate you on your Chairmanship and I want to thank
everybody for being here today. I appreciate your efforts in a
difficult time.
Before I get to my questions on debit interchange rules
directed at you, Chairman Bernanke, I just do want to say that
the issues of regulation that Senator Moran brought up with
community banks and credit unions is a big one. I brought it up
with members of this panel at least on four different
occasions. The inconsistencies with regulation and the ``not on
my watch'' as it applies to community banks is a big concern to
me and it continues to be a big concern to me and I do not know
that consolidation in our financial system is a positive thing
overall, especially for rural America.
That aside, I want to talk about the debit interchange
rules, and Chairman Bernanke, it is an issue that I am very
concerned about. I was wondering, is there any way to actually
ensure that community banks and credit unions are exempted in
practice from this provision?
Mr. Bernanke. I hesitate to give a final answer on that
because we are still getting comments and a lot of input----
Senator Tester. In your opinion.
Mr. Bernanke. I think it may not be the case. It may not be
the case that they will be in practice exempt, but I do not
know for sure. Of course, one way to address it, if Congress
wants to, would be to require the networks to differentiate.
Senator Tester. Let us talk about that for a second. I
mean, with the routing provisions that are in this bill, first
of all, it is illegal to turn down a credit card, correct, just
to say, I do not want to use that credit card. Have you got
another one?
Mr. Bernanke. I do not think so.
Senator Tester. That is not illegal? OK. So if you go into
a retailer and you have a card and they look at it and say, we
do not want that, we would rather have a different one, that is
OK?
Mr. Bernanke. You certainly have the right to accept
different types, Visa, American Express, and so on----
Senator Tester. Yes, yes, yes. But what I am talking about
in this particular case is one that has a bigger fee involved
to it as far as interchange----
Mr. Bernanke. The restrictions are more a function of
requirements imposed by the Visa company, for example, as
opposed to legal restrictions.
Senator Tester. Yes, but if we have a two-tiered system,
the amount charged by interchange fees by the smaller banks and
credit unions will be higher than those by the big banks,
correct?
Mr. Bernanke. Correct.
Senator Tester. So what stops a retailer from saying, I do
not want to use that card because that is one of the small bank
ones. I would rather use one of the bigger ones. What stops
them from doing that, anything?
Mr. Bernanke. Not now, unless the company requires
acceptance of all its cards, which in many cases they do.
Senator Tester. OK. So it is--OK. So in practice, I cannot
imagine Visa is out there checking out--I mean, if it is a Visa
card, it is a Visa card. They are going to do their thing
anyway. It would seem to me that there is going to be undue
harm done to smaller banks when the retailer looks at this and
says, you know what? I am going with the smallest interchange
possible because it is going to help my bottom line. Do you see
it being that way?
Mr. Bernanke. As I mentioned earlier, I think there are two
reasons why this exemption might not work. One is exactly what
you are saying, that merchants might turn down small bank
cards, and the other is that the networks may not find it
economical to have a two-tier system.
Senator Tester. OK. Chairman Bair, from your point of view,
how do you think it is going to impact the institutions that
you supervise, particularly the small ones?
Ms. Bair. Well, I think it remains to be seen whether they
can be protected with this. I am skeptical for all the reasons
Chairman Bernanke has articulated, and so I think if they are
forced down to the 12-cent level, that is going to reduce the
income that they get for debit cards, so I think they are going
to have to make that up somewhere, probably by raising the fees
that they have on transaction accounts.
It could also have the unintended consequence of pushing
them into prepaid cards as opposed to debit cards, and prepaid
cards do not have the same level of protection as debit cards,
for instance, under Reg E. It is important--it is more
difficult with deposit insurance. You have to be very careful
about how you structure those accounts to get deposit
insurance. So I think that might be--that would not be helpful
for consumers and that might be an unintended consequence.
So we agree with you. This really needs to be fixed, and
hopefully through the current regulatory authority, and that is
what we are looking at right now.
Senator Tester. Just let me ask this. You are not sitting
on this side of the table and I am not sitting on your side of
the table, but do you think it would be beneficial to delay
this provision to take a look at unintended consequences?
Ms. Bair. Yes, I--you know, it was--look, there are
legitimate policy arguments on both sides of this, but it was
done very quickly. I think the full policy ramifications, who
is paying for what, who is going to pay more and who is going
to pay less under this is something that maybe was not dealt
with as thoroughly as it might have been.
Senator Tester. Thank you all for being here. I wish we had
another two or 3 hours just for my questions. Thank you, Mr.
Chairman.
Chairman Johnson. Senator Wicker, welcome to the Committee.
Senator Wicker. Thank you, Mr. Chairman. I am delighted to
be on the Committee and I have enjoyed the testimony, which I
have watched on television from my office while trying to get a
few other things done, so I am glad to be back in the room, and
thank you all for your patience and for working with us today.
Let me ask Chairman Schapiro, Dodd-Frank is a familiar
term. Less familiar is Franken-Wicker, but it was an amendment
that Al Franken and I authored which passed, actually, in the
Senate by a vote of 64 to 35 with regard to the rating
agencies. Now, as you know, there are many people, including
me, who feel that the rating agencies were one of the principal
reasons that we encountered the meltdown that we did in 2008.
Our amendment would have required the securitized product to be
assigned for rating by the SEC rather than having the companies
themselves shop around for their favorite rating agency.
When we got to conference, this Franken-Wicker language was
dropped, but in the final version, the law does require the SEC
to implement a study on credit rating agencies and gives the
SEC the authority to implement Franken-Wicker if it is deemed
to be beneficial to the public's interest. So how is that study
coming and what are your thoughts on this?
Ms. Schapiro. That is right, Senator. We actually have many
studies on rating agencies, but this is certainly an important
one. We should be going out shortly with a request for comments
from the public on ways to--alternative ways to both structure
a system for the assignment of ratings as well as the specifics
of having the SEC do it or having a self-regulatory
organization do it or having another entity do it.
It has a 2-year time deadline, I believe, which is why we
have not gotten it out the door yet in terms of seeking public
comment, but the staff has worked on the notice and hopefully
it will go very soon. That will kick off the study from our
perspective and then we will be able, with the comments, begin
to put together the different ideas.
Senator Wicker. Do you share my conclusion that defective
and improper ratings were a large part of the problem in 2007-
2008?
Ms. Schapiro. I very much share that perspective and have
spoken a lot over the last 2 years about the contribution of
rating agencies to the financial crisis. And the SEC also gets
much broader responsibility under Dodd-Frank with respect to
rules and examinations of credit rating agencies, including a
report to Congress on our annual examination findings and other
issues, and we are well underway with all of those
examinations.
Senator Wicker. But under the law now, a company wishing to
be rated still has completely free reign to go out and shop
around and pick the rating agency of their choice?
Ms. Schapiro. We have proposed rules to require--to try to
discourage rating shopping, which would require disclosure that
you did shop around for ratings and you ultimately selected the
agency that gave you the highest rating in the preliminary
rating. So we have done some disclosure rules in that regard
and we have done a number of other rules to try to limit the
conflicts of interest that are really inherent in this issuer-
pays model that is the predominant model among the rating
agencies right now.
Senator Wicker. Well, thank you, and I hope you will be
attentive to this issue.
Chairman Bernanke, I have a question about qualified
residential mortgages and what the unintended consequences of
the QRMs might be in actually forcing or directing housing
finance toward the Government instead of toward the private
sector. As you know, the Federal Government now dominates
housing finance in this country, and I think it is the stated
position of the Administration, and certainly my position, that
we want private sector capital to return to the market to
replace taxpayer guaranteed mortgages.
Federal Housing Administration mortgages are exempt from
the risk retention requirement, the 5 percent risk retention
requirement, because they are considered by definition
qualified residential mortgages. Might this cause FHA mortgages
to grow and drive out the private sector and first-time
homebuyer mortgages, and what steps might we take to ensure
that the QRM rules do not artificially push even more borrowers
into taxpayer guaranteed mortgages rather than the private
market?
Mr. Bernanke. Well, I believe part of the proposal that
Treasury made was that FHA would become a smaller part of the
housing market and be restricted to the appropriate group of
people who are qualifying for that type of mortgage. Those
mortgages are implicitly Government guaranteed and therefore,
the securitization retention requirement is not necessarily
relevant.
I think the main purpose of the QRM is just to provide some
standardized underwriting criteria that are sufficiently strong
that the securitizer can be exempt from the retention
requirement. But they are entirely consistent with a private
market in securitization and a housing market where the
Government's role is quite limited, and if it is other than
through FHA and other special programs, it becomes relevant
only during periods of crisis.
Senator Wicker. Well, I know we are out of time, but have
you received comments or has the Fed received comments from
Americans expressing the view that this rule and the exemption
of Federal Housing Administration mortgages might drive more
and more mortgagors to the public rather than the private
market? Is this something that has been brought to your----
Mr. Bernanke. We have not issued a request yet for
comments; so we will do that and then we will get the comments,
but we have not gotten to that stage yet.
Senator Wicker. Thank you.
Chairman Johnson. Last but not least, Senator Isakson.
Senator Isakson. Mr. Chairman, thank you very much, and
thank you for including me, allowing me to sit at the dais
today, and thanks to all that have testified. I appreciate your
time and I will be brief.
My question will be for Ms. Bair, but it really applies to
all of you because all of you have some input on the qualified
residential mortgage rule that is being written. Senator
Wicker's comments could not be more appropriate.
In your testimony, your printed testimony, Ms. Bair, you
say that we will continue to work to move these rules forward
without delay. We are determined to get them right the first
time. And it is to that subject I want to speak.
The QRM amendment which Senator Hagan, myself, and Senator
Landrieu wrote, is very specific in what the theme of the
requirements shall be in terms of underwriting--verified
income, verified job, credit rating, ability to amortize the
mortgage. On down payment, it did not specify an amount, but it
specified that any amount of loan above 80 percent would have
to be privately insured and carry private mortgage insurance.
I have seen a letter written to you all by a large
institution recommending a down payment requirement for a loan
to be a QRM loan at 30 percent. What that would, in effect, do
would put a handful of people in control of the entire mortgage
market privately and force even more people into FHA than are
already there. Our markets from the VA loans of the post-World
War II until the beginning of the collapse, which was lending
practices in 2000, carried mortgage insurance on 90 and 95
percent loans that performed equally as well as larger down
payment loans. Forty-one percent of all purchasers are first-
time homebuyers, 95 percent of whom do not have 20 percent or
30 percent to put down.
So my request is, when you address this subject, because
you could protract what is already a protracted real estate
recession by denying liquidity in the private markets, to
reasonable mortgages underwritten properly. With that said, I
just hope you will follow the guidelines and the parameters
that were issued in a QRM amendment by Ms. Landrieu, Ms. Hagan,
and myself on the down payment subject and the private mortgage
insurance, as well. I hope you will be willing to do that.
Ms. Bair. Well, Senator, I do think it is important to
emphasize that the QRM standards will not be the standards for
all mortgages. They do not apply to portfolio lenders. They do
not apply for those who will have the 5 percent risk retention.
And I think the intention of the agencies is that there will be
multiple funding mechanisms for mortgages and for portfolio
lenders, those who retain all the risk as well as those that
just opt for the 5 percent risk retention, because there is
some skin in the game. There is some natural economic incentive
to have stronger underwriting standards. You can provide more
flexibility.
So the higher standards for QRMs are really just trying to
compensate for the lack of skin in the game by the issuer, and
so I do think we--I will have to be honest with you. I have
talked a lot with my staff about this. We are very open. We
want comment on this question. But we are unable to document
that PMI lowers default risk. We just cannot find it. And if
you have additional information, I would love to see it. We do
have a lot of data that shows strong correlations between LTVs
and loan performance.
So this is the framework we are trying to come up with. I
think we are absolutely consistent with Dodd-Frank as it was
written and we will seek comment on this and I will remain
open-minded on this, I commit to you. But I do want to make
sure everyone understands that we do not anticipate the QRM
standards to be the standards for all mortgages and that,
again, this is just to compensate for the lack of economic
incentive because there is no skin in the game on the part of
the issuer for portfolio lenders, and those securitizers who
want to retain the 5 percent, they will have much more
flexibility.
Senator Isakson. First of all, I will give you the
historical data. I am old enough to have sold houses in 1968
when 90 percent loans came into practice with MGIC and later in
1972 when 95 percent loans came into effect and there is good
historical data on the default rates being consistent with
those with larger down payments if they are well underwritten,
which is the whole intent of QRM.
But the other point that I would also make is, I understand
the 5 percent risk retention, but if QRM's down payment
requirement is so restrictive that it takes out most of the
marketplace, then you are going to have a very small number of
people controlling conventional lending to everybody else
because they will be risk retention lenders and they will be
able to price it and they will be able to control it, which
will dramatically raise the potential costs of the loans to the
borrowers, somewhat like B, C, and D credits and subprime did.
They began to push the rates up and securitized to sell a
premium rate, but in fact underwrote poorly on the loans.
So I want to--that is a very important decision you will
all be making and I hope you will--I will get the data to you
this afternoon, as a matter of fact. I have been working on it.
Thank you very much, and Mr. Chairman, thank you very much
for your time.
Chairman Johnson. Thanks, Senator Isakson.
We have a tough road ahead of us on the Committee, but I
believe we have a stronger financial system because of Dodd-
Frank. Over the next weeks and months, we will continue to
oversee the implementation of Dodd-Frank. I look forward to
hearing more from my colleagues and the regulators. I am sure
that we will continue to hear about numerous successes and
challenges, and it is important for us to conduct thorough
oversight.
Thanks again to my colleagues and our panelists for being
here today. This hearing is adjourned.
[Whereupon, at 12:19 p.m., the hearing was adjourned.]
[Prepared statements and responses to written questions
supplied for the record follow:]
PREPARED STATEMENT OF BEN S. BERNANKE
Chairman, Board of Governors of the Federal Reserve System
February 17, 2011
Chairman Johnson, Ranking Member Shelby, and other Members of the
Committee, thank you for the opportunity to testify about the Federal
Reserve's implementation of the Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010 (Dodd-Frank Act). The Dodd-Frank Act
addresses critical gaps and weaknesses in the U.S. regulatory
framework, many of which were revealed by the recent financial crisis.
The Federal Reserve is committed to working with the other U.S.
financial regulatory agencies to implement the act effectively and
expeditiously. We are also cooperating with our international
counterparts to further strengthen financial regulation, to ensure a
level playing field across countries, and to enhance international
supervisory cooperation. And we have revamped the supervisory function
at the Federal Reserve to allow us to better meet the objectives of the
act.
The act gives the Federal Reserve important responsibilities both
to make rules to implement the law and to apply the new rules. In
particular, the act requires the Federal Reserve to complete more than
50 rulemakings and sets of formal guidelines, as well as a number of
studies and reports. We have also been assigned formal responsibilities
to consult and collaborate with other agencies on a substantial number
of additional rules, provisions, and studies. So that we meet our
obligations on time, we are drawing on expertise and resources from
across the Federal Reserve System in banking supervision, economic
research, financial markets, consumer protection, payments, and legal
analysis. In all, more than 300 members of the Federal Reserve staff
are working on Dodd-Frank implementation projects. We have created a
senior staff position to coordinate our efforts and have developed
project-reporting and tracking tools to facilitate management and
oversight of all of our implementation responsibilities.
We have made considerable progress in carrying out our assigned
responsibilities. We have been providing significant support to the
Financial Stability Oversight Council, of which the Federal Reserve is
a member. We are assisting the council in designing its systemic risk
monitoring and evaluation process and in developing its analytical
framework and procedures for identifying systemically important nonbank
firms and financial market utilities. We also are helping the new
Office of Financial Research at the Treasury Department develop
potential data reporting standards to support the council's systemic
risk monitoring and evaluation duties. We contributed significantly to
the council's recent studies--one on the Volcker rule's restrictions on
banking entities' proprietary trading and private fund activities and a
second one on the act's financial-sector concentration limit. And we
are now developing for public comment the necessary rules to implement
these important restrictions and limits. Last week, the Board adopted a
final rule to ensure that activities prohibited by the Volcker rule are
divested or terminated in the time period required by the act.
We also have been moving forward rapidly in other areas. Last fall,
we issued a study on the potential effect of the act's credit risk
retention requirements on securitization markets, as well as an advance
notice of proposed rulemaking on the use of credit ratings in the
regulations of the Federal banking agencies. In addition, in December,
the Board and the other Federal banking agencies requested comment on a
proposed rule that would implement the capital floors required by the
Collins Amendment. In December, we also requested comment on proposed
rules that would establish standards for debit card interchange fees
and implement the act's prohibition on network exclusivity arrangements
and routing restrictions. In January, the Board, together with the
Office of the Comptroller of the Currency, Federal Deposit Insurance
Corporation, and Office of Thrift Supervision (OTS), provided the
Congress a comprehensive report on the agencies' progress and plans
relating to the transfer of the supervisory authority of the OTS for
thrifts and thrift holding companies. In addition, as provided by the
act, we and the Federal Reserve Banks each established offices to
consolidate and build on our existing equal opportunity programs to
promote diversity in management, employment, and business activities.
We continue to work closely and cooperatively with other agencies
to develop joint rules to implement the credit risk retention
requirements for securitizations, resolution plans (or ``living
wills'') for large bank holding companies and council-designated
nonbank firms, and capital and margin requirements for swap dealers and
major swap participants. We are consulting with the Securities and
Exchange Commission (SEC) and the Commodity Futures Trading Commission
(CFTC) on a variety of rules to enhance the safety and efficiency of
the derivatives markets, including rules that would require most
standardized derivatives to be centrally traded and cleared, require
the registration and prudential regulation of swap dealers and major
swap participants, and improve the transparency and reporting of
derivatives transactions. We also are coordinating with the SEC and the
CFTC on the agencies' respective rulemakings on risk-management
standards for financial market utilities, and we are working with
market regulators and central banks in other countries to update the
international standards for these types of utilities.
The transfer of the Federal Reserve's consumer protection
responsibilities specified in the act to the new Bureau of Consumer
Financial Protection (CFPB) is well under way. A team at the Board,
headed by Governor Duke, is working closely with the staff at the CFPB
and at the Treasury to facilitate the transition. We have provided
technical assistance as well as staff members to the CFPB to assist it
in setting up its functions. We have finalized funding agreements and
provided initial funding to the CFPB. Moreover, we have made
substantial progress toward a framework for transferring Federal
Reserve staff members to the CFPB and integrating CFPB employees into
the relevant Federal Reserve benefit programs.
One of the Federal Reserve's most important Dodd-Frank
implementation projects is to develop more-stringent prudential
standards for all large banking organizations and nonbank firms
designated by the council. Besides capital, liquidity, and resolution
plans, these standards will include Federal Reserve- and firm-conducted
stress tests, new counterparty credit limits, and risk-management
requirements. We are working to produce a well-integrated set of rules
that will significantly strengthen the prudential framework for large,
complex financial firms and the financial system.
Complementing these efforts under Dodd-Frank, the Federal Reserve
has been working for some time with other regulatory agencies and
central banks around the world to design and implement a stronger set
of prudential requirements for internationally active banking firms.
These efforts resulted in the adoption in the summer of 2009 of more
stringent regulatory capital standards for trading activities and
securitization exposures. And, of course, it also includes the
agreements reached in the past couple of months on the major elements
of the new Basel III prudential framework for globally active banks.
Basel III should make the financial system more stable and reduce the
likelihood of future financial crises by requiring these banks to hold
more and better-quality capital and more-robust liquidity buffers. We
are committed to adopting the Basel III framework in a timely manner.
In December 2010, we requested comment with the other U.S. banking
agencies on proposed rules that would implement the 2009 trading book
reforms, and we are already working to incorporate other aspects of the
Basel III framework into U.S. regulations.
To be effective, regulation must be supported by strong
supervision. The act expands the supervisory responsibilities of the
Federal Reserve to include thrift holding companies and nonbank
financial firms that the council designates as systemically important,
along with certain payment, clearing, and settlement utilities that are
similarly designated. Reflecting the expansion of our supervisory
responsibilities, we are working to ensure that we have the necessary
resources and expertise to oversee a broader range of financial firms
and business models.
The act also requires supervisors to take a macroprudential
approach; that is, the Federal Reserve and other financial regulatory
agencies are expected to supervise financial institutions and critical
infrastructures with an eye toward not only the safety and soundness of
each individual firm, but also taking into account risks to overall
financial stability.
We believe that a successful macroprudential approach to
supervision requires both a multidisciplinary and wide-ranging
perspective. Our experience in 2009 with the Supervisory Capital
Assessment Program (popularly known as the bank stress tests)
demonstrated the feasibility and benefits of employing such a
perspective. Building on that experience and other lessons learned from
the recent financial crisis, we have reoriented our supervision of the
largest, most complex banking firms to include greater use of
horizontal, or cross-firm, evaluations of the practices and portfolios
of firms, improved quantitative surveillance mechanisms, and better use
of the broad range of skills of the Federal Reserve staff. And we have
created a new Office of Financial Stability within the Federal Reserve,
which will monitor financial developments across a range of markets and
firms and coordinate with the council and with other agencies to
strengthen systemic oversight.
The Federal Reserve is committed to its long-standing practice of
ensuring that all of its rulemakings are conducted in a fair, open, and
transparent manner. Accordingly, we are disclosing on our public Web
site summaries of all communications with members of the public--
including banks, trade associations, consumer groups, and academics--
regarding matters subject to a proposed or potential future rulemaking
under the act. We also have implemented measures within the act to
enhance the Federal Reserve's transparency. In December, we publicly
released detailed information regarding individual transactions
conducted between December 1, 2007, and July 20, 2010, across a wide
range of Federal Reserve credit and liquidity programs, and we are
developing the necessary processes to disclose information concerning
transactions conducted after July 20, 2010, on a delayed basis as
provided in the act.
To conclude, the Dodd-Frank Act is a major step forward for
financial regulation in the United States. The Federal Reserve will
work closely with our fellow regulators, the Congress, and the
Administration to ensure that the law is implemented expeditiously and
in a manner that best protects the stability of our financial system
and our economy.
______
PREPARED STATEMENT OF SHEILA C. BAIR
Chairman, Federal Deposit Insurance Corporation
February 17, 2011
Chairman Johnson, Ranking Member Shelby, and Members of the
Committee, thank you for the opportunity to testify today on the
Federal Deposit Insurance Corporation's (FDIC) progress in implementing
the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-
Frank Act).
The recent financial crisis exposed grave shortcomings in our
framework for regulating the financial system. Insufficient capital at
many financial institutions, misaligned incentives in securitization
markets, and the rise of a largely unregulated shadow banking system
bred excess and instability in our financial system that led directly
to the crisis of September 2008. When the crisis hit, regulatory
options for responding to distress in large, nonbank financial
companies left policy makers with a no-win dilemma: either prop up
failing institutions with expensive bailouts or allow destabilizing
liquidations through the normal bankruptcy process. The bankruptcy of
Lehman Brothers Holdings Inc. (Lehman) in September 2008 triggered a
liquidity crisis at AIG and other institutions that froze our system of
intercompany finance and made the 2007-09 recession the most severe
since the 1930s.
The landmark Dodd-Frank Act enacted last year created a
comprehensive new regulatory and resolution regime that is designed to
protect the American people from the severe economic consequences of
financial instability. The Dodd-Frank Act gave regulators tools to
limit risk in individual financial institutions and transactions,
enhance the supervision of large nonbank financial companies, and
facilitate the orderly closing and liquidation of large banking
organizations and nonbank financial companies in the event of failure.
Recognizing the urgent need for reform and the importance of a
deliberative process, the Act directed the FDIC and the other
regulatory agencies to promulgate implementing regulations under a
notice and comment process and to do so within specified time frames.
The FDIC is required or authorized to implement some 44 regulations,
including 18 independent and 26 joint rulemakings. The Dodd-Frank Act
also grants the FDIC new or enhanced enforcement authorities, new
reporting requirements, and responsibility for numerous other actions.
We are now in the process of implementing the provisions of the
Dodd-Frank Act as expeditiously and transparently as possible. The
lessons of history--recent and distant--remind us that financial
markets cannot function for long in an efficient and stable manner
without strong, clear regulatory guidelines. We know all too well that
the market structures in place prior to the crisis led to misaligned
incentives, a lack of transparency, insufficient capital, and excessive
risk taking. As a result, the U.S. and global economies suffered a
grievous blow. Millions of Americans lost their jobs, their homes, or
both, even as almost all of our largest financial institutions received
assistance from the Government that enabled them to survive and
recover. Memories of such events tend to be short once a crisis has
passed, but we as regulators must never forget the enormous economic
costs of the inadequate regulatory framework that allowed the crisis to
occur in the first place. At the same time, our approach must also
account for the potential high cost of needless or ill-conceived
regulation--particularly to those in the vital community banking sector
whose lending to creditworthy borrowers is necessary for a sustained
economic recovery.
My testimony will review the FDIC's efforts to date to implement
the provisions of Dodd-Frank and highlight what we see as issues of
particular importance.
Implementing the Resolution Authority and Ending ``Too Big To Fail''
A significant number of the FDIC's rulemakings stem from the Dodd-
Frank Act's mandate to end ``Too Big to Fail.'' This includes our
Orderly Liquidation Authority under Title II of the Act, our joint
rulemaking with the Board of Governors of the Federal Reserve System
(FRB) on requirements for resolution plans (or living wills) that will
apply to systemically important financial institutions (SIFIs), and the
development of criteria for determining which firms will be designated
as SIFIs by the Financial Stability Oversight Council (FSOC).
Orderly Liquidation Authority
The Lehman bankruptcy in September 2008 demonstrated the confusion
and chaos that can result when a large, highly complex financial
institution collapses into bankruptcy. The Lehman bankruptcy had an
immediate and negative effect on U.S. financial stability and has
proven to be a disorderly, time-consuming, and expensive process.
Unfortunately, bankruptcy cannot always provide the basis for an
orderly resolution of a SIFI or preserve financial stability. To
overcome these problems, the Dodd-Frank Act provides for an Orderly
Liquidation Authority with the ability to: plan for a resolution and
liquidation, provide liquidity to maintain key assets and operations,
and conduct an open bidding process to sell a SIFI and its assets and
operations to the private sector as quickly as possible.
While Title I of the Dodd-Frank Act significantly enhances
regulators' ability to conduct advance resolution planning for SIFIs,
Title II vests the FDIC with legal resolution authorities similar to
those that it already applies to insured depository institutions
(IDIs).
If the FDIC is appointed as receiver, it is required to carry out
an orderly liquidation of the financial company. Title II also requires
that creditors and shareholders ``bear the losses of the financial
company'' and instructs the FDIC to liquidate a failing SIFI in a
manner that maximizes the value of the company's assets, minimizes
losses, mitigates risk, and minimizes moral hazard. Under this
authority, common and preferred stockholders, debt holders and other
unsecured creditors will know that they will bear the losses of any
institution placed into receivership, and management will know that it
could be replaced.
The new requirements will ensure that the largest financial
companies can be wound down in an orderly fashion without taxpayer
cost. Under Title II of the Dodd-Frank Act, there are no more bailouts.
In implementing the Act's requirements, our explicit goal is that all
market players should share this firm expectation and that financial
institution credit ratings should, over time, fully reflect this fact.
By developing a credible process for resolving a troubled SIFI, market
discipline will be reinforced and moral hazard reduced.
From the FDIC's more than 75 years of bank resolution experience,
we have found that clear legal authority and transparent rules on
creditor priority are important elements of an orderly resolution
regime. To that end, the FDIC issued an interim final rule implementing
certain provisions of our Orderly Liquidation Authority on January 25,
2011. In the interim rule, the FDIC posed questions to solicit public
comment on such issues as reducing moral hazard and increasing market
discipline. We also asked for comment on guidelines that would create
increased certainty in establishing fair market value of various types
of collateral for secured claims. The rule makes clear that similarly
situated creditors would never be treated in a disparate manner except
to preserve essential operations or to maximize the value of the
receivership as a whole. Importantly, this discretion will not be used
to favor creditors based on their size or interconnectedness. In other
words, there is no avenue for a backdoor bailout.
Comments on the interim rule and the accompanying questions will
help us further refine the rule and bring more certainty to the
industry as it navigates the recalibrated regulatory environment. This
summer we expect to finalize other rules under our Title II authority
that will govern the finer details of how the FDIC will wind down
failed financial companies in receivership.
Resolution Plans
Even with the mechanism of the Orderly Liquidation Authority in
place, ending ``Too Big to Fail'' requires that regulators obtain
critical information and shape the structure and behavior of SIFIs
before a crisis occurs. This is why the Dodd-Frank Act firms to
maintain credible, actionable resolution plans that will facilitate
their orderly resolution if they should fail. Without access to
critical information contained in credible resolution plans, the FDIC's
ability to implement an effective and orderly liquidation process could
be significantly impaired.
As noted in my September testimony, the court-appointed trustee
overseeing the liquidation of Lehman Brothers Inc. found that the lack
of a disaster plan ``contributed to the chaos'' of the Lehman
bankruptcy and the liquidation of its U.S. broker-dealer. Recognizing
this, the Dodd-Frank Act created critical authorities designed to give
the FDIC, the FRB, and the FSOC information from the largest
potentially systemic financial companies that will allow for extensive
advance planning both by regulators and by the companies themselves.
The Dodd-Frank Act requires the FDIC and the FRB jointly to issue
regulations within 18 months of enactment to implement new resolution
planning and reporting requirements that apply to bank holding
companies with total assets of $50 billion or more and nonbank
financial companies designated for FRB supervision by the FSOC.
Importantly, the statute requires both periodic reporting of
detailed information by these financial companies and the development
and submission of resolution plans that allow ``for rapid and orderly
resolution in the event of material financial distress or failure.''
The resolution plan requirement in the Dodd-Frank Act appropriately
places the responsibility on financial companies to develop their own
resolution plans in coordination with the FDIC and the FRB.
The Dodd-Frank Act lays out steps that must be taken with regard to
the resolution plans. First, the FRB and the FDIC must review each
company's plan to determine whether it is both credible and useful for
facilitating an orderly resolution under the Bankruptcy Code. Making
these determinations will necessarily involve the agencies having
access to the company and relevant information. This new resolution
plan regulation will require financial companies to look critically at
the often highly complex and interconnected corporate structures that
have emerged within the financial sector.
If a plan is found to be deficient, the company will be asked to
submit a revised plan to correct any identified deficiencies. The
revised plan could include changes in business operations and corporate
structure to facilitate implementation of the plan. If the company
fails to resubmit a plan that corrects the identified deficiencies, the
Dodd-Frank Act authorizes the FRB and the FDIC jointly to impose more
stringent capital, leverage or liquidity requirements. In addition, the
agencies may impose restrictions on growth, activities, or operations
of the company or any subsidiary. In certain cases, divestiture of
portions of the financial company may be required. Just last month,
Neil Barofsky, the Special Inspector General for the Troubled Asset
Relief Program, recognized that this regulatory authority, including
the ability to require divestiture, provides an avenue to convincing
the marketplace that SIFIs will not receive Government assistance in a
future crisis. \1\ The FDIC is working with the FRB to develop
requirements for these resolution plans. It is essential that we
complete this joint rule as soon as possible.
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\1\ Transcript of interview with Neil Barofsky, National Public
Radio, January 27, 2011. http://www.npr.org/2011/01/27/133264711/
Troubled-Asset-Relief-Program-Update
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SIFI Designation
The Dodd-Frank Act created the FSOC to plug important gaps between
existing regulatory jurisdictions where financial risks grew in the
years leading up to the recent crisis. An important responsibility of
the FSOC is to develop criteria for designating SIFIs that will be
subject to enhanced FRB supervision and the requirement to maintain
resolution plans. To protect the U.S. financial system, it is essential
that we have the means to identify which firms in fact qualify as SIFIs
so we do not find ourselves with a troubled firm that is placed into a
Title II liquidation without having a resolution plan in place.
Since enactment of the Dodd-Frank Act, experienced and capable
staff from each of the member agencies have been collaborating in
implementing the FSOC's responsibilities, including establishing the
criteria for identifying SIFIs. The Dodd-Frank Act specifies a number
of factors that can be considered when designating a nonbank financial
company for enhanced supervision, including: leverage; off-balance-
sheet exposures; and the nature, scope, size, scale, concentration,
interconnectedness, and mix of activities. The FSOC will develop a
combination of qualitative and quantitative measures of potential risks
posed by an individual nonbank institution to U.S. financial stability.
The nonbank financial sector encompasses a multitude of financial
activities and business models, and potential systemic risks vary
significantly across the sector. A staff committee working under the
FSOC has segmented the nonbank sector into four broad categories: (1)
the hedge fund, private equity firm, and asset management industries;
(2) the insurance industry; (3) specialty lenders; and (4) broker-
dealers and futures commission merchants. The Council has begun
developing measures of potential risks posed by these firms. Once these
measures are agreed upon, the FSOC may need to request data or
information that is not currently collected or otherwise available in
public filings.
Recognizing the need for accurate, clear, and high quality
information, Congress granted the FSOC the authority to gather and
review financial data and reports from nonbank financial companies and
bank holding companies, and if appropriate, request that the FRB
conduct an exam of the company for purposes of making a systemic
designation. By collecting more information in advance of designation,
the FSOC can be much more judicious in determining which firms it
designates as SIFIs. This will minimize both the threat of an
unexpected systemic failure and the number of firms that will be
subject to additional regulatory requirements under Title I.
Last October, the FSOC issued an Advance Notice of Proposed
Rulemaking regarding the criteria that should inform the FSOC's
designation of nonbank financial companies. The FSOC received
approximately 50 comments from industry trade associations, individual
firms, and individuals. On January 26, the FSOC issued a Notice of
Proposed Rulemaking, with a 30-day comment period, describing the
criteria that will inform--and the processes and procedures established
under the Dodd-Frank Act--the FSOC's designation of nonbank financial
companies. The FDIC would welcome comments particularly on whether the
rule can offer more specificity on criteria for SIFI designation. The
FSOC is committed to adopting a final rule on this issue later this
year, with the first designations to occur shortly thereafter.
Strengthening and Reforming the Deposit Insurance Fund
Prior to 2006, statutory restrictions prevented the FDIC from
building up the Deposit Insurance Fund (DIF) balance when conditions
were favorable in order to withstand losses under adverse conditions
without sharply increasing premiums. The FDIC was also largely unable
to charge premiums according to risk. In fact, it was unable to charge
most institutions any premium as long as the DIF balance exceeded $1.25
per $100 of insured deposits. Congress enacted reforms in 2006 that
permitted the FDIC to charge all banks a risk-based premium and
provided additional, but limited, flexibility to the FDIC to manage the
size of the DIF. The FDIC changed its risk-based pricing rules to take
advantage of the new law, but the onset of the recent crisis prevented
the FDIC from increasing the DIF balance. In this crisis, as in the
previous one, the balance of the DIF became negative, hitting a low of
negative $20.9 billion in December 2009. The DIF balance has improved
in each subsequent quarter, and stood at negative $8.0 billion as of
last September. Through a special assessment and the prepayment of
premiums, the FDIC took the necessary steps to ensure that it did not
have to rely on taxpayer funds during the crisis to protect insured
depositors.
In the Dodd-Frank Act, Congress revised the statutory authorities
governing the FDIC's management of the DIF. The FDIC now has the
ability to achieve goals for deposit insurance fund management that it
has sought to achieve for decades but has lacked the tools to
accomplish. The FDIC has increased flexibility to manage the DIF to
maintain a positive fund balance even during a banking crisis while
maintaining steady and predictable assessment rates throughout economic
and credit cycles.
Specifically, the Dodd-Frank Act raised the minimum level for the
Designated Reserve Ratio (DRR) from 1.15 percent to 1.35 percent and
removed the requirement that the FDIC pay dividends of one-half of any
amount in the DIF above a reserve ratio of 1.35 percent. The
legislation allows the FDIC Board to suspend or limit dividends when
the reserve ratio exceeds 1.50 percent.
FDIC analysis has shown that the dividend rule and the reserve
ratio target are among the most important factors in maximizing the
probability that the DIF will remain positive during a crisis, when
losses are high, and in preventing sharp upswings in assessment rates,
particularly during a crisis. This analysis has also shown that at a
minimum the DIF reserve ratio (the ratio of the DIF balance to
estimated insured deposits) should be about 2 percent in advance of a
banking crisis in order to avoid high deposit insurance assessment
rates when banking institutions are strained and least able to pay.
Consequently, the FDIC Board completed two rulemakings, one in
December 2010, and one earlier this month, that together form the basis
for a long-term strategy for DIF management and achievement of the
statutorily required 1.35 percent DIF reserve ratio by September 30,
2020. The FDIC Board adopted assessment rates that will take effect on
April 1, 2011. The Board also adopted lower rates that will take effect
when the DIF reserve ratio reaches 1.15 percent, which we expect will
approximate the long-term moderate, steady assessment rate that would
have been needed to maintain a positive fund balance throughout past
crises. The DRR was set at 2 percent, consistent with our analysis of a
long-term strategy for the DIF, and dividends were suspended
indefinitely. In lieu of dividends, the rules set forth progressively
lower assessment rate schedules when the reserve ratio exceeds 2
percent and 2.5 percent.
These actions increase the probability that the fund reserve ratio
will reach a level sufficient to withstand a future crisis, while
maintaining moderate, steady, and predictable assessment rates. Indeed,
banking industry participants at an FDIC Roundtable on deposit
insurance last year emphasized the importance of stable, predictable
assessments in their planning and budget processes. Moreover, actions
taken by the FDIC's current Board of Directors as a result of the Dodd-
Frank Act should make it easier for future Boards to resist inevitable
calls to reduce assessment rates or pay larger dividends at the expense
of prudent fund management and countercyclical assessment rates.
The Dodd-Frank Act also requires the FDIC to redefine the base used
for deposit insurance assessments as average consolidated total assets
minus average tangible equity. Earlier this month, the FDIC Board
issued a final rule implementing this requirement. The rule establishes
measures for average consolidated total assets and average tangible
equity that draw on data currently reported by institutions in their
Consolidated Report of Condition and Income or Thrift Financial Report.
In this way, the FDIC has implemented rules that minimize the number of
new reporting requirements needed to calculate deposit insurance
assessments. As provided by the Dodd-Frank Act, the FDIC's rule
adjusted the assessment base for banker's banks and custodial banks.
Using the lessons learned from the most recent crisis, our rule
changed the large bank pricing system to better differentiate for risk
and better take into account losses from large institution failures
that the FDIC may incur. This new system goes a long way toward
reducing the procyclicality of the risk-based assessment system by
calculating assessment payments using more forward-looking measures.
The system also removes reliance on long-term debt issuer ratings
consistent with the Dodd-Frank Act.
The FDIC projects that the change to a new, expanded assessment
base will not materially change the overall amount of assessment
revenue that the FDIC would have collected prior to adoption of these
rules. However, the change in the assessment base, in general, will
result in shifting more of the overall assessment burden away from
community banks and toward the largest institutions, which rely less on
domestic deposits for their funding than do smaller institutions, as
Congress intended.
Under the new assessment base and large bank pricing system, the
share of the assessment base held by institutions with assets greater
than $10 billion will increase from 70 percent to 78 percent, and their
share of overall dollar assessments will increase commensurately from
70 percent to 79 percent. However, because of the combined effect of
the change in the assessment base and increased risk differentiation
among large banks in the new large bank pricing system, many large
institutions will experience significant changes in their overall
assessments. The combined effect of changes in this final rule will
result in 59 large institutions paying lower dollar assessments and 51
large institutions paying higher dollar assessments (based upon
September 30, 2010 data). In the aggregate, small institutions will pay
30 percent less, due primarily to the change in the assessment base,
thus fewer than 100 of the 7,600 plus small institutions will pay
higher assessments.
Strengthening Capital Requirements
One of the most important mandates of the Dodd-Frank Act is Section
171--the Collins Amendment--which we believe will do more to strengthen
the capital of the U.S. banking industry than any other section of the
Act.
Under Section 171 the capital requirements that apply to thousands
of community banks will serve as a floor for the capital requirements
of our largest banks, bank holding companies and nonbanks supervised by
the FRB. This is important because in the years before the crisis, U.S.
regulators were embarking down a path that would allow the largest
banks to use their own internal models to set, in effect, their own
risk-based capital requirements, commonly referred to as the ``Basel II
Advanced Approach.''
The premise of the Advanced Approach was that the largest banks,
because of their sophisticated internal-risk models and superior
diversification, simply did not need as much capital in relative terms
as smaller banks. The crisis demonstrated the fallacy of this thinking
as the models produced results that proved to be grossly optimistic.
Policy makers from the Basel Committee to the U.S. Congress have
determined that this must not happen again. Large banks need the
capital strength to stand on their own. The Collins Amendment assures
that whatever advances in risk modeling may come to pass, they will not
be used to allow the largest banks to operate with less capital than
our Nation's Main Street banks.
The Federal banking agencies currently have out for comment a
Notice of Proposed Rulemaking to implement Section 171 by replacing the
transitional floor provisions of the Advanced Approach with a permanent
floor equal to the capital requirements computed under the agencies'
general risk-based capital requirements. The proposed rule would also
amend the general risk-based capital rules in way designed to give
additional flexibility to the FRB in crafting capital requirements for
designated nonbank SIFIs.
The Collins Amendment, moreover, does more than this. While
providing significant grandfathering and exemptions for smaller banking
organizations, the amendment also mandates that the holding company
structure for larger organizations not be used to weaken consolidated
capital below levels permitted for insured banks. That aspect of the
Collins Amendment, which ensures that bank holding companies will serve
as a source of strength for their insured banks, will be addressed in a
subsequent rulemaking.
The Dodd-Frank Act also required regulators to eliminate reliance
on credit ratings in our regulations. As you know, our regulatory
capital rules and Basel II currently rely extensively on credit
ratings. Last year, the banking agencies issued an Advance Notice of
Proposed Rulemaking seeking industry comment on how we might design an
alternative standard of credit worthiness. Unfortunately, the comments
we received, for the most part, lacked substantive suggestions on how
to approach this question. While we have removed any reliance on credit
ratings in our assessment regulation, developing an alternative
standard of creditworthiness for regulatory capital purposes is proving
more challenging. The use of credit ratings for regulatory capital
covers a much wider range of exposures; we cannot rely on nonpublic
information, and the alternative standard should be usable by banks of
all sizes. We are actively exploring a number of alternatives for
dealing with this problem.
Separately and parallel to the Dodd-Frank Act rulemakings, the
banking agencies are also developing rules to implement Basel III
proposals for raising the quality and quantity of regulatory capital
and setting new liquidity standards. The agencies issued a Notice of
Proposed Rulemaking in January that proposes to implement the Basel
Committee's 2009 revisions to the Market Risk Rule. We expect to issue
a Notice of Proposed Rulemaking that will seek comment on our plans to
implement Basel III later this year.
Reforming Asset-Backed Securitization
The housing bust and the financial crisis arose from a historic
breakdown in U.S. mortgage markets. While emergency policies enacted at
the height of the crisis have helped to stabilize the financial system
and plant the seeds for recovery, mortgage markets remain deeply mired
in credit distress and private securitization markets remain largely
frozen. Moreover, serious weaknesses identified with mortgage servicing
and foreclosure are now introducing further uncertainty into an already
fragile market.
It is clear that the mortgage underwriting practices that led to
the crisis, which frequently included loans with low or no
documentation in addition to other risk factors such as impaired credit
histories or high loan-to-value ratios, must be significantly
strengthened. To this point, this has largely been accomplished through
the heightened risk aversion of lenders, who have significantly
tightened standards, and investors, who have largely shunned private
securitization deals. Going forward, however, risk aversion will
inevitably decline and there will be a need to ensure that lending
standards do not revert to the risky practices that led to the last
crisis.
In the case of portfolio lenders, underwriting policies are subject
to scrutiny by Federal and State regulators. While regulators apply
standards of safe and sound lending, they typically do not take the
form of prespecified guidelines for the structure or underwriting of
the loans. For these portfolio lenders, the full retention of credit
risk by the originating institution tends to act as a check on the
incentive to take risks. Provided that the institution is otherwise
well capitalized, well run, and well regulated, the owners and managers
of the institution will bear most of the consequences for risky lending
practices. By contrast, the crisis has illustrated how the mortgage
securitization process is somewhat more vulnerable to the misalignment
of incentives for originators and securities issuers to limit risk
taking, because so much of the credit risk is passed along to investors
who may not exercise due diligence over loan quality.
The excessive risk-taking inherent in the originate-to-distribute
model of lending and securitization was specifically addressed in the
Dodd-Frank Act by two related provisions. One provision, under Section
941 of the Act, mandates that the FSOC agencies write rules that
require the securitizers (and, in certain circumstances, originators)
of asset-backed securities to retain not less than 5 percent of the
credit risk of those securities. The purpose of this provision is to
encourage more careful lending behavior by preventing securitizers from
avoiding the consequences of their risk-taking. Section 941 also
mandates that the agencies define standards for Qualifying Residential
Mortgages (QRMs) that will be exempt from risk retention when they are
securitized. An interagency committee is working to define both the
mechanism for risk retention and standards for QRMs.
Defining an effective risk retention mechanism and QRM requirements
are somewhat complex tasks that have required extensive deliberation
among the agencies. Because securitization structures and the
compensation of securitizers can take many alternate forms, it is
important that the rule be structured in a way that will minimize the
ability of issuers to circumvent its intent. While we continue to work
to move these rules forward without delay, we are also determined to
get them right the first time. The confidence of the marketplace in
these rules may well determine the extent to which private
securitization will return in the wake of the crisis.
Long-term confidence in the securitization process cannot be
restored unless the misalignment of servicing incentives that
contributed to the present crisis is also addressed through these
rules. There is ample research showing that servicing practices are
critically important to mortgage performance and risk. \2\ Regulators
must use both their existing authorities and the new authorities
granted under the Dodd-Frank Act to establish standards for future
securitizations to help assure that, as the private securitization
market returns, incentives for loss mitigation and value maximization
in mortgage servicing are appropriately aligned.
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\2\ For example, see, Ashcraft, Adam B. and Til Schuermann,
``Understanding the Securitization of Subprime Mortgage Credit'', Staff
Report No. 318, Federal Reserve Bank of New York, March 2008, p. 8.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1071189 and ``Global
Rating Criteria for Structured Finance Servicers'', Fitch Ratings/
Structured Finance, August 16, 2010, p. 7.
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The FDIC took a significant step in this regard when updating our
rules for safe harbor protection with regard to the treatment of
securitized assets in failed bank receiverships. Our final rule,
approved in September, established standards for loan level disclosure,
loan documentation, compensation, and oversight of servicers. It
includes incentives to assure that loans are made and managed in a way
that achieves sustainable lending and maximizes value for all
investors. There is already evidence of market acceptance of these
guidelines in the $1.2 billion securitization issue by Ally Bank
earlier this month, which fully conformed to the FDIC safe harbor rules
for risk retention.
In short, the desired effect of the risk retention and QRM rules
will be to give both loan underwriting and Administration and loan
servicing much larger roles in credit risk management. Lenders and
regulators need to embrace the lessons learned from this crisis and
establish a prudential framework for extending credit and servicing
loans on a sounder basis. Servicing provisions that should be part of
the QRM rule include disclosure of ownership interests in second-liens
by servicers of a first mortgage and appropriate compensation
incentives.
Better alignment of economic incentives in the securitization
process will not only address key safety-and-soundness and investor
concerns, but will also provide a stronger foundation for the new
Consumer Financial Protection Bureau (CFPB) as it works to improve
consumer protections for troubled borrowers in all products and by all
servicers.
Additional Implementation Activities
While we have focused on the important ongoing reforms where the
Dodd-Frank Act assigned a significant role to the FDIC, we have been
pleased to work closely with the other regulators on several other
critical aspects of the Act's implementation.
Earlier this month, the FDIC Board approved a draft interagency
rule to implement Section 956 of the Dodd-Frank Act, which sets forth
rules and procedures governing the awarding of incentive compensation
in covered financial institutions. Implementing this section will help
address a key safety-and-soundness issue that contributed to the recent
financial crisis--namely, that poorly designed compensation structures
and poor corporate governance can misalign incentives and induce
excessive risk taking within financial organizations. The proposed rule
is proportionate to the size and complexity of individual banks and
does not apply to banks with less than $1 billion in assets. For the
largest firms, those with over $50 billion in assets, the proposal
requires deferral of a significant portion of the incentive
compensation of identified executive officers for at least 3 years and
board-level identification and approval of the incentive compensation
of employees who can expose the firm to material loss.
Another important reform under the Dodd-Frank Act is the Volcker
Rule, which prohibits proprietary trading and acquisition of an
interest in hedge or private equity funds by IDIs. The FSOC issued its
required study of proprietary trading in January of this year, and
joint rules implementing the prohibition on such trading are due by
October of this year. The Federal banking agencies will be working
together, with the FSOC coordinating, to issue a final rule by the
statutory deadline.
In addition to these rulemakings, the FDIC has a number of other
implementation responsibilities, including new reporting requirements
and mandated studies. Among the latter is a study to evaluate the
definitions of core and brokered deposits. As part of this study, we
are hosting a roundtable discussion next month to gather valuable input
from bankers, deposit brokers, and other market participants.
Preparation for Additional Responsibilities
The FDIC Board of Directors has recently undertaken a number of
organizational changes to ensure the effective implementation of our
responsibilities pursuant to the Dodd-Frank Act.
As I previously described in my September testimony before this
Committee, the FDIC has made organizational changes in order to enhance
our ability to carry out the Dodd-Frank Act responsibilities, as well
as our core responsibilities for risk management supervision of insured
depository institutions and consumer protection. The new Office of
Complex Financial Institutions (OCFI) will be responsible for orderly
liquidation authority, resolution plans, and monitoring risks in the
SIFIs. The Division of Depositor and Consumer Protection will focus on
the FDIC's many responsibilities for depositor and consumer protection.
In response to the Committee's request for an update about the
transfer of employees to the new CFPB, I can report that we continue to
work with the Treasury Department and the other banking agencies on the
transfer process of employees to ensure a smooth transition. The number
of FDIC employees detailed to the CFPB will necessarily be limited
since the FDIC retains the compliance examination and enforcement
responsibilities for most FDIC-regulated institutions with $10 billion
or less in assets. Nonetheless, there are currently seven FDIC
employees being detailed to the Treasury Department and the CFPB to
work on a wide range of examination and legal issues that will confront
the CFPB at its inception. There are also several more employees who
have expressed interest in assisting the CFPB and are being evaluated
by the Treasury Department. Recognizing that FDIC employees have
developed expertise, skills, and experience in a number of areas of
benefit to the CFPB, our expectation has been that a number of
employees would actively seek an opportunity to assist the CFPB in its
earliest stages, or on a more permanent basis.
Finally, consistent with the requirements of Section 342, the FDIC
in January established a new Office of Minority and Women Inclusion
(OMWI). Transferring the existing responsibilities and employees of the
FDIC's former Office of Diversity and Economic Opportunity into the new
OMWI has allowed for a smooth transition and no disruption in the
FDIC's ongoing diversity and outreach efforts. Our plans for the OMWI
include the addition of a new Senior Deputy Director and other staff as
needed to ensure that the new responsibilities under Section 342 are
carried out, as well as an OMWI Steering Committee which will promote
coordination and awareness of OMWI responsibilities across the FDIC and
ensure that they are managed in the most effective manner.
Regulatory Effectiveness
The FDIC recognizes that while the changes required by the Dodd-
Frank Act are necessary to establish clear rules that will ensure a
stable financial system, these changes must be implemented in a
targeted manner to avoid unnecessary regulatory burden. We are working
on a number of fronts to achieve that necessary balance. An example is
the recent rule to change the deposit insurance assessment system,
which relied as much as possible on the current regulatory reporting
structure. Although some additional reporting will be required for some
institutions, most institutions should see their reporting burden
unchanged or slightly reduced as some items that were previously
required will no longer be reported.
At the January 20 meeting of the FDIC's Advisory Committee on
Community Banking, we engaged the members--mostly bankers themselves--
in a full and frank discussion of other ways to ease the regulatory
burden on small institutions. Among the ideas discussed at that meeting
were:
Conduct a community bank impact analysis with respect to
implementation of regulations under the Dodd-Frank Act,
Identify which questionnaires and reports can be
streamlined through automation,
Review ways to reduce the total amount of reporting
required of banks,
Impose a moratorium on changes to reporting obligations
until some level of regulatory burden reduction has been
achieved,
Develop an approach to bank reporting requirements that is
meaningful and focuses on where the risks are increasing, and
Ensure that community banks are aware that senior FDIC
officials are available and interested in receiving their
feedback regarding our regulatory and supervisory process.
The FDIC is particularly interested in finding ways to eliminate
unnecessary regulatory burden on community banks, whose balance sheets
are much less complicated than those of the larger banks. Our goal is
to facilitate more effective and targeted regulatory compliance. To
this end, we have established as a corporate performance goal for the
first quarter of 2011 to modify the content of our Financial
Institution Letters (FILs)--the vehicle used to alert banks to any
regulatory changes or guidance--so that every FIL issued will include a
section making clear the applicability to smaller institutions (under
$1 billion). In addition, by June 30 we plan to complete a review of
all of our recurring questionnaires and information requests to the
industry and to develop recommendations to improve the efficiency and
ease of use and a plan to implement these changes.
The FDIC has challenged its staff to find additional ways of
translating some of these ideas into action. This includes launching an
intensive review of existing reporting requirements to identify areas
for streamlining. We have also initiated a process whereby, as part of
every risk management examination, we will solicit the views of the
institution on aspects of the regulatory and supervisory process that
may be adversely affecting credit availability.
Above all, it is important to emphasize to small and midsized
financial institutions that the Dodd-Frank reforms are not intended to
impede their ability to compete in the marketplace. On the contrary, we
expect that these reforms will do much to restore competitive balance
to the marketplace by restoring market discipline and appropriate
regulatory oversight to systemically important financial companies,
many of which received direct Government assistance in the recent
crisis.
Conclusion
In implementing the Dodd-Frank Act, it is important that we
continue to move forward with dispatch to remove unnecessary regulatory
uncertainties faced by the market and the industry. In passing the Act,
the Congress clearly recognized the need for a sounder regulatory
framework within which banks and other financial companies could
operate under rules that would constrain the excessive risk taking that
caused such catastrophic losses to our financial system and our economy
during the financial crisis.
In the wake of the passage of the Act, it is essential that this
implementation process move forward both promptly and deliberately, in
a manner that resolves uncertainty as to what the new framework will be
and that promotes long-term confidence in the transparency and
stability of our financial system. Throughout this process, regulators
must maintain a clear view of the costs of regulation--particularly to
the vital community banking sector--while also never forgetting the
enormous economic costs of the inadequate regulatory framework that
allowed the crisis to occur in the first place. We have a clear
obligation to members of the public who have suffered the greatest
losses as a result of the crisis to prevent such an episode from ever
recurring again.
Thank you for the opportunity to testify.
______
PREPARED STATEMENT OF MARY L. SCHAPIRO
Chairman, Securities and Exchange Commission
February 17, 2011
Chairman Johnson, Ranking Member Shelby, and Members of the
Committee: Thank you for inviting me to testify today on behalf of the
Securities and Exchange Commission regarding our implementation of the
Dodd-Frank Wall Street Reform and Consumer Protection Act (``Dodd-Frank
Act'' or ``Act''). The Act includes over 100 rulemaking provisions
applicable to the SEC, and also requires the SEC to conduct more than
twenty studies and create five new offices.
Last September, I testified about our progress and plans for
implementing the Act. Among other things, I described our new internal
processes and cross-disciplinary working groups, the expanded
opportunities for public comment we are providing, our emphasis on
increased transparency in dealings with the public, the frequent and
collaborative consultations we were undertaking with other financial
regulators, and the priorities we created to assist us in complying in
a timely manner with the Act's mandates. My prior testimony also
provided an overview of the principal areas of Commission
responsibility under the Act.
Since that time, the Commission has made significant progress. To
date, in connection with the Dodd-Frank Act, the Commission has issued
25 proposed rule releases, seven final rule releases, and two interim
final rule releases. We have received thousands of public comments,
completed five studies, and hosted five roundtables. My testimony today
will provide an overview of these activities.
OTC Derivatives
Among the key provisions of the Act are those that will establish a
new oversight regime for the over-the-counter (OTC) derivatives
marketplace. Title VII of the Act requires the SEC to work with other
regulators--the Commodity Futures Trading Commission (CFTC) in
particular--to write rules that address, among other things, capital
and margin requirements, mandatory clearing, the operation of trade
execution facilities and data repositories, business conduct standards
for security-based swap dealers, and public transparency for
transactional information. These rulemakings are intended to improve
transparency and facilitate the centralized clearing of swaps, helping,
among other things, to reduce counterparty risk. In addition, they
should enhance investor protection by increasing disclosure regarding
security-based swap transactions and helping to mitigate conflicts of
interest involving security-based swaps. Finally, these rulemakings
should serve our broader objective of providing a framework that allows
the OTC derivatives market to continue to develop in a more
transparent, efficient, accessible, and competitive manner.
Title VIII of the Act provides for increased regulation of
financial market utilities and financial institutions that engage in
payment, clearing and settlement activities that are designated as
systemically important. The purpose of Title VIII is to mitigate
systemic risk in the financial system and promote financial stability.
To date, the SEC has proposed nine rulemakings required by Title
VII:
Antifraud and antimanipulation rules for security-based
swaps that would subject market conduct in connection with the
offer, purchase, or sale of any security-based swap to the same
general antifraud provisions that apply to all securities and
would explicitly reach misconduct in connection with ongoing
payments and deliveries under a security-based swap; \1\
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\1\ See, Release No. 34-63236, ``Prohibition Against Fraud,
Manipulation, and Deception in Connection with Security-Based Swaps''
(November 3, 2010), http://www.sec.gov/rules/proposed/2010/34-
63236.pdf.
Rules regarding trade reporting, data elements, and real-
time public dissemination of trade information for security-
based swaps that would lay out who must report security-based
swaps, what information must be reported, and where and when it
must be reported; \2\
---------------------------------------------------------------------------
\2\ See, Release No. 34-63346, ``Regulation SBSR--Reporting and
Dissemination of Security-Based Swap Information'' (November 19, 2010),
http://www.sec.gov/rules/proposed/2010/34-63346.pdf.
Rules regarding the obligations of security-based swap data
repositories that would require them to register with the SEC
and specify other requirements with which they must comply; \3\
---------------------------------------------------------------------------
\3\ See, Release No. 34-63347, ``Security-Based Swap Data
Repository Registration, Duties, and Core Principles'' (November 19,
2010), http://www.sec.gov/rules/proposed/2010/34-63347.pdf.
Rules relating to mandatory clearing of security-based
swaps that would set out the way in which clearing agencies
provide information to the SEC about security-based swaps that
the clearing agencies plan to accept for clearing; \4\
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\4\ See, Release No. 34-63557, ``Process for Submissions for
Review of Security-Based Swaps for Mandatory Clearing and Notice Filing
Requirements for Clearing Agencies; Technical Amendments to Rule 19b-4
and Form 19b-4 Applicable to All Self-Regulatory Organizations''
(December 15, 2010), http://www.sec.gov/rules/proposed/2010/34-
63557.pdf.
Rules regarding the exception to the mandatory clearing
requirement for hedging by end-users that would specify the
steps that end-users must follow, as required under the Act, to
notify the SEC of how they generally meet their financial
obligations when engaging in security-based swap transactions
exempt from the mandatory clearing requirement; \5\
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\5\ See, Release No. 34-63556, ``End-User Exception of Mandatory
Clearing of Security-Based Swaps'' (December 15, 2010), http://
www.sec.gov/rules/proposed/2010/34-63556.pdf.
Rules regarding registration and regulation of security-
based swap execution facilities that would define them, specify
their registration requirements, and establish their duties and
implement the core principles for security-based swap execution
facilities laid out in the Act; \6\
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\6\ See, Release No. 34-63825, ``Registration and Regulation of
Security-Based Swap Execution Facilities'' (February 2, 2011), http://
www.sec.gov/rules/proposed/2011/34-63825.pdf.
Joint rules with the CFTC regarding the definitions of swap
and security-based swap dealers, and major swap and security-
based swap participants; \7\
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\7\ See, Release No. 34-63452, ``Further Definition of ``Swap
Dealer'', ``Security-Based Swap Dealer'', ``Major Swap Participant'',
``Major Security-Based Swap Participant'', and ``Eligible Contract
Participant'' (December 7, 2010), http://www.sec.gov/rules/proposed/
2010/34-63452.pdf.
Rules regarding the confirmation of security-based swap
transactions that would govern the way in which certain of
these transactions are acknowledged and verified by the parties
who enter into them; \8\ and
---------------------------------------------------------------------------
\8\ See, Release No. 34-63727, ``Trade Acknowledgment and
Verification on Security-Based Swap Transactions'' (January 14, 2011),
http://www.sec.gov/rules/proposed/2011/34-63727.pdf.
Rules intended to address conflicts of interest at
security-based swap clearing agencies, security-based swap
execution facilities, and exchanges that trade security-based
swaps. \9\
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\9\ See, Release No. 34-63107, ``Ownership Limitations and
Governance Requirements for Security-Based Swap Clearing Agencies,
Security-Based Swap Execution Facilities, and National Securities
Exchanges with Respect to Security-Based Swaps under Regulation MC''
(October 14, 2010), http://www.sec.gov/rules/proposed/2010/34-
63107.pdf.
We also adopted interim final rules regarding the reporting of
outstanding security-based swaps entered into prior to the date of
enactment of the Dodd-Frank Act. \10\ These interim final rules require
certain security-based swap dealers and other parties to preserve and
report to the SEC or a registered security-based swap data repository
certain information pertaining to any security-based swap entered into
prior to the July 21, 2010, passage of the Dodd-Frank Act and whose
terms had not expired as of that date.
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\10\ See, Release No. 34-63094, ``Reporting of Security-Based Swap
Transaction Data'' (October 13, 2010), http://www.sec.gov/rules/
interim-final-temp.shtml.
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As required by Title VIII of the Act, our staff also is working
closely with the Federal Reserve Board and CFTC to develop a common
framework to supervise financial market utilities, such as clearing
agencies registered with the SEC, that the Financial Stability
Oversight Council (FSOC) designates as systemically important. For
example, last December we coordinated with the other agencies to
propose rules under Title VIII regarding the filing of notices of
material changes to rules, procedures, or operations by systemically
important financial market utilities. In addition, in December the FSOC
issued an advance notice of proposed rulemaking regarding the criteria
and analytical framework that should be applied in designating
financial market utilities under the Dodd-Frank Act. \11\
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\11\ The FSOC's advance notice of proposed rulemaking can be found
at http://www.treasury.gov/initiatives/Documents/VIII%20-
%20ANPR%20on%20FMU%20Designations%20111910.pdf.
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Our staff also has been actively coordinating with the other
agencies on the new authority granted to the SEC and CFTC to develop
standards for these financial market utilities. Moreover, the SEC and
CFTC staffs have begun working with staff from the Federal Reserve
Board to develop a framework for consulting and working together on
supervision and examination of systemically important financial market
utilities consistent with Title VIII.
Private Fund Adviser Registration and Reporting
Under Title IV of the Dodd-Frank Act, large hedge fund advisers and
private equity fund advisers will be required to register with the
Commission beginning in July of this year. Under the Act, venture
capital fund advisers and private fund advisers with less than $150
million in assets under management in the United States will be exempt
from the new registration requirements. In addition, family offices
will not be subject to registration. To implement these provisions, the
Commission has proposed:
Amendments to Form ADV, the investment adviser registration
form, to facilitate the registration of advisers to hedge funds
and other private funds and to gather information about these
private funds, including identification of the private funds'
auditors, custodians and other ``gatekeepers;'' \12\
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\12\ See Release No. IA-3110, Rules Implementing Amendments to the
Investment Advisers Act of 1940 (November 19, 2010), http://
www.sec.gov/rules/proposed/2010/ia-3110.pdf.
To implement the Act's mandate to exempt from registration
advisers to private funds with less than $150 million in assets
under management in the United States; \13\
---------------------------------------------------------------------------
\13\ See, id.
A definition of ``venture capital fund'' that distinguishes
these funds from other types of private funds; \14\ and
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\14\ See, Release No. IA-3111, ``Exemptions for Advisers to
Venture Capital Funds, Private Fund Advisers With Less Than $150
Million in Assets Under Management and Foreign Private Advisers''
(November 19, 2010), http://www.sec.gov/rules/proposed/2010/ia-
3111.pdf.
A definition of ``family office'' that focuses on firms
that provide investment advice only to family members (as
defined by the rule), certain key employees, charities and
trusts established by family members and entities wholly owned
and controlled by family members. \15\
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\15\ See, Release No. IA-3098, ``Family Offices'' (October 12,
2010); http://www.sec.gov/rules/proposed/2010/ia-3098.pdf.
In addition, following consultation with staff of the FSOC member
agencies, the Commission and CFTC jointly proposed rules to implement
the Act's mandate to require advisers to hedge funds and other private
funds to report information for use by the FSOC in monitoring for
systemic risk to the U.S. financial system. \16\ The proposal, which
builds on coordinated work on hedge fund reporting conducted with
international regulators, would institute a ``tiered'' approach to
gathering the systemic risk data which would remain confidential. Thus,
the largest private fund advisers--those with $1 billion or more in
hedge fund, private equity fund, or ``liquidity fund'' assets--would
provide more comprehensive and more frequent systemic risk information
than other private fund advisers.
---------------------------------------------------------------------------
\16\ See, Release No. IA-3145, ``Reporting by Investment Advisers
to Private Funds and Certain Commodity Pool Operators and Commodity
Trading Advisors on Form PF'' (January 26, 2011), http://www.sec.gov/
rules/proposed/2011/ia-3145.pdf.
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Asset-Backed Securities
Section 943 of the Dodd-Frank Act requires the Commission to adopt
rules on the use of representations and warranties in the market for
asset-backed securities (ABS). In January, the Commission adopted final
rules \17\ that require ABS issuers to disclose the history of
repurchase requests received and repurchases made relating to their
outstanding ABS. Issuers will be required to make their initial filing
on February 14, 2012, disclosing the repurchase history for the 3 years
ending December 31, 2011. The disclosure requirements will apply to
issuers of registered and unregistered ABS, including municipal ABS,
though the rules provide municipal ABS an additional 3-year phase-in
period.
---------------------------------------------------------------------------
\17\ See, Release No. 33-9175, ``Disclosure for Asset-Backed
Securities Required by Section 943 of the Dodd-Frank Wall Street Reform
and Consumer Protection Act'' (January 20, 2011), http://www.sec.gov/
rules/final/2011/33-9175.pdf.
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Section 945 requires the Commission to issue rules requiring an
asset-backed issuer in a Securities Act registered transaction to
perform a review of the assets underlying the ABS and disclose the
nature of such review. In January, the Commission adopted final rules
to implement Section 945. \18\ Under the final rules, the type of
review conducted may vary, but at a minimum must be designed and
effected to provide reasonable assurance that the prospectus disclosure
about the assets is accurate in all material respects. The final rule
provides a phase-in period to allow market participants to adjust their
practices to comply with the new requirements.
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\18\ See, Release No. 33-9176, ``Issuer Review of Assets in
Offerings of Asset-Backed Securities'' (January 20, 2011), http://
www.sec.gov/rules/final/2011/33-9176.pdf.
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Section 942(a) of the Dodd-Frank Act eliminated the automatic
suspension of the duty to file reports under Section 15(d) of the
Exchange Act for ABS issuers and granted the Commission authority to
issue rules providing for the suspension or termination of this duty to
file reports. The Commission has proposed rules in connection with this
provision of the Act which would permit suspension of the reporting
obligations for ABS issuers when there are no longer asset-backed
securities of the class sold in a registered transaction held by
nonaffiliates of the depositor. \19\
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\19\ See, Release No. 34-63652, ``Suspension of the Duty to File
Reports for Classes of Asset-Backed Securities Under Section 15(d) of
the Securities Exchange Act of 1934'' (January 6, 2011), http://
www.sec.gov/rules/proposed/2011/34-63652.pdf.
---------------------------------------------------------------------------
We are working closely with other regulators to jointly create the
risk retention rules required by Section 941 of the Act, which will
address the appropriate amount, form and duration of required risk
retention for ABS securitizers, and will define qualified residential
mortgages. We expect that the Commission will consider proposed risk
retention rules in the near future.
Credit Rating Agencies
Under the Dodd-Frank Act, the Commission is required to undertake
approximately a dozen rulemakings related to nationally recognized
statistical rating organizations (NRSROs). The Act requires the SEC to
address, among other things, internal controls and procedures,
conflicts of interest, credit rating methodologies, transparency,
ratings performance, analyst training, credit rating symbology, and
disclosures accompanying the publication of credit ratings. The staff
plans to recommend rule proposals to the Commission on these matters in
the near future. \20\
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\20\ In addition, last September the Commission issued an
amendment to Regulation FD that implements Section 939B of the Act,
which requires that the SEC amend Regulation FD to remove the specific
exemption from the rule for disclosures made to NRSROs and credit
rating agencies for the purpose of determining or monitoring credit
ratings. See Release No. 33-9146, Removal from Regulation FD of the
Exemption for Credit Rating Agencies (September 29, 2010), http://
www.sec.gov/rules/final/2010/33-9146.pdf.
---------------------------------------------------------------------------
In addition, the Act requires every Federal agency to review its
regulations that require use of credit ratings as an assessment of the
credit worthiness of a security and undertake rulemakings to remove
these references and replace them with other standards of credit
worthiness that the agency determines are appropriate. \21\ On February
9, 2011, the Commission proposed rule amendments that would remove
credit ratings as conditions for companies seeking to use short-form
registration when registering securities for public sale. \22\ Under
the proposed rules, the new test for eligibility to use Form S-3 or
Form F-3 short-form registration would be tied to the amount of debt
and other nonconvertible securities a particular company has sold in
registered primary offerings within the previous 3 years. Additional
rule proposals in response to Section 939A will be forthcoming.
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\21\ See, Section 939A of the Dodd-Frank Act.
\22\ See, Release No. 33-9186, ``Removing Security Ratings as
Condition for Short-Form Registration'' (February 9, 2011), http://
www.sec.gov/rules/proposed/2011/33-9186.pdf.
---------------------------------------------------------------------------
The Act also requires the SEC to conduct three studies relating to
credit rating agencies. In December, the Commission requested comment
on the feasibility and desirability of standardizing credit rating
terminology. \23\ The additional NRSRO-related studies concern (1)
alternative compensation models for rating structured finance products
and (2) NRSRO independence. Given the complexity of the issues it
raises, we likely will seek comment on the compensation study in the
near future so as to provide commentators an extended period in which
to communicate their views.
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\23\ See, Release No. 34-63573, ``Credit Rating Standardization
Study'' (December 17, 2010), http://www.sec.gov/rules/other/2010/34-
63573.pdf.
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Corporate Governance and Executive Compensation
Section 951 of the Act requires public companies subject to the
Federal proxy rules to provide a shareholder advisory ``say-on-pay''
vote on executive compensation at least once every 3 years and a
separate advisory vote at least once every 6 years on whether the say-
on-pay resolution will be presented for shareholder approval every 1,
2, or 3 years. In addition, Section 951 requires disclosure about--and
a shareholder advisory vote to approve--compensation related to merger
or similar transactions, known as ``golden parachute'' arrangements. In
January, the Commission adopted rules to implement these provisions of
Section 951. \24\ The rules provide smaller reporting companies a 2-
year delayed compliance period for the say-on-pay and ``frequency''
votes. Section 951 also requires that institutional investment managers
report their votes on these matters at least annually. The Commission
proposed rules to implement this requirement last October, and we
expect that these rules will be finalized shortly. \25\
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\24\ See, Release No. 33-9178, ``Shareholder Approval of Executive
Compensation and Golden Parachute Compensation'' (January 25, 2011),
http://www.sec.gov/rules/final/2011/33-9178.pdf.
\25\ See, Release No. 34-63123, ``Reporting of Proxy Votes on
Executive Compensation and Other Matters'' (October 18, 2010), http://
www.sec.gov/rules/proposed/2010/34-63123.pdf.
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Section 957 of the Act requires the rules of each national
securities exchange to be amended to prohibit brokers from voting
uninstructed shares on the election of directors (other than
uncontested elections of directors of registered investment companies),
executive compensation matters, or any other significant matter, as
determined by the Commission by rule. To date, the Commission has
approved changes to the rules of the New York Stock Exchange, the
Nasdaq Stock Market and the International Securities Exchange. \26\ We
anticipate that corresponding changes to the rules of other national
securities exchanges will be considered by the Commission in the near
future.
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\26\ See, Release No. 34-62874 (September 9, 2010), http://
www.sec.gov/rules/sro/nyse/2010/34-62874.pdf; Release No. 34-62992
(September 24, 2010), http://www.sec.gov/rules/sro/nasdaq/2010/34-
62992.pdf; Release No. 34-63139 (October 20, 2010), http://www.sec.gov/
rules/sro/ise/2010/34-63139.pdf.
---------------------------------------------------------------------------
The Commission also is required by the Act to adopt several
additional rules related to corporate governance and executive
compensation. We anticipate that the staff will recommend proposed
rules for the Commission's consideration in the near future, which will
mandate new listing standards relating to the independence of
compensation committees and establish new disclosure requirements and
conflict of interest standards that boards must observe when retaining
compensation consultants. \27\ In addition, Section 956 requires the
Commission, jointly with other financial regulators, to adopt
incentive-based compensation regulations or guidelines that apply to
covered financial institutions, including broker-dealers and investment
advisers, with assets of $1 billion or more. The Commission staff has
been working closely with the other regulators to prepare a proposal
implementing this provision.
---------------------------------------------------------------------------
\27\ See, Section 952 of the Dodd-Frank Act. Under the Act, these
rules are to be adopted by the Commission within 360 days from the date
of enactment of the Act.
---------------------------------------------------------------------------
The Act also requires the Commission to adopt rules mandating new
listing standards relating to specified ``clawback'' policies \28\ and
rules requiring new disclosures about executive compensation and
company performance, \29\ executive pay ratios, \30\ and employee and
director hedging. \31\ These provisions of the Act do not contain
rulemaking deadlines, but are being considered and assessed by the
staff.
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\28\ See, Section 954 of the Dodd-Frank Act.
\29\ See, Section 953(a) of the Dodd-Frank Act.
\30\ See, Section 953(b) of the Dodd-Frank Act.
\31\ See, Section 955 of the Dodd-Frank Act.
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Investment Adviser Rulemaking and Investment Adviser Related Studies
In consultation with the State securities regulators, the
Commission proposed rules and amendments to Form ADV (the adviser
registration form) to implement the new threshold for registering
advisers with the SEC rather than State regulators. Under the Act, the
threshold increased from $25 million to $100 million in assets under
management. \32\ As a result of this change, we expect that
approximately 4,100 investment advisers will switch from SEC to State
registration. In addition, approximately 750 large private fund
advisers will newly register with the Commission as a result of the
Act's private fund adviser provisions.
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\32\ See, Release No. IA-3110, ``Rules Implementing Amendments to
the Investment Advisers Act of 1940'' (November 19, 2010), http://
www.sec.gov/rules/proposed/2010/ia-3110.pdf.
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In addition, the SEC recently released three Dodd-Frank-mandated
staff studies related to improving the investment adviser and broker-
dealer regulatory frameworks.
First, the Commission published a staff study on enhancing
investment adviser examinations. \33\ The study concludes that the
Commission's investment adviser examination program requires a source
of funding sufficiently stable to prevent examination resources from
being outstripped by future growth in the number of registered advisers
(i.e., that the resources are scalable to any future increase--or
decrease--in the number of registered investment advisers). The study
identified three options for Congress to consider:
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\33\ ``Staff Study on Enhancing Investment Adviser Examinations''
(January 19, 2011), http://www.sec.gov/news/studies/2011/
914studyfinal.pdf; See also, ``Commissioner Elisse B. Walter, Statement
on Study Enhancing Investment Adviser Examinations'' (Required by
Section 914 of Title IX of the Dodd-Frank Wall Street Reform and
Consumer Protection Act) (Jan. 2010), http://www.sec.gov/news/speech/
2011/spch011911ebw.pdf. I did not participate in the study or the vote
authorizing its publication.
Impose ``user fees'' on SEC-registered investment advisers
that could be retained by the Commission to fund the investment
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adviser examination program;
Authorize one or more SROs to examine, subject to SEC
supervision, all SEC-registered investment advisers; or
Authorize FINRA to examine dual registrants for compliance
with the Advisers Act.
Second, we published a staff study on the obligations of investment
advisers and broker-dealers. \34\ That study made two primary
recommendations: that the Commission (1) exercise its discretionary
rulemaking authority under the Act to implement a uniform fiduciary
standard of conduct for broker-dealers and investment advisers when
they are providing personalized investment advice about securities to
retail investors; and (2) consider harmonization of broker-dealer and
investment adviser regulation when retail investors obtain the same or
substantially similar services and when such harmonization adds
meaningfully to investor protection. Under the Act, the uniform
fiduciary standard to which broker-dealers and investment advisers
would be subject would be ``no less stringent'' than the standard that
applies to investment advisers today.
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\34\ See, ``Study on Investment Advisers and Broker-Dealers''
(January 21, 2011), http://www.sec.gov/news/studies/2011/
913studyfinal.pdf; See also, ``Statement by SEC Commissioners Kathleen
L. Casey and Troy A. Paredes Regarding Study on Investment Advisers and
Broker-Dealers'' (January 21, 2011), http://www.sec.gov/news/speech/
2011/spch012211klctap.htm.
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Third, we published a staff study on investor access to information
about investment professionals. Today, investors must search two
separate databases for information about broker-dealers and investment
advisers. The primary recommendation was to centralize access to these
two databases to enable investors to simultaneously search both
databases and receive unified search results. \35\
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\35\ See, ``Study and Recommendations on Improved Investor Access
to Registration Information About Investment Advisers and Broker-
Dealers'' (January 26, 2011), http://www.sec.gov/news/studies/2011/
919bstudy.pdf.
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Specialized Disclosure Provisions
Title XV of the Act contains specialized disclosure provisions
related to conflict minerals, coal or other mine safety, and payments
by resource extraction issuers to foreign or U.S. Government entities.
The conflict minerals provision of the Act, Section 1502, requires
issuers to disclose annually whether any conflict minerals that are
necessary to the functionality or production of a product originated in
the Democratic Republic of the Congo or an adjoining country. If so,
issuers are further required to provide a report describing, among
other matters, the measures taken to exercise due diligence on the
source and chain of custody of those minerals. The report must include
an independent private sector audit that is certified by the person
filing the report.
Section 1503 of the Act, which relates to mine safety, requires
mining companies to disclose information about health and safety
violations in their periodic reports filed with the Commission. It also
requires issuers to file Form 8-K reports disclosing receipt of
specified orders or notices from the Mine Safety and Health
Administration. The disclosure requirement currently is in effect by
operation of the Act.
Section 1504 of the Act requires resource extraction issuers that
are required to file annual reports with the Commission and that engage
in commercial development of oil, natural gas, and minerals to disclose
annually information about any payment made by the issuer or its
subsidiaries, or an entity under the control of the issuer, to the U.S.
or a foreign Government for the purpose of the commercial development
of oil, natural gas, or minerals.
The Commission published rule proposals relating to these three
provisions of the Act in December. \36\ The comment periods were
scheduled to close on January 31, 2011, but the Commission recently
extended the comment periods for all three rule proposals for 30 days,
to March 2, 2011. \37\ The nature of the proposed disclosure
requirements differs from the disclosure traditionally required by the
Exchange Act, and comments were requested on a variety of significant
aspects of the proposed rules. After receiving requests for extensions
of the public comment period for all three rule proposals, we
determined that providing the public additional time to consider
thoroughly the matters addressed by the releases and to submit
comprehensive responses would benefit the Commission in its
consideration of final rules.
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\36\ See, Release No. 34-63547, ``Conflict Minerals'' (December
15, 2010), http://www.sec.gov/rules/proposed/2010/34-63547.pdf; Release
No. 33-9164, ``Mine Safety Disclosure'' (December 15, 2010), http://
www.sec.gov/rules/proposed/2010/33-9164.pdf, Release No. 34-63549,
``Disclosure of Payments by Resource Extraction Issuers'' (December 15,
2010), http://www.sec.gov/rules/proposed/2010/34-63549.pdf.
\37\ See, Release No. 34-63793, ``Conflict Minerals'' (extension
of comment period) (January 28, 2011), http://www.sec.gov/rules/
proposed/2011/34-63793.pdf; Release No. 33-9179, ``Mine Safety
Disclosure'' (extension of comment period) (January 28, 2011), http://
www.sec.gov/rules/proposed/2011/33-9179.pdf; Release No. 34-63795,
``Disclosure of Payments by Resource Extraction Issuers'' (extension of
comment period) (January 28, 2011), http://www.sec.gov/rules/proposed/
2011/34-63795.pdf.
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Whistleblower
Section 922 of the Act requires the SEC, under regulations
prescribed by the Commission, to pay awards to individuals who
voluntarily provide the Commission with original information that leads
to the successful enforcement of (1) an SEC action that results in
monetary sanctions exceeding $1 million or (2) certain related actions.
The Dodd-Frank Act substantially expands the agency's authority to
compensate individuals who provide the SEC with information about
violations of the Federal securities laws. Prior to the Act, the
agency's bounty program was limited to insider trading cases, and the
amount of an award was capped at 10 percent of the penalties collected
in the action.
Last November, the Commission proposed rules mapping out the
procedure for would-be whistleblowers to provide critical information
to the agency. \38\ The proposed rules convey how eligible
whistleblowers can qualify for an award through a transparent process
that provides them an opportunity to assert their claim to an award. We
also have fully funded the SEC Investor Protection Fund, which will be
used to pay awards to qualifying whistleblowers. Pending the adoption
of final rules, Enforcement staff has been reviewing and tracking
whistleblower complaints submitted to the Commission.
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\38\ See, Release No. 34-63237, ``Proposed Rules for Implementing
the Whistleblower Provisions of Section 21F of the Securities Exchange
Act of 1934'' (November 3, 2010), http://www.sec.gov/rules/proposed/
2010/34-63237.pdf. In addition, last October, the Commission provided
its first annual report to Congress on the Whistleblower Program as
provided by the Act.
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The Act requires the Commission to create a separate office within
the SEC to administer and enforce whistleblower provisions of the Act.
Soon, we plan to announce the selection of a Whistleblower Coordinator
to oversee the whistleblower program.
Exempt Offerings
Section 413(a) of the Act requires the Commission to exclude the
value of an individual's primary residence when determining if that
individual's net worth exceeds the $1 million threshold required for
``accredited investor'' status. This change was effective upon
enactment of the Act, but the Commission is also required to revise its
rules to reflect the new standard. The Commission proposed rule
amendments in January that would implement this provision, and would
clarify the treatment of any indebtedness secured by the residence in
the net worth calculation. \39\
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\39\ See, Release No. 33-9177, ``Net Worth Standard for Accredited
Investors'' (January 25, 2011), http://www.sec.gov/rules/proposed/2011/
33-9177.pdf.
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In addition, under Section 926 of the Act, the Commission is
required to adopt rules that disqualify securities offerings involving
certain ``felons and other `bad actors' '' from relying on the safe
harbor from Securities Act registration provided by Rule 506 of
Regulation D. We expect that the staff will recommend proposed rules
for the Commission's consideration soon.
Volcker Rule
On January 18, 2011, the FSOC approved and released to the public a
study formalizing its findings and recommendations for implementing
section 619 of the Dodd-Frank Act, commonly referred to as the Volcker
Rule. \40\ Commission staff actively participated in the study. We
recently solicited public comments in advance of our rule proposal
concerning the SEC's implementation of the Volcker Rule. \41\
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\40\ The FSOC Volcker Rule study and recommendations can be found
at http://www.treasury.gov/initiatives/Documents/
Volcker%20sec%20%20619%20study%20final%201%2018%2011%20rg.pdf.
\41\ See, http://sec.gov/spotlight/dodd-frank/volckerrule.htm.
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Procedural Rules for SRO Filings
Section 916 of the Act amended Section 19(b) of the Securities
Exchange Act of 1934, which governs the handling of proposed rule
changes submitted by SROs. Among other things, Section 916 required the
Commission to promulgate rules setting forth the procedural
requirements of proceedings to determine whether a proposed rule change
should be disapproved. In satisfaction of this requirement, the
Commission adopted new Rules of Practice to formalize the process it
will use when conducting proceedings to determine whether an SRO's
proposed rule change should be disapproved under Section 19(b)(2) of
the Exchange Act. \42\ The new rules are intended to add transparency
to the Commission's conduct of those proceedings, to address the
process the Commission will follow to institute proceedings and provide
notice of the grounds for disapproval under consideration, and to
provide interested parties with an opportunity to submit written
materials to the Commission.
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\42\ See, Release No. 34-63049, ``Delegation of Authority to the
Director of the Division of Trading and Markets'' (Effective Date:
October 12, 2010), http://www.sec.gov/rules/final/2010/34-63049.pdf;
Release No. 34-63699, ``Delegation of Authority to the Chief
Accountant'' (Effective Date: January 18, 2011), http://www.sec.gov/
rules/final/2011/34-63699.pdf; and Release No. 34-63723, ``Rules of
Practice'' (Effective Date: January 24, 2011), http://www.sec.gov/
rules/final/2011/34-63723.pdf.
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Creation of SEC Offices
Beyond the whistleblower office, the Act requires the Commission to
create four new offices within the Commission, specifically, the Office
of Credit Ratings, \43\ Office of the Investor Advocate, \44\ Office of
Minority and Women Inclusion, \45\ and Office of Municipal Securities.
\46\ As each of these offices is statutorily required to report
directly to the Chairman, the creation of these offices is subject to
approval by the Commission's appropriations subcommittees to reprogram
funds for this purpose. Until approval is received, the initial
functions of the offices are being performed on a limited basis by
other divisions and offices. Below is a summary of our plans for each
office, as well as the current status as to each.
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\43\ See, Section 932 of the Dodd-Frank Act.
\44\ See, Section 915 of the Dodd-Frank Act.
\45\ See, Section 342 of the Dodd-Frank Act.
\46\ See, Section 979 of the Dodd-Frank Act.
Office of Credit Ratings--The office will be responsible
for administering the rules of the Commission with respect to
the practices of NRSROs in determining ratings; promoting
accuracy in credit ratings issued by NRSROs; ensuring that such
ratings are not unduly influenced by conflicts of interest; and
conducting examinations of each NRSRO at least annually.
Currently, the NRSRO-related rulemaking functions remain with
staff within the Commission's Division of Trading and Markets,
and the examination functions continue to be performed by the
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existing Office of Compliance Inspections and Examination.
Office of the Investor Advocate--The office will assist
retail investors in resolving significant problems they may
have with the Commission or with SROs; identify areas in which
investors would benefit from changes in Commission regulations
or SRO rules; identify problems that investors have with
financial service providers and investment products; and
analyze the potential impact on investors of proposed
Commission regulations and SRO rules. The office will include
an Ombudsman as required by the Act. Currently, activities
regarding investor perspectives in rulemaking continue to be
performed by staff in the existing Office of Investor Education
and Advocacy.
Office of Minority and Women Inclusion--The Office of
Minority and Women Inclusion will be responsible for all
matters of the agency relating to diversity in management,
employment, and business activities. The director of this
office will advise the Chairman on the impact of the policies
and regulations of the SEC on minority-owned and women-owned
businesses. The director also will develop and implement
standards for: equal employment opportunity and the racial,
ethnic, and gender diversity of the workforce and senior
management of the SEC; increased participation of minority-
owned and women-owned businesses in the programs and contracts
of the agency, including standards for coordinating technical
assistance to such businesses; and assessing the diversity
policies and practices of entities regulated by the SEC.
Currently, activities regarding diversity in hiring and small
business contracting continue to be performed by staff in the
existing EEO Office.
Office of Municipal Securities--The office will administer
the rules pertaining to broker-dealers, advisors, investors,
and issuers of municipal securities, \47\ as well as coordinate
with the Municipal Securities Rulemaking Board on rulemaking
and enforcement actions. Currently, those functions continue to
be assigned to staff within the Division of Trading and
Markets.
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\47\ Section 975 of the Act also requires the registration of
municipal advisors with the Commission. This new registration
requirement became effective on October 1, 2010, making it unlawful for
any municipal advisor to provide advice to a municipality unless
registered with the Commission. Last September, the Commission adopted
an interim final rule establishing a temporary means for municipal
advisors to satisfy the registration requirement. In December, the
Commission proposed a permanent rule creating a new process by which
municipal advisors must register with the SEC.
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Internal Operations
In the past 2 years the SEC has taken significant and comprehensive
steps to reform the way it operates. We have brought in new leadership
and senior management, revitalized and restructured our enforcement,
examination and corporation finance operations, revamped our handling
of tips and complaints, taken steps to break down internal silos and
create a culture of collaboration, improved our risk assessment
capabilities, recruited more staff with specialized expertise and real
world experience, and enhanced safeguards for investors' assets, among
other things. Despite these changes, much work remains, and we continue
to seek ways to improve our operations.
To assist the SEC in assessing its operational efficiency, Section
967 of the Dodd-Frank Act directed the agency to engage the services of
an independent consultant to study a number of specific areas of SEC
internal operations and of the SEC's relationship with SROs. On October
15, 2010, the Commission engaged Boston Consulting Group (BCG) to
perform the organizational study. During the past four months, our
staff has been fully engaged with BCG, participating in interviews,
providing documentation, and responding to questions. BCG's report is
due March 14, and we expect it will include recommendations that will
identify additional efficiencies for SEC operations.
Funding for Implementation of the Dodd-Frank Act
The provisions of the Dodd-Frank Act represent a major expansion of
the SEC's responsibilities and will require significant additional
resources for full implementation. To date, the SEC has proceeded with
the first stages of implementation of the Dodd-Frank Act without
additional funding. As described above, implementation up to this point
has largely involved performing studies, analysis, and the writing of
rules. These tasks have taken staff time from other responsibilities,
and have been done almost entirely with existing staff and without
additional expenses in areas such as information technology.
The budget justification I recently submitted \48\--provided in
connection with the President's fiscal year 2012 (FY2012) budget
request--estimates that, over time, full implementation of the Dodd-
Frank Act will require a total of approximately 770 new staff, of which
many will need to be expert in derivatives, hedge funds, data
analytics, credit ratings, or other new or expanded responsibility
areas. The SEC also will need to invest in technology, to facilitate
the registration of additional entities and capture and analyze data on
these new markets.
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\48\ In accordance with past practice, the budget justification of
the agency was submitted by the Chairman of the Commission and was not
voted on by the full Commission.
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Sixty percent, or 468, of the new staff positions requested are
necessary initially to implement Dodd-Frank responsibilities. This
number includes positions that I anticipate are needed to fully staff
the five new offices at adequate levels. The agency also will need to
invest in technology to facilitate the registration of additional
entities and capture and analyze data on the new markets. It is
estimated the costs of these new positions and technology investments
will be approximately $123 million. The remaining positions requested
in the budget will be used to strengthen and support core SEC
operations and to continue reforming its operations and fostering
stronger protections for investors.
In addition to the new positions requested in FY2012, I also
anticipate that an additional 296 positions will be required in FY2013
for full implementation of the Dodd-Frank Act. It is important to note
that the SEC's FY2012 funding will be fully offset by matching
collections of fees on securities transactions. Currently, the
transaction fees collected by the SEC are approximately 2 cents per
$1,000 of transactions. Under the Dodd-Frank Act, beginning with
FY2012, the SEC is required to adjust fee rates so that the amount
collected will match the total amount appropriated for the agency by
Congress. Under this mechanism, SEC funding will be deficit-neutral, as
any increase or decrease in the SEC's budget would result in a
corresponding rise or fall in offsetting fee collections.
Conclusion
Though the SEC's efforts to implement the Dodd-Frank Act have been
extensive, our work is far from over. As we proceed with
implementation, we look forward to continuing to work closely with
Congress, our fellow regulators and members of the financial and
investing public. Thank you for inviting me here today to share with
you our progress on and plans for implementation. I look forward to
answering your questions.
______
PREPARED STATEMENT OF GARY GENSLER
Chairman, Commodity Futures Trading Commission
February 17, 2011
Good morning Chairman Johnson, Ranking Member Shelby, and Members
of the Committee. I thank you for inviting me to today's hearing on
implementing the Dodd-Frank Wall Street Reform and Consumer Protection
Act. I am pleased to testify on behalf of the Commodity Futures Trading
Commission (CFTC). I also thank my fellow Commissioners and CFTC staff
for their hard work and commitment on implementing the legislation.
I am honored to appear at today's hearing alongside fellow
regulators with whom we are working so closely to implement the Dodd-
Frank Act. We have consulted and coordinated closely with the
Securities and Exchange Commission (SEC), Federal Reserve Board,
Treasury Department, Federal Deposit Insurance Corporation (FDIC),
Office of the Comptroller of the Currency and other regulators on
rulemakings to oversee the swaps markets. Throughout this process,
interagency cooperation has been extraordinary and has improved our
proposed rulemakings.
Before I move into the testimony, I want to congratulate Chairman
Johnson on becoming Chairman of the Committee. I look forward to
working with you and all Members of the Committee.
The Dodd-Frank Act
On July 21, 2010, President Obama signed the Dodd-Frank Act. The
Act amended the Commodity Exchange Act (CEA) to establish a
comprehensive new regulatory framework for swaps and security-based
swaps. Title VII of the Act, which relates to swaps, was enacted to
reduce risk, increase transparency and promote market integrity within
the financial system by, among other things:
1. Providing for the registration and comprehensive regulation of
swap dealers and major swap participants;
2. Imposing clearing and trade execution requirements on
standardized derivatives products;
3. Creating robust record keeping and real-time reporting regimes;
and
4. Enhancing the Commission's rulemaking and enforcement authorities
with respect to, among others, all registered entities and
intermediaries subject to the Commission's oversight.
The reforms mandated by Congress will reduce systemic risk to our
financial system and bring sunshine and competition to the swaps
markets. Markets work best when they are transparent, open and
competitive. The American public has benefited from these attributes in
the futures and securities markets since the great regulatory reforms
of the 1930s. The reforms of Title VII will bring similar features to
the swaps markets. Lowering risk and improving transparency will make
the swaps markets safer and improve pricing for end-users.
Title VIII of the Dodd-Frank Act gives the Financial Stability
Oversight Council (FSOC) and the Federal Reserve Board important roles
in clearinghouse oversight by authorizing the Council to designate
certain clearinghouses as systemically important and by permitting the
Federal Reserve to recommend heightened prudential standards in certain
circumstances. It also gives the CFTC heightened authorities with
respect to those clearinghouses that are deemed systemically important
by the FSOC.
Implementation
The Dodd-Frank Act is very detailed, addressing all of the key
policy issues regarding regulation of the swaps marketplace. To
implement these regulations, the Act requires the CFTC and SEC, working
with our fellow regulators, to write rules generally within 360 days.
At the CFTC, we initially organized our effort around 30 teams who have
been actively at work. We have recently added another team. We had our
first meeting with the 30 team leads the day before the President
signed the law.
The CFTC is working deliberatively and efficiently to promulgate
rules required by Congress. The talented and dedicated staff of the
CFTC has stepped up to the challenge and has recommended thoughtful
rules--with a great deal of input from each of the five Commissioners--
that would implement the Act. Thus far, the CFTC has approved 39
notices of proposed rulemaking, two interim final rules, four advanced
notices of proposed rulemaking and one final rule.
The CFTC's process to implement the rulemakings required by the Act
includes enhancements over the agency's prior practices in five
important areas. Our goal was to provide the public with additional
opportunities to inform the Commission on rulemakings, even before
official public comment periods. I will expand on each of these five
points in my testimony.
1. We began soliciting views from the public immediately after the
Act was signed and prior to approving proposed rulemakings.
This allowed the agency to receive input before the pens hit
the paper.
2. We hosted a series of public, staff-led roundtables to hear ideas
from the public prior to considering proposed rulemakings.
3. We engaged in significant outreach with other regulators--both
foreign and domestic--to seek input on each rulemaking.
4. Information on both staff's and Commissioners' meetings with
members of the public to hear their views on rulemakings has
been made publicly available at cftc.gov.
5. The Commission held public meetings to consider proposed
rulemakings. The meetings were webcast so that the Commission's
deliberations were available to the public. Archive webcasts
are available on our Web site as well.
Two principles are guiding us throughout the rule-writing process.
First is the statute itself. We intend to comply fully with the
statute's provisions and Congressional intent to lower risk and bring
transparency to these markets.
Second, we are consulting heavily with both other regulators and
the broader public. We are working very closely with the SEC, the
Federal Reserve, the FDIC, the OCC and other prudential regulators,
which includes sharing many of our memos, term sheets and draft work
product. We also are working closely with Treasury and the new Office
of Financial Research. As of Tuesday, CFTC staff has had 422 meetings
with other regulators on implementation of the Act.
In addition to working with our American counterparts, we have
reached out to and are actively consulting and coordinating with
international regulators to harmonize our approach to swaps oversight.
As we are with domestic regulators, we are sharing many of our memos,
term sheets and draft work product with international regulators as
well. Our discussions have focused on clearing and trading
requirements, clearinghouses more generally and swaps data reporting
issues, among many other topics.
Specifically, we have been consulting directly and sharing
documentation with the European Commission, the European Central Bank,
the UK Financial Services Authority and the new European Securities and
Markets Authority. We also have shared documents with the Japanese
Financial Services Authority and consulted with Members of the European
Parliament and regulators in Canada, France, Germany, and Switzerland.
Through this consultation, we are working to bring consistency to
regulation of the swaps markets. In September of last year, the
European Commission released its swaps proposal. As we had in the Dodd-
Frank Act, the E.C.'s proposal covers the entire derivatives
marketplace--both bilateral and cleared--and the entire product suite,
including interest rate swaps, currency swaps, commodity swaps, equity
swaps and credit default swaps. The proposal includes requirements for
central clearing of swaps, robust oversight of central counterparties
and reporting of all swaps to a trade repository. The E.C. also is
considering revisions to its existing Markets in Financial Instruments
Directive (MiFID), which includes a trade execution requirement, the
creation of a report with aggregate data on the markets similar to the
CFTC's Commitments of Traders reports and accountability levels or
position limits on various commodity markets.
We also are soliciting broad public input into the rules. On July
21st, we listed the 30 rule-writing teams and set up mailboxes for the
public to comment directly. We determined it would be best to engage
the public as broadly as possible even before publishing proposed
rules. As of Tuesday, we have received 2,856 submissions from the
public through the e-mail inboxes as well as 1,258 official comments in
response to notices of proposed rulemaking. The CFTC and the SEC in
December proposed a joint rule to further define the terms ``swap
dealer'' and ``major swap participant.'' The comment period on this
proposal is open until February 22. To the extent that members of the
public have comments on other rules that apply to swap dealers and
major swap participants and have not yet submitted them, they may
include those comments within their submissions on this rule. The CFTC
will use its discretion to include those in the comment files and
consider them for the related rules.
We also have organized nine roundtables to hear specifically on
particular subjects. We have coordinated the majority of our
roundtables with the SEC and have joined with other regulators on
several of them as well. These meetings have allowed us to hear
directly from investors, market participants, end-users, academics,
exchanges and clearinghouses on key topics including governance and
conflicts of interest, real time reporting, swap data record keeping
and swap execution facilities, among others. The roundtables have been
open to the public, and we have established call-in numbers for each of
them so that anyone can listen in.
Additionally, many individuals have asked for meetings with either
our staff or Commissioners to discuss swaps regulation. As of Tuesday,
we have had more than 540 such meetings. We are now posting on our Web
site a list of all of the meetings CFTC staff and I have with outside
organizations, as well as the participants, issues discussed and all
materials given to us.
We began publishing proposed rulemakings at our first public
meeting to implement the Act on October 1, 2010. We have sequenced our
proposed rulemakings over 11 public meetings thus far. Our next meeting
is scheduled for February 24.
Public meetings have allowed us to discuss proposed rules in the
open. For the vast majority of proposed rulemakings, we have solicited
public comments for a period of 60 days. On a few occasions, the public
comment period lasted 30 days. As part of seeking public comment on
each of the individual rules, we also have asked a question within many
of the proposed rulemakings relating to the timing for the
implementation of various requirements under these rules. In looking
across the entire set of rules and taking into consideration the costs
of cumulative regulations, public comments will help inform the
Commission as to what requirements can be met sooner and which ones
will take a bit more time.
We have thus far proposed rulemakings in 26 of the 30 areas
established last July. We still must propose rules on capital and
margin requirements, product definitions (jointly with the SEC) and the
Volcker Rule. We also are considering comments received in response to
advanced notices of proposed rulemaking with regard to disruptive
trading practices and segregation of funds for cleared swaps.
A number of months ago we also set up a 31st rulemaking team tasked
with developing conforming rules to update the CFTC's existing
regulations to take into account the provisions of the Act.
End-User Margin
One of the rules on which the CFTC is working closely with the SEC,
the Federal Reserve and other prudential regulators will address margin
requirements for swap dealers and major swap participants.
Congress recognized the different levels of risk posed by
transactions between financial entities and those that involve
nonfinancial entities, as reflected in the nonfinancial end-user
exception to clearing. Transactions involving nonfinancial entities do
not present the same risk to the financial system as those solely
between financial entities. The risk of a crisis spreading throughout
the financial system is greater the more interconnected financial
companies are to each other. Interconnectedness among financial
entities allows one entity's failure to cause uncertainty and possible
runs on the funding of other financial entities, which can spread risk
and economic harm throughout the economy. Consistent with this,
proposed rules on margin requirements should focus only on transactions
between financial entities rather than those transactions that involve
nonfinancial end-users.
Existing Derivatives Contracts
Congress provided for the legal certainty for swaps entered into
prior to the date of enactment of the Dodd-Frank Act. Questions also
have been raised regarding the clearing mandate and margin
requirements. With respect to the clearing requirement and margin, I
believe that the new rules should apply on a prospective basis only as
to transactions entered into after the rules take effect.
Financial Stability Oversight Council
The Dodd-Frank Act established the FSOC to ensure protections for
the American public. I am honored to serve on the Council. The
financial system should allow people who want to hedge their risk to do
so without concentrating risk. One of the challenges for this Council
and for the American public is that like so many other industries, the
financial industry has gotten very concentrated. Adding to our
challenge is the perverse outcome of the financial crisis, which may be
that some in the markets have come to believe that large financial
firms will--if in trouble--have the backing of the taxpayers. As it is
unlikely that we could ever ensure that no financial institution will
fail--because surely, some will in the future--we must do our utmost to
ensure that when those challenges arise, the taxpayers are not forced
to stand behind those institutions and that these institutions are free
to fail.
There are very important decisions that the Council will make, such
as determinations about systemically important nonbank financial
companies and systemically important financial market utilities and
clearinghouses, resolving disputes between agencies and completing
important studies as dictated by the Dodd-Frank Act. Though these
specific decisions are significant, it is essential that we make sure
that the American public doesn't bare the risk of the financial system
and that the system works for the American public, investors, small
businesses, retirees, and homeowners.
The Council's eight current voting members have coordinated
closely. Treasury's leadership has been invaluable. To support the
FSOC, the CFTC is providing both data and expertise relating to a
variety of systemic risks, how those risks can spread through the
financial system and the economy and potential ways to mitigate those
risks. We also have had the opportunity to coordinate with Treasury and
the Council on each of the studies and proposed rules issued by the
FSOC.
Conclusion
Before I close, I will briefly address the resource needs of the
CFTC. The futures marketplace that the CFTC currently oversees is
approximately $40 trillion in notional amount. The swaps market that
the Act tasks the CFTC with regulating has a notional amount roughly
seven times the size of that of the futures market and is significantly
more complex. Based upon figures compiled by the Office of the
Comptroller of the Currency, the largest 25 bank holding companies
currently have $277 trillion notional amount of swaps.
The CFTC's current funding is far less than what is required to
properly fulfill our significantly expanded mission. Though we have an
excellent, hardworking and talented staff, we just this past year got
back to the staff levels that we had in the 1990s. To take on the
challenges of our expanded mission, we will need significantly more
staff resources and--very importantly--significantly more resources for
technology. Technology is critical so that we can be as efficient as an
agency as possible in overseeing these vast markets.
The CFTC currently is operating under a continuing resolution that
provides funding at an annualized level of $169 million. The President
requested $261 million for the CFTC in his proposed fiscal year (FY)
2011 budget. This included $216 million and 745 full-time equivalent
employees for prereform authorities and $45 million to provide half of
the staff estimated at that time needed to implement the Act. Under the
continuing resolution, the Commission has operated in FY2011 at its
FY2010 level. In the budget released on Monday, the President requested
$308 million for the CFTC for FY2012 that would provide for 983 full-
time equivalent employees.
Given the resource needs of the CFTC, we are working very closely
with self regulatory organizations, including the National Futures
Association, to determine what duties and roles they can take on in the
swaps markets. Nevertheless, the CFTC has the ultimate statutory
authority and responsibility for overseeing these markets. Therefore,
it is essential that the CFTC have additional resources to reduce risk
and promote transparency in the swaps markets.
Thank you, and I'd be happy to take questions.
______
PREPARED STATEMENT OF JOHN WALSH
Acting Comptroller of the Currency, Office of the Comptroller of the
Currency
February 17, 2011
Statement Required by 12 U.S.C. 250: The views expressed herein are
those of the Office of the Comptroller of the Currency and do not
necessarily represent the views of the President.
Chairman Johnson, Ranking Member Shelby, and Members of the
Committee, I appreciate the opportunity to describe the initiatives the
Office of the Comptroller of the Currency (OCC) has undertaken to
implement the Dodd-Frank Wall Street Reform and Consumer Protection Act
(Dodd-Frank Act). My testimony reports on the OCC's work to date to
implement Dodd-Frank in the following key areas:
The OCC's progress integrating the staff and functions of
the Office of Thrift Supervision (OTS) into the OCC, and
identifying employees for transfer to the Consumer Financial
Protection Bureau (CFPB);
Highlights of our work to date in implementing important
policy and rulemaking initiatives required by Dodd-Frank,
including the OCC's participation on the Financial Stability
Oversight Council (FSOC or Council), and the challenges of
ensuring that these initiatives are appropriately coordinated
with other participating agencies and with international
efforts to reform capital and liquidity standards for financial
institutions; and the Council's achievements thus far; and
Provides an update on a significant issue that was just
emerging at the time of the Committee's last hearing on Dodd-
Frank implementation by reporting on the steps that the OCC,
working with our fellow regulators, has taken to identify and
address irregularities in institutions' foreclosure processes
and our efforts to foster development and implementation of
comprehensive and nationally applicable mortgage servicing
standards.
I. Implementation of Agency Restructuring
A. OTS/OCC Integration
As the Committee is aware, the Dodd-Frank Act transfers from OTS to
the OCC supervisory responsibilities for Federal savings associations,
as well as rulemaking authority relating to all savings associations.
Under the statute, all OTS employees will be transferred to either the
OCC or the Federal Deposit Insurance Corporation (FDIC) no later than
90 days after the ``transfer date,'' which is 1 year after enactment
unless extended for an additional six months by the Secretary of the
Treasury. The allocation is to be based generally on the proportion of
Federal versus State savings associations regulated by the OTS.
When I testified before this Committee in September of last year,
\1\ I described the steps the OCC had begun to take to prepare for our
expanded supervisory responsibilities and for the integration of OTS
staff that is so essential to the success of that effort. Since then,
we have continued to work closely with the OTS, the Board of Governors
of the Federal Reserve System (FRB), and the FDIC to prepare for the
smooth and effective transfer of OTS staff, authority and
responsibilities, and property and other assets. Much remains to be
done, but I am pleased to report that the agencies are on track to
complete the transfer of functions and staff by the target date of July
21, 2011. The following summarizes key elements of this progress. A
detailed description of all our activities is set forth in the
interagency Joint Implementation Plan (Plan) submitted to the Committee
on Banking, Housing, and Urban Affairs of the Senate, the Committee on
Financial Services of the House of Representatives, and the Inspectors
General of the Department of the Treasury, the FDIC, and the FRB on
January 25, 2011. \2\
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\1\ Testimony of John Walsh, Acting Comptroller of the Currency,
Before the Committee on Banking, Housing, and Urban Affairs of the
United States Senate, September 30, 2010.
\2\ The Plan was submitted pursuant to section 327 of the Dodd-
Frank Act. See, ``Interagency Joint Implementation Plan'' at
www.occ.gov/publications/publications-by-type/other-publications/pub-
other-jointimplementation-plan.pdf. The Plan provides additional detail
about the agencies' progress in implementing the employee protections
that Dodd-Frank provides to transferring OTS employees, including
retirement benefits; health, dental, vision, and long-term care; and
life insurance. The Plan also discusses the integration of OTS
employees into the OCC's pay structure.
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Because Dodd-Frank transfers the vast majority of OTS
responsibilities to the OCC on the transfer date, most of the OTS's
approximately 1,000 employees will transfer to the OCC. \3\ The OCC
recognizes that retaining the unique talent and experience of OTS staff
is essential for the effective supervision of Federal savings
associations going forward. Our work in preparing for the full
integration of the OTS staff is focused on: ensuring that the
protections afforded by the legislation are fully and equitably
implemented; building a sustainable organizational structure that will
successfully accomplish supervision and regulation of both national
banks and Federal savings associations; fostering an environment that
will maximize opportunities for staff; and promoting communication with
all employees throughout the transition. Pursuant to section 314(b) of
Dodd-Frank, on November 3, 2010, I designated Timothy T. Ward to be
Deputy Comptroller for Thrift Supervision. Mr. Ward, who joined the OCC
after 26 years at the OTS and its predecessor agency, reports to the
Senior Deputy Comptroller for the OCC's Midsize/Community Bank
Supervision (M/CBS) and is leading the planning process for integration
of the OTS's examination and supervision functions and staff. He serves
as a key senior management group member, and will coordinate the
nationwide network of Senior Thrift Advisors and function as the key
advisor to other Deputy Comptrollers on large and problem thrifts.
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\3\ The final number of staff who transfer to the OCC will include
those personnel who do not transfer to the FDIC to support functions
transferred to that agency, those personnel who do not transfer to the
CFPB, and those personnel who do not choose to leave the agency for
other reasons prior to the transfer date.
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Realignment of Staffing To Prepare for Expanded Supervisory
Responsibilities
The OCC will assign OTS employees, to the extent practicable, to
OCC positions performing the same functions and duties that the OTS
employees performed prior to the transfer. To assist in this effort,
the OCC has reached out to OTS employees in a number of ways at the
agency and business unit level. For example, because most OTS employees
will transfer into the OCC's M/CBS organization, the Senior Deputy
Comptroller for M/CBS has held four OTS-wide conference calls
explaining its organizational structure and the decisions that are
being made to accommodate the transfer of OTS staff. Similar
conversations are occurring for other functional areas.
Approximately 670 Federal savings associations will be transferred
to the OCC on the transfer date. OCC's Community Bank Supervision staff
will supervise the vast majority of them, while the Midsize and Large
Bank Supervision programs will supervise Federal savings associations
with profiles that align with those units. The Special Supervision
portfolio will also expand to include certain troubled Federal savings
associations. The OCC is working with the OTS to execute an orderly
transfer of authority and responsibilities that will ensure the
effective supervision of both national banks and Federal savings
associations.
To provide thrift supervision leadership continuity and facilitate
the integration of the OTS into the OCC, five senior OTS managers
responsible for thrift supervision already have accepted positions in
OCC's M/CBS organization. Although they will not officially assume
these positions until the transfer date, they are actively
participating in the OCC's planning activities. Their extensive
knowledge of the OTS organization, the staff, and Federal savings
associations is an invaluable resource as we prepare for the
transition. The OCC is in the process of filling the remaining
positions created by the OCC's structural changes through a competitive
posting process open to both qualified OTS and OCC staff.
Training and Certification of Employees
Training will be critical to the combined success of the OCC and
the OTS. Ultimately, the OCC's National Bank Examiner commission will
expand to ensure that each commissioned examiner has the skill set and
credentials to lead examinations of both national banks and Federal
savings associations. Initially, the agencies are reviewing each of
their training and certification programs to identify where OCC and OTS
training programs overlap and where gaps need to be addressed.
Review and Continuation of OTS Regulations
Dodd-Frank requires the OCC, the FDIC, and the FRB to identify
those continued OTS regulations that each agency will enforce. The OCC
and the FDIC must consult with each other in identifying these
regulations, and the OCC, the FRB, and the FDIC must publish a list of
these identified regulations in the Federal Register not later than the
transfer date. The agencies have begun the task of identifying these
OTS regulations and will publish the lists required by the legislation
on or before the transfer date.
Working together with OTS staff, the OCC is considering how to
integrate the OTS's regulations with the OCC's regulations. This
process is expected to include certain changes that would be effective
as of the July 21, 2011, transfer date and to continue in phases after
that date. Any substantive changes proposed to either the OCC's or the
OTS's regulations affecting savings associations will be published in
the Federal Register.
Thrift Industry Outreach
The OCC recognizes the importance of communicating regularly with
the industry throughout this process to address concerns, clarify
expectations, and promote effective supervision of Federal savings
associations. The communication process began with a personal letter
that I sent to the chief executive officer of each Federal savings
association in September. Two additional letters have been sent since
that time to share further information about the integration process.
Senior OCC leaders have also accepted numerous invitations to
participate in industry-sponsored events that provide an opportunity to
speak directly with management representatives of Federal savings
associations. Additionally, the OCC has developed a day-long program
for thrift executives to provide information and perspective on the
agency's approach to supervision and regulation. The OCC District
Deputy Comptrollers and OTS Regional Directors are cohosting 17 of
these sessions in locations around the country during the first quarter
of 2011. More than 1,000 thrift industry representatives have
registered to attend one of these sessions. The feedback received from
attendees at the first seven sessions has been very positive.
B. Transfers of Specified Functions to the CFPB
OCC has continued to provide extensive assistance to Treasury and
the CFPB to support the stand up of the CFPB. We have provided
extensive information about our human resources policies and practices,
compensation structure and OCC-unique benefits, and copies of all of
our position descriptions. We have worked with Treasury and CFPB staff
and our payroll provider, the National Finance Center, to enable the
CFPB to replicate the OCC's NB pay plan and compensation system,
accelerating its ability to hire employees under their own authorities
and provide the compensation and benefits allowed for under the Dodd-
Frank Act.
In the late fall, OCC established an Expression of Interest process
for employees who may be interested in pursuing work with the CFPB,
either on a temporary basis (detail) or permanently. Having a cadre of
interested employees has allowed us to respond to requests for
assistance with targeted OCC resources with unique skill sets.
The OCC has met with the CFPB implementation team several times
over the past few months to discuss a mutually agreeable transfer
process for OCC employees who are interested in going to the CFPB and
have the requisite skills and experience to perform the work. We are
committed to following through on the development and execution of this
process.
In addition to human resource related matters, the OCC has
responded to numerous data requests, held informational meetings, and
provided technical support to assist the CFPB as it develops processes
to fulfill its consumer protection function. Informational meetings
have been held to discuss OCC processes relating to the Equal Credit
Opportunity Act (ECOA), the CARD Act, and general bank supervision as
well as enforcement authorities and practices. Consumer compliance
policies and training materials have been provided. Extensive meetings
have been held with the OCC's Customer Assistance Group and a team
leader from this group was detailed to help the CFPB develop its
consumer complaints function. Most recently in response to a request
for information on the CARD Act, the OCC agreed to make a presentation
at the CFPB's seminar on the effects of the CARD Act.
II. Implementation of Dodd-Frank Policy and Rulemaking Initiatives
In my September 2010 testimony, I described the OCC's early
postenactment efforts to support the organization and operation of the
FSOC and our participation in the important interagency rulemaking
projects that were just then starting up. The OCC now is actively
working on approximately 85 Dodd-Frank projects ranging in scope from
our extensive efforts to prepare to integrate the OTS's staff and
supervisory responsibilities to consultation on a variety of
rulemakings being undertaken by other agencies. While significant
progress has occurred on a number of these policy and rulemaking
initiatives, the OCC continues to face substantial challenges in the
implementation of some of Dodd-Frank's provisions. This portion of my
testimony provides highlights the progress we have made thus far in
implementing key Dodd-Frank initiatives and describes the most
significant challenges to implementation that we have identified.
A. Rulemaking and Policy Initiatives: Milestones Achieved
Financial Stability Oversight Council
The OCC actively participates in the FSOC. The FSOC's mission is to
identify risks to financial stability that could arise from the
activities, material financial distress, or failure of large,
interconnected financial companies; to recommend standards for
implementation by the agencies in specified areas; to promote market
discipline; and to respond to emerging threats to the stability of the
U.S. financial system.
The FSOC already has undertaken a number of significant actions. At
its first meeting in October 2010, the FSOC approved publication of an
advance notice of proposed rulemaking (ANPR) seeking public comments
regarding the criteria and analytical framework for designation of
nonbank financial firms for enhanced supervision by the FRB pursuant to
section 113 of the Dodd-Frank Act. Based on a review of comments
received and consideration by the members of the FSOC, at its January
2011 meeting the FSOC approved a notice of proposed rulemaking relating
to section 113. The proposed rule lays out the framework that the FSOC
proposes to use to determine whether a nonbank financial company could
pose a threat to the financial stability of the United States. It also
implements the process that the FSOC would use when considering whether
to subject a firm to supervision by the FRB and heightened prudential
standards.
The FSOC has also taken steps to implement the provisions of the
Dodd-Frank Act known as the ``Volcker Rule,'' which prohibit banking
entities from engaging in proprietary trading and from maintaining
certain relationships with hedge funds and private equity funds. The
Volcker Rule requires the FSOC to study and make recommendations on
implementing its restrictions. Under section 619, the OCC and other
agencies must consider the recommendations of the FSOC study in
developing and adopting regulations to implement the Volcker Rule. To
assist the FSOC in conducting the study and formulating its
recommendations, in October 2010 the FSOC issued a request for
information through public comment. Based on a review of comments
received and consideration by the members of the FSOC, the FSOC issued
the Volcker Rule study and recommendations in January 2011. Informed by
the study, the rulemaking agencies have begun the process of drafting
regulations to implement the Volcker Rule. The statute sets a deadline
of October 2011 for completion of that work.
Establishment of the Office of Minority and Women Inclusion
Pursuant to section 342 of the Dodd-Frank Act, the OCC has
established an Office of Minority and Women Inclusion. On January 19,
2011, I named Joyce Cofield Director of this office. Ms. Cofield, who
has 28 years of experience in human capital management, workforce
diversity and business operations, will report to the Comptroller and
provide executive direction, set policies, and oversee all matters of
the OCC relating to diversity in management, employment, and business
activities. The establishment of this office and the appointment of Ms.
Cofield will ensure that the OCC will continue to be atop the list of
``Best Places To Work'' in the Federal Government for issues relating
to the broadest definition of diversity.
Incentive Compensation Rulemaking
The OCC, FRB, FDIC, OTS, National Credit Union Administration
(NCUA), Securities Exchange Commission (SEC), and Federal Housing
Finance Agency (FHFA) (the Agencies) are in the process of issuing a
proposal to implement the incentive-based compensation provisions in
Section 956 of the Dodd-Frank Act. The proposed rule will require the
reporting of certain incentive-based compensation arrangements by a
covered financial institution \4\ and prohibit incentive-based
compensation arrangements at a covered financial institution that
provide excessive compensation or that could expose the institution to
inappropriate risks that could lead to a material financial loss.
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\4\ Section 956(e)(2) defines a ``covered financial institution''
to mean a depository institution or depository institution holding
company; a registered broker-dealer; a credit union; an investment
adviser; Fannie Mae; Freddie Mac; and ``any other financial
institution'' that the regulators jointly determine, by rule, should be
covered by section 956. Institutions with less than $1 billion in
assets are not subject to section 956.
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The material financial loss provisions of the proposed rule
establish general requirements applicable to all covered institutions
and additional requirements applicable to larger covered financial
institutions. The generally applicable requirements provide that an
incentive-based compensation arrangement, or any feature of any such
arrangement, established or maintained by any covered financial
institution for one or more covered persons must balance risk and
financial rewards and be compatible with effective controls and risk
management and supported by strong corporate governance.
The proposed rule includes two additional requirements for ``larger
financial institutions,'' which for the Federal banking agencies, NCUA,
and the SEC means those covered financial institutions with total
consolidated assets of $50 billion or more. First, a larger financial
institution must defer 50 percent of incentive-based compensation for
its executive officers for a period of at least 3 years. Second, the
board of directors (or committee thereof) of a larger financial
institution also must identify, and approve the incentive-based
compensation arrangements for, individuals (other than executive
officers) who have the ability to expose the institution to possible
losses that are substantial in relation to the institution's size,
capital, or overall risk tolerance. These individuals may include, for
example, traders with large position limits relative to the
institution's overall risk tolerance and other individuals that have
the authority to place at risk a substantial part of the capital of the
covered financial institution.
Credit Risk Retention
Section 941 of the Dodd-Frank Act requires the OCC, FRB, FDIC, and
SEC to issue joint regulations requiring securitizers of asset-backed
securities to retain an economic interest in a portion of the credit
risk for assets that the securitizer packages into the securitization
for sale to others. Where these regulations address the securitization
of residential mortgage assets, the Department of Housing and Urban
Development and the FHFA are also part of the joint rulemaking group.
The Treasury Secretary, as Chairperson of FSOC, is directed to
coordinate the joint rulemaking.
In order to correct adverse market incentive structures revealed by
the crisis, section 941 requires the securitizer to retain a portion of
the credit risk on assets it securitizes, unless those assets are
originated in accordance with conservative underwriting standards
established in regulation. This new regulatory regime will give
securitizers direct financial disincentives against packaging loans
that are underwritten poorly.
As the FRB has noted in its recent study of the securitization
markets (also required by section 941), the securitization markets
provide an important mechanism for making credit available for
businesses, households, and governments. \5\ In drafting the proposed
rules mandated by section 941, the agencies are taking a number of
priorities into account. These include incorporating appropriate
incentives that encourage high-quality underwriting of loans included
in securitizations; designing robust forms of risk retention that
reflect the diversity of securitization structures used in the
marketplace; and recognizing the diversity of asset classes commonly
securitized. The statute requires the agencies not only to create low-
risk underwriting standards for certain asset classes used in
securitizations, but also to define the appropriate form and amount of
risk retention interests, consider circumstances in which it might be
appropriate to shift the retention obligation to the originator of the
securitized assets, and create rules addressing complex securitizations
backed by other asset-backed securities. Various exemptions from the
risk retention requirements also must be implemented. In particular,
the banking agencies, SEC, HUD and the FHFA are directed to define
``qualified residential mortgages'' with underwriting and product
features that historical loan performance data indicate result in a
lower risk of default. Securitizations of QRMs are specifically
exempted from the credit risk retention requirements.
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\5\ Board of Governors of the Federal Reserve System, Report to
Congress on Risk Retention, (October 2010).
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Work on the notice of proposed rulemaking is nearing completion and
the agencies hope to be able to publish a proposal in the next month.
B. Implementation Challenges
Capital and Liquidity: Coordination of Dodd-Frank
Initiatives With International Reforms
The Dodd-Frank Act focused considerable attention on enhancing the
capital and liquidity standards of U.S. financial companies. The
banking agencies and FSOC are called upon to develop and publish
numerous studies and regulations that will materially affect the level
and composition of capital and liquidity for both banks and certain
nonbank financial companies. As I have indicated in previous testimony
to this Committee \6\ and reiterated in a recent speech, \7\ one of the
main challenges facing supervisors in this area is the need to
coordinate Dodd-Frank implementation efforts with agency actions to
adopt recent reforms announced by the Basel Committee on Banking
Supervision (Basel Committee), the so-called Basel III reforms. While
these two significant public policy initiatives are not identical in
their design and standards, they share many common objectives and
address many of the same underlying issues. It is incumbent on the
agencies to consider these reforms in a coordinated, mutually
reinforcing manner, so as to enhance the safety and soundness of the
U.S. and global banking system, while not damaging competitive equity
or restricting access to credit.
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\6\ See, supra, note 1.
\7\ See, John Walsh, ``Acting Comptroller of the Currency, Remarks
at the Exchequer Club'' (January 19, 2011).
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As noted above, various provisions of Dodd-Frank seek to enhance
the capital and liquidity standards of U.S. financial companies. The
U.S. agencies are making appropriate progress in drafting the required
studies and regulations to effectuate Congressional intent in these
areas. A summary of these efforts is provided below:
Under sections 115(a) and 115(b) of Dodd-Frank, in order to
prevent or mitigate risk to financial stability, the FSOC may
make recommendations to the FRB \8\ concerning the
establishment of prudential standards applicable to nonbank
financial companies supervised by the FRB and certain large
bank holding companies. These prudential standards, which are
to be more stringent than those applicable to other companies
that do not pose similar risk to financial stability, are
expected to address risk-based capital requirements, leverage
limits, and liquidity requirements, among other provisions. The
FSOC has commenced work on this project and expects to provide
recommendations to the FRB shortly.
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\8\ Under section 165 of Dodd-Frank, the FRB, on its initiative or
pursuant to recommendations by FSOC under Sections 115(a) and 115(b),
shall establish prudential standards applicable to nonbank financial
companies supervised by the FRB and certain large bank holding
companies.
Section 171(b) of Dodd-Frank requires the banking agencies
to establish minimum risk-based capital requirements applicable
to insured depository institutions, depository institution
holding companies, and nonbank financial companies supervised
by the FRB. On December 30, 2011, the banking agencies
published a notice of proposed rulemaking addressing the
requirements of section 171(b). Agencies continue to encourage
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public comment on this proposal through February 28, 2011.
Section 115(c) of Dodd-Frank requires the FSOC to conduct a
study of the feasibility, benefits, costs, and structure of a
contingent capital requirement for certain nonbank financial
companies and bank holding companies. FSOC has commenced work
on this requirement earlier than initially projected in order
to articulate a U.S. position on this important topic in
advance of international deliberations at the Basel Committee,
Financial Stability Board, and other organizations.
Section 616(c) of Dodd-Frank amends the International
Lending Supervision Act of 1983 by providing that each Federal
banking agency shall seek to make capital standards
countercyclical, so that the amount of required capital
increases in times of economic expansion and decreases in times
of economic contraction, consistent with safety and soundness.
Consistent with this provision, the agencies are actively
considering the establishment of countercyclical capital
requirements in proposed regulations implementing the Basel III
reforms.
As noted in my testimony before this Committee on September 30 of
last year, the Basel III reforms focus on many of the same issues and
concerns that the Dodd-Frank Act sought to address. These reforms of
the Basel Committee are designed to strengthen global capital and
liquidity standards governing large, internationally active banks and
promote a more resilient banking sector. Like Dodd-Frank, the Basel III
reforms tighten the definition of what counts as regulatory capital by
placing greater reliance on higher quality capital instruments; expand
the types of risk captured within the capital framework; establish more
stringent capital requirements; provide a more balanced consideration
of financial stability and systemic risks in bank supervision practices
and capital rules; and call for leverage ratio requirement and global
minimum liquidity standards. Since the Basel III enhancements can take
effect in the U.S. only through formal rulemaking by the banking
agencies, U.S. agencies have the opportunity to integrate certain Basel
III implementation efforts with the heightened prudential standards
required by Dodd-Frank. Such coordination in rulemaking will ensure
consistency in the establishment of capital and liquidity standards for
similarly situated organizations, appropriately differentiate relevant
standards for less complex organizations, and consider broader economic
impact assessments in the development of these standards.
Credit Ratings
The OCC recognizes that issues surrounding credit ratings were a
significant factor in market overconfidence that contributed to losses
in the markets for mortgage-backed securities in 2008-2009. The Dodd-
Frank Act includes a number of important remedial measures to address
this problem, including structural changes at the ratings agencies,
greater SEC oversight of the ratings process, and loan-level
disclosures to investors in asset-backed securities. In this context of
enhanced regulation that Dodd-Frank provides, the absolute prohibition
against any references to ratings under section 939A goes further than
is reasonably necessary. Moreover, it has become clear, as we have
tried to implement this requirement, that the disadvantages of the
prohibition are substantial.
Section 939A of Dodd-Frank requires each Federal agency to review
its regulations that refer to, or require the use of, credit ratings in
connection with an assessment of the creditworthiness of a security or
money market instrument. Each agency must then remove from its
regulations any reference to or requirement for reliance on credit
ratings and must develop alternative standards of creditworthiness to
serve as a substitute for reliance on credit ratings.
In accordance with section 939A, the OCC reviewed its regulations
and determined that credit ratings are referenced in two key areas: (1)
regulations governing which investment securities banks may purchase
and hold; and (2) regulations governing banking institutions' risk-
based capital requirements. Together, these regulations prevent banks
from making excessively speculative investments and help to assess the
relative risk of securities holdings.
In an effort to modify its regulations pursuant to the requirements
of section 939A, the OCC published an ANPR in August 2010 requesting
comment on alternative creditworthiness measures for its investment
securities regulations. Shortly thereafter, the OCC joined with the
FDIC and FRB in publishing an ANPR requesting comment on alternatives
for the agencies' risk-based capital regulations.
Additionally, the FRB, FDIC, and OCC hosted a forum on alternatives
to credit ratings that included representatives from various sectors of
the financial industry, including community, regional, and
internationally active banking institutions, financial analysts and
consultants, credit rating agencies, and insurance industry regulators,
as well as members of academia.
The comments received in response to the ANPRs, as well as the
discussion during the credit ratings forum, reinforced my concerns.
Although the commenters generally concurred with the agencies' stated
criteria for developing alternative creditworthiness standards, they
failed to suggest practical alternatives that could be implemented
across the banking industry.
In response to the OCC's requests for comment on how best to
implement section 939A, regional and community banks noted that using
internal risk assessment systems to measure credit worthiness for
regulatory purposes would be costly and time consuming. These
commenters noted that while cost and burden would be a factor for all
banks, it is likely to be more pronounced for community and regional
banks, and may therefore place them at a disadvantage compared to
larger institutions that have advanced analytical capabilities and
whose in-house systems and management capabilities could be converted
to apply new standards. A number of commenters stated that the costs
could be so great as to shut out smaller institutions from being able
to purchase certain types of high quality investment securities.
These concerns could be addressed if section 939A is amended in a
targeted manner that allows institutions to make limited use of credit
ratings. Precluding undue or exclusive reliance on credit ratings,
rather than imposing an absolute bar to their use, would strike a more
appropriate balance between the need to address the problems created by
overreliance on credit ratings with the need to enact sound regulations
that do not adversely affect credit availability or impede economic
recovery. With appropriate operational and due diligence requirements,
credit ratings can be a valuable factor to consider when evaluating the
creditworthiness of money market instruments and other securities.
Additionally, without amendment to allow the use of ratings as one
of the factors taken into consideration in evaluating creditworthiness,
the provision would prevent the Federal banking agencies from
implementing internationally agreed capital, liquidity, and other
prudential standards--including the strong new Basel III framework that
is now being finalized. The banking agencies already have had to
propose a limited implementation of an internationally negotiated
framework applicable to traded assets. Because of section 939A, the
Federal banking agencies' proposal to amend the risk-based capital
rules for market risk, published on January 11, 2011, did not include
ratings-based provisions that would have significantly increased the
amount of capital required to be held against traded assets. The
continued inability of the banking agencies to implement important
portions of the international standards will adversely affect our
ability to negotiate strong new global standards designed to prevent a
recurrence of the recent financial crisis.
Inconsistent or Duplicative Supervisory Responsibilities
Other implementation difficulties arise outside the rulemaking
context. One example concerns the respective roles of the banking
agencies and the CFPB in dealing with consumer complaints. Under the
Dodd-Frank Act, the function of handling consumer complaints is not a
function that transfers to the CFPB, but the CFPB has various
responsibilities concerning consumer complaints. At the same time,
other provisions of the Dodd-Frank Act envision that the prudential
regulators will also have responsibilities handling consumer
complaints, and those responsibilities are not confined to complaints
concerning banks of $10 billion or more in asset size. Absent
clarification of the CFPB's role, it is difficult for the prudential
regulators to determine how to staff their consumer complaint
operations, and if we downsize those operations to handle only
complaints involving institutions of less than $10 billion in size, it
is not clear how complaints involving larger institutions will be
handled.
Another area of concern is the confusing overlap of roles of the
Federal banking agencies and the CFPB for supervising and enforcing
fair lending provisions for insured depository institutions with total
assets greater than $10 billion. The Federal banking agencies currently
oversee depository institutions' compliance with the Fair Housing Act,
the ECOA, and the Federal Reserve Board's Regulation B, using
interagency examination guidelines issued by the Federal Financial
Institutions Examination Council. Under the Dodd-Frank Act, the banking
agencies will continue to perform this function for institutions under
our supervision with $10 billion or less in total assets. For larger
institutions, the legislation assigns exclusive supervisory
responsibility for ``Federal consumer financial laws'' to the CFPB. The
definition of ``Federal consumer financial laws'' includes the ECOA and
Regulation B, but not the Fair Housing Act. Because conduct that
violates the Fair Housing Act generally also violates the ECOA, the
CFPB's examination for compliance with ECOA should suffice to address
compliance with the Fair Housing Act.
However, if the intent of the legislation is for the CFPB to
supervise larger institutions for compliance with the ECOA and
Regulation B, but for the Federal banking agencies to supervise such
institutions' compliance with the Fair Housing Act, this result risks
significant inefficiency and potential confusion regarding
accountability in this area.
Another provision presenting potential concerns are the particular
requirements for how the prudential supervisors and the CFPB conduct
examinations of institutions with $10 billion or more in size. We
strongly favor efficient coordination of the activities of the
prudential regulators and the CFPB, but the particular requirements set
out in the Dodd-Frank Act would direct multistep activities that are
inefficient, overbroad, and sufficiently time-consuming that safety and
soundness based remedial actions that institutions should be required
to take immediately could be delayed.
While we plan to work with the CFPB to ensure appropriate oversight
of these activities without creating duplicative and potentially
inconsistent supervision, we also believe these areas would benefit
from Congressional clarification.
III. Other Developments
At the time of this Committee's Dodd-Frank implementation hearing
in September, concerns about foreclosure processing at the largest
mortgage servicers were just beginning to command wide attention. In
the months since then, the OCC, together with the other Federal banking
regulators, has taken unprecedented steps to investigate the problem.
This section provides an overview of that work, and the related
initiative to develop comprehensive national mortgage servicing
standards.
A. Foreclosure Processing Irregularities
Following reports of irregularities in the foreclosure processes of
several major mortgage servicers in the latter part of 2010, the OCC,
together with the FRB, the FDIC, and the OTS, undertook an
unprecedented project of coordinated horizontal examinations of
foreclosure processing at the 14 largest \9\ federally regulated
mortgage servicers during fourth quarter 2010. In addition, the
agencies conducted interagency examinations \10\ of MERSCORP and its
wholly owned subsidiary, Mortgage Electronic Registration Systems, Inc.
(MERS), and Lender Processing Servicers (LPS), which provide
significant services to support mortgage servicing and foreclosure
processing across the industry. The primary objective of the
examinations was to evaluate the adequacy of controls and governance
over bank foreclosure processes, including compliance with applicable
Federal and State law. Examiners also evaluated bank self assessments
and remedial actions as part of this process, assessed foreclosure
operating procedures and controls, interviewed bank staff involved in
the preparation of foreclosure documents, and reviewed approximately
2,800 borrower foreclosure cases \11\ in various stages of foreclosure.
Examiners focused on foreclosure policies and procedures,
organizational structure and staffing, vendor management including use
of third parties, including foreclosure attorneys, quality control and
audits, accuracy and appropriateness of foreclosure filings, and loan
document control, endorsement, and assignment. When reviewing
individual foreclosure files, examiners checked for evidence that
servicers were in contact with borrowers and had considered alternate
loss mitigation efforts, including loan modifications, in addition to
foreclosure.
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\9\ Agencies conducted foreclosure-processing examinations at
Aurora Bank, Bank of America, Citibank, EverBank, GMAC/Ally Bank, HSBC,
OneWest, JPMC, MetLife, PNC, Sovereign Bank, SunTrust, U.S. Bank, and
Wells Fargo.
\10\ The interagency examination of MERS was led by the OCC with
participation by the FHFA, FRB, FDIC, and OTS. The interagency
examination of LPS was led by the FRB with participation by FDIC, OCC,
and OTS.
\11\ The foreclosure file sample was selected independently by
examination teams based on preestablished criteria. Foreclosure files
at each bank were selected from the population of in-process and
completed foreclosures during 2010. In addition, the foreclosure file
sample at each bank included foreclosures from both judicial States and
nonjudicial States.
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To ensure consistency in the examinations, the agencies used
standardized work programs to guide the assessment and document
findings of each institution's corporate governance process and the
individual case review. Specifically, work programs were categorized
into the following areas:
Policies and Procedures--Examiners determined if the
policies and procedures in place ensured adequate controls over
the foreclosure process and that affidavits, assignments, and
other legal documents were properly executed and notarized in
accordance with applicable laws, regulations, and contractual
requirements.
Organizational Structure and Staffing--Examiners reviewed
the functional unit(s) responsible for foreclosure processes,
including staffing levels, qualifications, and training
programs.
Management of Third-Party Service Providers--Examiners
reviewed the financial institutions' governance of key third
parties used throughout the foreclosure process.
Quality Control and Internal Audits--Examiners assessed
foreclosure quality control processes. Examiners also reviewed
internal and external audit reports, including Government-
sponsored enterprise (GSE) and investor audits and reviews of
foreclosure activities, and institutions' self-assessments to
determine the adequacy of these compliance and risk management
functions.
Compliance With Applicable Laws--Examiners checked
compliance with applicable State and local requirements as well
as internal controls intended to ensure compliance.
Loss Mitigation--Examiners determined if servicers were in
direct communication with borrowers and whether loss mitigation
actions, including loan modifications, were considered as
alternatives to foreclosure.
Critical Documents--Examiners determined whether servicers
had control over the critical documents in the foreclosure
process, including appropriately endorsed notes, assigned
mortgages, and safeguarding of original loan documentation.
Risk Management--Examiners determined whether institutions
appropriately identified financial, reputation, and legal
risks, and whether these risks were communicated to the board
of directors and senior management.
In general, the examinations found critical deficiencies and
shortcomings in foreclosure governance processes, foreclosure document
preparation processes, and oversight and monitoring of third party law
firms and vendors. These deficiencies have resulted in violations of
State and local foreclosure laws, regulations, or rules and have had an
adverse affect on the functioning of the mortgage markets and the U.S.
economy as a whole. By emphasizing timeliness and cost efficiency over
quality and accuracy, examined institutions fostered an operational
environment that is not consistent with conducting foreclosure
processes in a safe and sound manner.
Despite these deficiencies, the examination of specific cases and a
review of servicers' custodial activities found that loans were
seriously delinquent, and that servicers maintained documentation of
ownership and had a perfected interest in the mortgage to support their
legal standing to foreclose. In addition, case reviews evidenced that
servicers were in contact with troubled borrowers and had considered
loss mitigation alternatives, including loan modifications. A small
number of foreclosure sales should not have proceeded because of an
intervening event or condition, such as the borrower: (a) being covered
by the Servicemembers Civil Relief Act; (b) filing bankruptcy shortly
before the foreclosure action; or (c) being approved for a trial period
modification.
While all servicers exhibited some deficiencies, the nature of the
deficiencies and the severity of issues varied by servicer. The OCC and
the other Federal banking agencies with relevant jurisdiction are in
the process of finalizing actions that will incorporate appropriate
remedial requirements and sanctions with respect to the servicers
within their respective jurisdictions. We also continue to assess and
monitor servicers' self-initiated corrective actions. We expect that
our actions will comprehensively address servicers' identified
deficiencies and will hold servicers to standards that require
effective and proactive risk management of servicing operations, and
appropriate remediation for customers who have been financially harmed
by defects in servicers' standards and procedures.
We also intend to leverage our findings and lessons learned in this
examination and enforcement process to contribute to the development of
national mortgage servicing standards. This initiative is discussed in
more detail below.
B. New National Mortgage Servicing Standards
The interagency foreclosure processing examinations revealed
significant weaknesses in mortgage servicing related to foreclosure
oversight and operations. Outside the scope of the foreclosure review,
however, we have also seen servicing-related problems arise for
borrowers seeking mortgage relief.
Two practices in particular are generally recognized to have
adversely affected borrowers seeking to avoid foreclosure. For example,
I have questioned the practice of continuing foreclosure proceedings
even when a trial modification had been negotiated and is in force--the
so-called ``dual track'' issue. Indeed, the OCC has directed national
bank servicers to suspend foreclosure proceedings for borrowers in
successfully performing trial modifications when they have the legal
ability under the servicing contract to do so. Another significant
issue relates to the sufficiency of staffing. Frequently, troubled
borrowers find that there is no one individual or team who takes
responsibility for monitoring and acting on their loan modification
requests. This can lead to lost time, lost documents, and lost homes.
These borrowers need to have a single point of contact that they can go
to in these situations. And servicers need to have appropriately
trained and dedicated staff, reporting to management, with the
authority and responsibility to address the borrower's concerns so they
cannot ``fall through the cracks.''
But the problems with servicing are not limited to the practices
affecting delinquent loans, and recent experience highlights the need
for uniform standards for mortgage servicing that apply to all facets
of servicing the loan, from loan closing to payoff. The OCC believes
that mortgage servicing standards should apply uniformly to all
mortgage servicers and provide the same safeguards for consumers,
regardless of whether a mortgage has been securitized. To be meaningful
and effective, these standards should be directly enforceable by
Federal and State agencies rather than rely on the actions of private
parties to enforce the terms of servicing contracts affecting a limited
class of mortgage loans. A key driver of servicing practices has been
and continues to be secondary market requirements. We will not achieve
improvements in mortgage servicing without corresponding changes in
requirements imposed by the GSEs.
To further this effort and discussion, the OCC developed a
framework for comprehensive mortgage servicing standards that we shared
with other agencies, and we are now participating in an interagency
effort to develop a set of comprehensive and robust, nationally
applicable mortgage servicing standards. Our objective is to develop
uniform standards that govern processes for:
Handling borrower payments, including applying payments to
principal and interest and taxes and insurance before they are
applied to fees, and avoiding payment allocation processes
designed primarily to increase fee income;
Providing adequate borrower notices about their accounts
and payment records, including a schedule of fees, periodic and
annual statements, and notices of payment history, payoff
amount, late payment, delinquency, and loss mitigation;
Responding promptly to borrower inquiries and complaints,
and promptly resolving disputes;
Providing an avenue for escalation and appeal of unresolved
disputes;
Effective incentives to work with troubled borrowers,
including early outreach and counseling;
Making good faith efforts to engage in loss mitigation and
foreclosure prevention for delinquent loans, including
modifying loans to provide affordable and sustainable payments
for eligible troubled borrowers;
Implementing procedures to ensure that documents provided
by borrowers and third parties are maintained and tracked so
that borrowers generally will not be required to resubmit the
same documented information;
Providing an easily accessible single point of contact for
borrower inquiries about loss mitigation and loan
modifications;
Notifying borrowers of the reasons for denial of a loan
modification, including information on the NPV calculation;
Implementing strong foreclosure governance processes that
ensure compliance with all applicable legal standards and
documentation requirements, and oversight and audit of third
party vendors;
Not taking steps to foreclose on a property or conduct a
foreclosure sale when the borrower is in a trial or permanent
modification and is not in default on the modification
agreement; and
Ensuring appropriate levels of trained staff to meet
current and projected workloads.
We are still at a relatively early stage in this process, but the
fact that we share these common objectives will help ensure that the
agencies can achieve significant reforms in mortgage servicing
practices across the board for all types of mortgage servicing firms.
IV. Conclusion
Let me close by assuring the Committee that, as we work to
implement the initiatives required by the Dodd-Frank Act, the OCC
remains fully engaged in its primary mission of ensuring the safety and
soundness as well as the vibrancy of the national banking system.
We continue to closely monitor and evaluate developments in the
system. The system is beginning to return to profitability--though
revenue generation and margins are low compared to historical
experience. In the large banks, we see a return to balance sheet
strength as capital, reserve, and liquidity levels have been rebuilt
over the past 3 years. Although credit risk remains elevated, we see
steady improvements contributing to an overall lower risk profile in
the largest banks. Conditions are also stabilizing for community banks.
While embedded losses continue to produce bank failures among community
banks, the vast majority of community banks continue to play a vibrant
role in the Nation's financial system. But, going forward, banks of all
sizes will face a business landscape that is significantly changed by
postcrisis market developments and by new rules implementing Dodd-
Frank. These developments affect both the ability of banks to generate
revenue and the costs and viability of particular activities or lines
of business. Their efficiency may be affected in the shorter term and
their business models in the long run. The OCC is committed to
supervising the effects of these changes to ensure the continuing
safety and soundness of the national banks we supervise.
I appreciate this opportunity to update the Committee on the work
we are doing to implement Dodd-Frank and I am happy to answer your
questions.
RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN JOHNSON
FROM BEN S. BERNANKE
Q.1. Recently, some have voiced concerns that the timeframe for
the rulemakings required by the Dodd-Frank Wall Street Reform
and Consumer Protection Act (Dodd-Frank) is too short to allow
for adequate consideration of the various comments submitted or
to review how the new rules may impact our financial markets.
Does the current timeframe established by Dodd-Frank allow each
rulemaking to be completed in a thoughtful and deliberative
manner?
A.1. Response not provided.
Q.2. Please identify the key trends in the derivatives market
that your agencies are currently monitoring to ensure systemic
stability.
A.2. Response not provided.
Q.3. In defining the exemption for ``qualified residential
mortgages,'' are the regulators considering various measures of
a lower risk of default, so that there will not just be one
``bright line'' factor to qualify a loan as a Q.R.M.?
A.3. Response not provided.
Q.4. What data are you using to help determine the definition
of a Qualified Residential Mortgage?
A.4. Response not provided.
Q.5. Dodd-Frank (Sec 939A) required the regulators to remove
any reference or requirement of reliance on credit ratings from
its regulations. In his testimony, Acting Comptroller of the
Currency John Walsh wrote: ``[R]egional and community banks
noted [in their comments] that using internal risk assessment
systems to measure credit worthiness for regulatory purposes
would be costly and time consuming . . . . These concerns could
be addressed if section 939A is amended in a targeted manner
that allows institutions to make limited use of credit ratings.
Precluding undue or exclusive reliance on credit ratings,
rather than imposing an absolute bar to their use, would strike
a more appropriate balance between the need to address the
problems created by overreliance on credit ratings with the
need to enact sound regulations that do not adversely affect
credit availability or impede economic recovery.''
What is the status of this effort and what types of
alternative measures are being considered? Do you share the
concerns raised by community banks, and what is your reaction
to Acting Comptroller Walsh's comments on this issue?
A.5. Response not provided.
Q.6. Please discuss the status of your efforts to implement the
stress test provisions under Dodd-Frank? To what extent have
you collaborated with the other banking regulators and how do
you plan to leverage the Office of Financial Research?
A.6. Response not provided.
Q.7. Please discuss the current status and timeframe of
implementing the Financial Stability Oversight Council's (FSOC)
rulemaking on designating nonbank financial companies as being
systemically important. As a voting member of FSOC, to what
extent is the Council providing clarity and details to the
financial marketplace regarding the criteria and metrics that
will be used by FSOC to ensure such designations are
administered fairly? Is the intent behind designation decisions
to deter and curtail systemically risky activity in the
financial marketplace? Are diverse business models, such as the
business of insurance, being fully and fairly considered as
compared with other financial business models in this
rulemaking?
A.7. Response not provided.
Q.8. On February 1, the Fed decided to not move forward with
three Regulation Z rulemakings, instead deferring to the CFPB
to complete these rules. There are three additional Regulation
Z rulemakings pending. Does the Fed intend to complete these
rulemakings?
A.8. Response not provided.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR SHELBY
FROM BEN S. BERNANKE
Q.1. The Dodd-Frank Act requires an unprecedented number of
rulemakings over a short period of time. As a result, some
deadlines have already been missed and some agencies expect to
miss additional deadlines. It appears that many of the
deadlines in Dodd-Frank are not realistic. Which Dodd-Frank
deadlines do you anticipate not being able to meet? If Congress
extended the deadlines, would you object? If your answer is
yes, will you commit to meeting all of the statutory deadlines?
If Congress affords additional time for rulemaking under the
Dodd-Frank Act, will you be able to produce higher-quality,
better coordinated rules?
A.1. The Board has made considerable progress in carrying out
its assigned responsibilities for issuing final rules under the
Dodd-Frank Act. In October, for example, the Board issued an
interim final rule to ensure that real estate appraisers are
free to use their independent professional judgment in
assigning home values without influence or pressure from those
with interests in the transactions. The rule also seeks to
ensure that appraisers receive customary and reasonable
payments for their services. In February, the Board announced
its approval of a final rule to implement the provisions of the
Act that give banking firms a period of time to conform their
activities and investments to the prohibitions and restrictions
of the so-called Volcker Rule. The Board recognizes the concern
expressed by the Congress regarding agency delay in the
rulemaking process and will work to ensure that the law is
implemented in a manner that is timely, best protects the
stability of our financial system, and strengthens the U.S.
economy.
The Board maintains a projected schedule of rulemakings on
its public Web site. While the Board generally has met the
congressionally mandated schedule in the Dodd-Frank Act, the
Board recently announced that final action on the
implementation of the debit interchange fee standards and
related rules under section 1075 of the Act will be delayed
beyond the April 21, 2011, action date in the Act. The Board
has devoted significant resources to timely completion of the
rulemaking and expects that due to the complexity of this
rulemaking, importance of the issues it raises, and the
significant amount of public comment received, the Board will
act on the final rule before the July 21, 2011, effective date
of the statutory requirement.
The provisions of the Dodd-Frank Act are important and grew
out of the exigencies and difficulties experienced during the
recent financial crisis. It is important that the steps taken
by Dodd-Frank Act be implemented well and in a timely fashion.
We will continue to work diligently to meet whatever schedule
Congress determines is appropriate for effectively implementing
and executing the policy objectives of the Act.
Q.2. Secretary Geithner recently talked about the difficulty of
designating nonbank financial institutions as systemic. He
said, ``it depends too much on the state of the world at the
time. You won't be able to make a judgment about what's
systemic and what's not until you know the nature of the
shock.'' \1\ If it is impossible to know which firms are
systemic until a crisis occurs, the Financial Stability
Oversight Council will have a very difficult time objectively
selecting systemic banks and nonbanks for heightened
regulation. As a member of the Council, do you believe that
firms can be designated ex ante as systemic in a manner that is
not arbitrary? If your answer is yes, please explain how.
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\1\ See, Special Inspector General for the Troubled Asset Relief
Program, ``Extraordinary Assistance Provided to Citigroup, Inc.''
(SIGTARP 11-002) (Jan. 13, 2011) (available at: http://www.sigtarp.gov/
reports/audit/2011/
Extraordinary%20Financial%20Assistance%20Provided%20to%20Citigroup,%20In
c.pdf), at 43.
A.2. The Dodd-Frank Act requires the Council to designate
nonbank financial firms for Federal Reserve supervision and
regulation if material financial distress at the firm could
pose a threat to U.S. financial stability. Making designation
decisions will be challenging, but we are committed to
assisting the Council in devising standards and processes for
designations that are as consistent across firms as reasonably
possible. Certain characteristics--such as a firm's size, its
interconnectedness with other firms or markets, and the
availability of substitutes for the financial services it
provides--will affect the likelihood and the magnitude of
spillovers from a firm's distress to the broader financial
system and real economy in a variety of stress scenarios. The
Council is also considering factors that are intended to
account for different types of economic conditions in
determining designations.
The Council has issued a notice of proposed rulemaking on
the nonbank financial firm designation process that indicates
the Council's intent to incorporate information on these
characteristics into its designation process. The Council's
decisions about the designation of nonbank financial firms will
be based on substantial information and analysis about the
characteristics of financial firms and markets and will provide
significant due process to affected companies.
Q.3. Section 112 of the Dodd-Frank Act requires the Financial
Stability Oversight Council to annually report to Congress on
the Council's activities and determinations, significant
financial market and regulatory developments, and emerging
threats to the financial stability of the United States. Each
voting member of the Council must submit a signed statement to
the Congress affirming that such member believes the Council,
the Government, and the private sector are taking all
reasonable steps to ensure financial stability and mitigate
systemic risk. Alternatively, the voting member shall submit a
dissenting statement. When does the Council expect to supply
the initial report to Congress?
A.3. Section 112 requires the Council to make an annual report
to Congress. The Council has been working diligently to
implement its statutory authorities and responsibilities
outlined under section 112 of the Dodd-Frank Act. For example,
the Council has begun to develop a framework and infrastructure
to evaluate potential systemic risks to the financial stability
of the United States and to monitor financial market and
regulatory developments. As a member agency of the Council, the
Board is providing assistance to the Council in these efforts.
The Board is committed to continuing to work with the Council
and the other member agencies to assist the Council in
implementing all of its responsibilities and duties under
section 112 within the timeframe provided under the Act. The
Board expects the Council will submit its report to Congress by
July 21, 2011.
Q.4. Which provisions of Dodd-Frank create the most incentives
for market participants to conduct business activities outside
the United States? Have you done any empirical analysis on
whether Dodd-Frank will impact the competitiveness of U.S.
financial markets? If so, please provide that analysis.
A.4. The extent to which the Dodd-Frank Act creates incentives
for market participants to conduct business activities outside
the United States will depend importantly on (i) the extent to
which other major jurisdictions adopt similar regulatory
frameworks and (ii) the manner in which the Federal financial
regulatory agencies implement the provisions of the Act. The
outcomes of both of these processes are far from over. As a
result, assessing the extent to which the Dodd-Frank Act might
provide incentives for financial firms to move businesses
overseas is difficult at this time.
International coordination of financial reform is essential
for achieving global financial stability. Fortunately, from the
U.S. perspective, the international agenda to date has been
well aligned with the Dodd-Frank Act and the complementary
endeavors of the U.S. financial regulatory agencies. We have
worked hard in the Basel Committee and Financial Stability
Board over the past few years to achieve international
regulatory outcomes that are consistent with U.S. reform goals,
and there are a few areas where we in the United States are
continuing to work particularly hard to keep our reforms well
aligned with international efforts. These areas include, among
others, our efforts as part of the Financial Stability
Oversight Council to establish criteria for measuring the
systemic importance of nonbank financial firms, our ongoing
work to determine how to apply the stricter prudential
standards for systemically important financial firms under the
Dodd-Frank Act to foreign banks, and the implementation of
Dodd-Frank reforms for over-the-counter derivatives and
incentive compensation. We hope that all countries will
similarly strive to harmonize domestic rules with international
standards.
Of course, some parts of the Dodd-Frank Act are unlikely to
become part of the international financial regulatory
framework. For example, the Volcker Rule in section 619 limits
the authority of banks to engage in proprietary trading of
securities and derivatives and to sponsor and invest in private
funds. The derivatives push-out rule in section 716 forces U.S.
banks to push certain derivatives activities into affiliates.
Section 622 of the Act also contains a financial sector
concentration limit. We understand that other countries are
unlikely to adopt these sorts of restrictions.
Although not all aspects of financial reform will be
perfectly consistent across countries, our challenge is
nevertheless to achieve global consistency on the core reforms
necessary to protect financial stability while providing a
playing field that is as level as possible. Achieving these
objectives will require a continued commitment to international
collaboration and a resolve to continue to push reforms
forward, even as the pressures for reform generated by the
financial crisis begin to ease.
To the extent consistent with its statutory obligations,
the Board will consider competitive considerations as we work
to implement the provisions of the Act and will monitor the
competitive and other effects of the Act as part of our ongoing
efforts to protect U.S. financial stability and the safety and
soundness of U.S. financial institutions.
Q.5. More than 6 months have passed since the passage of the
Dodd-Frank Act, and you are deeply involved in implementing the
Act's approximately 2,400 pages. Which provisions of the Dodd-
Frank Act are proving particularly difficult to implement? Have
you discovered any technical or substantive errors in the Dodd-
Frank legislation? If so, please describe them.
A.5. The Board has made considerable progress in completing its
assigned responsibilities under the Act. As we continue to work
through our rulemaking and other implementation projects, we
will communicate challenges, including technical or substantive
errors we encounter in the legislation, to you in response to
this inquiry.
Q.6. What steps are you taking to understand the impact that
your agency's rules under Dodd-Frank will have on the U.S.
economy and its competitiveness? What are the key ways in which
you anticipate that requirements under the Dodd-Frank Act will
affect the U.S. economy and its competitiveness? What are your
estimates of the effect that the Dodd-Frank Act requirements
will have on the jobless rate in the United States?
A.6. Since the Dodd-Frank Act was enacted, the Federal Reserve,
both independently and in conjunction with other agencies, has
made considerable progress towards adopting regulations
designed to promote financial market stability, strengthen
financial institutions, and reduce systemic risk to the
financial system and the economy. Measuring the impact of these
regulations on the overall economy, however, is exceptionally
challenging, especially given that many significant Government
regulations aimed at strengthening the financial system and
financial institutions are still in development. And even after
the various provisions of the act are implemented, any estimate
of their economic effects would be inherently quite uncertain.
Nevertheless, the effects of the act are likely to be much less
important than those of other factors now influencing
unemployment and economic growth. In particular, the current
slow pace of the recovery appears to be primarily driven by
ongoing problems in the housing market and the commercial
construction sector, the extremely tight budget conditions
facing State and local governments, and a general need for many
households and firms to repair their balance sheets in the wake
of falling real estate values and a deep recession.
As noted in the study issued by the Secretary of the
Treasury pursuant to section 123 of the Dodd-Frank Act,
financial regulation can affect the economy through two main
channels. First, financial regulation can affect the supply and
cost of credit by promoting or inhibiting allocative
efficiency, which in turn can have implications for the overall
economy. Financial regulation also can affect the riskiness of
individual financial institutions and the financial system as a
whole. For example, financial regulations that reduce default
risk will help lower the expected cost of resolutions, thereby
benefiting the economy by making systemic financial crises less
likely. Thus, regulations that increase efficiency and reduce
excessive risk-taking can bring substantial long-run benefits
to American households and firms. As the experience of the last
few years amply demonstrates, financial instability can be
extremely costly in terms of unemployment and overall economic
well-being.
The Federal Reserve is cognizant of the fact that poorly
designed rules can adversely affect the supply and cost of
credit, or unintentionally increase risk. Accordingly,
examining proposed rules for their possible unintended
consequences is a key part of Federal Reserve rulemaking. In
exercising its rulemaking authority under the act, the Federal
Reserve strives to avoid any disruption to the functioning of
the financial system and the broader economy that might be
caused by its rules.
With respect to global competitiveness, the Federal Reserve
(together with other U.S. Government regulatory agencies) seeks
to preserve a level playing field that will continue to allow
U.S. companies to compete effectively and fairly in the global
economy through ongoing discussions with foreign supervisory
authorities on possible changes to bank capital standards and
other international rules affecting financial markets and
firms.
Q.7. What steps are you taking to assess the aggregate costs of
compliance with each Dodd-Frank rulemaking? What steps are you
taking to assess the aggregate costs of compliance with all
Dodd-Frank rulemakings, which may be greater than the sum of
all of the individual rules' compliance costs? Please describe
all relevant reports or studies you have undertaken to quantify
compliance costs for each rule you have proposed or adopted.
Please provide an aggregate estimate of the compliance costs of
the Dodd-Frank rules that you have proposed or adopted to date.
A.7. The Board complies with its obligation under the Paperwork
Reduction Act (PRA) (44 U.S.C. 3501, et seq.) to estimate the
paperwork burden (specifically record keeping, reporting, and
disclosure requirements) imposed by the Board's rules and to
keep this burden as low as possible. As required under the PRA,
the Board seeks public comment on the paperwork burden imposed
by its rules by providing notice in the Federal Register. The
level of burden estimated under the PRA is then described, in
detail, in the Federal Register notice for each final rule
adopted by the Board, after taking account of the comments
received during the public comment process. These Federal
Register notices and final burden estimates are best evaluated
in the context of each statutorily required rule and can be
found on the Board's public Web site.
Q.8. The Fed, the SEC, the FDIC, and the CFTC are all
structured as boards or commissions. This means that before
they can implement a rule they must obtain the support of a
majority of their board members. How has your board or
commission functioned as you have been tackling the difficult
job of implementing Dodd-Frank? Have you found that the other
members of your board or commission have made positive
contributions to the process?
A.8. The members of the Board of Governors are working
cooperatively and constructively to implement the provision of
the Dodd-Frank Act. The Board has established a series of
committees that allow for direct input by Board members into,
and supervision of staff working on, each Dodd-Frank
rulemaking. This approach has allowed the Board to draw on the
expertise of its members and, at the same time, work in an
efficient and collaborative way. All rules are then reviewed by
the full Board before being published for comment and then
again before final adoption.
To aid the Board in these efforts, since the enactment of
the Dodd-Frank Act, the Board has approved a number of staffing
and organizational changes, drawing on resources from across
the Federal Reserve System in areas such as banking
supervision, economic research, financial markets, consumer
protection, payments, and legal analysis. In all, more than 300
staff are working to assist in completing the Dodd-Frank Act
rulemakings and related provisions. The Board also has created
a senior staff position to coordinate our efforts and developed
project reporting and tracking tools to facilitate management
and oversight of all of our implementation responsibilities.
The Board's Senior Advisor for Regulatory Reform Implementation
provides updates to the Board on progress and ensures that
important issues are put before the Board and other system
leaders for resolution.
Q.9. Numerous calls have arisen for a mandatory ``pause'' in
foreclosure proceedings during the consideration of a mortgage
modification. Currently, what is the average number of days
that customers of the institutions that you regulate are
delinquent at the time of the completed foreclosure? If
servicers were required to stop foreclosure proceedings while
they evaluated a customer for mortgage modification, what would
be the effect on the foreclosure process in terms of time and
cost. What effect would these costs have on the safety and
soundness of institutions within your regulatory jurisdiction.
Please differentiate between judicial and nonjudicial States in
your answers and describe the data that you used to make these
estimates.
A.9. As of year-end 2010, the average number of days between a
delinquency start and foreclosure completion had grown to 474
days from 378 days at year-end 2009. For the period from 1998
through 2010, the number of days from delinquency to
foreclosure was, on average, 404 days. The number of days
required to complete a foreclosure is higher in judicial States
as the first table below demonstrates.
The second table shows the average amount of lost expense
as a percent of a foreclosure balance. \1\ The data indicate
that lengthening the number of days required to complete a
foreclosure adds to the relative cost of the overall process,
and the cost is higher in judicial States. Although it is
difficult to quantify the incremental effect of further
procedural delays in foreclosures, delays and uncertainty
resulting from flaws in the foreclosure process have the
potential to delay recovery in housing markets and to undermine
confidence in our financial and legal systems. For this reason,
the Federal Reserve has emphasized the importance of using loan
modifications as a means to prevent avoidable foreclosures and
continues to encourage effective loan modifications as the most
beneficial outcome from both consumers and the banking
industry.
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\1\ Lost interest expense is computed by first multiplying one-
twelfth of the annual interest rate on the loan by the number of months
between the start of delinquency and the foreclosure. This product is
then divided by the loan balance at foreclosure end to get costs as a
percent of loan balance.
Q.10. The burden of complying with Dodd-Frank will not affect
all banks equally. Which new Dodd-Frank Act rules will have the
most significant adverse impact on small and community banks?
Which provisions of Dodd-Frank will have a disparate impact on
small banks as compared to large banks? Do you expect that the
number of small banks will continue to decline over the next
decade? If so, is the reason for this decline the Dodd-Frank
Act? Have you conducted any studies on the costs Dodd-Frank
will impose on small and community banks? If so, please
---------------------------------------------------------------------------
describe the results and provide copies of the studies.
A.10. The reforms contained within the Dodd-Frank Act are
principally directed at constraining the activities and risks
of the largest, most interconnected financial institutions, not
at small or community banks. Moreover, small and community
banks are exempted from many of the Act's restrictions.
Accordingly, the Act as a whole should help level the
competitive playing field between large and small banks.
However, many community banks are concerned about an expected
increase in overall regulatory burden as a result of the Act's
implementation.
For example, many community banks are concerned about
potential future regulatory burden from new consumer protection
rules they expect to be promulgated by the Consumer Financial
Protection Bureau (CFPB) established under Dodd-Frank. Many
community banks are also concerned about Dodd-Frank's
regulation of debit card interchange fees, noting that proposed
requirements will raise their operating costs and that caps
imposed on the amount that large banks may charge for
interchange could result in a significant decline in revenues
for smaller banks, a substantial concern given the relatively
limited options small banks have for earning noninterest
income. Other provisions of the Act that raise concerns for
community banks include the provision that prohibits Federal
agencies from using credit ratings in their regulations, and
provisions that could apply central clearing and trading
requirements or swap dealer regulation to the OTC derivatives
activities of small banks.
The number of small banks has been declining steadily for a
number of decades. This trend reflects a highly competitive
market for financial products and services, as well as
significant demographic and technological changes. Legislation
has also affected the number of small banks in the United
States by, for example, allowing interstate banking and
eliminating the requirement for a bank holding company to own a
separate bank in each of the states in which it was operating.
While many community banks have argued that the costs of
complying with new regulatory burdens arising from the Dodd-
Frank Act will accelerate the decline in the number of small
banks, relatively few of the major provisions of Dodd-Frank
apply in a meaningful way to small banks. As a result, it is
not clear that Dodd-Frank will be a material driver of future
declines in the numbers of small banks in the United States. To
date, we have not conducted a study on the costs Dodd-Frank
will impose on small and community banks.
The Federal Reserve is committed to working with the other
U.S. financial regulatory agencies to implement the Dodd-Frank
Act and related reforms in a manner that both achieves the
law's key financial stability objectives and appropriately
takes into account the risk profiles and business models of
small and community banks.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR REED
FROM BEN S. BERNANKE
Q.1. It is my understanding that the Federal Reserve has a
1,887 page supervision manual for Bank Holding Companies, a
1,767 page supervision manual for commercial banks, and a 675
page manual for trading and capital markets activities, and
several other supervision manuals that apply to your covered
institutions. I appreciate that there is a lot of ground for
the Federal Reserve staff examiners to cover. For the largest
financial institutions, what is the process for ensuring that
your examiners cover all of the applicable materials from these
manuals on a regular basis at each institution?
A.1. The Federal Reserve's risk-focused program for supervising
the largest banking organizations on a consolidated basis
entails developing a comprehensive understanding of each
organization and assessing the risks to which each organization
is exposed. A supervisory plan is tailored to each organization
based on this institutional understanding and risk assessment
and typically includes a combination of continuous onsite and
offsite monitoring, targeted examination/inspection activities,
and detailed reviews of operations and internal controls. In
addition to extensive supervision at the individual firm level,
these organizations are grouped into a portfolio of firms which
facilitates cross-portfolio peer perspectives. The findings
from the supervisory activities conducted throughout the year
are combined into a comprehensive assessment that leads to the
assignment of supervisory ratings.
In conducting these activities, examiners are expected to
utilize sufficient examination procedures to reach informed
judgments on the factors included in the rating systems for
State member banks and bank holding companies, as appropriate.
The Federal Reserve ensures the integrity of this process
through oversight by senior Board and System officials and
through a quality assurance process that includes horizontal
reviews of activities across organizations and reviews of
Reserve Bank operations. The Federal Reserve's supervisory
manuals are intended to serve as reference documents for staff
as they engage in supervisory activities. Staff is not expected
to review each element contained in these manuals because the
supervision of the largest institutions is tailored to an
institution's unique business activities and risk profile.
Q.2. Do you believe that the Federal Reserve needs to conduct
routine, full-scale examinations of the largest firms in order
to identify risks and concerns that may not be identified by
the firms themselves?
A.2. As noted above, Federal Reserve staff develops and
executes a comprehensive supervisory plan tailored to the areas
of primary risk for each banking organization, with the depth
and breadth of the plan typically being greater for the largest
and most complex organizations, as well as those with the most
dynamic risk profiles. A primary objective of these supervisory
activities is to understand and assess an organization's
ability to identify, measure, monitor, and control primary
risks to the consolidated organization, and examination and
other activities are undertaken to maintain this understanding
and assessment across risk management and control functions
(credit, legal, and compliance, liquidity, market, operational,
and reputational risks) for the consolidated organization.
These activities result in supervisory assessments that are
comparable to those generated under a routine, full scope
examination.
For each banking organization there are selected portfolios
and business lines that are primary drivers of risk or revenue,
or that otherwise materially contribute to understanding
inherent risk or assessing controls for a broader corporate
function. Independent from each firm's internal efforts to
identify risks and concerns, Federal Reserve staff analyze
external factors and internal trends in the firm's strategic
initiatives--as evidenced by budget and internal capital
allocations and other factors--to identity significant
activities and areas vulnerable to volatility in revenue,
earnings, capital, or liquidity that represent material risks
for the organization. This determination of material portfolios
and business lines considers all associated risk elements,
including legal and compliance risks.
A wide variety of examination and other supervisory
activities are utilized by Federal Reserve staff to identify,
understand, and assess primary firmwide risk management or
control mechanisms, and the underlying material portfolios and
business lines. These activities may identify certain functions
that require more intensive supervisory focus due to
significant change in inherent risk, control processes, or key
personnel; potential concerns regarding the adequacy of
controls; or the absence of sufficiently recent examination
activities for a primary firmwide risk management or control
function, either by the Federal Reserve or another primary
supervisor or functional regulator.
It is important to add that with passage of the Dodd-Frank
Act, the Federal Reserve and other agencies are expected to
supervise financial institutions and critical infrastructures
with an eye toward not only the safety and soundness of each
individual firm, but also taking into account risks to overall
financial stability. In response, the Federal Reserve is
developing a macroprudential approach to supervision with
explicit focus on identifying risks and concerns, strengthening
systemic oversight and addressing stability concerns.
Q.3. Can you provide your view on the Basel III framework and
also the extent, if any, that Basel III may conflict with the
requirements of the Dodd-Frank Act and how are you responding
to these conflicts?
A.3. The Board of Governors of the Federal Reserve System
(Board) actively participates on and contributes to the work of
the Basel Committee on Banking Supervision (BCBS) to advance
sound supervisory policies for internationally active banking
organizations and improve the stability of the international
banking system. On December 16, 2010, the BCBS published,
``Basel III: A global regulatory framework for more resilient
banks and banking systems.'' The Basel III framework, as part
of the BCBS's ongoing efforts to improve the resilience of the
banking sector, increases the quality, quantity, consistency,
and transparency of capital, introduces new global liquidity
standards, and strengthens capital requirements for certain
risk exposures. The Board generally supports the Basel III
framework and will continue working collaboratively with the
BCBS and the Financial Stability Board in the ongoing efforts
to develop an appropriate approach to ensure that systemically
important financial institutions have a sufficient degree of
loss-absorbing capacity.
The Board has identified key areas where the requirements
of the Basel III framework and Dodd-Frank Act conflict. For
instance, the Dodd-Frank Act's requirement under Section 939A
to remove-any reference to or requirement of reliance on
ratings in Federal regulations conflicts with, or significantly
complicates, the implementation of the Basel III framework,
which requires the use of credit ratings for determining the
risk-based capital requirements of certain exposures. To
address the requirements of Section 939A, the U.S. Federal
banking agencies issued an advanced notice of proposed
rulemaking August 25, 2010, seeking comments on alternatives to
the use of credit ratings in risk-based capital rules and are
in the process of developing alternative approaches.
In addition, Section 171 of the Dodd-Frank Act (commonly
referred to as the ``Collins Amendment'') establishes certain
requirements for U.S. leverage and risk-based capital
requirements that are not included in the Basel III framework.
To address certain requirements of Section 171, the agencies
requested comment on December 15, 2010, on a proposed
rulemaking that would require a banking organization operating
under the advanced approaches. (Basel II-based) capital
standards to meet, on an ongoing basis, the higher of the
generally applicable (Basel I-based) and the advanced
approaches minimum risk-based capital requirements. Also, under
the Basel III framework, certain capital instruments that will
no longer qualify for inclusion in regulatory capital will be
phased out over a period of 10 years. Under Section 171,
however, such instruments would be subject to a more rapid
phase out period of 3 years. The agencies will address this and
other provisions of Section 171 in subsequent rulemakings.
The Board is analyzing several other sections of Dodd-Frank
Act that pose potential conflicts with the Basel III framework.
We expect to have a more comprehensive list of such conflicts
in the next few months as we work through the elements of the
domestic rulemaking related to the Basel III framework.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR MENENDEZ
FROM BEN S. BERNANKE
Q.1. One of the most important reforms in Dodd-Frank was
requiring systemically significant firms to hold more capital
and have better liquidity to prevent another crisis. The crisis
would not have happened had we not allowed big banks and some
nonbanks to acquire so much debt and leverage. What steps are
being taken to ensure that these capital, leverage, and
liquidity requirements are implemented robustly?
A.1. The Federal Reserve Board is in the process of
strengthening capital, leverage and liquidity requirements for
systemically important institutions through a number of
international and domestic initiatives. As part of its response
to the financial crisis, the Basel Committee approved the final
Basel 3 Accord in December 2010. The Accord will make the
global financial system more stable and reduce the likelihood
of future devastating financial crises by requiring
internationally active banks to hold more and better quality
capital and more robust liquidity buffers against the risks
they run. The Accord will increase the capacity of banks to
absorb losses and withstand funding pressures without relying
on public support, and reduce the likelihood that stresses in
the financial system would result in damaging spillovers to the
real economy. The Accord will also reduce the incentives for
banks to take excessive risks in the first place. National
jurisdictions are required to issue legislation or regulations
to implement the Accord by the end of 2013. The Board, in
conjunction with the other U.S. banking agencies, is currently
working on proposed rules to implement the Accord in the United
States consistent with that timetable. The Federal Reserve
System is also engaged in a capital planning review exercise
that, by design, assesses the firms' capital planning
processes, including the outcome of their internal stress
tests. Part of the capital planning review includes an
assessment of the largest BHCs' plans to meet the increased
capital requirements associated with the Basel 3 Accord.
While the Basel Accord is directed at banks and bank
holding companies, additional efforts are underway to increase
the regulation and supervision of systemically important
nonbank financial institutions. As you are aware, some of the
most destabilizing events of the recent financial crisis
involved the collapses of large, nonbank financial firms. The
Dodd-Frank Act usefully includes provisions that enable the
Federal Government to expand the perimeter of regulation and
help ensure that any nonbank financial firm with an outsized
systemic footprint is subject to strong Federal oversight on a
consolidated basis. The Financial Stability Oversight Council
(FSOC) recently issued a notice of proposed rulemaking on the
designation process for systemically important nonbank
financial institutions (nonbank SIFIs) and is expected to
finalize those rules later this year, paving the way for
possible future designations. Nonbank firms designated by the
FSOC will be subject to consolidated supervision by the Federal
Reserve Board, including consolidated capital, leverage, and
liquidity requirements.
The Board is also in the process of developing the enhanced
prudential standards contained in sections 165 and 166 of the
Dodd-Frank Act for both bank holding companies with
consolidated assets greater than $50 billion as well as nonbank
SIFIs designated by the FSOC. The enhanced prudential standards
include risk-based capital, leverage and liquidity
requirements, as well as single-counterparty credit exposure
limits and requirements to produce resolution plans, run stress
tests, and comply with enhanced risk management standards. The
enhanced prudential standards generally must increase in
stringency as the firm's systemic footprint increases and not
result in sharp, discontinuous changes for firms with a similar
systemic footprint. Final rules implementing sections 165 and
166 are due in January 2012, and the Board expects to issue
proposed rules in the coming months. Our goal is to produce a
well-integrated set of rules that meaningfully reduces the
probability of failure of our largest, most complex financial
firms and the losses to the financial system in the event of
their failure.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN
FROM BEN S. BERNANKE
Q.1. Banks, Capital, and Losses. The ongoing foreclosure crisis
and the foreclosure fraud scandal are issues of great national
importance, and of particular importance in my home State.
And right now the four largest banks are the most exposed
to the shaky real estate market--they have over 40 percent of
the mortgage servicing contracts and second lien mortgages.
Despite this exposure to potential housing-related losses,
as well as looming new capital rules from Dodd-Frank and the
Basel Committee, the Federal Reserve is conducting stress tests
that will pave the way for 19 of the largest banks to once
again buy back their stock and issue dividends.
The three largest banks also have about $121 billion in
debt guaranteed by the FDIC which costs taxpayers, gives this
debt a funding advantage, and is not being counted by the
stress tests.
By easing dividend and stock restrictions on big
banks, are we adding to the advantage that they have
over their smaller competitors?
Everyone agrees that lending has contracted but
bonuses are booming. Won't paving the way for dividend
payments to investors--including their own executives--
limit the banks' ability to deploy their capital to
support the recovery?
There is a lot of uncertainty about the future of
the housing market and new capital requirements, and
each dollar paid out to shareholders is a dollar less
in equity for the bank. How can we ensure that allowing
big banks to issue dividends now won't damage their
capital levels and future stability?
Should one of these 19 companies encounter issues
with their capital base, are the Fed and FDIC ready to
use their new authorities under Dodd-Frank right now--
the ``Grave Threat Divestiture'' and ``Orderly
Liquidation Authority,'' respectively?
If not now, when will those authorities be ready?
A.1. Response not provided.
Q.2. Capital Rules and Foreign Banks. A recent report in the
Wall Street Journal raised concerns about foreign banks
shedding their Bank Holding Company designations in an effort
to evade new capital requirements imposed by the Dodd-Frank
Act. There appear to be concerns about the level of capital at
some of these institutions. And though Dodd-Frank contains
several anti-evasion provisions, including Section 113 and
Section 117, those provisions apply, respectively, to Nonbank
Financial Companies and Bank Holding Companies that received
TARP funding.
Is it your interpretation that Dodd-Frank does not
contain anti-evasion authority that would apply to this
situation? Please explain any authority that the Board
does have.
Would such anti-evasion authority be useful for the
Board to carry out its mission of Bank Holding Company
supervision and systemic risk mitigation?
A.2. Response not provided.
Q.3. Mortgage Servicing and Examinations. In November, the GAO
released a study on abandoned foreclosures, also known as
``bank walkaways.'' With respect to mortgage servicing, the
report found:
According to our interviews with Federal banking
regulators, mortgage servicers' practices . . . have
not been a major focus covered in their supervisory
guidance in the past. The primary focus in these
regulators' guidance is on activities undertaken by the
institutions they oversee that create the significant
risk of financial loss for the institutions. Because a
mortgage servicer is generally managing loans that are
actually owned or held by other entities, the servicer
is not exposed to losses if the loans become delinquent
or if no foreclosure is completed. As a result, the
extent to which servicers' management of the
foreclosure process is addressed in regulatory guidance
and consumer protection laws has been limited and
uneven. For example, guidance in the mortgage banking
examination handbook that OCC examiners follow when
conducting examinations of banks' servicing activities
notes that examiners should review the banks' handling
of investor-owned loans in foreclosure, including
whether servicers have a sound rationale for not
completing foreclosures in time or meeting investor
guidelines. In contrast, the guidance included in the
manual Federal Reserve examiners use to oversee bank
holding companies only contained a few pages related to
mortgage servicing activities, including directing
examiners to review the income earned from the
servicing fee for such operations, but did not
otherwise address in detail foreclosure practices.
In addition, until recently, the extent to which these
regulators included mortgage servicing activities in
their examinations of institutions was also limited.
According to OCC and Federal Reserve staff, they
conduct risk-based examinations that focus on areas of
greatest risk to their institutions' financial
positions as well as some other areas of potential
concern, such as consumer complaints. Because the risks
from mortgage servicing generally did not indicate the
need to conduct more detailed reviews of these
operations, federal banking regulators had not
regularly examined servicers' foreclosure practices on
a loan-level basis, including whether foreclosures are
completed. For example, OCC officials told us their
examinations of servicing activities were generally
limited to reviews of income that banks earn from
servicing loans for others and did not generally
include reviewing foreclosure practices.
Please describe your agencies' views of the risks related
the banks' servicing divisions, including:
The losses stemming from the servicing divisions of
the banks that you regulate.
What further losses, if any, you expect.
How your agencies have changed your examination
procedures relating to banks' servicing divisions.
Whether there will be uniform standards for
servicing examination across all Federal banking
agencies.
A.3. Response not provided.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR TESTER
FROM BEN S. BERNANKE
Q.1. The ``routing'' provisions included in the Fed's proposed
debit interchange rules would seem to provide merchants with an
opportunity to discriminate against purchases made with cards
from ``exempt'' small issuers which would hear larger
interchange rates. What responsibility and authority does the
Fed have to ensure that small issuers aren't discriminated
against through subtle ``steering'' by merchants or more
explicit discrimination against transactions made with cards
from small issuers?
A.1. Response not provided.
Q.2. In drafting your proposed debit interchange rules, to what
extent did the Fed evaluate the impact of those proposed rules
on consumers?
A.2. Response not provided.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARNER
FROM BEN S. BERNANKE
Q.1. For each of the witnesses, though the Office of Financial
Research does not have a Director, what are each of you doing
to assist OFR in harmonizing data collection, compatibility,
and analysis?
A.1. Response not provided.
Q.2. Chairman Bernanke, I understand the FSOC has organized and
released proposed rules on how it will designate systemically
significant nonbank financial companies for regulation.
A.2. Response not provided.
Q.3. As you know, I worked quite extensively on Title 1 and
Title 2, and I worked very hard to include this authority and
specifically, to make sure that this authority was not
restricted by exempting any class of institution. But the bill
did specifically include a list of 10 factors that together,
were intended to paint a thorough picture of the systemic risks
that threatened our economy during the last few years. One of
the things financial institutions asked for, and I thought was
reasonable and the Congress thought reasonable, was that the
Council provide some specificity around those factors so that
if a company wanted to manage the risks it posed and avoid
designation, it could.
I am concerned that your draft rule merely restates the
criteria without providing any quantitative guidance for
companies. This is not about evasion--the Council has authority
to react to attempts at evasion. And this is not about rigid
rules that must be triggered before the council can act,
because the Council can also look at qualitative issues and the
whole picture.
I also feel that there is a benefit to including specifics
that companies can manage to as long as the specifics really
get at systemic risk, companies managing within the parameters
you set will by definition reduce the systemic risk present in
the financial system. There is nothing wrong with teaching to
the test if the test is well designed and there shouldn't be
anything wrong with companies managing to the Council's
parameters if they are well designed.
Why did the draft rule fail to provide any specifics,
unlike, banking regulators do when it comes to Tier 1 capital,
or leverage ratios, or core deposits? Will you reconsider the
rule to give companies more specific measures so that they can
manage the risk they pose?
A.3. Response not provided.
Q.4. Chairman Bernanke, your agency was charged with working
together to develop orderly liquidation plans for systemically
significant financial institutions so that they can avoid
needing resolution under Title 2 if they fail. Where are we in
that process and when can we expect companies to start
submitting plans to you for review and approval?
A.4. Response not provided.
Q.5. Chairman Bernanke, most of the companies subject to the
requirement for an orderly liquidation plan are multinational
in at least some respect. What cross border issues have you
uncovered and how are you working to address those issues? Are
there any legal barriers to resolving those issues in a way
that ensures the plans work?
A.5. Response not provided.
Q.6. Chairman Bernanke, many of my colleagues have brought up
concerns about how the proposed interchange rule will affect
small financial institutions and, ultimately, consumers.
Specifically the rule does not address how merchants make
routing choices, which could significantly affect volume for
small institutions. So I want to ask you, how do you anticipate
that this proposed cap will affect consumers and their access
to banking services?
If banks raise account fees, limit access to certain
services, and banking generally becomes more expensive for
consumers, will that push people out of the regulated banking
space that many people have worked hard to bring them into?
A.6. Response not provided.
Q.7. Chairman Bernanke, I believe that the Qualified
Residential Mortgage is a significant effort towards repairing
our underwriting problems and lack of private sector investment
in the housing market right now. I understand there is concern
that because these qualified mortgages will be exempted from
risk retention standards, we want this type of mortgage to be
affordable and available. Can you tell us how you are weighing
the construct of a QRM--including down payment, income, LTV,
and the use of private insurance?
A.7. Response not provided.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR MERKLEY
FROM BEN S. BERNANKE
Q.1. Federal Reserve Supervision of Largest Financial Firms.
The rulemaking for Dodd-Frank is a critical part of ensuring
financial reform and protecting the economy and taxpayers.
Equally important, though, is the manner in which the Federal
Reserve, as the supervisor of the largest financial firms,
conducts its supervisory responsibilities. Could you please
update the Committee on improvements to the supervisory process
put in place over the past 2 years. In addition, can you please
describe improvements to the examination process, including
what types of full-scope examinations (including but not
limited to stress tests) that the largest bank holding
companies are subjected to on an annual basis. In addition,
what processes does the Federal Reserve use to ensure that its
staff conducting examinations identify risks or compliance
problems that are not identified by the bank holding companies
themselves.
A.1. Response not provided.
Q.2. Financial Crisis and Economic Growth. Please provide your
best estimate of (1) how much U.S. gross domestic product was
lost during the period of 2009 through the present as a result
of the 2007-08 financial crisis and (2) how much of the U.S.
debt added during the period of 2009 through the present was as
a result of the 2007-08 financial crisis (for example, lost tax
revenue and increased mandatory payments)?
Do you agree that failure to speedily implement necessary
financial reforms represents a very serious fiscal risk to the
United States?
A.2. Response not provided.
Q.3. Community Banks and Economic Growth. I have heard from
some of my local community banks that certain capital,
accounting, and examination rules may be working at cross
purposes with the ability of community banks to serve the
economic growth needs of the families and small businesses they
serve in their communities, especially when compared to
standards applied to the largest national banks. I wish to
bring several to your attention and ask that you comment:
The Financial Accounting Standards Board's proposed
exposure draft on ``Troubled Debt Restructurings''
(TDRs) has been pointed out as possibly creating a
capital disincentive for banks to engage in work-outs
and modifications with their business borrowers because
of the effect of immediately having to declare those
loans ``impaired.'' In addition, for banks over $10
billion in asset size, there may be additional direct
costs for FDIC premiums based on a formula that
considers TDR activity.
The disallowance to Risk-Based Capital of the
amount of Allowance for Loan Losses (ALLL) in excess of
1.25 percent of Risk Weighted Assets has been flagged
as a challenge in this environment, where some firms
have ALLL that significantly exceeds that threshold.
This may serve to understate the risk-based capital
strength of the bank, adding to costs and negatively
impacting customer and investor perceptions of the
bank's strength.
It has been reported that examiners have rejected
appraisals that are less than 9 months old when
regulatory guidance calls for accepting appraisals of
up to 12 months.
Community banks are subject to examination in some
cases as frequently as every 3 months. In contrast,
some suggest that our largest national banks may not
ever undergo an examination as thorough, with the
challenges surrounding loan documentation, foreclosure,
and MERS as a glaring example of the results.
Are there regulatory or supervisory adjustments in these or
related areas that need to be made to facilitate community
banks' abilities to serve their communities?
In addition, have you considered ways in which capital
charges, accounting rules, and examination rules for community
banks in particular can be adapted to be less procyclical, such
that they do not become stricter into an economic downturn and
lighter at the top of an upturn?
Finally, what procedures do you have in place to ensure
that our community banks and our largest national banks are not
subject to differing examination standards, even when they are
examined by different regulators?
A.3. Response not provided.
Q.4. International Coordination Regarding Resolution. Our
largest financial firms today operate across many national
boundaries. Some firms are aiming to conduct 50 percent or more
of their business internationally. Can you update the Committee
on the status and any challenges regarding the establishment of
mechanisms, plans, and other aspects of coordination between
international regulatory bodies to ensure that financial firms
operating internationally can be effectively placed into the
Dodd-Frank resolution regime and are not otherwise able to
attain ``too big to fail'' status through international
regulatory arbitrage?
Please also update the Committee on the status of the
regulation of international payments systems and other internal
systemic financial market utilities so that the entities that
manage or participate in them are not able to avoid the
resolution regime through international regulatory arbitrage.
A.4. Response not provided.
Q.5. Repo and Prime Brokerage. During the financial crisis, the
instability of the triparty repurchase agreement (repo) markets
and prime brokerage relationships played critical roles in the
collapse of several major financial firms. As the quality of
the repo collateral began to decline and as both repo and prime
brokerage ``depositors'' began to doubt the stability of their
counterparties (because of the toxic positions in the trading
accounts of the counterparties), a classic bank run emerged,
only this time it was at the wholesale level. Please provide an
update on rulemaking and other policy changes designed to
reduce risks to our financial system in the repo markets and in
prime brokerage.
A.5. Response not provided.
Q.6. Derivatives Oversight. Counterparty risk and other risks
associated with derivatives played a central role in the
financial crisis, especially in fueling the argument that firms
such as AIG were too big or too interconnected to fail. What
oversight systems do you plan to have in place to ensure that
any accommodations made in the course of rulemaking for
nonfinancial commercial parties do not create holes in the
regulatory structure that permit the accumulation of hidden or
outsized risk to the U.S. financial system and economy.
A.6. Response not provided.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO
FROM BEN S. BERNANKE
Q.1. Regarding the FSOC's recently proposed Notice of Proposed
Rulemaking on the authority to require Federal Reserve
supervision and regulation of certain nonbank financial
companies, will the Council propose metrics adapted for the
risks presented by particular industry sectors for notice and
comment, and does the Council intend to designate nonbank
financial companies before those industry-specific metrics are
published?
A.1. Response not provided.
Q.2. Dodd-Frank requires that risk retention be jointly
considered by the regulators for each different type of asset
and includes a specific statutory mandate related to any
potential reforms of the commercial mortgage-backed securities
to limit disruptions. Given the importance of rigorous cost-
benefit and economic impact analyses and the need for due
consideration of public comments, do your agencies need more
time than is provided by the looming April deadline?
A.2. Response not provided.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR CORKER
FROM BEN S. BERNANKE
Q.1. Chairman Bernanke, the Federal Reserve has issued proposed
changes to disclosures under Regulation Z and the Truth in
Lending Act with the comment period having ended in December
2010. It has been brought to my attention that the model
disclosure forms included in the proposed rule related to
certain credit insurance products steer customers away from
those products with claims that may not be relevant to a
particular customer's situation--i.e., ``This product will cost
up to $118.00 per month.'' (Model Form H-17(B)). While I am
aware of the risks associated with certain credit insurance
products, the experience in Tennessee has been that many
consumers have benefited from this type of insurance coverage.
Model disclosures containing strong warnings against purchasing
this type of protection may leave consumers unprotected and in
a worse financial situation than currently today with credit
protection in place. Can you discuss the Federal Reserve model
disclosure testing methodologies to determine the impact of
certain terms and phrases used in model disclosures and
customer responses to those terms and phrases?
A.1. The Federal Reserve Board has recently issued proposals to
revise Regulation Z, which implements the Truth in Lending Act
(TILA). Among other things, the proposals published in August
2009 and September 2010 would revise the disclosures provided
to consumers in connection with the purchase of credit
insurance and similar products, such as debt cancellation
coverage or debt suspension coverage (credit protection
products). These new disclosure requirements would apply to
credit protection products purchased in connection with any
consumer credit transaction. The Board used consumer testing to
develop the model disclosures in both the August 2009 and
September 2010 proposed rules for credit protection products.
On February 1, 2011, the Board announced that it does not
expect to finalize three pending Regulation Z proposals prior
to the transfer of authority for such rulemakings to the
Consumer Financial Protection Bureau (CFPB). Those rulemakings
include the proposed disclosures for ``credit protection''
products. The Board will transfer the record of these
rulemakings to the CFPB for its consideration before any final
rules are issued. Thus, the CFPB also would be the agency to
determine whether further study is needed, including whether
additional consumer testing would be appropriate.
You express concern about the Board's proposed model
disclosures for these products. You state that the proposed
disclosures would steer consumers away from credit protection
products with claims that might not be relevant to a particular
customer's situation. The Board believes that in order for
consumers to benefit from the disclosures, the disclosures must
be clear and meaningful. Accordingly, the proposed disclosures
that were published for comment were based, in part, on
consumer testing to ensure that consumers understand the
product. The model disclosures seek to provide consumers with
timely information regarding the costs and risks of credit
protection products in addition to the benefits promoted by
creditors or other vendors. Even if a particular risk may not
affect every consumer, there can be benefit in alerting all
consumers who potentially may be affected. However, in weighing
whether the benefits of the added disclosure outweigh its
costs, it would be appropriate also to consider the likelihood
that the risk will occur.
You also ask about the consumer testing methodologies used
by the Board to determine the impact of the language used in
the proposed model disclosures, and about consumers' responses
to this language. The Board conducted consumer testing for the
proposed model forms with the assistance of a consulting firm,
ICF Macro (Macro) that specializes in designing and testing
such documents. Consumer testing was conducted in connection
with both the August 2009 and September 2010 proposals. Macro
conducted six rounds of testing in various locations around the
country, with a total of 60 individual interviews with
consumers of varying demographic backgrounds. Four rounds of
testing were conducted before the Board issued the August 2009
proposals; two rounds were conducted in connection with the
September 2010 proposal.
In connection with the September 2010 proposed rules,
testing of the disclosures and notices related to credit
insurance was carried out through two rounds of interviews.
Before each round of interviews, Macro developed model
disclosures. In some cases, multiple versions of each type of
disclosure were developed so that the impact of varying
language or format could be studied. Board staff attended all
rounds of testing. After each round, Macro briefed Board staff
on key findings, as well as their implications for disclosure
design and layout.
Individual interviews with consumers were approximately 75
minutes long. While the interview guide varied between rounds,
the general structure of these interviews was very similar.
Participants were given a disclosure and asked to ``think
aloud'' while they reviewed the document, indicating whenever
they found something surprising, interesting, or confusing.
Following this ``think aloud'' process, participants were asked
specific questions about the information on the disclosure to
determine how well they could find and interpret the content.
The participants were then given a new disclosure to review and
the interviewer took them through the same process.
The consumer testing results generally demonstrated that
that the proposed model forms communicate important information
in a clear and effective way, which should enable consumers to
comprehend complex information and make informed financial
decisions. In addition, findings from the last round of testing
showed that comprehension of the disclosure was high when the
information was presented in tabular question-and-answer
format. As a result, the proposed model forms use this format.
Comprehension of the content of this disclosure was also high.
However, because of concerns about ``information overload,''
some of the information on the tested disclosure form was not
included in the proposed model forms published for comment. The
following three reports prepared by Macro describe the results
of the 2009 and 2010 testing, and are available on the Board's
public Web site at: http://www.federalreserve.gov/boarddocs/
meetings/2009/20090723/Full%20HELOC_Macro%20Report.pdf (August
2009 Proposed Rules for Home-Equity Lines of Credit); http://
www.federalreserve.gov/boarddocs/meetings/2009/20090723/
Full%20Macro%20CE%20Report.pdf (August 2009 Proposed Rules for
Closed-end Mortgage Loans); http://www.federalreserve.gov/
newsevents/press/bcreg/
bcreg20100816_MacroBOGReportOtherDisclosures(7-10)(FINAL).pdf
(September 2010 Proposal).
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER
FROM BEN S. BERNANKE
Q.1. A Bloomberg news story, citing a Financial Stability
Oversight Council (FSOC) staff report marked ``confidential,''
indicates that there is a parallel regulatory track with
respect to the designation of systemically significant nonbank
financial companies. The Bloomberg story mentions FSOC staff
are moving forward with ``confidential'' criteria that will be
used to designate systemically important nonbank financial
institutions. However, unlike the proposed rule, which merely
restates the statutory language, these confidential criteria
are not subject to public comment and has yet to be reviewed by
anyone outside of the council aside from this news report. This
raises serious questions about the transparency of FSOC's
rulemaking process.
From what has been reported, portions of the leaked report
conclude that an insurer failure could create adverse
macroeconomic impact. This conclusion appears to have been
reached without the required insurance expertise, which has yet
to be appointed. A similar conclusion was made with respect to
hedge funds.
Unfortunately, there has been no public disclosure of the
criteria or metrics that were used to arrive at this
conclusion. As such, could you explain what metrics were
applied and by whom in reaching this conclusion? What basis did
the FSOC staff use to select these criteria?
Chairwoman Bair's written testimony to this Committee
states: ``The nonbank financial sector encompasses a multitude
of financial activities and business models, and potential
systemic risks vary significantly across the sector. A staff
committee working under the FSOC has segmented the nonbank
sector into four broad categories: (1) the hedge fund, private
equity firm, and asset management industries; (2) the insurance
industry; (3) specialty lenders, and (4) broker-dealers and
futures commission merchants. The council has begun developing
measures of potential risks posted by these firms.''
``The FSOC is committed to adopting a final rule on this
issue later this year, with the first designations to occur
shortly thereafter.'' Since the rulemaking process is already
underway, do you know if the administration is planning to make
this report public?
Will there be an opportunity for public comment on it
before any final rules are promulgated?
What is your logic behind identifying these four
categories?
Will you publish and seek comment on the industry-specific
metrics that will applied, before such assessments begin, so
that Congress can have confidence that FSOC is exercising its
authority appropriately and impacted financial companies can be
assured that they are not being treated arbitrarily?
A.1. The Council is working to develop a framework to help it
identify systemically important nonbank firms. On January 26,
2011, the Council issued a notice of proposed rulemaking (NPR)
\1\ seeking public comment on a proposed framework that the
Council could use to determine whether a nonbank financial
company may pose a threat to the financial stability of the
United States. In developing the proposed framework set forth
in the NPR, the Council considered the comments received on its
earlier advance notice of proposed rulemaking (ANPR). \2\
Issuing the NPR continued the Council's commitment to solicit
input from the public as the Council works to develop a robust
and disciplined framework to support any designation decisions
that it makes.
---------------------------------------------------------------------------
\1\ 76 FR 4555 (2011).
\2\ 75 FR 61653 (2010).
---------------------------------------------------------------------------
The preamble to the NPR sets forth a framework for
assessing the threat a nonbank financial company may pose to
the financial stability of the United States. The proposed
framework groups the statutory factors that the Council must
consider into the following six categories: size, lack of
substitutes, interconnectedness, leverage, liquidity risk and
maturity mismatch, and existing regulatory scrutiny. The
Council has begun to gather and analyze data to develop metrics
to evaluate each of the six categories. The Council also
intends to tailor the metrics to the principal business lines
and business models of a nonbank financial company as
appropriate.
The Council has received many comments on the NPR and is in
the process of reviewing these comments. Many commenters
suggested that the Council provide more detail regarding the
framework and criteria it will use as it considers possible
designations. As it moves forward with developing its framework
to support designation, the Council is considering how best to
reflect these comments in its final rule. The Council also is
considering how to continue to allow for transparency and
public input in its process.
As a member agency of the Council, the Board is providing
assistance to the Council as it works to establish its
framework.
------
RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN JOHNSON
FROM SHEILA C. BAIR
Q.1. Recently, some have voiced concerns that the timeframe for
the rulemakings required by the Dodd-Frank Wall Street Reform
and Consumer Protection Act (Dodd-Frank) is too short to allow
for adequate consideration of the various comments submitted or
to review how the new rules may impact our financial markets.
Does the current timeframe established by Dodd-Frank allow each
rulemaking to be completed in a thoughtful and deliberative
manner?
A.1. The FDIC recognizes the importance of providing sufficient
time for interested parties to comment on all proposed rules
and studies required by the Dodd-Frank Act. We are committed to
providing adequate time for that process. It is critical,
therefore, that we try to strike an appropriate balance in our
efforts to implement the Dodd-Frank Act between timely and
efficient rulemaking and careful review and consideration of
public comment. As stated in my testimony, ``regulators must
maintain a clear view of the costs of regulation--particularly
to the vital community banking sector--while also never
forgetting the enormous economic costs of the inadequate
regulatory framework that allowed the crisis to occur in the
first place.'' Moreover, ``it is essential that this
implementation process move forward both promptly and
deliberately, in a manner that resolves uncertainty as to what
the new framework will be and that promotes long-term
confidence in the transparency and stability of our financial
system,'' On the other hand, we do recognize that the industry
is adjusting to significant changes in banking laws and
regulation, and there is cost associated with that.
The FDIC establishes comment periods consistent with the
timeframes dictated by the statute. As a general matter, the
FDIC tries to provide a 60-day comment period for each
significant proposed rule, and for some rules we have provided
comment periods as long as 90 days. As a matter of practice,
the FDIC often accepts and considers comments filed after the
established deadlines but before the rulemakings are finalized.
Q.2. In defining the exemption for ``qualified residential
mortgages,'' are the regulators considering various measures of
a lower risk of default, so that there will not just be one
``bright line'' factor to qualify a loan as a Q.R.M.?
A.2. Section 941 of the Dodd-Frank Act, titled, Regulation of
Credit Risk Retention, requires the FDIC (together with the
Federal Reserve Board, Offce of the Comptroller of the
Currency, Securities and Exchange Commission, Department of
Housing and Urban Development, and the Federal Housing Finance
Agency--collectively, the ``agencies'') to require securitizers
to retain no less than 5 percent of the credit of any assets
transferred to investors through the issuance of an asset-
backed security (ABS). Section 941 exempts certain ABS
issuances from the general risk retention requirement,
including ABS issuances collateralized exclusively by
``qualified residential mortgages'' (QRM), as jointly defined
by the agencies.
An interagency working group is near completion of a notice
of proposed rulemaking to implement section 941. I anticipate
the proposed rule will solicit public comment on various
options for satisfying the credit risk retention requirements
of section 941, as well as the appropriateness of certain
exemptions. I believe that, based on the data and other
information described in the response to Question 3 (below),
the underwriting and product features for QRM loans should
include standards related to the borrower's ability and
willingness to repay the mortgage (as measured by the
borrower's debt-to-income (DTI) ratio); the borrower's credit
history; the borrower's down payment amount and sources; the
loan-to-value (LTV) ratio for the loan; the form of valuation
used in underwriting the loan; the type of mortgage involved;
and the owner-occupancy status of the property securing the
mortgage.
Q.3. What data are you using to help determine the definition
of a Qualified Residential Mortgage?
A.3. In considering how to determine whether a mortgage is a
QRM, the agencies are examining data from multiple sources. For
example, the agencies are reviewing data on mortgage
performance supplied by the Applied Analytics division
(formerly McDash Analytics) of Lender Processing Services
(LPS). To minimize performance differences arising from
unobservable changes across products, and to focus on loan
performance through stressful environments, for the most part,
the agencies are considering data for prime fixed-rate loans
originated from 2005 to 2008. This data set includes
underwriting and performance information on approximately 8.9
million mortgages.
As is typical among data provided by mortgage servicers,
the LPS data do not include detailed information on borrower
income and on other debts the borrower may have in addition to
the mortgage. For this reason, the agencies are also examining
data from the 1992 to 2007 waves of the triennial Survey of
Consumer Finances (SCF). Because families' financial conditions
will change following the origination of a mortgage, the
analysis of SCF data focused on respondents who had purchased
their homes in either the survey year or the previous year.
This data set included information on approximately 1,500
families. In addition, it is my understanding that the agencies
are examining a combined data set of loans purchased or
securitized by a Government-sponsored enterprise from 1997 to
2009. This data set consists of more than 78 million mortgages,
and includes data on loan products and terms, borrower
characteristics (for example, income and credit score), and
performance data through the third quarter of 2010.
Q.4. Dodd-Frank (Sec 939A) required the regulators to remove
any reference or requirement of reliance on credit ratings from
its regulations. In his testimony, Acting Comptroller of the
Currency John Walsh wrote: ``(R)egional and community banks
noted (in their comments) that using internal risk assessment
systems to measure credit worthiness for regulatory purposes
would be costly and time consuming . . . . These concerns could
be addressed if section 939A is amended in a targeted manner
that allows institutions to make limited use of credit ratings.
Precluding undue or exclusive reliance on credit ratings,
rather than imposing an absolute bar to their use, would strike
a more appropriate balance between the need to address the
problems created by overreliance on credit ratings with the
need to enact sound regulations that do not adversely affect
credit availability or impede economic recovery.''
What is the status of this effort and what types of
alternative measures are being considered? Do you share the
concerns raised by community banks, and what is your reaction
to Acting Comptroller Walsh's comments on this issue?
A.4. The Federal banking agencies continue to work toward
developing alternatives to credit ratings. On August 25, 2010,
the banking agencies issued an Advance Notice of Proposed
Rulemaking (ANPR) seeking industry comment on how we might
design an alternative standard of creditworthiness, For the
most part, the comments we received lacked substantive
suggestions on how to answer this question, Although we have
removed any reliance on credit ratings in our assessment
regulation, developing an alternative standard of
creditworthiness for regulatory capital purposes is proving
more challenging, The use of credit ratings for regulatory
capital covers a much wider range of exposures; we cannot rely
on nonpublic information, and the alternative standard should
be usable by banks of all sizes. We are actively exploring a
number of alternatives for dealing with this problem.
We agree with the concerns raised by Acting Comptroller
Walsh, which stem from the difficult nature of designing
alternative standards of creditworthiness that are
appropriately risk sensitive and can be consistently applied
across banking organizations of all sizes. We also agree with
the concerns of community banks that internal risk assessments
would place a significant burden on smaller banks, as would
some of the other alternatives discussed in the NPR.
Notwithstanding these concerns, the agencies will continue to
work toward the development of a pragmatic solution for all
banks.
Q.5. You have said that the resolution plans are a critical
component of ending ``too big to fail.'' What is the status of
that rulemaking?
A.5. Section 165 of the Dodd-Frank Act requires the FDIC to
promulgate joint rules with the Federal Reserve setting forth
the regulatory standards and filing requirements for resolution
plans. The plans are to be jointly reviewed and enforced by the
FDIC and Federal Reserve. The FDIC is working closely with the
Federal Reserve to jointly promulgate rules under Section 165
of Title I. It is the FDIC's publicly expressed desire to issue
a proposed rulemaking in the very near term. The standards
would establish a time line and process for firms to submit
resolution plans.
Q.6. Please discuss the current status and timeframe of
implementing the Financial Stabilty Oversight Council's (FSOC)
rulemaking on designating nonbank financial companies as being
systemically important. As a voting member of FSOC, to what
extent is the Council providing clarity and details to the
financial marketplace regarding the criteria and metrics that
will be used by FSOC to ensure such designations are
administered fairly? Is the intent behind designation decisions
to deter and curtail systemically risky activity in the
financial marketplace? Are diverse business models, such as the
business of insurance, being fully and fairly considered as
compared with other financial business models in this
rulemaking?
A.6. The FSOC has issued a notice of proposed rulemaking
regarding the designation of nonbank financial firms under
Title I of the Dodd-Frank Act. The notice of proposed
rulemaking seeks public comment on the best methods to approach
the designation of firms, and the application of systemic
determination criteria on an institution-specific basis. The
proposal suggests using a framework to analyze the firms, and
applying metrics that would be tailored to that firm's business
model and industry sector. As provided in the proposed rule:
``The Council would evaluate nonbank financial companies in
each of the (six categories of the framework as proposed under
the rule) using quantitative metrics where possible. The
Council expects to use its judgment, informed by data on the
six categories, to determine whether a firm should be
designated as systemically important and supervised by the
Board of Governors. This approach incorporates both
quantitative measures and qualitative judgments.'' The six
broad categories are size, suitability, interconnectedness,
leverage, liquidity risk, and existing regulatory scrutiny.
Designated firms will be subjected to heightened prudential
standards developed to reduce the risk the firms may pose to
U.S. financial stability. As an important element of the
analysis, diverse business models and industry specific
considerations are being taken into account.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR SHELBY
FROM SHEILA C. BAIR
Q.1. The Dodd-Frank Act requires an unprecedented number of
rulemakings over a short period of time. As a result, some
deadlines have already been missed and some agencies expect to
miss additional deadlines. It appears that many of the
deadlines in Dodd-Frank are not realistic. Which Dodd-Frank
deadlines do you anticipate not being able to meet? If Congress
extended the deadlines, would you object? If your answer is
yes, will you commit to meeting all of the statutory deadlines?
If Congress affords additional time for rulemaking under the
Dodd-Frank Act, will you be able to produce higher-quality,
better coordinated rules?
A.1. The FDIC is committed to meeting any statutory deadlines
on rulemakings for which it has sole rule writing authority.
Joint rules and rules written in consultation with other
agencies generally take more time, but to date these deadlines
have been met as well.
While the FDIC might not object to an extension of the
Dodd-Frank Act deadlines, we believe the statutory timeframes
are appropriate and serve a useful purpose. On the one hand, as
I stated in my recent written testimony before the Committee,
``in implementing the Dodd-Frank Act, it is important that we
continue to move forward with dispatch to remove unnecessary
regulatory uncertainties faced by the market and the
industry.'' Moreover, ``it is essential that this
implementation process move forward both promptly and
deliberately, in a manner that resolves uncertainty as to what
the new framework will be and that promotes long-term
confidence in the transparency and stability of our financial
system.'' On the other hand, we do recognize that the industry
is adjusting to significant changes in banking laws and
regulation, and there is cost associated with that.
In addition, the FDIC recognizes the importance of
providing sufficient time for interested parties to comment on
all proposed rules and studies required by the Dodd-Frank Act.
We are committed to providing adequate time for that process.
It is critical, therefore, that we try to strike an appropriate
balance in our efforts to implement the Dodd-Frank Act between
timely and efficient rulemaking and careful review and
consideration of public comment. As stated in my testimony,
``regulators must maintain a clear view of the costs of
regulation--particularly to the vital community banking
sector--while also never forgetting the enormous economic costs
of the inadequate regulatory framework that allowed the crisis
to occur in the first place.''
Q.2. Secretary Geithner recently talked about the difficulty of
designating nonbank financial institutions as systemic. He
said, ``it depends too much on the state of the world at the
time. You won't be able to make a judgment about what's
systemic and what's not until you know the nature of the
shock.'' \1\ If it is impossible to know which firms are
systemic until a crisis occurs, the Financial Stabilty
Oversight Council will have a very difficult time objectively
selecting systemic banks and nonbanks for heightened
regulation. As a member of the Council, do you believe that
firms can be designated ex ante as systemic in a manner that is
not arbitrary? If your answer is yes, please explain how.
---------------------------------------------------------------------------
\1\ See, ``Special Inspector General for the Troubled Asset Relief
Program, Extraordinary Assistance Provided to Citigroup, Inc.''
(SIGTARP 11-002) (Jan. 13, 2011) (available at: http://www.sigtarp.gov/
reports/auditl2011/
Extraordinary%20Financia1%20Assistance%20Provided%20to%20Citigroup,%20In
c.pdf), at 43.
A.2. Yes, we believe it is possible and necessary to designate
firms as systemically significant prior to an actual crisis.
The designation process can be established using a defined
framework and criteria, together with clear and understandable
procedures.
There is an important distinction to be made between a
systemic risk determination that is made under Title II to
authorize appointment of the FDIC as receiver for a financial
company, and the designation of firms as systemically important
under Title I of the Dodd-Frank Act. The systemic risk
determination under Title II is made at the time of financial
distress, and requires a finding that the firm is in default or
in danger of default and that its insolvency would pose a
threat to the financial stability of the U.S., among other
findings. That determination will depend upon the circumstances
at the moment. On the other hand, the determination of systemic
significance under Title I, while addressing similar analysis
regarding potential threat to U.S. financial stability, is
focused on the need to develop and apply--prior to crisis--
heightened supervisory standards applicable to such firms,
including a requirement that the firm develop resolution plans.
It is vital that those firms which may possibly threaten U.S.
financial stability be identified and subject to these
heightened standards, and submit resolution plans as mandated
by Congress prior to the actual occurrence of financial
distress.
To provide a defined framework and explain the process, the
FSOC has issued a notice of proposed rulemaking regarding the
designation of nonbank financial firms under Title I of the
Dodd-Frank Act. The notice of proposed rulemaking seeks public
comment on the best methods to approach the designation of
firms, and the application of systemic determination criteria
on an institution-specific basis, The proposal suggests using a
framework to analyze the firms and applying metrics that would
be tailored to that firm's business model and industry sector.
As provided in the proposed rule: ``The Council would evaluate
nonbank financial companies in each of the [six categories of
the framework as proposed under the rule] using quantitative
metrics where possible. The Council expects to use its
judgment, informed by data on the six categories, to determine
whether a firm should be designated as systemically important
and supervised by the Board of Governors. This approach
incorporates both quantitative measures and qualitative
judgments.''
Q.3. Section 112 of the Dodd-Frank Act requires the Financial
Stabilty Oversight Council to annually report to Congress on
the Council's activities and determinations, significant
financial market and regulatory developments, and emerging
threats to the financial stability of the United States. Each
voting member of the Council must submit a signed statement to
the Congress affirming that such member believes the Council,
the Government, and the private sector are taking all
reasonable steps to ensure financial stability and mitigate
systemic risk. Alternatively, the voting member shall submit a
dissenting statement. When does the Council expect to supply
the initial report to Congress?
A.3. The report is required on an annual basis, and we expect
that the report will be submitted in a timely fashion this
July.
Q.4. Which provisions of Dodd-Frank create the most incentives
for market participants to conduct business activities outside
the United States? Have you done any empirical analysis on
whether Dodd-Frank will impact the competitiveness of U.S.
financial markets? If so, please provide that analysis.
A.4. The Dodd-Frank Act contains no provisions that
specifically encourage the conduct of business outside of the
U.S. The FDIC has not conducted an empirical analysis of the
potential impact of the Act on the decision making of financial
firms in locating their operations internationally. However,
these decisions will likely continue to be based on a large
number of considerations. Foremost among them will continue to
be the location of their customers. The U.S. economy is the
world's largest, encompassing about a quarter of global
economic activity. Its capital markets also remain the world's
largest and most sophisticated. This leading global position
not only makes the U.S. a preferred venue for conducting
banking and other financial activities, but it also
necessitates a strong regulatory framework for ensuring
financial stability and safe and sound banking practices.
It is true that short-term international competitive
imbalances could arise if there were a failure to coordinate
capital requirements, resolution procedures, and other
regulatory practices designed to promote financial stability.
However, as we have seen in the aftermath of the recent global
financial crisis, some of the countries where financial
practices were allowed to weaken the most saw their financial
institutions experience large losses that ultimately undermined
their sovereign balance sheets and macroeconomic stability.
Clearly, winning such a race to the bottom is no recipe for
long-term competitive advantage in finance or in overall
economic performance.
The Dodd-Frank Act mandates more than 70 studies, many of
which relate to the effects of the Act's provisions on the
economy and the functioning of financial markets. As described
in our testimony, the FDIC is working on a number of fronts,
both on our own and in concert with our regulatory
counterparts, to complete these assigned studies and carry out
rulemakings as mandated by the Act as expeditiously, as
carefully, and as transparently as possible.
Q.5. More than 6 months have passed since the passage of the
Dodd-Frank Act, and you are deeply involved in implementing the
Act's approximately 2,400 pages. Which provisions of the Dodd-
Frank Act are proving particularly difficult to implement? Have
you discovered any technical or substantive errors in the Dodd-
Frank legislation? If so, please describe them.
A.5. It is still relatively early in the implementation
process. As you know, the Act charges the FDIC and other
regulators with interpreting a number of new statutory
provisions through rulemakings with differing time lines. While
some final rules are in place (such as the FDIC's initial
orderly liquidation authority interim final rule and the final
rule changing the Deposit Insurance Fund assessment base), much
still needs to be done.
Agency rulemaking typically involves notice and opportunity
for comment. One benefit of that process is that it helps
identify the more difficult interpretive issues and flesh out
reasonable options for addressing them.
So far, the most difficult practical issue has been
identifying substitutes for credit ratings in some particular
contexts. Section 939A of the statute requires the elimination
of credit ratings rather than supplementing their use. While
the FDIC's final large bank pricing rule adopted earlier this
month has eliminated reliance on long-term debt issuer ratings,
we are still in the process of developing substitute measures
for creditworthiness in other areas, such as the capital rules.
Q.6. What steps are you taking to understand the impact that
(the) your agency's rules under Dodd-Frank will have on the
U.S. economy and its competitiveness? What are the key ways in
which you anticipate that requirements under the Dodd-Frank Act
will affect the U.S. economy and its competitiveness? What are
your estimates of the effect that the Dodd-Frank Act
requirements will have on the jobless rate in the United
States?
A.6. As you know, the FDIC is required or authorized by
Congress to implement some 44 regulations, including 18
independent and 26 joint rulemakings. As we proceed with
implementing the provisions of the Dodd-Frank Act as
expeditiously and transparently as possible, we undertake the
same steps that we follow in any regulatory process, from
providing a comment period through meeting requirements of the
Paperwork Reduction Act, Regulatory Flexibility Act, the Riegle
Community Development and Regulatory Improvement Act of 1992,
and the FDIC's own Statement of Policy for rulemaking (all
discussed in further detail in response to Question 7).
The FDIC has not conducted an empirical analysis of the
potential impact of Dodd-Frank Act on the economy and market
competitiveness. However, we remain mindful of the devastating
effects that the 2008 financial crisis visited on the U.S.
economy, and the lingering consequences of the crisis on the
functioning of the U.S. financial system. For example, in the
6-month period following the failure of Lehman Brothers in
September of 2008, the U.S. economy lost some 3.9 million
payroll jobs, and the monthly volume of domestically produced
steel declined by approximately one-half. As you know, it was
with these types of economic consequences in mind that the
FDIC, Federal Reserve, and U.S. Department of Treasury
undertook the programs of extraordinary assistance that helped
to stabilize U.S. financial markets and institutions. Without
those programs, the economic consequences would surely have
been much worse.
Although these stabilization programs have mostly been
wound down, U.S. financial markets and institutions have been
slow in recovering from the crisis. FDIC-insured institutions
have seen their total loan balances shrink for 9 of the past 10
quarters, with the only quarter of growth resulting from
accounting changes in early 2010 that resulted in billions of
dollars in securitized assets returning to bank balance sheets.
Meanwhile, the volume of private asset-backed securitization
remains at just a small fraction of its precrisis level, as
investors continue to be reluctant to purchase the types of
securities that were the result of hundreds of billions of
dollars of losses during the crisis.
Proper implementation of the provisions of the Dodd-Frank
Act can do much to improve the functioning of U.S. financial
markets and restore their ability to support economic activity.
For example, the forthcoming risk retention rule requiring
issuers of asset-backed securities to retain at least 5 percent
of the credit risk should help to reassure investors that newly
issued securities will be much more likely to perform over the
long-term than the mortgage-related securities issued in the
middle of the last decade.
Financial stability is not an end in itself. It is a means
to an end, which is to support economic activity and put
Americans back to work. As we have seen, the economic costs of
financial instability are high and long-lasting. The FDIC is
committed to fulfilling its responsibilities under the Dodd-
Frank Act, restoring investor confidence, and laying the
foundation for a stronger U.S. economy.
Q.7. What steps are you taking to assess the aggregate costs of
compliance with each Dodd-Frank rulemaking? What steps are you
taking to assess the aggregate costs of compliance with all
Dodd-Frank rulemakings, which may be greater than the sum of
all of the individual rules' compliance costs? Please describe
all relevant reports or studies you have undertaken to quantify
compliance costs for each rule you have proposed or adopted.
Please provide an aggregate estimate of the compliance
costs of the Dodd-Frank rules that you have proposed or adopted
to date.
A.7. As we have described, the Dodd-Frank Act mandates more
than 70 studies, many of which relate to the effects of its
provisions on the economy and the functioning of financial
markets. In addition, there also are a number of preexisting
statutory provisions requiring the FDIC to consider costs
imposed on insured depository institutions by new regulations,
both as a general matter and through specific provisions. For
example:
Section (7)(b)(2)(B)(iii) of the FDI Act requires
the FDIC Board, when setting assessments, to consider
the ``projected effects of the payment of assessments
on the capital and earnings of insured depository
institutions'' among other factors.
Section 302 of the Riegle Community Development and
Regulatory Improvement Act of 1994 requires the FDIC
and the other banking agencies to consider--consistent
with the principles of safety and soundness and the
public interest--(1) any administrative burdens that
such regulations place on depository institutions,
including small depository institutions and customers
of depository institutions; and (2) the benefit of such
regulations.
The Paperwork Reduction Act, 44 U.S.C. 3501 et
seq., requires OMB approval of any ``information
collection,'' including review of whether any paperwork
burden imposed by the proposed regulation is warranted
by the benefits to be accrued.
The Regulatory Flexibility Act, 5 U.S.C. 601 et
seq., generally requires a Federal agency to provide a
regulatory flexibility analysis for a proposed rule
describing the impact on small entities, as defined by
the Small Business Administration.
Further, the FDIC's Statement of Policy for rulemaking
expressly states, ``Prior to issuance, the potential benefits
associated with the regulation or statement of policy are
weighed against the potential costs.'' The FDIC remains
committed to fulfilling all of these statutory requirements to
study the economic impact of its rulemaking as it also fulfills
its extensive rulemaking mandate under the Dodd-Frank Act.
Q.8. Section 115 of the Dodd-Frank Act asks the Financial
Stabilty Oversight Council to make recommendations to the
Federal Reserve on establishing more stringent capital
standards for large financial institutions. In addition,
Section 165 requires the Fed to adopt more stringent standards
for large financial institutions relative to smaller financial
institutions. Chairman Bernanke's testimony for this hearing
implied that the Basel III framework satisfies the Fed's
obligation to impose more stringent capital on large financial
institutions. As a member of the Financial Stabilty Oversight
Council, do you agree with Chairman Bernanke that the Basel III
standards are sufficient to meet the Dodd-Frank Act requirement
for more stringent capital standards? Please explain the basis
for your answer.
A.8. The Basel III agreement stated that heightened capital
standards would be developed for the largest banks. To the
extent such standards are developed and require additional
loss-absorbing capital, there is a potential that such
standards could meet the requirements of Section 165.
Q.9. The Fed, the SEC, the FDIC, and the CFTC are all
structured as boards or commissions. This means that before
they can implement a rule they must obtain the support of a
majority of their board members. How has your board or
commission functioned as you have been tackling the difficult
job of implementing Dodd-Frank? Have you found that the other
members of your board or commission have made positive
contributions to the process?
A.9. As you know, section 2 of the Federal Deposit Insurance
Act provides that the FDIC is to be managed by a five-member
Board of Directors. Our existing Board structure and governance
procedures have functioned well as we work to fulfill our
responsibilities under the Dodd-Frank Act. The expertise and
perspective the Board members have brought to each stage of the
Act's implementation to date has been very valuable. Board
members have provided constructive feedback and candid
comments, demonstrating their understanding of both the
challenges and opportunities that the Act presents for the FDIC
and the other regulatory agencies. In addition, Board members
have supported the FDIC's numerous and continuing efforts to
make implementation of the Act and the Board's deliberative
process as open and transparent as possible. As Chairman, I
have appreciated their ongoing support and guidance as we
continue to move forward through the rulemaking and functional
implementation process.
Q.10. Numerous calls have arisen for a mandatory ``pause'' in
foreclosure proceedings during the consideration of a mortgage
modification. Currently, what is the average number of days
that customers of the institutions that you regulate are
delinquent at the time of the completed foreclosure? If
servicers were required to stop foreclosure proceedings while
they evaluated a customer for mortgage modification, what would
be the effect on the foreclosure process in terms of time and
cost. What effect would these costs have on the safety and
soundness of institutions within your regulatory jurisdiction.
Please differentiate between judicial and nonjudicial States in
your answers and describe the data that you used to make these
estimates.
A.10. FDIC-supervised banks are not required to report the
number of days customers are delinquent at the time of a
completed foreclosure. However, there is evidence that the time
needed to complete foreclosure has been rising. Industry data
as of August 2010 suggests that the number of consecutive
missed payments prior to foreclosure had risen to 5.5, up from
2.9 missed payments at year-end 2007, The length of a
foreclosure proceeding (judicial and nonjudicial) would vary
widely by State based on rules and standards governing notice
of default, mandatory mediation or counseling, and cure or
redemption periods, as well as backlogs that have resulted from
the rapid rise in foreclosure filings during the past 2 years.
The FDIC believes loss mitigation is essential to stabilize
the housing market and minimize losses to insured banks and
thrifts. Far from being simply a socially desirable practice to
preserve home ownership, effective loss mitigation is
consistent with safe-and-sound banking practice and has
positive macroeconomic consequences. Modification may improve
the value of distressed mortgages by achieving long-term
sustainable cash flows for lenders and investors that exceed
the value that can be gained through foreclosure. A net present
value test is typically used to confirm that a modification
would minimize losses to financial institutions and investors.
In cases where the borrower cannot afford the lowest payment
allowed, foreclosure should proceed expeditiously to minimize
the financial impact on institutions, communities, and the
housing market. In some cases it may be reasonable to begin
conducting preliminary filings for seriously past-due loans in
States with long foreclosure time lines. Nonetheless, it is
vitally important that the modification process be brought to
conclusion before a foreclosure sale is scheduled. Failure to
coordinate the foreclosure and modification processes could
confuse and frustrate homeowners and could result in
unnecessary foreclosures. Servicers should identify a single
point of contact to work with homeowners once it becomes
evident the homeowner is in distress. This single point of
contact must be appropriately authorized to provide current,
accurate information about the status of the borrower's loan or
loan modification application, as well as provide a sign-off
that all loan modification efforts have failed before a
foreclosure sale. This approach will go a long way toward
eliminating the potential conflict and miscommunication between
loan modifications and foreclosures and providing borrowers
assurance that their modification application is being
considered in good faith.
Q.11. The burden of complying with Dodd-Frank will not affect
all banks equally. Which new Dodd-Frank Act rules will have the
most significant adverse impact on small and community banks?
Which provisions of Dodd-Frank will have a disparate impact on
small banks as compared to large banks? Do you expect that the
number of small banks will continue to decline over the next
decade? If so, is the reason for this decline the Dodd-Frank
Act? Have you conducted any studies on the costs Dodd-Frank
will impose on small and community banks? If so, please
describe the results and provide copies of the studies.
A.11. The FDIC believes the Dodd-Frank Act financial reform
legislation will not cause undue burden or costs on community
banks. The legislation's primary focus is on large financial
institutions. Provisions that specifically apply to large
institutions include new rules on proprietary trading, the
composition of capital, and risk retention by asset-backed
securities issuers, as well the provisions in Title I and Title
II that, together, will establish an orderly liquidation
process for systemically important institutions and end the
perception that a large institution are ``too big to fail.'' We
believe there are tangible benefits for community banks in the
Dodd-Frank Act, such as and end to ``too big to fail,''
increased oversight of their nonbanks competitors (which will
help level the financial services playing field), an increase
in the coverage limit and an expansion of the assessment base
for Federal deposit insurance, and community bank exemptions
from certain other new requirements. The change in the deposit
insurance assessment base alone, one based on domestic deposits
to one focused on assets, will effectively reduce community
bank premiums by about 30 percent.
Further, the FDIC believes that certain aspects of the
Dodd-Frank Act will have a significant positive impact on small
and community banks, particularly regarding the development of
a more level playing field with respect to regulatory capital
requirements. For instance, the Collins Amendment will place a
floor under the so-called advanced approached to risk-based
capital rules, which will ensure the resulting capital
requirements for large banks and bank holding companies are no
lower than the capital requirements required of small and
community banks that hold similar exposures. In addition, the
Dodd-Frank Act will require large bank holding companies to
hold additional capital beyond that required of smaller
institutions to account for the greater risk that large bank
holding companies pose to the financial system.
As I discussed during the Committee's hearing, new rules on
interchange fees may present an issue for community banks, and
we are discussing this with the Federal Reserve. There is some
concern about the interchange rule's effectiveness and whether
community banks can continue to charge higher fees,
particularly if networks are not required to have a two-tiered
pricing structure.
We have seen significant consolidation in the number of
U.S. banks in recent decades, as a result of both economic
forces and statutory changes that facilitate branching. This
process of consolidation tends to accelerate during periods of
industry distress, But there is no regulatory policy,
intention, or goal to reduce the number of banks. The FDIC has
long supported the community bank model, and believes that
community banks play an essential role in a U.S. economy where
more than two thirds of all new jobs are created by small
businesses. Ultimately, we need healthy banks that can provide
credit in their communities.
We have not performed a study on the costs of the Dodd-
Frank Act for small community banks; however, we believe that
any costs will be relatively low as the legislation primarily
impacts large institutions. Further, any major rulemaking will
require that we conduct an impact analysis on community banks,
The FDIC shares the public's concern about unnecessary
regulatory burden, and we are engaging in dialogue with the
banking industry through the FDIC Advisory Committee on
Community Banking and our examination process to ensure the
supervisory process is not burdensome and the potential effect
on credit availability is mitigated.
Q.12. When the Dodd-Frank Act passed, President Obama said
``There will be no more tax-funded bailouts--period.''
Nevertheless, Secretary Geithner recently said: ``In the future
we may have to do exceptional things again if we face (another
financial crisis).'' \2\ Presumably, Secretary Geithner means
more taxpayer bailouts when he talks about the need to do
``exceptional things.'' Can you envision any situation in which
the FDIC could use the new resolution authority to bail out
creditors, regardless of whether they are long-term bondholders
or short-term commercial paper lenders? Which types of
creditors will fall within the ``essential services'' exception
to the mandatory clawback provision under Title II of Dodd-
Frank? Trade creditors? Commercial paper lenders? Repurchase
agreement lenders?
---------------------------------------------------------------------------
\2\ See, ``Special Inspector General for the Troubled Asset Relief
Program, Extraordinwy Assistance Provided to Citigroup, Inc.'' (SIGTARP
11-002) (Jan. 13, 2011) (available at: http://www.sigtarp.gov/reports/
audit/2011/
Extraordinary%20Financia1%20Assistance%20Provided%20to%20Citigroup,%20In
c.pdf), at 44.
A.12. Irrespective of how creditors are treated in a Title II
resolution, there can be no taxpayer bailout. The Dodd-Frank
Act permits the FDIC as receiver for a systemically significant
financial company to borrow funds from the U.S. Treasury to
ensure an orderly liquidation. The Act makes very clear,
however, that in the event that the assets of the receivership
estate are not sufficient to repay the Treasury borrowings in
full, the FDIC must assess the industry in an amount sufficient
to repay all borrowings from the Treasury. As a result, no
taxpayer funds will ever be at risk.
With respect to the ability of the FDIC as receiver to
transfer the operations of a failed systemically significant
financial company to a third party or to operate the business
through a bridge financial company after the receiver has been
appointed and shareholders and creditors have taken appropriate
losses, it is possible in such a resolution that certain
creditors could be paid more than their liquidation share. The
receiver may do so in the event that it would result in lower
losses to the entire operation of the company since the
receiver would be able to transfer the intangible franchise
value of the company to a third party. It is possible that
commercial paper lenders or unsecured derivative counterparties
could fall into this category. If either of those types of
creditors received additional payments from the receiver in
order to benefit all creditors, they would be subject to the
clawback provision. The Act requires the FDIC to clawback any
additional funds paid to creditors (other than those deemed
essential) prior to assessing the industry in the event the
assets of the receivership estate are insufficient to repay the
Treasury for funds borrowed.
As noted above, commercial paper lenders would not be
considered essential and exempt from the clawback requirement.
Instead, creditors deemed essential are more likely to be
service providers that cannot be easily replaced. Our
experience is that if a service provider is not paid for its
prefailure work, then it typically will not want to continue to
provide services after the failure, In most cases, the receiver
would simply replace the service provider. In limited
instances, the receiver may determine that it can not replace
the service provider and so make payment on prefailure
expenses. The simplest example is the local utility. If the
receiver does not pay the prefailure electric bill, the lights
will be turned off. The receiver would not be able to find
another provider of electricity and obviously could not fulfill
its mission without electrical power. Similarly, if unique
software were provided by a small company and such company
would go out of business if its prefailure bills were not paid,
the receiver may also determine that such a service is
essential.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN
FROM SHEILA C. BAIR
Q.1. Capital Rules for Systemically Important Financial
Institutions--The Basel Committee on Banking Supervision set
the so-called ``Basel III'' minimum capital requirements for
banks at 8 percent, with an additional 2.5 percent buffer. But
a study by the Bank for International Settlements suggests that
the optimal capital ratio would actually be about 13 percent. A
Government-sponsored panel in Switzerland has said that massive
banks UBS and Credit Suisse should hold 19 percent capital.
The Financial Stabilty Oversight Council, or FSOC, will
recommend capital requirements for the largest financial
institutions--the so-called ``Systemically Important Financial
Institutions.''
Do you favor increasing capital for systemically important
financial companies above the 10.5 percent Basel III ratio? If
so, what is the right number?
A.1. The Basel Committee agreed that systemically important
banks would be required to have additional loss-absorbing
capacity over and above the requirements announced for smaller
banks. We continue to support these heightened expectations.
Given the unique risk to the financial system posed by these
organizations, it is important that these organizations are
more resilient to stress. We are working closely with the other
Federal banking agencies to determine the appropriate capital
surcharge.
Q.2. Wall Street often argues that increased capital and equity
requirements will lead to decline in lending. However, a recent
paper by professors at the Stanford Business School argues that
large banks with access to diverse sources of funding can both
continue lending and meet higher equity requirements, either by
replacing some liabilities with equity or by expanding their
balance sheets. Do you agree with this conclusion?
Wall Street often argues that higher capital means higher
costs for borrowers. Do you believe that banks could adapt to
new capital requirements in ways that do not pass costs on to
customers and borrowers, for example, by cutting outsized
salaries and bonuses?
A.2. Although it will not be cost free to move to a stronger
capital regime, we do not agree that the new requirements will
reduce the availability of credit or significantly raise
borrowing costs. Furthermore, the new standards allow a
substantial phase-in period that will provide banks with ample
time to raise capital through retained earnings. In addition,
the new standards will help to level the playing field between
large and small banks in the U.S. as well as between U.S. banks
and their overseas competitors.
In addition to the Stanford Business School paper, studies
by economists at Harvard, the University of Chicago, and the
Bank for International Settlements argue persuasively that the
impact on the cost of credit will be modest, and that these
costs will be far outweighed by the benefits of a more stable
financial system.
Q.3. Banks, Capital, and Losses--The ongoing foreclosure crisis
and the foreclosure fraud scandal are issues of great national
importance, and of particular importance in my home State.
And right now the four largest banks are the most exposed
to the shaky real estate market--they have over 40 percent of
the mortgage servicing contracts and second lien mortgages.
Despite this exposure to potential housing-related losses,
as well as looming new capital rules from Dodd-Frank and the
Basel Committee, the Federal Reserve is conducting stress tests
that will pave the way for 19 of the largest banks to once
again buy back their stock and issue dividends.
The three largest banks also have about $121 billion in
debt guaranteed by the FDIC which costs taxpayers, gives this
debt a funding advantage, and is not being counted by the
stress tests.
By easing dividend and stock restrictions on big banks, are
we adding to the advantage that they have over their smaller
competitors?
A.3. We believe large banks should hold more capital than their
smaller competitors commensurate with their heightened risk
profile and any potential systemic implications of financial
distress. With respect to your question on easing dividend and
stock restrictions on large banks, we do not believe that
dividend and capital repurchases, which involve significant
cash outlays, should be allowed until we are fully confident
that these firms will have the financial resources to remain
strong under a stressed scenario and to repay debt guaranteed
by the FDIC.
Q.4. Everyone agrees that lending has contracted but bonuses
are booming. Won't paving the way for dividend payments to
investors--including their own executives--limit the banks'
ability to deploy their capital to support the recovery?
A.4. We are in favor of a strong earnings retention policy to
ensure banks continue prudent lending to support the economic
recovery. We would be concerned about prematurely resuming or
increasing capital distributions without first determining that
the capital and liquidity position of a bank would remain
strong under a stressed scenario.
Q.5. There is a lot of uncertainty about the future of the
housing market and new capital requirements, and each dollar
paid out to shareholders is a dollar less in equity for the
bank. How can we ensure that allowing big banks to issue
dividends now won't damage their capital levels and future
stability?
A.5. Banks must plan for the heightened capital requirements
under Basel III, capital surcharges needed for banks that are
systemically important, and any potential changes to business
models that might result from the Dodd-Frank Act. Furthermore,
the banking agencies historically have expected banks to
operate with capital positions well above the minimum
requirements to account for risks that are not adequately
captured by the risk-based capital framework. Banks need to be
prudent with their capital positions, especially in uncertain
economic times.
Finally, banks need to have adequate liquidity reserves in
place to repay TLGP debt guaranteed by the FDIC. Regulators
should not approve dividend and capital repurchases, which
involve significant cash outlays by financial firms, until we
are all fully confident that these firms will have the
financial resources to repay debt guaranteed by the FDIC.
Q.6. Should one of these 19 companies encounter issues with
their capital base, are the Fed and FDIC ready to use their new
authorities under Dodd-Frank right now--the ``Grave Threat
Divestiture'' and ``Orderly Liquidation Authority,''
respectively?
If not now, when will those authorities be ready?
A.6. Yes, the FDIC stands ready to serve as receiver should it
be appointed under the authorities established under Title II
of the Dodd-Frank Act.
With regard to the orderly liquidation authority, the FDIC
issued a notice of proposed rulemaking (published October 19,
2010) to implement certain orderly liquidation provisions of
Title II. The FDIC approved an Interim Final Rule on January
18, 2011, which addressed the payment of similarly situated
creditors, the honoring of personal services contracts, the
recognition of contingent claims, the treatment of any
remaining shareholder value in the case of a covered financial
company that is a subsidiary of an insurance company, and
limitations on liens that the FDIC may take on assets of a
covered financial company that is an insurance company or
covered subsidiary.
A second notice of proposed rulemaking was approved by our
Board on March 15 and included the orderly additional questions
for public comment. The proposed rule provides details of the
orderly liquidation process including additional details on the
role of the FDIC as receiver for a covered financial company,
claims processes and priorities, recoupment of compensation
from certain senior executive officers of covered financial
companies, criteria to be applied by the FDIC in determining if
a company is ``predominantly engaged in activities that are
financial in nature or incidental thereto'' (and therefore a
financial company subject to the Title II orderly liquidation
authority), and insights regarding preferential and fraudulent
transfers. The FDIC will issue additional rules to address
receivership termination, receivership purchaser eligibility
requirements, and records retention requirements.
With regard to the Title I provisions granting authority to
the FDIC to issue orders compelling divestiture, the authority
is confined to those firms properly subject to the resolution
planning requirement of section 165 of the Dodd-Frank Act.
Section 165 provides authority to the FDIC to act jointly with
the Federal Reserve to issue an order to correct deficiencies
identified in a firm's resolution plan. The standards for
review, and the process by which firms will be found deficient
and curative actions taken, will be the subject of joint
rulemaking by the FDIC and the Federal Reserve, as required by
section 165(d) of the Act. The FDIC is working closely with the
Federal Reserve to implement section 165, and we expect to
issue a proposed rulemaking in the very near term.
Q.7. Mortgage Servicing and Examinations--In November, the GAO
released a study on abandoned foreclosures, also known as
``bank walkaways.'' With respect to mortgage servicing, the
report found:
According to our interviews with Federal banking
regulators, mortgage servicers' practices . . . have not been a
major focus covered in their supervisory guidance in the past.
The primary focus in these regulators' guidance is on
activities undertaken by the institutions they oversee that
create the significant risk of financial loss for the
institutions. Because a mortgage servicer is generally managing
loans that are actually owned or held by other entities, the
servicer is not exposed to losses if the loans become
delinquent or if no foreclosure is completed. As a result, the
extent to which servicers' management of the foreclosure
process is addressed in regulatory guidance and consumer
protection laws has been limited and uneven. For example,
guidance in the mortgage banking examination handbook that OCC
examiners follow when conducting examinations of banks'
servicing activities notes that examiners should review the
banks' handling of investor-owned loans in foreclosure,
including whether servicers have a sound rationale for not
completing foreclosures in time or meeting investor guidelines.
In contrast, the guidance included in the manual Federal
Reserve examiners use to oversee bank holding companies only
contained a few pages related to mortgage servicing activities,
including directing examiners to review the income earned from
the servicing fee for such operations, but did not otherwise
address in detail foreclosure practices.
In addition, until recently, the extent to which these
regulators included mortgage servicing activities in their
examinations of institutions was also limited. According to OCC
and Federal Reserve staff, they conduct risk-based examinations
that focus on areas of greatest risk to their institutions'
financial positions as well as some other areas of potential
concern, such as consumer complaints. Because the risks from
mortgage servicing generally did not indicate the need to
conduct more detailed reviews of these operations, Federal
banking regulators had not regularly examined servicers'
foreclosure practices on a loan-level basis, including whether
foreclosures are completed. For example, OCC officials told us
their examinations of servicing activities were generally
limited to reviews of income that banks earn from servicing
loans for others and did not generally include reviewing
foreclosure practices.
Please describe your agencies' views of the risks related
(to) the banks' servicing divisions, including:
The losses stemming from the servicing divisions of
the banks that you regulate.
What further losses, if any, you expect.
How your agencies have changed your examination
procedures relating to banks' servicing divisions.
Whether there will be uniform standards for
servicing examination across all Federal banking
agencies.
A.7. To date, there is no evidence of serious mortgage
servicing deficiencies or losses related to such deficiencies
at State nonmember banks supervised by the FDIC. Overall, FDIC-
supervised banks tend to be less involved in mortgage servicing
activities than larger institutions. Mortgage servicing is
significantly concentrated in a handful of large financial
institutions regulated by the OCC or Federal Reserve. For
example, according to data in the September 30, 2010, Reports
of Condition and Income, the top six servicers in the U.S. are
national banks and account for almost 84 percent of all loans
serviced by federally insured institutions. As noted in the GAO
report excerpted above, the FDIC is the primary regulator for
servicers that represent only 1.2 percent of the market.
When the FDIC is the primary Federal regulator for a bank
with mortgage banking activities, our examiners follow an
examination process that includes a core review of the
institution's mortgage banking policies and procedures,
origination and underwriting standards, internal controls,
audit, and information systems.
The FDIC participated in an interagency review of certain
financial institutions' mortgage servicing departments in late
2010 and early 2011. Based on the results of this review, we
see opportunities to strengthen standards governing mortgage
servicing, foreclosure processes, and loss mitigation. This may
require more stringent oversight of servicers' risk management
and operational controls as well as ensuring internal and
external audits are designed to identify weaknesses and report
them to management. It may also require that more attention be
paid to the reputational risks associated with servicing
failures. In addition, the FDIC is working with other bank
regulatory agencies to develop national mortgage servicing
standards. Once these standards are finalized, the agencies
will consider what revisions may need to be made to existing
examination procedures to ensure servicing operations meet
specified requirements.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARNER
FROM SHEILA C. BAIR
Q.1. For each of the witnesses, though the Offce of Financial
Research does not have a Director, what are each of you doing
to assist OFR in harmonizing data collection, compatibility,
and analysis?
A.1. The FDIC has ongoing discussions with the Office of
Financial Research (OFR) staff. We look forward to sharing our
considerable experience in obtaining, aggregating, analyzing
and reporting financial data and information, and expect to
contribute significant support to the OFR.
Q.2. Chairman Bair, each of your agencies was charged with
working together to develop orderly liquidation plans for
systemically significant financial institutions so that they
can avoid needing resolution under Title 2 if they fail. Where
are we in that process and when can we expect companies to
start submitting plans to you for review and approval?
A.2. Section 165 of the Dodd-Frank Act requires the FDIC to
promulgate joint rules with the Federal Reserve that set forth
the regulatory standards and filing requirements for resolution
plans. The plans are to be jointly reviewed and enforced by the
FDIC and Federal Reserve. The FDIC is working closely with the
Federal Reserve to jointly promulgate rules under section 165
of Title I. It is the FDIC's publicly expressed desire to issue
these standards in the very near term. The standards would
establish a time line and process for firms to submit
resolution plans.
Q.3. Chairman Bair, most of the companies subject to the
requirement for an orderly liquidation plan are multinational
in at least some respect. What cross border issues have you
uncovered and how are you working to address those issues? Are
there any legal barriers to resolving those issues in a way
that ensures the plans work?
A.3. A primary challenge the FDIC is addressing in the area of
international coordination is conforming resolution regimes and
the adoption of consistent resolution and receivership
mechanisms, standards and policies in order to more effectively
conduct an orderly resolution of internationally active firms.
In coordination with the Financial Stability Board (FSB) Cross-
Border Crisis Management Group and as Chair of the Basel
Committee on Banking Supervision (BCBS) Cross-Border
Resolutions Group, the FDIC has led a number of meetings during
2010 with international resolution authorities and supervisors
to address these challenges and identify obstacles to
overcoming them.
In order to address the challenges presented by cross-
border resolutions, the Financial Stability Board (FSB) has
made various recommendations to be adopted by participating
jurisdictions. In its recently published paper titled,
``Reducing the Moral Hazard Posed by Systemically Important
Financial Institutions (SIFIs),'' the FSB outlines
recommendations to assist in resolving a systemically important
international financial institution. The paper recommends that
comprehensive resolution regimes and tools must be established
in order for SIFIs to be resolved properly. The various
recommendations are:
All jurisdictions should undertake the necessary
legal reforms to ensure that they have in place a
resolution regime which would make feasible the
resolution of any financial institution without
taxpayer exposure to loss from solvency support while
protecting vital economic functions through mechanisms
which make it possible for shareholders and unsecured
and uninsured creditors to absorb losses in their order
of seniority.
Each country should have a designated resolution
authority responsible for exercising resolution powers
over financial institutions. The resolution authority
should have the powers and tools proposed in the FSB
note on Key Attributes of Effective Resolution Regimes
and in the BCBS Cross-Border Bank Resolution Group
Recommendations and the flexibility to tailor
resolution measures to the specific nature of financial
institutions' domestic and international business
activities.
National authorities should consider restructuring
mechanisms to allow recapitalization of a financial
institution as a going concern by way of contractual
and/or statutory (i.e., within-resolution) debt-equity
conversion and write-down tools, as appropriate to
their legal frameworks and market capacity. Such
mechanisms require that a robust resolution regime be
in place.
The FSB's program has built on work undertaken by the BCBS
Cross-Border Bank Resolution Group, cochaired by the FDIC since
2007. In support of these efforts, the FDIC is participating in
multiple international working groups that are analyzing
resolution challenges associated with derivatives booking
practices, business line management and legal entity
operations, global payment systems, intragroup guarantees and
interconnectedness, resolvability, contingent capital, and
similar issues. Also, to inform decision making and assist in
the conformance of resolution regimes, the FSB is conducting a
stock-taking of the resolution regimes and approaches in
multiple jurisdictions. The FDIC has been an active participant
in these efforts. There are ongoing institution-specific Crisis
Management Group meetings involving relevant international
supervisors and resolution authorities relative to firm-
specific recovery and resolution planning.
Q.4. Chairman Bair, I believe that the Qualified Residential
Mortgage is a significant effort towards repairing our
underwriting problems and lack of private sector investment in
the housing market right now. I understand there is concern
that because these qualified mortgages will be exempted from
risk retention standards, we want this type of mortgage to be
affordable and available. Can you tell us how you are weighing
the construct of a QRM--including down payment, income, LTV,
and the use of private insurance?
A.4. Section 941 of the Dodd-Frank Act, titled, Regulation of
Credit Risk Retention, requires the FDIC (together with the
Federal Reserve Board, Office of the Comptroller of the
Currency, Securities and Exchange Commission, Department of
Housing and Urban Development, and the Federal Housing Finance
Agency) to require securitizers to retain no less than 5
percent of the credit of any assets transferred to investors
through the issuance of an asset-backed security (ABS). Section
941 exempts certain ABS issuances from the general risk
retention requirement, including ABS issuances collateralized
exclusively by ``qualified residential mortgages'' (QRMs), as
jointly defined by the agencies.
An interagency working group is near completion of a notice
of proposed rulemaking to implement section 941. I anticipate
the proposed rule will solicit public comment on various
options for satisfying the credit risk retention requirements
of section 941, as well as the appropriateness of certain
exemptions. In considering how to determine whether a mortgage
qualifies for the QRM exemption, the agencies are examining
data from several sources. One data set consists of 10 years of
performance information on more than 78 million mortgage loans,
and includes data on loan products and terms, borrower
characteristics (for example, income and credit score), and
performance data through the third quarter of 2010.
I believe the underwriting and product features for QRM
loans should include standards related to the borrower's
ability and willingness to repay the mortgage (as measured by
the borrower's debt-to-income (DTI) ratio); the borrower's
credit history; the borrower's down payment amount and sources;
the loan-to-value (LTV) ratio for the loan; the form of
valuation used in underwriting the loan; the type of mortgage
involved; the owner-occupancy status of the property securing
the mortgage; and whether the loan documents include mortgage
servicing standards that require the servicer to work with the
borrower if the borrower is past due or in default.
The proposed QRM standards should be transparent to, and
verifiable by, originators, securitizers, investors, and
supervisors. This approach should assist originators of all
sizes in determining whether residential mortgages will qualify
for the QRM exemption, and assist ABS issuers and investors in
assessing whether a pool of mortgages will meet the
requirements of the QRM exemption. In addition, I believe the
approach taken by the proposal should allow individual QRM
loans to be modified after securitization without the loan
ceasing to be a QRM in order to avoid creating a disincentive
to engaging in appropriate loan modifications.
As required by section 941, the agencies will also consider
information regarding the credit risk mitigation effects of
mortgage guarantee insurance or other credit enhancements
obtained at the time of origination. If such guarantees are
backed by sufficient capital, they likely lower the credit risk
faced by lenders or purchasers of securities because they
typically payout when borrowers default. However, the agencies
have not identified studies or historical loan performance data
adequately demonstrating that mortgages with such credit
enhancements are less likely to default than other mortgages,
after adequately controlling for loan underwriting or other
factors known to influence credit performance--especially LTV
ratios. Therefore, at this time I do not believe the proposal
should include any criteria regarding mortgage guarantee
insurance or other types of insurance or credit enhancements.
The proposal should, however, solicit public comment on the
appropriateness of recognizing such insurance or credit
enhancements, and the appropriate definition, characteristics,
and requirements for QRM loans for purposes of the final rule.
Again, the proposed rule will be open to public comment and
the FDIC and the other agencies will take such comments into
account in their deliberations.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR MERKLEY
FROM SHEILA C. BAIR
Q.1. Community Banks and Economic Growth--I have heard from
some of my local community banks that certain capital,
accounting, and examination rules may be working at cross
purposes with the ability of community banks to serve the
economic growth needs of the families and small businesses they
serve in their communities, especially when compared to
standards applied to the largest national banks. I wish to
bring several to your attention and ask that you comment:
The Financial Accounting Standards Board's proposed
exposure draft on ``Troubled Debt Restructurings'' (TDRs) has
been pointed out as possibly creating a capital disincentive
for banks to engage in work-outs and modifications with their
business borrowers because of the effect of immediately having
to declare those loans ``impaired.'' In addition, for banks
over $10 billion in asset size, there may be additional direct
costs for FDIC premiums based on a formula that considers TDR
activity.
The disallowance to Risk-Based Capital of the amount of
Allowance for Loan Losses (ALLL) in excess of 1.25 percent of
Risk Weighted Assets has been flagged as a challenge in this
environment, where some firms have ALLL that significantly
exceeds that threshold. This may serve to understate the risk-
based capital strength of the bank, adding to costs and
negatively impacting customer and investor perceptions of the
bank's strength.
It has been reported that examiners have rejected
appraisals that are less than 9 months old when regulatory
guidance calls for accepting appraisals of up to 12 months.
Community banks are subject to examination in some cases as
frequently as every 3 months. In contrast, some suggest that
our largest national banks may not ever undergo an examination
as thorough, with the challenges surrounding loan
documentation, foreclosure, and MERS as a glaring example of
the results.
Are there regulatory or supervisory adjustments in these or
related areas that need to be made to facilitate community
banks' abilities to serve their communities?
In addition, have you considered ways in which capital
charges, accounting rules, and examination rules for community
banks in particular can be adapted to be less procyclical, such
that they do not become stricter into an economic downturn and
lighter at the top of an upturn?
Finally, what procedures do you have in place to ensure
that our community banks and our largest national banks are not
subject to differing examination standards, even when they are
examined by different regulators?
A.1. The FDIC reviews its supervisory programs regularly to
ensure they are effective, consistent, and applied equitably.
We agree that the past several years have been very difficult
for financial institutions as they have experienced the effects
of weakness in economic and real estate markets. As you point
out, loan accounting and related financial reporting standards
can significantly impact financial institutions during economic
downturns as the volume of problem credits increases. As banks
work with borrowers to prudently restructure loans--an activity
that has been encouraged by the banking regulators to help
troubled borrowers--U.S. generally accepted accounting
principles (GAAP) require certain modified loans to be
designated as Troubled Debt Restructurings (TDRs). This is not
a regulatory directive but rather a longstanding accounting
requirement. The FDIC believes that accurate and timely
financial and regulatory reporting in conformity with GAAP,
which is required by statute, fosters transparency and provides
decision-useful information for financial institution
stakeholders.
The Financial Accounting Standards Board (FASB) October
2010 proposal on TDRs is intended to clarify the existing
accounting standards on TDRs by providing additional guidance
on aspects of these standards for which diversity in practice
has developed. We presume the proposal is not designed to
change existing criteria for determining when a loan
modification constitutes a TDR, i.e., when a borrower is
experiencing financial difficulties and a concession has been
granted by the lender. For the most part, the proposed
clarifications would provide useful guidance to institutions.
However, we urged the FASB to revise one portion of the
proposal to ensure a restructuring is not automatically a TDR
simply because a borrower does not have access to funds at a
market rate for debt with similar risk characteristics as the
restructured note. In an environment where some otherwise
creditworthy borrowers have found it difficult to obtain or
renew credit, we are concerned this proposed clarification may
be interpreted in a manner that would result in many
modifications, extensions, and renewals of loans being
mischaracterized as TDRs. In its redeliberations on this
proposal to address issues raised by commenters, the FASB has
decided to modify the provision that concerned us.
The FDIC Board approved a final rule revising the risk-
based assessment system for large insured depository
institutions on February 7, 2011. Large institutions generally
are those with at least $10 billion in total assets. Under the
final rule, assessment rates for these institutions will be
calculated using scorecards that combine CAMELS ratings and
certain forward-looking financial measures to assess the risk a
large institution poses to the Deposit Insurance Fund. The
multiple quantitative measures in these scorecards are intended
to differentiate risk based on how large institutions would
fare during periods of economic stress. One of these measures
considers the volume of underperforming loans--a component of
which is loans that are TORs--as a percentage of capital and
reserves. In developing the revised large institution
assessment system, computations of the scorecards' new measures
using financial data from 2005 through 2008 were found to be
predictive of the performance of large institutions in 2009.
Therefore, we believe it is appropriate to consider TORs as one
of many data inputs to this assessment system.
The Allowance for Loan and Lease Losses (ALLL) covers
estimated credit losses on individually evaluated loans
determined to be impaired, as well as estimated credit losses
inherent in the remainder of the loan and lease portfolio. As
such, the ALLL is set aside to absorb specific losses that have
yet to be recognized for accounting purposes. Therefore, the
ALLL's loss absorbing capacity is limited to certain credit
losses and is unavailable to absorb losses in the same manner
as other capital instruments. To recognize this limited loss-
absorbing capability, the current risk-based capital rules
provide that ALLL is only included in tier 2 capital up to 1.25
percent of risk-weighted assets. This view of the limited loss-
absorbing capacity of ALLL was reinforced by the recent Basel
II agreement released by the Basel Committee for Banking
Supervision which retained the existing treatment.
Real estate appraisals are also a significant issue during
real estate downturns, and this economic cycle has been no
exception. Many institutions have been prudently updating
appraisals to better understand collateral position and, as you
point out, examiners review appraisal reports as part of their
loan review process. There have been some misconceptions about
regulatory expectations for appraisals, and we believe recent
guidance has helped clarify requirements. On December 2, 2010,
the Federal banking agencies issued the Interagency Appraisal
and Evaluation Guidelines. These guidelines provide banks with
the regulators' perspective on how valuations should be used in
the loan modification process, clarifies criteria for
inspecting mortgaged properties' physical condition, eliminates
confusing terminology, provides explanations on the use of
automated valuation models, and strengthens the independence of
the collateral valuation function. Overall, we believe this
guidance will enhance banks' understanding of regulatory
expectations and flexibilities related to collateral valuation.
We agree that there are differences in the examination
approach for large and community financial institutions. Large
banks are typically supervised by examiners stationed at the
institution on a resident basis and perform continuous
supervisory activities during the year. In such cases, one
annual Report of Examination is generated under statutory
examination timeframes as well as ``targeted'' examinations at
various intervals. Targeted reviews delve into a financial
institution's specific business lines and are used to examine
the safety and soundness of certain activities through
transaction testing and reviews of policies and procedures. For
example, targeted reviews recently have been completed at
several large institutions to investigate internal foreclosure
processes. On the other hand, community bank supervision relies
on point-in-time annual on-site examinations and off-site
surveillance during interim periods. We also conduct
visitations at certain community institutions to determine
their success in achieving the goals of corrective programs or
look into any areas of emerging risk. The on-site component of
these visitations typically lasts a week or less. Although
there is a different approach for supervising large and small
institutions, both rely on a risk-focused methodology
customized to each institution's size, business lines, and
inherent risk.
The Federal banking agencies recognize the importance of
consistent examinations for all institution sizes, and we take
steps to ensure the supervisory process is applied fairly for
large banks and community institutions. The Federal Financial
Institutions Examination Council (FFIEC) was created, in part,
to ensure that financial institutions are subject to
appropriate examination standards. Accordingly, the FFIEC
sponsors a variety of collaborative workstreams among the
Federal banking agencies relating to examination procedures,
data collection efforts, and training processes that help
ensure financial institutions are supervised consistently.
Q.2. International Coordination Regarding Resolution--Our
largest financial firms today operate across many national
boundaries. Some firms are aiming to conduct 50 percent or more
of their business internationally. Can you update the Committee
on the status and any challenges regarding the establishment of
mechanisms, plans, and other aspects of coordination between
international regulatory bodies to ensure that financial firms
operating internationally can be effectively placed into the
Dodd-Frank resolution regime and are not otherwise able to
attain ``too big to fail'' status through international
regulatory arbitrage?
A.2. Given the complexity and complications of resolving
internationally active institutions, the FDIC continues to
engage counterparts in other countries to develop greater
understanding and coordination to improve the ability of
achieving an orderly liquidation in the event of the failure of
such an institution. While some of this work involves working
toward Memorandums of Understanding (MOUs) with other
countries, much of the focus of bilateral and multilateral
efforts (through the Basel Committee on Bank Supervision and
the Financial Stability Board (FSB)) are on reforming foreign
laws to allow better coordination with U.S. law, and
identifying and addressing potential conflicts.
With respect to MOUs, for example, the FDIC entered into an
MOU with the Bank of England in January 2010 to expand
cooperation when we act as resolution authorities in resolving
troubled deposit-taking financial institutions with activities
in the U.S. and the United Kingdom. In addition, the FDIC and
the China Banking Regulatory Commission signed an agreement in
May 2010 to expand cooperation on contingency planning,
coordination and information sharing related to crisis
management and the potential resolution of banks active in the
two countries.
Further, in coordination with the FSB Cross-Border Crisis
Management Group, and as Chair of the Basel Committee on
Banking Supervision (BCBS) Cross-Border Resolutions Group, the
FDIC has led a number of meetings during 2010 with
international resolution authorities and supervisors to address
the challenges in the area of international coordination and
identify obstacles to overcoming them.
In order to address the challenges presented by cross-
border resolutions, the FSB has made various recommendations to
be adopted by participating jurisdictions. In its October 2010
paper titled, ``Reducing the Moral Hazard Posed by Systemically
Important Financial Institutions (SIFIs),'' the FSB outlines
recommendations to assist in resolving a systemically important
international financial institution. The paper recommends that
comprehensive resolution regimes and tools must be established
in order for SIFIs to be resolved properly. The various
recommendations are:
All jurisdictions should undertake the necessary
legal reforms to ensure that they have in place a
resolution regime which would make feasible the
resolution of any financial institution without
taxpayer exposure to loss from solvency support while
protecting vital economic functions through mechanisms
which make it possible for shareholders and unsecured
and uninsured creditors to absorb losses in their order
of seniority.
Each country should have a designated resolution
authority responsible for exercising resolution powers
over financial institutions. The resolution authority
should have the powers and tools proposed in the FSB
note on Key Attributes of Effective Resolution Regimes
and in the BCBS Cross-border Bank Resolution Group
Recommendations and the flexibility to tailor
resolution measures to the specific nature of financial
institutions' domestic and international business
activities.
National authorities should consider restructuring
mechanisms to allow recapitalization of a financial
institution as a going concern by way of contractual
and/or statutory (i.e., within-resolution) debt-equity
conversion and write-down tools, as appropriate to
their legal frameworks and market capacity. However, to
be effective, such mechanisms require that a robust
resolution regime already be in place.
In support of these efforts, the FDIC is participating in
multiple international working groups that are analyzing
resolution challenges associated with derivatives booking
practices, business line management and legal entity
operations, global payment systems, intragroup guarantees and
interconnectedness, resolvability, contingent capital, and
similar issues.
Another important aspect of the FDIC's efforts to promote
cooperative efforts with international regulators is through
the FDIC's work with the Federal Reserve to formalize the
structure and content of resolution plans (living wills). For
an internationally active institution, one function of a
resolution plan will be to identify business lines that operate
in international jurisdictions and delineate how such
operations could be addressed in the event of a failure,
recognizing that such operations may be subject to the laws of
other countries.
Q.3. Please also update the Committee on the status of the
regulation of international payments systems and other internal
systemic financial market utilities so that the entities that
manage or participate in them are not able to avoid the
resolution regime through international regulatory arbitrage.
A.3. The Financial Stability Oversight Council (FSOC) has
issued an advance notice of proposed rulemaking addressing the
designation of financial market utilities (FMUs) as
systemically significant and subject to heightened supervision
under Title VIII of the Dodd-Frank Act. A notice of proposed
rulemaking is expected to be issued by the FSOC sometime later
this month. While these entities are not subject to heightened
prudential standards under Title I of the Act, they will be
subject to further rulemaking and prudential standards under
Title VII. Furthermore, to the extent that such activities are
carried out through a bank holding company or nonbank financial
company designated under Title I for heightened supervision,
the entity and the activities it engages in will be subject to
supervision by the Federal Reserve.
An FMU typically would be resolved under applicable State
or Federal insolvency law, including liquidation or
reorganization under the Bankruptcy Code. One of these entities
could potentially be subject to resolution under title II of
the Dodd-Frank Act if it is a financial company predominantly
engaged in financial activities and a systemic risk
determination were to be made under section 203 of the Dodd-
Frank Act. However, such a determination would be made at the
time an FMU were to become troubled. While U.S. entities may be
subject to resolution under Title II of the Dodd-Frank Act,
Title II orderly liquidation authority does not extend to
foreign-based corporate entities. International bodies, such as
the FSB, International Organization of Securities Commissions
(IOSCO) and the Basel Committee on Banking Supervision provide
a forum to monitor the nature and extent of any differences in
the implementation of supervisory standards on an international
basis. These international bodies are working to address issues
associated with international payment systems and the potential
destabilizing effects that could occur if a major payment
system were to fail or suffer severe disruptions due to the
failure of a large member. In particular, the FSB Cross-Border
Crisis Management Group has established a work stream relating
to global payments operations and is developing recommendations
related to global payments operations in the context of a
cross-border resolution. This work also is being conducted on a
firm-specific basis through the FSB Crisis Management Group.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO
FROM SHEILA C. BAIR
Q.1. Dodd-Frank requires that risk retention be jointly
considered by the regulators for each different type of asset
and includes a specific statutory mandate related to any
potential reforms of the commercial mortgage-backed securities
to limit disruptions. Given the importance of rigorous cost-
benefit and economic impact analyses and the need for due
consideration of public comments, do your agencies need more
time than is provided by the looming April deadline?
A.1. Section 941 of the Dodd-Frank Act, titled, Regulation of
Credit Risk Retention, requires the FDIC (together with the
Federal Reserve Board, Office of the Comptroller of the
Currency, Securities and Exchange Commission, Department of
Housing and Urban Development, and the Federal Housing Finance
Agency) to require securitizers to retain no less than 5
percent of the credit of any assets transferred to investors
through the issuance of an asset-backed security (ABS). Section
941 exempts certain ABS issuances from the general risk
retention requirement, including ABS issuances collateralized
exclusively by assets insured or guaranteed by the U.S.
Government or an agency thereof, or ``qualified residential
mortgages'' (QRMs), as jointly defined by the agencies.
An interagency working group has convened well over 50
times since the enactment of the Dodd-Frank Act for purposes of
developing a proposal to implement section 941. All
implementation issues have been analyzed and vetted thoroughly
and we expect to reach an appropriate consensus informed by the
unique supervisory expertise of the respective agencies.
The interagency working group is near completion of a
notice of proposed rulemaking. It is my expectation that the
proposed rule would solicit public comment on various options
for satisfying the credit risk retention requirements of
section 941, including an option that recognizes widely used
industry practices in structuring commercial mortgage-backed
securities, as well as the appropriateness of certain
exemptions. The proposed rule also will set forth and solicit
public comment on the economic and cost-benefit analyses
required under the Administrative Procedure Act, the Regulatory
Flexibility Act, and Unfunded Mandates Reform Act of 1995.
I believe that the many options included in the proposed
rules with respect to the risk retention requirements should
ensure that securitizers retain a meaningful amount of credit
risk in a way that minimizes the potential adverse impact of
the proposed rule on the availability and costs of credit to
consumers and businesses. At the same time, the proposed rules
should be consistent with the stated objectives of section 941
and foster sound underwriting and prudent risk management
practices with respect to loans that are originated for
securitization. The FDIC Board is expected to approve and adopt
the proposed rule in advance of the statutory deadline.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER
FROM SHEILA C. BAIR
Q.1. A Bloomberg news story, citing a Financial Stabilty
Oversight Council (FSOC) staff report marked ``confidential,''
indicates that there is a parallel regulatory track with
respect to the designation of systemically significant nonbank
financial companies. The Bloomberg story mentions FSOC staff
are moving forward with ``confidential'' criteria that will be
used to designate systemically important nonbank financial
institutions. However, unlike the proposed rule, which merely
restates the statutory language, these confidential criteria
are not subject to public comment and has yet to be reviewed by
anyone outside of the council aside from this news report. This
raises serious questions about the transparency of FSOC's
rulemaking process.
From what has been reported, portions of the leaked report
conclude that an insurer failure could create adverse
macroeconomic impact. This conclusion appears to have been
reached without the required insurance expertise, which has yet
to be appointed. A similar conclusion was made with respect to
hedge funds.
Unfortunately, there has been no public disclosure of the
criteria or metrics that were used to arrive at this
conclusion. As such, could you explain what metrics were
applied and by whom in reaching this conclusion? What basis did
the FSOC staff use to select these criteria?
A.1. The FSOC continues to develop the criteria and metrics
that will be used in identifying firms as systemic, drawing
upon relevant information from both public and supervisory
sources. We also believe that we will likely need to gather
information from firms given their complexity and the lack of
readily available information that is necessary to measure
their potential systemic impact. The FDIC believes that it is
important to identify firms that could possibly need to be
resolved under Title II authority since all firms designated as
systemically significant are required to provide the FDIC and
FRB with resolution plans. Resolution plans will significantly
aid in our preparation efforts, resulting in a more orderly
resolution. The FSOC has issued a notice of proposed rulemaking
regarding the designation of nonbank financial firms under
Title I of the Dodd-Frank Act. The notice of proposed
rulemaking seeks public comment on the best methods to approach
the designation of firms, and the application of systemic
determination criteria on an institution-specific basis. The
FDIC believes that the FSOC rulemaking on this issue should
include significant detail on the process to be used by the
FSOC in making designations, but also the criteria that the
FSOC will employ when making designations.
The FDIC has been a strong advocate for transparency and
public engagement in the regulatory processes surrounding the
implementation of Act, adopting an ``open door'' policy under
which the public has and will continue to have a larger role in
the process than ever before. Under the policy, public
disclosure of meetings between senior FDIC officials and
private sector individuals is required to enhance openness and
accountability. In addition, the FDIC has conducted various
public forums and roundtables, seeking public engagement and
feedback regarding related issues in the Dodd-Frank Act.
Q.2. Chairwoman Bair's written testimony to this Committee
states:
The nonbank financial sector encompasses a multitude of
financial activities and business models, and potential
systemic risks vary significantly across the sector. A
staff committee working under the FSOC has segmented
the nonbank sector into four broad categories: (1) the
hedge fund, private equity firm, and asset management
industries; (2) the insurance industry; (3) specialty
lenders; and (4) broker-dealers and futures commission
merchants. The council has begun developing measures of
potential risks posed by these firms.
The FSOC is committed to adopting a final rule on this
issue later this year, with the first designations to
occur shortly thereafter.
Since the rulemaking process is already underway, do you
know if the Administration is planning to make this report
public?
A.2. We are not aware of any plans to make this report public;
however, we believe it is important that any final rule should
include significant detail on the process to be used by the
FSOC in making designations and the criteria that the FSOC will
employ when making designations.
Q.3. Will there be an opportunity for public comment on it
before any final rules are promulgated?
A.3. The FSOC issued a notice of proposed rulemaking regarding
the designation of nonbank financial firms under Title I of the
Dodd-Frank Act on January 26, 2011, and the comment period
closed on February 25, 2011. The FSOC received 39 comments. The
notice of proposed rulemaking sought public comment on the
application of systemic determination criteria on an
institution-specific basis. This is important from the FDIC's
perspective, since all firms designated as systemic will be
required to provide us and the FRB with resolution plans, that
detail their assets, liabilities, counterparty exposures, and
other key structural aspects of their organization on a legal
entity and consolidated basis. The proposal suggests using a
framework to analyze the firms and applying metrics that would
be tailored to that firm's business model and industry sector.
As provided in the proposed rule: ``The Council would evaluate
nonbank financial companies in each of the (six categories of
the framework as proposed under the rule) using quantitative
metrics where possible. The Council expects to use its
judgment, informed by data on the six categories, to determine
whether a firm should be designated as systemically important
and supervised by the Board of Governors. This approach
incorporates both quantitative measures and qualitative
judgments.''
As stated, the FDIC believes that the rule should include
significant detail on the process to be used by the FSOC in
making designations and the criteria that the FSOC will employ
when making designations.
Q.4. What is your logic behind identifying these four
categories?
A.4. These four broad categories of nonbank financial firms are
considered reflective of the nonbank financial services
industry generally. These broad groupings need to be
established for purposes of creating appropriate analytic
tools, and allows for thoughtful analysis and judgment by the
FSOC. The broad delineations characterize groups as firms that
invest assets for themselves or others and seek an equity-like
return (asset managers), firms that primarily underwrite risks
other than credit risk, such as life or casualty risks
(insurers), firms that create or trade financial instruments as
market-makers or for the account of others (broker/dealers),
and other nonbank firms that extend credit (specialty lenders).
There will be firms that do not clearly fit within a particular
category, and for this reason these categories are not being
suggested as fixed elements of the FSOC proposed analytic
framework. The proposed framework addresses factors that
analyze the firm's possible impact to U.S. financial stability
in the event of financial distress, analyzes characteristics of
the firm in six broad categories (size, substitutability,
interconnectedness, leverage, liquidity risk, existing
regulatory scrutiny) in order to assess the impact of spillover
effects in the event of insolvency and the firm's vulnerability
to financial distress. These standards are being proposed for
public comment and are designed to be consistent with
congressional mandate as set forth in the Dodd-Frank Act.
Q.5. Will you publish and seek comment on the industry-specific
metrics that will (be) applied, before such assessments begin,
so that Congress can have confidence that FSOC is exercising
its authority appropriately and impacted financial companies
can be assured that they are not being treated arbitrarily?
A.5. The FSOC is responsible for making such a determination in
conformance with the law and its transparency policy. As a
voting member of the FSOC, the FDIC believes that these
transparency and public openness standards should be vigorously
applied. The FDIC believes that any rule should include
significant detail on the process to be used by the FSOC in
making designations and the criteria that the FSOC will employ
when making designations.
Q.6. In 2004, the FDIC issued a report assessing the banking
industry's exposure to an implicit Government guarantee of the
GSEs. The report indicated that, ``As of September 30, 2003,
the initial effect of eliminating the implicit guarantee would
reduce the value of banking industry GSE-related securities by
$12 billion, or 1.1 percent. This initial loss of market value
of securities would not severely harm overall liquidity of the
banking industry. Individual institutions could be affected
more depending on the amount, maturity structure, and mix of
their GSE-related holdings.'' As you know Basel III and Dodd-
Frank both continue the favored treatment of GSE debt. What are
you and other regulators doing to reduce the exposure of the
banking industry to Fannie Mae and Freddie Mac?
A.6. Basel III liquidity standards would require banks to hold
unencumbered liquid assets sufficient to meet 30 days of a
predefined stressed outflow. The published standard limits the
amount of GSE exposures in this pool of liquid assets to not
more than 40 percent of the total pool. The standards further
limit the reliance on GSEs by requiring a 15 percent
``haircut'' on their balances prior to the calculation of the
pool.
Additionally, from a supervisory perspective, the FDIC and
the other banking agencies review banks' fixed income
portfolios and attendant policies at each supervisory
examination, and analyze the institution's investment decision-
making process. The FDIC will continue to monitor GSE debt
investments at State nonmember institutions and will ensure
that banks have effective investment portfolio management
processes to mitigate risk.
Q.7. Do you believe that our banking industry would be more
stable if the favored treatment of GSE debt was removed?
A.7. When the recent financial crisis was in full swing, the
activities of the GSEs supported financial stability. Without
the ability of GSEs to support prudently underwritten mortgage
credit during the last few years, the cyclical downturn in
housing markets we have experienced would doubtless have been
far worse. The more difficult question is, what is the effect
of GSE activities during the upward phase of the business
cycle: whether explicit and implicit Federal support for the
housing sector encouraged the formation of the housing price
bubble in the years leading to the crisis. It is difficult to
disentangle all the factors that contributed to that bubble. To
the extent GSEs can maintain and promote prudent credit
underwriting standards for the loans they guarantee, they may
be a force to constrain speculative excess during ``boom''
periods.
We also would note that policy changes in the treatment of
GSE obligations could have implications for the ability of
banks to meet capital and liquidity requirements. Removing the
preferential treatment GSEs receive would make compliance with
the new Basel III requirements more costly for U.S. banks.
Moreover, such a change also could adversely affect the
liquidity of GSE obligations. For example, at present GSE's
obligations frequently serve as collateral in a debt repurchase
agreement market that enhances the liquidity of banks that hold
these obligations even as they hold assets with higher returns
that could be earned by holding liquid U.S. Treasury
securities.
Q.8. Has the FDIC done any follow up of this 2004 study so that
it has a clear understanding of the exposure of our banking
system to GSE debt given the fact that the GSE's are in
conservatorship? If so, can you provide those details to this
Committee? If not, why not?
A.8. No, the FDIC has not published a follow-up to our 2004
study. We do, however, continue to monitor closely GSE debt
investments at all institutions through our internal
supervisory processes. These efforts enable us to understand,
analyze, and monitor the exposure of the banking system to GSE
debt.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR WICKER
FROM SHEILA C. BAIR
Q.1. Chairman Bair, I am concerned that in our haste to
identify institutions that pose a systemic risk, we may rely
too heavily on the top line amount of assets a company may hold
or manage and overlook the fact that many of these assets may
be in individual smaller funds.
Can you please tell me how you will determine a way to look
at individual investment funds and not the aggregate amount of
assets under a manager in determining if a fund is systemically
important?
A.1. In order to make a determination regarding systemic
importance, it will be crucial for the FSOC to have a robust
set of metrics that can be used to appropriately measure the
factors that contribute to systemic risk. While total assets
under management is one important measure, it is only one of
many different quantitative and qualitative metrics that must
be viewed together in order to develop a complete picture of
systemic importance. Since any measure is only as good as the
data that is used to calculate it, it is vitally important that
the FSOC have a robust set of detailed data at its disposal.
The FSOC has taken the SIFI designation process seriously and
has sought public input into the development of robust metrics.
On October 2, 2010, the FSOC issued an Advance Notice of
Proposed Rulemaking (ANPR), followed up a Notice of Proposed
Rulemaking on January 26, 2011. The ANPR sought public comment
on a host of issues, particularly the metrics that should be
used to make SIFI determinations. In light of public comments
received, the FSOC is considering issuing a revised notice of
proposed rulemaking in the coming months to provide the public
with an opportunity to comment on a more refined set of
metrics.
Q.2. I am wondering if we should be worried more about funds
collapsing rather than managers collapsing. If the funds are
independent of each other's liabilities, what is our
responsibility or concern about an individual manager?
A.2. We should be concerned about systemic risk associated with
both the fund and the fund manager. From the fund perspective,
it is possible that the interconnectedness of the fund with the
broader financial market could cause systemic instability in
the event that the fund suffered financial distress. It is also
possible that a particular fund or group of funds are highly
interconnected with their fund managers, such that financial
distress at the fund manager could lead to systemic instability
either through the interactions of the fund manager with the
financial markets or out of market concern that the fund
manager may be unable to provide liquidity or capital support
to a particular fund in a time of distress. As one example,
during the recent financial crisis, money market mutual funds
with financially weaker managers were more susceptible to
investment withdrawals and much more likely to ``break the
buck'' than similar funds that were managed by more financially
secure managers.
------
RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN JOHNSON
FROM MARY L. SCHAPIRO
Q.1. Recently, some have voiced concerns that the timeframe for
the rulemakings required by the Dodd-Frank Wall Street Reform
and Consumer Protection Act (Dodd-Frank) is too short to allow
for adequate consideration of the various comments submitted or
to review how the new rules may impact our financial markets.
Does the current timeframe established by Dodd-Frank allow each
rulemaking to be completed in a thoughtful and deliberative
manner?
A.1. Implementation of the Dodd-Frank Act is a substantial
undertaking. The Act's requirement that a significant number of
Commission rulemakings be completed within 1 year of the date
of enactment poses significant challenges to the Commission.
Throughout, the staff and Commission have been diligent in
working to meet the deadlines imposed by the Dodd-Frank Act
while also taking the time necessary to thoughtfully consider
the issues raised by the various rulemakings.
We recognize that many of our new rules may have
substantial market implications. As a result, we must be sure
we have assessed those implications and provide market
participants sufficient time to understand the obligations that
may apply to them. We are considering how to sequence the
implementation of rules so that market participants have
sufficient time to develop the infrastructure needed to comply,
and we also anticipate that many final rules will include
implementation periods that will provide additional time for
market participants to take necessary steps to achieve
compliance. We also are taking steps to gather additional input
on our implementation process where appropriate, such as the
joint roundtable held on May 2-3 with the CFTC regarding the
adoption of derivatives rules under Title VII.
Given the significant issues involved in many of the Dodd-
Frank rules, it will not always be possible to meet the
statutory deadlines imposed under the Act. Indeed, we have
missed certain of the deadlines set forth in that Act and
expect we similarly will miss others in the future. While we
obviously are desirous of meeting the Act's deadlines, it is
critical that we get the rules right.
Q.2. In carrying out the required rulemaking under Title VII,
the SEC and the CFTC are instructed under Dodd-Frank to ``treat
functionally or economically similar products or entities . . .
in a similar manner.'' However, some of the rules defining the
key infrastructure for the new derivatives regime that have
been proposed by the SEC and CFTC contain some significant and
important differences, as is demonstrated by the different
definitions for rules governing Swap Execution Facilities. How
do your two agencies plan to reconcile these differences before
the final rules are adopted later this year?
A.2. Since the Dodd-Frank Act was passed last July, the
Commission staff has been engaged in ongoing discussions with
CFTC staff regarding our respective approaches to implementing
the statutory provisions for SEFs and security-based SEFs. In
many cases, these discussions have led to a common approach--
for example, both proposals have similar registration programs,
as well as similar filing processes for rule changes and new
products. As you note, however, there are differences in
certain areas, such as the treatment of requests for quotes,
block trades, and voice brokerage.
Our proposal reflects the Commission's preliminary views as
to how the Dodd-Frank Act would best be applied to the trading
of security-based swaps, which differ in certain ways from the
swaps that will be regulated by the CFTC. We look forward to
input from the public as to whether these differences are
adequately supported by functional distinctions in the trading
and liquidity characteristics of swaps and security-based
swaps, as well as comments as to how the agencies' rules may be
further harmonized. Based on this feedback, we plan to work
with the CFTC to achieve greater harmonization of the rules for
SEFs and security-based SEFs to the extent practicable.
Throughout this process, we are particularly mindful of the
potential burdens on entities that will be dually registered
with the Commission and the CFTC. To this end, we have
specifically requested comment in our proposal on the impact of
the overall regulatory regime for such registrants, such as
areas where differences in the Commission and the CFTC
approaches may be particularly burdensome. We are also
sensitive to the opportunity for regulatory arbitrage with
respect to non-U.S. markets, and my staff has been working
closely with their international colleagues to find common
ground with respect to the regulation of SEFs. We expect to
benefit from significant public input on both of these issues,
and we will carefully consider such input in crafting our final
rule.
Q.3. Please identify the key trends in the derivatives market
that your agencies are currently monitoring to ensure systemic
stability.
A.3. Although the Commission will not have direct electronic
access to detailed swap and security-based swap data until the
Dodd-Frank Act's requirements are fully implemented, the
Commission currently receives periodic updates of available
trade information that covers substantially all single-name and
index credit default swap transactions. Commission staff
currently is using this data to develop better information
regarding net exposures of U.S-based market participants (or
market participants trading in a U.S.-based reference entity).
Commission staff intends to assess and monitor how these net
exposures vary by market participant, time, and instruments to
better understand when or if concentrations of risk develop.
Commission staff also is supporting an ongoing effort to
classify the more than 1,400 market participants and 8,000
trading accounts managed by these participants to develop a
better understanding of how swap and security-based swap
transactions are being used. Because there is no standard
formatting for the reporting of such transactions or the
details of the relevant counterparties, considerable effort is
required to assemble and verify the underlying data. Based on
this experience, Commission staff has been meeting regularly
with representatives of potential data repositories to discuss
specifications for the Commission's direct electronic access to
data in order to make such data as useful as possible to the
Commission.
Though these efforts have been somewhat limited in scope
(e.g., equity swaps and debts swaps have not yet been covered),
we expect that the data-related requirements of the Dodd-Frank
Act will assist the Commission in developing better resources
for identifying key trends in the security-based swap market.
Q.4. In defining the exemption for ``qualified residential
mortgages,'' are the regulators considering various measures of
a lower risk of default, so that there will not just be one
``bright line'' factor to qualify a loan as a Q.R.M.?
A.4. The definition of ``qualified residential mortgage'' in
the proposed rule issued jointly by the Commission and other
regulators at the end of March 2011 takes into account
underwriting and product features that historical loan
performance data indicate result in a lower risk of default as
required by the statute. Specifically, the underwriting and
product features established by the Commission and other
regulators for qualified residential mortgages include
standards related to the borrower's ability and willingness to
repay the mortgage (as measured by the borrower's debt-to-
income ratio); the borrower's credit history; the borrower's
down payment amount; the loan-to-value ratio for the loan; the
form of valuation used in underwriting the loan; the type of
mortgage involved; and the owner-occupancy status of the
property securing the mortgage. As stated in the Agencies'
Notice of Proposed Rulemaking, a substantial body of evidence,
both in academic literature and developed for rulemaking,
supports the view that loans that meet the minimum standards
established by the agencies have low credit risk even in
stressful economic environments that combine high unemployment
with sharp drops in house prices.
Q.5. What data are you using to help determine the definition
of a Qualified Residential Mortgage?
A.5. In considering how to determine the definition of
``qualified residential mortgage,'' the relevant agencies
examined data from several sources. For example, the agencies
reviewed data on mortgage performance supplied by the Applied
Analytics division (formerly McDash Analytics) of Lender
Processing Services (LPS). To minimize performance differences
arising from unobservable changes across products, and to focus
on loan performance through stressful environments, the
agencies for the most part considered data from prime fixed-
rate loans originated from 2005 to 2008. This data set included
underwriting and performance information on approximately 8.9
million mortgages. As is typical among data provided by
mortgage servicers, the LPS data do not include detailed
information on borrower income and on other debts the borrower
may have had in addition to the mortgage. For this reason, the
agencies also examined data from the 1992 to 2007 waves of the
triennial Survey of Consumer Finances (SCF). \1\ Because
families' financial conditions will change following the
origination of a mortgage, the analysis of SCF data focused on
respondents who had purchased their homes either in the survey
year or the previous year. This data set included information
on approximately 1,500 families. The agencies also examined a
combined data set of loans purchased or securitized by Federal
National Mortgage Association and Federal Home Loan Mortgage
Corporation (the ``Enterprises'') from 1997 to 2009. The
Enterprises' data set consisted of more than 75 million
mortgages, and include data on loan products and terms,
borrower characteristics (e.g., income and credit score), and
performance data through the third quarter of 2010.
---------------------------------------------------------------------------
\1\ The SCF is conducted every three years by the Board of
Governors of the Federal Reserve System, in cooperation with the
Department of the Treasury, to provide detailed information on the
finances of U.S. families. The SCF collects information on the balance
sheet, pension, income, and other demographic characteristics of U.S.
families. To ensure the representativeness of the study, respondents
are selected randomly using a scientific sampling methodology that
allows a relatively small number of families to represent all types of
families in the Nation. Additional information on the SCF is available
at http://www.federalreserve.gov/pubs/oss/oss2/method.html.
Q.6. The Congress considered that a significant contributor to
the crisis were compensation systems that encouraged management
to take excessive risks. What is the experience so far with the
---------------------------------------------------------------------------
new ``say on pay'' rules for public companies?
A.6. Public companies subject to the federal proxy rules are
required to conduct ``say-on-pay'' votes at annual meetings
beginning on January 21, 2011. The Commission's rules on the
say-on-pay vote became effective on April 4, 2011. Although
many companies have begun to conduct these votes, it is too
early to gauge how these votes will be received and how
shareholders will react to the opportunity to cast an advisory
vote on executive compensation.
Q.7. Dodd-Frank required the SEC to conduct a 6-month study on
investor protection and the duty of care observed by broker-
dealers and by investment advisers who provide personalized
investment advice to retail investors and gave it new
rulemaking authority. In January, the majority of the
Commission voted to issue a staff report on this subject. The
Report recommended rulemaking to create a new uniform fiduciary
duty standard and harmonize the regulation of broker-dealers
and investment advisors. Two Commissioners said that additional
study is needed, and called for more analysis of the existing
problems and justification that the study's recommendations
would improve investor protection.
Does the Commission or staff plan to further study all
Commissioners' questions? How do you plan to proceed in this
area to assure that such significant questions are addressed
prior to making new rules?
A.7. In the study required under Section 913 of the Dodd-Frank
Act, Commission staff recommended implementing a uniform
fiduciary standard that would accommodate different existing
business models and fee structures, preserve investor choice,
and not decrease investors' access to existing products,
services, or service providers. In preparing the study, the
staff considered the comment letters received in response to
the Commission's solicitation of comment and considered the
potential costs and other burdens associated with implementing
the recommended fiduciary standard. We will continue to be
mindful of the potential economic impact going forward. In
light of this ongoing focus, I have asked a core team of
economists from the Commission's Division of Risk, Strategy and
Financial Innovation (Risk Fin) to study among other things,
data pertaining to the standards of conduct in place under the
existing broker-dealer and investment adviser regulatory
regimes to further inform the Commission.
Ultimately, if the Commission does engage in rulemaking
under Section 913, as with any proposed rulemaking, the
Commission would conduct an economic analysis regarding the
impact of any proposed rules. Such analysis would include the
views of Risk Fin, which has broad experience analyzing
economic and empirical data. The Commission would then consider
public comment on any such proposal, including public comment
on the Commission's analysis of costs and benefits. Any final
rulemaking would also take into account not only the views of
all interested parties, but also the potential impact of such
rules on the financial marketplace, including the impact on
retail investors and the advice they receive from financial
professionals.
Q.8. Please discuss the current status and timeframe of
implementing the Financial Stability Oversight Council's (FSOC)
rulemaking on designating nonbank financial companies as being
systemically important. As a voting member of FSOC, to what
extent is the Council providing clarity and details to the
financial marketplace regarding the criteria and metrics that
will be used by FSOC to ensure such designations are
administered fairly? Is the intent behind designation decisions
to deter and curtail systemically risky activity in the
financial marketplace? Are diverse business models, such as the
business of insurance, being fully and fairly considered as
compared with other financial business models in this
rulemaking?
A.8. The process of designating institutions as systemically
important financial institutions, or SIFIs, is designed to
identify large, nonbank financials that might pose a risk to
the financial system and provide heightened prudential
regulation of such firms by the Federal Reserve, and to reduce
the moral hazard risks of ``too big to fail.''
The Council published a Notice of Proposed Rulemaking (NPR)
early this year concerning the SIFI designation process, but
has not yet made determinations regarding the application
specific criteria for greater review or designation. In
general, I think differences in industries and business models
need to be closely considered and that an identical set of
quantitative criteria may not be equally helpful to different
types of institutions. For example, the factors that would be
relevant in looking at insurance companies may differ from
those that should be considered for hedge funds.
Given the important public interest in this exercise, and
the inevitable judgment that will be required, I believe it is
important to establish an FSOC decision-making framework that
(1) is built to the maximum extent possible on the use of
objective criteria; (2) provides a fair and transparent
process; and (3) provides for the regular review and revisiting
of determinations to ensure they are current and meaningful. I
also think it is vital to try to identify the objective factors
that the Council will consider with as much specificity as
possible, and to make the process generally as transparent and
responsive to public input as possible. As a member of the
Council, I will be especially focused on providing transparency
in the process in considering the adoption of final rules. The
Council plans to provide additional guidance regarding its
approach to designations and will seek public comment on it.
Q.9. The Dodd-Frank Act created an important program to help
the SEC identify major violations of the securities laws by
motivating persons with original information about such
violations to come forward and act as whistleblowers, subject
to very limited statutory exceptions.
Please describe the experience thus far with the program.
The National Whistleblower Center has recently reported
that the existence of a whistleblower rewards program does not
negatively impact the willingness of employees to use internal
corporate compliance program, based on its analysis of cases
filed under the False Claims Act in recent years and other
data. What is your appraisal of the study by the National
Whistleblower Center? Do you intend to consider such
statistical analysis and data in arriving at final rules for
the SEC Whistleblower Program?
A.9. Since the passage of the Dodd-Frank Act, we have been
working hard to establish our new whistleblower program. Last
November, we proposed rules to implement the statute. To date,
the Commission has received hundreds of comments from a wide
variety of interested persons and entities. Staff is in the
process of reviewing and analyzing those comments, which will
be considered in connection with the adoption of final
Commission rules. We recently have seen an uptick in high
quality, detailed complaints from whistleblowers, and we expect
this trend to grow once the Commission's rules are finalized.
In February, we announced the hiring of Sean McKessy, the
first Chief of our new Office of the Whistleblower, to oversee
the program. In addition, the whistleblower fund that will be
used to pay awards to qualifying whistleblowers is fully
funded.
Not surprisingly, the issue of the rules' possible impact
on internal compliance programs was among the most common of
the comments we received in response to our proposed rules. Any
staff recommendation on final rules will take into
consideration the National Whistleblowers Center study and any
additional empirical data provided to us.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR SHELBY
FROM MARY L. SCHAPIRO
Q.1. The Dodd-Frank Act requires an unprecedented number of
rulemakings over a short period of time. As a result, some
deadlines have already been missed and some agencies expect to
miss additional deadlines. It appears that many of the
deadlines in Dodd-Frank are not realistic. Which Dodd-Frank
deadlines do you anticipate not being able to meet? If Congress
extended the deadlines, would you object? If your answer is
yes, will you commit to meeting all of the statutory deadlines?
If Congress affords additional time for rulemaking under the
Dodd-Frank Act, will you be able to produce higher-quality,
better coordinated rules?
A.1. As your question suggests, implementation of the Dodd-
Frank Act is a substantial undertaking. The Act's requirements
that a significant number of Commission rulemakings be
completed within 1 year of the date of enactment poses
significant challenges to the Commission. Throughout, the staff
and Commission have been diligent in working to meet the
deadlines imposed by the Dodd-Frank Act while also taking the
time necessary to thoughtfully consider the issues raised by
the various rulemakings.
We recognize that many of our new rules may have
substantial market implications. As a result, we must be sure
we have assessed those implications and provide market
participants sufficient time to understand the obligations that
may apply to them.
Given the significant issues involved in many of the Dodd-
Frank rules, it will not always be possible to meet the
statutory deadlines imposed under the Act. Indeed, we have
missed certain of the deadlines set forth in that Act and
expect we similarly will miss others in the future. While we
obviously are desirous of meeting the Act's deadlines, it is
critical that we get the rules right.
To help keep the public informed, we have created a new
section on our Web site that provides detail about the
Commission's implementation of the Act. We also are taking
steps to gather additional input on our implementation process
where appropriate, such as the joint roundtable held on May 2
and 3 with the CFTC regarding the adoption of derivatives rules
under Title VII. We value, and are committed to seeking, the
broad public input and consultation needed to promulgate these
important rules.
Q.2. Secretary Geithner recently talked about the difficulty of
designating nonbank financial institutions as systemic. He
said, ``it depends too much on the state of the world at the
time. You won't be able to make a judgment about what's
systemic and what's not until you know the nature of the
shock.'' If it is impossible to know which firms are systemic
until a crisis occurs, the Financial Stability Oversight
Council will have a very difficult time objectively selecting
systemic banks and nonbanks for heightened regulation. As a
member of the Council, do you believe that firms can be
designated ex ante as systemic in a manner that is not
arbitrary? If your answer is yes, please explain how.
A.2. It is important to begin by distinguishing between
designations made pursuant to Title I of the Dodd-Frank Act
(i.e., as a systemically important financial institutions, or
SIFIs, subject to heightened prudential oversight by the
Federal Reserve) and ``systemic risk determinations'' for
special resolution of financial companies made pursuant to
Title II.
Regarding Title II systemic risk determinations for special
resolution of financial companies, I agree that regulators
would not normally make such determinations without first
understanding the nature of the shock that gave rise to risk
and the potential need for the determination.
The SIFI designation, however, is separate and apart from
the Title II designation. Although it is not likely possible to
identify all potential causes of, and conditions leading to,
systemic risk, it should be possible to identify firms that
engage in levels of activity sufficient to warrant further
oversight. The purpose of SIFI, then, is to examine a broader
range of firms so that large, interconnected and potentially
systemic firms do not ``fall through the regulatory cracks.''
Furthermore, through additional consolidated Federal
Reserve oversight, the goal of SIFI designations should be to
proactively address the risks in such firms so that they do not
become ``too big to fail'' institutions. It is important to
note that large interconnected firms exist whether or not SIFI
designations are made. The purpose of SIFI is not to create a
new type of entity, but rather to acknowledge that such large
entities may exist, identify them when possible, and to bring
them under the fold of prudential oversight in a way that may
enable a bankruptcy--or orderly wind down--for firms that might
otherwise have posed ``too big to fail risks'' on the market
and the Government. There is always the possibility that new
risks will develop that were not considered systemic, or even
well-understood, as designations are made. But that should not
deter regulators from identifying firms that are susceptible to
the risk that are presently well understood. For these
designations, FSOC will seek to determine whether the
``material financial distress; or the nature, scope, size,
scale, concentration, interconnectedness, or mix of the
activities of [a] U.S. nonbank financial company, could pose a
threat to the financial stability of the United States.'' This
will require a deep understanding of the ongoing
characteristics of a nonbank financial company (for example,
its size and leverage, among other things) rather than the
nature of particular ``shocks'' that might give rise to a
specific near term systemic risk.
Accordingly, I do believe SIFI designations can be made ex
ante without being arbitrary. Given the inevitable judgment
involved, however, I believe it is important to establish an
FSOC decision-making framework that (1) is built, to the
maximum extent possible, on the use of objective criteria; (2)
provides a fair and transparent process; and (3) provides for
the regular review and revisiting of determinations to ensure
they are both current and meaningful.
Q.3. Section 112 of the Dodd-Frank Act requires the Financial
Stability Oversight Council to annually report to Congress on
the Council's activities and determinations, significant
financial market and regulatory developments, and emerging
threats to the financial stability of the United States. Each
voting member of the Council must submit a signed statement to
the Congress affirming that such member believes the Council,
the Government, and the private sector are taking all
reasonable steps to ensure financial stability and mitigate
systemic risk. Alternatively, the voting member shall submit a
dissenting statement. When does the Council expect to supply
the initial report to Congress?
A.3. I expect the Council will supply its initial report to
Congress at some point later this year.
Q.4. Which provisions of Dodd-Frank create the most incentives
for market participants to conduct business activities outside
the United States? Have you done any empirical analysis on
whether Dodd-Frank will impact the competitiveness of U.S.
financial markets? If so, please provide that analysis.
A.4. There are a number of provisions in the Federal securities
laws that require the Commission to consider the competitive
effects of its rules. Many of those provisions further require
the Commission, before approving a rule, to determine that the
rule is necessary and appropriate in the public interest, and
for the protection of investors. Section 3(f) of the Exchange
Act generally requires the Commission to consider whether the
rules will promote efficiency, competition, and capital
formation. In addition, the Commission must consider the impact
these rules would have on competition under Section 23(a) of
the Exchange Act.
The releases that accompany our rules include our analysis
of these issues. To the extent that the Commission believes
that a proposed rule would create an incentive for market
participants to conduct business activities outside the United
States, that effect would be discussed in the analysis
contained in the release. We also seek comment on the
competitive impact of our rules, both to elicit this
information as well as to better inform us of the potential
effects of our rules.
In addition, the Commission is consulting bilaterally and
through multilateral organizations with counterparts abroad
regarding the international consequences of implementation of
the Dodd-Frank Act. The Commission, for example, together with
the CFTC, is directed by the Dodd-Frank Act to consult and
coordinate with foreign regulators on the establishment of
consistent international standards with respect to the
regulation of swaps, security-based swaps, swap entities and
security-based swap entities. We believe that the recently
formed IOSCO Task Force on OTC Derivatives Regulation, which
the Commission cochairs, as well as other international fora,
will help this effort.
Q.5. More than 6 months have passed since the passage of the
Dodd-Frank Act, and you are deeply involved in implementing the
Act's approximately 2,400 pages. Which provisions of the Dodd-
Frank Act are proving particularly difficult to implement? Have
you discovered any technical or substantive errors in the Dodd-
Frank legislation? If so, please describe them.
A.5. The Dodd-Frank Act includes over 100 rulemaking provisions
applicable to the SEC. As discussed above, we recognize that
many of the rules that result may have substantial market
implications. Accordingly, we are taking the time to
thoughtfully consider how to sequence the implementation of
rules so that market participants have sufficient time to
develop the infrastructure needed to comply. We also anticipate
that certain final rules will include implementation periods
that will provide additional time for market participants to
take the necessary steps to achieve compliance.
In the course of our efforts to implement the Dodd-Frank
Act, we have discovered technical errors or inconsistencies in
some of the provisions of the statute. To date, we have been
able to work around these errors in our rulemaking. If we find
that we cannot do so in a particular circumstance, we will
reach out to Congress with potential legislative fixes.
Q.6. What steps are you taking to understand the impact that
your agency's rules under Dodd-Frank will have on the U.S.
economy and its competitiveness? What are the key ways in which
you anticipate that requirements under the Dodd-Frank Act will
affect the U.S. economy and its competitiveness? What are your
estimates of the effect that the Dodd-Frank Act requirements
will have on the jobless rate in the United States?
A.6. As with all of the Commission's rulemaking, we are
carefully analyzing the costs and benefits of the rules we are
implementing under the Dodd-Frank Act. In its proposing
releases, the Commission includes a cost-benefit analysis and
invites public comment. In adopting releases, the Commission
responds to those comments and revises its analysis as
appropriate.
In addition, as set forth in various administrative law
provisions, the Commission undertakes other types of analyses
in its rulemaking. For example, the Commission estimates the
information collection burdens under the Paperwork Reduction
Act, and also assesses the potential effects on small entities
under the Regulatory Flexibility Act.
The Commission also is subject to particular provisions in
the federal securities laws that require it generally to
consider the effects of its rules on competition, efficiency
and capital formation (e.g., Section 3(f) of the Securities
Exchange Act of 1934 and similar provisions in the Securities
Act of 1933, Investment Company Act of 1940, and Investment
Advisers Act of 1940). Moreover, under Section 23(a) of the
Exchange Act, the Commission must consider the impact any rule
would have on competition. The Commission has included these
analyses in its rulemaking releases under the Dodd-Frank Act
and solicited comment on the analyses.
Q.7. What steps are you taking to assess the aggregate costs of
compliance with each Dodd-Frank rulemaking? What steps are you
taking to assess the aggregate costs of compliance with all
Dodd-Frank rulemakings, which may be greater than the sum of
all of the individual rules' compliance costs? Please describe
all relevant reports or studies you have undertaken to quantify
compliance costs for each rule you have proposed or adopted.
Please provide an aggregate estimate of the compliance costs of
the Dodd-Frank rules that you have proposed or adopted to date.
A.7. As noted, the Commission undertakes various types of
analyses to determine the costs and impacts of its rules. In
its cost-benefit analyses, the rulemaking staff from the
responsible Division works closely with the economists from our
Division of Risk, Strategy, and Financial Innovation (Risk Fin)
to identify the proposed rule's possible costs and benefits
(including the compliance costs and other economic impacts of
rules) and to develop an analysis that takes into account the
relevant data and economic literature. Once senior members of
the division primarily responsible for the rule and Risk Fin
have reviewed this information, each of the Commissioners
review and comment extensively on the draft proposing release.
Ultimately, the proposing release, including the economic and
cost-benefit analyses, is voted on by the Commission for
release to the public.
Specifically with respect to compliance costs resulting
from paperwork burdens, the Commission in each proposed
rulemaking seeks comment from the public on the estimated
paperwork burden associated with each rule. It analyzes the
comments received, makes appropriate changes based on these
comments, and includes a discussion of the comments received
and any changes made in the adopting release.
To better inform the Commission of the aggregate cost of
its rules, in several proposing releases related to Dodd-Frank,
the Commission has specifically asked commenters about the
interaction of a particular rulemaking with other provisions of
the Dodd-Frank Act or rules adopted thereunder. In the
proposing release regarding the process for review of security-
based swaps for mandatory clearing, for example, the Commission
requested comment in its cost-benefit analysis on whether other
provisions of the Dodd-Frank Act for which Commission
rulemaking was required were likely to have an effect on the
costs and benefits of the proposed rules.
Q.8. Section 115 of the Dodd-Frank Act asks the Financial
Stability Oversight Council to make recommendations to the
Federal Reserve on establishing more stringent capital
standards for large financial institutions. In addition,
Section 165 requires the Fed to adopt more stringent standards
for large financial institutions relative to smaller financial
institutions. Chairman Bernanke's testimony for this hearing
implied that the Basel III framework satisfies the Fed's
obligation to impose more stringent capital on large financial
institutions. As a member of the Financial Stability Oversight
Council, do you agree with Chairman Bernanke that the Basel III
standards are sufficient to meet the Dodd-Frank Act requirement
for more stringent capital standards? Please explain the basis
for your answer.
A.8. While the Commission is not a member of the Basel
Committee, I understand that the Basel III standards will be
phased in gradually and that the Committee will use that
transition period to assess whether the proposed design and
calibration of the standards is appropriate over a full credit
cycle and for different types of business models. The capital
requirements in the Basel III standards also will be subject to
an observation period and will include a review clause to
address any unintended consequences. I look forward to
reviewing these standards with other members of the Financial
Stability Oversight Council to determine whether they fulfill
the Dodd-Frank Act requirement for increased capital standards.
Q.9. The Fed, the SEC, the FDIC, and the CFTC are all
structured as boards or commissions. This means that before
they can implement a rule they must obtain the support of a
majority of their board members. How has your board or
commission functioned as you have been tackling the difficult
job of implementing Dodd-Frank? Have you found that the other
members of your board or commission have made positive
contributions to the process?
A.9. The Commission has begun implementing the Dodd-Frank Act
in the same manner as it performs its other responsibilities--
with dedication and the benefits that each Commissioner's
insights, experience and expertise provide. To assist
Commissioners in handling the significantly increased workload
represented by the Dodd-Frank rulemaking, each has been
authorized to hire an additional counsel. I feel strongly that
our rulemaking--be it Dodd-Frank or otherwise--is better
informed, considers a wider array of potential outcomes, and is
articulated more clearly because of the combined contributions
of each Commissioner.
Q.10. The SEC and CFTC are both spending many resources on
writing rules and initiating the oversight programs for over-
the-counter derivatives. These parallel efforts are in many
respects redundant, costly, and potentially damaging to the
market. Would a combined SEC-CFTC unit to deal with swaps and
security-based swaps reduce implementation costs, eliminate the
redundancy of having two sets of rules, and provide for a more
certain and effective regulatory regime?
A.10. There are important similarities between swaps and
security-based swaps that warrant close coordination between
the SEC and the CFTC--just as there are similarities between
other products for which jurisdiction is divided between the
two agencies. A combined SEC-CFTC unit to deal with swaps and
security-based swaps would be one way of addressing the
challenges of parallel oversight of these two categories of
products. Even with a combined effort, however, differing
approaches to regulation and oversight may be warranted for
different types of swaps and security-based swaps. For example,
differing approaches to regulating security-based swaps that
are economic substitutes for securities (such as total return
swaps on single equity securities, where the total return swap
provides economic exposure equivalent to owning a single
security) may be warranted to avoid arbitrage opportunities
between the securities markets and these security-based swaps.
Such regulatory arbitrage could, among other things, lead to
further fragmentation in U.S. equity markets and reduce
investor confidence in these markets.
Q.11. Title VIII of Dodd-Frank deals with more than
systemically important financial market utilities. Under Title
VIII, the SEC and CFTC are authorized to prescribe and enforce
regulations containing risk management standards for financial
institutions engaged in payment, clearance, and settlement
activities designated by the Financial Stability Oversight
Council as systemically important. Should the Council designate
any activities under Title VIII? If the Council designates any
activities as systemically important, what are the limits to
your authority under Title VIII with respect to your regulated
entities that engage in designated activities? What specific
actions are beyond the authority of the CFTC and SEC?
A.11. The Financial Stability Oversight Council has the
authority to apply the same standards used for designating
financial market utilities (FMUs) to financial institutions'
payment, clearing and settlement (PCS) activity that is--or is
likely to become--systemically important. This approach
reflects a view that financial institutions may, in some
circumstances, perform PCS activities that pose risks to the
financial system broadly comparable to those posed by certain
FMUs. Accordingly, additional supervision that may be warranted
in such cases should not be limited simply because of the
organizational structure of the entity performing the activity.
That said, such organizational differences do require that
appropriate additional supervisory controls be implemented
differently. This is reflected in the differing powers provided
to the Council with respect to PCS activity--versus FMU
activity--under Title VIII of the Dodd-Frank Act. To date the
Council has focused its attention on rulemaking concerning FMUs
and financial institutions themselves, but I look forward to
working with my colleagues on the Council to develop an
approach for reviewing PCS activity.
Q.12. One of the purposes of joint rulemaking was to bring the
best minds of both agencies together to design a uniform
regulatory approach for OTC derivatives. In one recent joint
proposal, the SEC and CFTC took two different approaches to
further defining ``swap dealer'' and ``security-based swap
dealer.'' Specifically, the release applied the dealer-trader
distinction that has been used to interpret the term ``dealer''
under the 1934 Act only to security-based swap dealers, not to
swap dealers. Does this violate the Dodd-Frank mandate that you
work together?
A.12. The Commission and CFTC have worked closely in developing
rules and related interpretations regarding the definitions of
``swap dealer'' and ``security-based swap dealer.'' In so
doing, we have been mindful of practical differences between
how ``swaps'' and ``security-based swaps'' are used and traded.
These differences include the use of swaps for hedging purposes
by ``natural long'' entities in the agricultural, energy and
resource sectors, as well as the use of aggregators in the
swaps markets.
I believe that the proposed interpretations of the ``swap
dealer'' and the ``security-based swap dealer'' definitions are
generally parallel, while appropriately accounting for those
differences between swaps and security-based swaps and
reflecting the Commission's historic use of the ``dealer-
trader'' distinction.
I expect the staff and Commission will carefully consider
commenters' views on the rules and interpretations regarding
the dealer definitions prior to promulgating a final rule.
Q.13. One of the concerns of foreign regulators and foreign
market participants is a lack of clarity about the application
of your derivatives regulation. What are the limits of your
ability to regulate foreign swap participants and foreign
transactions in the swap market? Do you think that the CFTC and
SEC should define the bounds of their regulatory authority in a
formal rulemaking? If not, why not?
A.13. The Commission has been actively considering how the
mandates in the Dodd-Frank Act should interact with the global
derivatives market and its participants, particularly those
entities and transactions that may be subject to regulation by
a foreign regulatory authority. We are keenly aware that the
existing derivatives market is global in nature, and that
cross-border issues abound, as derivatives transactions often
involve counterparties and products from around the world.
The application of Title VII provisions to foreign market
participants raises difficult issues regarding competition,
arbitrage and international comity, among others. We believe
that providing guidance on the reach of Title VII to the market
either through rulemaking or other means is important. Given
the complicated, interwoven nature of these matters, we have
sought to avoid a piecemeal approach through the rules we have
proposed thus far.
As we have been working through the implementation of each
of the provisions in Title VII, we have been meeting with
foreign and domestic market participants to understand their
views. Additionally, the Commission continues to be actively
engaged in ongoing bilateral and multilateral discussions with
foreign regulators regarding the direction of international
derivatives regulation generally, and the Commission's efforts
to implement Title VII's requirements.
Q.14. So far, the SEC's Dodd-Frank rulemakings total more than
4,300 pages. Even if the SEC gets the additional staff it
believes it needs to implement Dodd-Frank, the Commissioners
still have to review every rule under consideration. Chairman
Schapiro, how much of your own time is taken up reviewing all
these rules? Have you personally read each proposed and final
rule release? To which areas are you devoting less time than
you otherwise would because you must devote so much of your
time to Dodd-Frank implementation?
A.14. On average, I am spending close to two-thirds of my time
on Dodd-Frank rulemaking. By the time that each proposing and
adopting release is voted on by the Commission, I have (a) met
with staff in multiple meetings to discuss policy options, pros
and cons (including the costs and benefits), and Commission
views; (b) read and commented upon a term sheet and multiple
drafts of each release, and (c) had numerous meetings with
outside parties on the rules. Because of the responsibility to
implement Dodd-Frank, I am spending less time on other non-
Dodd-Frank rulemaking, and am accepting fewer public speaking
requests that require travel, than was the case prior to Dodd-
Frank's adoption.
Q.15. The Dodd-Frank Act established a reserve fund for the
SEC, which was intended to enable the SEC to respond quickly to
unexpected events, like the flash crash, and to help the SEC
through an extended Continuing Resolution. The President's
budget, however, includes $20 million in direct obligations
from the reserve fund to pay for routine information technology
needs. If the SEC uses its emergency reserve fund to cover
routine expenses that should be on budget, what will the SEC do
when it faces a true emergency?
A.15. In establishing the Reserve Fund for the SEC starting in
FY2012, the Dodd-Frank Act gives the agency authority to use
the Fund for expenses the Commission determines are necessary
to carry out the agency's functions. The Reserve Fund will be
helpful in addressing three main kinds of funding issues:
multiyear technology initiatives, extended Continuing
Resolutions (CR), and emergencies such as the ``flash crash''
that may require the quick expenditure of funds to address
issues that arise.
The SEC is required to deposit into the Fund $50 million a
year in registration fees, and the balance of the Fund cannot
exceed $100 million. Under the Act, the SEC can cover salaries
and expenses from this Fund, and then must notify Congress of
each expense.
Since the provision takes effect in FY2012, the President's
Budget contains an estimate of how much will be obligated from
the Reserve Fund in that year. The estimate is $20 million, and
it assumes that those funds will be spent primarily on
technology. Potential projects include an e-Discovery system
for the enforcement, examination, and other programs; knowledge
management; and security improvements.
This estimate would leave $30 million available in the
Reserve Fund for FY2012, which could be used for emergency
needs should they arise.
Q.16. The SEC staff recently completed a study on whether a
fiduciary duty should be imposed on broker-dealers, many of
whom serve small towns. The study, however, failed to conduct
an empirical analysis of the costs of imposing such a legal
obligation. Before moving forward on any rulemaking in this
area, do you believe that it is important for the SEC to
conduct an empirical analysis of both the compliance costs and
the impact on the availability of financial services,
especially in rural communities?
A.16. The Commission solicited comments and data as part of the
study required by Section 913 of the Dodd-Frank Act and
received over 3,500 comment letters. Commission staff reviewed
all of the comment letters and considered the many complex
issues raised in them. In conjunction with drafting the study,
Commission staff also met with interested parties representing
investors, broker-dealers, investment advisers, other
representatives of the financial services industry, academics,
state securities regulators, the North American Securities
Administrator Association, and the Financial Industry
Regulatory Authority.
As part of the Section 913 study, Commission staff did
consider the impact of the study's recommendation of a uniform
fiduciary duty on rural broker-dealers--most directly in
connection with the staff's consideration of potential loss of
investor choice, as mandated by the study. \1\
---------------------------------------------------------------------------
\1\ Staff of the U.S. Securities and Exchange Commission, Study on
Investment Advisers and Broker-Dealers as required by Section 913 of
the Dodd-Frank Wall Street Reform and Consumer Protection Act, 162
(January 2011).
---------------------------------------------------------------------------
Commission staff considered whether potentially underserved
portions of the retail investor population, including those
located in rural areas, might be adversely affected by any of
the options considered under Section 913. The staff concluded
that the recommended uniform fiduciary standard would, in and
of itself, not adversely impact such populations' access to
financial products and services. In fact, the staff concluded
that retail investors generally would benefit from the uniform
fiduciary standard because it would better assure the integrity
of the advice they receive, while continuing to allow for
various compensation schemes (commissions and flat fees) and
product offerings.
The staff does not expect the uniform fiduciary standard to
have a disproportionate impact in rural areas. Many financial
planners and other investment advisers operate in small towns
today, subject to a fiduciary standard of conduct. The staff's
recommendations were designed to be flexible and to accommodate
different existing business models and fee structures.
In preparing the study, the staff considered the potential
costs and other burdens associated with implementing the
recommended fiduciary standard. We will continue to be mindful
of the potential economic impact going forward. In light of
this ongoing focus, I have asked a core team of economists from
the Commission's Division of Risk, Strategy and Financial
Innovation (Risk Fin) to review, among other things, data
pertaining to the standards of conduct in place under the
existing broker-dealer and investment adviser regulatory
regimes to further inform the Commission.
Ultimately, if the Commission does engage in rulemaking
under Section 913, as with any proposed rulemaking, the
Commission would conduct an economic analysis regarding the
impact of any proposed rules. Such analysis would include the
views of Risk Fin, which has broad experience analyzing
economic and empirical data. The Commission would then consider
public comment on any such proposal, including public comment
on the Commission's analysis of costs and benefits. Any final
rulemaking would also take into account not only the views of
all interested parties, but also the potential impact of such
rules on the financial marketplace, including the impact on
retail investors and the advice they receive from financial
professionals. Like you, I want our regulations to promote
retail investor access to affordable investment products,
including those investors in rural communities.
Q.17. The Department of Labor recently proposed to broaden the
definition of ``fiduciary'' under ERISA. This proposal may have
substantial effects on retail investors and SEC registrants.
Phyllis Borzi of the Department of Labor mentioned last week
that the Department has been working closely with the SEC on
the issue. \2\ Which members of the SEC staff and which
Commissioners have consulted with the Department of Labor on
its fiduciary rulemaking and what has the nature of those
consultations been?
---------------------------------------------------------------------------
\2\ Meredith Z. Maresca, ``Borzi Says DOL Focusing on Initiatives
For Disclosures, Exchanges, Lifetime Income'', BNA Daily Report for
Executives (Feb. 23, 2011) (available at: http://news.bna.com/drln/
display/
no_alpha.adp?mode=si&frag_id=19639762&item=9DA7A4B5F927841A448E47A7E5934
B24) (``Borzi added that the Labor Department has been working closely
with the Securities and Exchange Commission on the fiduciary
regulations to make sure that the definition of fiduciary is
`compatible and harmonized' for both agencies.'').
A.17. Since the Commission issued its Section 913 study,
Commission staff has received and reviewed additional comments
on the study, has continued to meet with interested parties to
discuss their reactions to the study, and has discussed with
staff of the Department of Labor its proposed rulemaking on
fiduciary status. For example, with respect to developing
business conduct standards for swap and security-based swap
dealers and major participants, senior staff of the Division of
Trading and Markets and Commodity Futures Trading Commission
are coordinating with staff of the Department of Labor
regarding the relationship between these business conduct
standards and rules (both existing and proposed) under ERISA.
Senior members of Commission staff, including Douglas J.
Scheidt, Chief Counsel and Associate Director of the Division
of Investment Management, and Lourdes Gonzalez, Acting Co-Chief
Counsel of the Division of Trading and Markets, together with
the staff from the CFTC and the Department of Labor, have
participated in joint briefings with Congressional staff on
these issues. Commission staff also attended the hearings held
by the Department of Labor on March 1 and 2 to hear the
concerns raised by affected parties. Commission staff is
committed to continuing this consultative process. Similarly,
if the Commission engages in rulemaking to address the
recommendations in the Section 913 study, we would do so in
consultation with the staff of the Department of Labor,
recognizing, of course, the different mandates of the statutes
---------------------------------------------------------------------------
that the agencies administer.
Q.18. The SEC describes its treatment of small companies under
the say-on-pay rule as an exemption, but it is more
appropriately described as delayed implementation. Why did the
SEC choose not to exempt small companies from the say-on-pay
requirements as permitted by Section 951 of the Dodd-Frank Act?
More generally, what efforts are you making to assess and
address the unique burdens faced by smaller public companies
under Dodd-Frank Act requirements?
A.18. After reviewing and considering comments received from
the public on the say-on-pay proposing release, the Commission
adopted a temporary exemption for smaller reporting companies
so that these issuers will not be required to conduct either a
shareholder advisory vote on executive compensation or a
shareholder advisory vote on the frequency of say-on-pay votes
until their first annual or other meeting of shareholders
occurring on or after January 21, 2013. Based on the comments
received, the Commission believes investors in smaller
reporting companies have the same interest as investors in
larger reporting companies in voting on executive compensation
and in clear and simple disclosure of golden parachute
compensation in connection with mergers and similar
transactions. However, after reviewing comments on the
potential burdens on smaller reporting companies, the
Commission determined it was appropriate to provide additional
time before smaller reporting companies are required to conduct
the shareholder advisory votes on executive compensation and
the frequency of say-on-pay votes.
In providing a delayed effective date for the say-on-pay
and frequency votes for smaller reporting companies, the
Commission noted that the delay should allow those companies to
observe how the rules operate for other companies and permit
them to better prepare for implementation of the rules. The
Commission also noted that delayed implementation for smaller
reporting companies will allow us to evaluate the
implementation of the adopted rules by larger companies and
provide us an additional opportunity to consider whether
adjustments to the rules would be appropriate for smaller
reporting companies before the rules become applicable to them.
The Dodd-Frank Act authorizes the Commission to exempt an
issuer or class of issuers from the requirements, but only
after considering, among other things, whether the requirements
disproportionately burden small issuers. The 2-year deferral
period is designed to assist the Commission in its
consideration of these factors and will enable us to adjust the
rule, if appropriate, before it applies to smaller issuers.
More generally, in implementing the Dodd-Frank Act, the
Commission is carefully considering the unique burdens faced by
smaller public companies. For example, the Commission recently
issued a rule proposal to modify the calculation of ``net
worth'' for purposes of the ``accredited investor'' definition
to exclude the value of an individual's primary residence when
calculating net worth. In developing the proposal, the
Commission was mindful of the potential burden on small
businesses and drafted the proposal to balance concerns
relating to the impact on small businesses and the regulatory
purpose of the proposal by specifying that debt secured by an
individual's primary residence, up to the value of such primary
residence, is excluded from the net worth calculation, thereby
deducting only the equity value in the primary residence in the
net worth calculation. Before we adopt the final rule, the
Commission and staff will carefully weigh the public comments
to ensure we strike the right balance.
As we continue to implement the provisions of the Dodd-
Frank Act, we will continue to consider how the rules will
impact smaller public companies, with particular focus on
public comments we receive regarding the burdens they face and
ways we can reduce those burdens.
Q.19. Recent SEC failures like Stanford and Madoff illustrate
that even when resources are dedicated to inspecting a
particular firm, fraud may go unchecked. If the SEC receives
the resources it asks for, what will it do to ensure that those
resources are used productively?
A.19. The SEC already has taken significant action over the
past 2 years to ensure resources are used productively. We have
new management across the major divisions and offices, and we
created a new Division of Risk, Strategy, and Financial
Innovation to refocus the agency's attention on--and response
to--new products, trading practices, and risks. We also created
new Chief Operating Officer and Chief Compliance Officer
positions, and have moved to modernize our information
technology, including a centralized system for tips and
complaints, enforcement and examination management systems,
risk analysis tools, and financial management systems.
To better ensure effective performance in detecting and
addressing fraud, the agency has carried out a comprehensive
restructuring of its two largest programs--enforcement and
examinations. These reforms are intended to maximize our use of
resources and permit the agency to move more swiftly and
strategically.
Specifically, the Division of Enforcement has streamlined
its procedures to bring cases more quickly; removed a layer of
management to permit more staff to be allocated to front-line
investigations; created five national specialized investigative
groups dedicated to high-priority areas of enforcement; and
created a new Office of Market Intelligence to serve as the hub
for the effective handling of tips, complaints, and referrals.
The Office of Compliance Inspections and Examinations (OCIE)
reorganized the agency's national examination program in
response to rapidly changing Wall Street practices and lessons
learned from the Madoff and Stanford frauds. The changes
provide greater consistency and efficiencies across our 11
regions and sharpen the staff's focus on identifying the higher
risk firms that it targets for examination. OCIE also
implemented new policies requiring examiners to routinely
verify the existence of client assets with third party
custodians, counterparties, and customers. Going forward, the
national exam program will continue to conduct sweeps in
critical areas from trading practices to market manipulation to
structured products.
Q.20. You have made a number of structural changes in the
Division of Enforcement and Office of Compliance Inspections
and Examinations. What performance metrics is the SEC using to
assess the effectiveness of those changes? Does the SEC track
the number of hours that a compliance examination or
enforcement action takes?
A.20. The structural reforms implemented within the Division of
Enforcement are composed of several initiatives with the
overarching goal of increasing the speed, efficiency, and
expertise with which the division investigates potential
violations of the Federal securities laws and makes enforcement
recommendations to the Commission. The Enforcement Division
tracks the number of investigations opened and closed, the
number of enforcement actions filed, the timeliness in which
actions are filed, and the relative efficiency of various
investigative groups (including the handling of
programmatically significant matters by those groups). Much of
this information is broken down by office as well as by senior
managers (Associate Directors) who supervise investigative
groups nationwide. In addition, in annual publications (either
its Performance and Accountability Report or Select SEC and
Market Data publication) the Commission provides the following
performance information relating to the work of the Enforcement
Division:
Percentage of enforcement actions successfully
resolved (``successfully resolved'' means a favorable
outcome for the SEC whether through a settlement,
litigation, or the issuance of a default judgment). In
fiscal year 2010, 92 percent of enforcement actions
were successfully resolved.
Percentage of first enforcement actions filed
within 2 years of an investigation commencing. In
fiscal year 2010, 67 percent of first enforcement
actions were filed within 2 years.
Amount of disgorgement and penalties ordered. In
fiscal year 2010, SEC obtained orders in judicial and
administrative proceedings requiring securities law
violators to disgorge illegal profits of approximately
$1.82 billion and to pay penalties of approximately
$1.03 billion.
Trading halts where inadequate public disclosure.
In fiscal year 2010, SEC halted trading in securities
of 254 issuers about which there was inadequate public
disclosure.
Orders barring service as officer or director of
public companies. In fiscal year 2010, SEC sought
orders barring 71 defendants and respondents from
serving as officers and directors of public companies.
While the number of enforcement actions that we bring each
year and the speed with which we bring them are important
performance factors, we also recognize that meaningful and
effective investor protection requires that significant,
complex, and difficult cases be investigated and filed. For
this reason, Enforcement, as part of its recent structural
reforms, generates a national priority case report that
identifies and tracks cases deemed programmatically
significant. Matters are designated as high priority based on
criteria, such as the deterrent impact of a case, the
egregiousness of the conduct, the nature of the parties
involved, and the extent of investor harm. Enforcement tracks
the number of pending national priority investigations as well
as the number of national priority investigations that have
resulted in enforcement actions. In addition to the national
priority case report, the division is in the pilot stage of
establishing qualitative metrics for all of its enforcement
actions. Under the new qualitative metrics, enforcement actions
will be rated qualitatively in the following four areas: (1)
the deterrent message of the case; (2) the seriousness and
scope of the misconduct; (3) the nature of the parties involved
in the misconduct; and (4) the priority of the subject matter.
Once implemented, Enforcement believes that these qualitative
metrics will assist in ensuring that programmatic priorities
are being met and that the measurement of the Division's
performance is fair and consistent.
The Enforcement Division does not track the number of hours
that an enforcement action takes. As noted above, the division
tracks--and the Commission reports on--the percentage of
actions filed within 2 years after an investigation commenced.
The mission of OCIE's National Exam Program is to improve
compliance with Federal securities laws, prevent fraud, monitor
risks, and inform Commission policy. OCIE has established key
performance indicators (KPIs) to help assess the efficiency and
effectiveness of its National Exam Program. Currently, OCIE
monitors--or is in the process of establishing processes to
monitor--the following KPIs related to each of these four
objectives:
Improve compliance
Number of exams completed;
Percentage of exams completed within 180 days;
Percentage of firms receiving deficiency letters
asserting that they have taken corrective action in
response to findings; and
Number of industry outreach and education
programs targeted to areas identified as raising
particular compliance risk.
Prevent fraud
Percentage of exams receiving deficiency letters
and/or referred to Enforcement;
Percentage of Enforcement investigations arising
from National Exam Program referrals, as well as the
frequency with which enforcement investigations arise
from such referrals;
Percentage of completed examinations identifying
significant findings; and
Recoveries to investors from examinations.
Monitor risk
Percentage of examinations that are conducted for
cause; and
Number of cause exams that result from tips.
Inform Commission policy
Number of exams that inform policy;
Number of consultations, coordinated events,
reports or initiatives with other divisions; and
Coordinated exams and other efforts with SROs and
other regulators.
OCIE does not monitor the number of hours that a compliance
exam takes.
Q.21. Section 965 of the Dodd-Frank Act directed the Commission
to set up staffs to conduct examinations of investment
advisers, investment companies, and broker-dealers within the
Division of Investment Management and Division of Trading and
Markets. Instead of eliminating OCIE and moving OCIE examiners
back into the divisions, the SEC is preserving OCIE and
creating a redundant examination staff within the divisions. In
light of SEC budget concerns, wouldn't it make sense to comply
with the Dodd-Frank directive by moving existing examiners back
into the relevant divisions rather than creating a duplicative
set of examiners?
A.21. In seeking to comply with Section 965 of the Dodd-Frank
Act, we are sensitive to the need to maximize the use of
limited resources and avoid ineffective or duplicative
examinations. While I believe it will be helpful to have
experienced and well-trained examiners operating in the policy
divisions (for example, to help ensure ``real world''
examination findings inform our rule writing and to assist in
integrating the expertise of our policy divisions into our
examinations), I do not believe that all OCIE examiners should
be placed into these two divisions.
The convergence of the financial services industry over the
past several decades has made it increasingly important to have
significant interdisciplinary skills available for any given
examination. Housing all of the Commission's examiners in two
different policy divisions would result in an examination
program divided along statutory lines that does not generally
reflect business realities. Moreover, a centralized examination
program is better positioned to look for risks across entire
markets, effectively examine the integrated operations of
today's financial service providers, internally share
information and examination skills, procedures and practices
and ensure that examinations are conducted and managed in a
consistent and cohesive manner. Splitting the OCIE staff into
two divisions may therefore create inefficiencies and weaken
the effectiveness of the examination program.
Q.22. The SEC recently proposed rules to implement the venture
capital exemption adviser in Section 407 of the Dodd-Frank Act.
Nevertheless, the SEC subjected venture capital advisers to
significant reporting obligations, thereby seemingly violating
the exemption's purpose of treating venture capital fund
advisers differently than other private fund advisers. Could
the SEC take an alternative approach that would respect the
spirit as well as the letter of the Congressionally mandated
exemption for venture capital advisers?
A.22. The Dodd-Frank Act provides that the Commission shall
require venture capital fund advisers pursuant to Section 407
of the Act to submit such reports as the Commission determines
necessary or appropriate in the public interest or for the
protection of investors. To implement this Congressional
requirement, the Commission proposed those reporting
requirements for public comment in November 2010. Those
proposed requirements are a subset of the information required
of registered private fund advisers, specifically, basic
information about the adviser in a check-box or short answer
format. The Commission did not propose, for example, to require
exempt venture capital fund advisers to complete and file the
narrative disclosure brochure required of registered advisers.
We have received numerous comments from industry and the public
about the proposed reporting requirements, and the Commission
will take those comments into account when considering changes
to the proposals before adopting these reporting requirements.
In January, the Commission proposed for public comments
systemic risk reporting requirements (i.e., new Form PF). As
proposed, the requirement to file Form PF would apply only to
registered advisers and therefore would not apply to exempt
venture capital fund advisers.
Q.23. One of the frequently cited concerns about the SEC's
proposed approach to implementing the whistleblower provisions
of the Dodd-Frank Act is that it will undermine companies'
existing compliance programs. How is the SEC taking these
concerns into account?
A.23. On November 3, 2010, the Commission proposed rules to
reward individuals who provide the agency with high-quality
tips that lead to successful enforcement actions. To date, the
Commission has received hundreds of comments from a wide
variety of interested persons and entities concerning the
proposed rules. Staff is in the process of reviewing and
analyzing those comments, which will be considered in
connection with the adoption of final Commission rules.
Whistleblowers can be an invaluable source of information
to uncover securities fraud and better protect investors. I
believe it is important--consistent with the statute's language
and our mission to protect investors--to ensure that
whistleblowers can bring us their evidence of securities
violations expeditiously. Although there is great value in
whistleblowers reporting matters internally when appropriate,
there may be numerous instances when such reporting is not
appropriate.
When the Commission proposed its rules, we attempted to
achieve a balance that preserved the important role that
internal compliance programs play while remaining true to the
statute's purpose of encouraging whistleblowers to come
forward. With that in mind, we included provisions in the
proposed rules intended to encourage, but not require,
employees to continue to report potential violations through
existing company processes in addition to making whistleblower
submissions. For example, the proposed rules provide that an
employee who reports information through appropriate company
procedures would be treated as a whistleblower under the SEC's
program as of the date the employee reported internally so long
as the employee provides the same information to the SEC within
90 days. By taking advantage of this provision, employees would
be able to report internally first while preserving their
``place in line'' for a possible award from the SEC.
Additionally, the proposed rules provide that the Commission
can consider, as a basis for paying a higher percentage award,
whether a whistleblower first reported the violation through
effective company compliance programs. Additional ideas in this
area have been raised during the public comment process which
will be considered before adoption of final rules.
In sum, I believe we can adopt rules which achieve a
balance that preserves the important role that internal
compliance programs can play while remaining consistent with
the statute's purpose of encouraging whistleblowers to come
forward.
Q.24. In response to one of my questions at the hearing, you
stated ``We are actively and aggressively recruiting for a
Chief Economist at the SEC.'' Yet, the SEC Chief Economist
position has remained unfilled since last summer. Why have your
recruiting efforts been unsuccessful for so long? How has your
new Division of Risk, Strategy, and Financial Innovation
changed the role that economic analysis plays in informing the
SEC's formulation, proposal, and adoption of rules? Please give
an example of a Dodd-Frank rulemaking or study in which the
Division played a particularly important role. Given that you
noted at the hearing that you are trying to grow the number of
economists at the SEC, how many of the 780 new positions (612
FTE) that the SEC is requesting for FY2012 does the SEC intend
to fill with Ph.D. economists?
A.24. As I noted in my testimony, our search for a new Chief
Economist was active and aggressive. We interviewed a number of
highly qualified candidates from a distinguished field
comprised of individuals suggested by a wide variety of
sources, including our former Chief Economists. In connection
with this process, I made clear that the Chief Economist will
report directly to me with respect to all economic matters. In
addition, as I testified, the Chief Economist also will serve
as Director of Risk Fin.
On May 20, 2011, Dr. Craig M. Lewis, the Madison S.
Wigginton Professor of Finance at Vanderbilt University's Owen
Graduate School of Management, was named the Commission's Chief
Economist and Director of Risk Fin. Professor Lewis is a
distinguished economist with a clear understanding of the
complexities of financial markets. As the head of the Division,
he will not only lead our qualified team of expert economists,
but will also help to inject strong data-driven analysis into
the SEC's decision-making process.
In creating Risk Fin, we made economic analysis a core
function within the broader Risk Fin mission. In so doing, I
believe we have created conditions in which economic analysis
at the SEC can flourish. Putting our economists together with
mathematicians and financial engineers will enhance the
Division's ability to provide timely and reliable empirical
analysis of current market phenomena and their implications.
Risk Fin had also begun to tap the deep pool of talent
experienced market professionals offer, until recent budgetary
constraints temporarily curtailed those efforts. Bringing a
broad range of analytic disciplines and experienced
practitioners into a single division that has economic analysis
of rule proposals as a core responsibility will, in my view,
generate synergies that can only assist the Commission in
fulfilling its responsibilities.
Risk Fin assists and supports the rulemaking initiatives of
other divisions, and does not itself write rules. Risk Fin
continues to be actively involved in all SEC rulemaking
initiatives, including those stemming from Dodd-Frank.
Moreover, examples of Dodd-Frank-related studies for which Risk
Fin has taken the lead SEC role include the recent joint SEC-
CFTC staff Study on the Feasibility of Requiring Use of
Standardized Algorithmic Descriptions for Financial Derivatives
(April 7, 2011, pursuant to Dodd-Frank sec. 719(b)) and the
Security-Based Swap Block Trade Definition Analysis (Jan. 13,
2011) appended to Regulation SBSR--Reporting and Dissemination
of Security-Based Swap Information (Release No. 34-63346 (Nov.
19, 2019)), both posted on the SEC's Web site. The Division
also made a significant contribution to the joint SEC-CFTC
staff Report on the Market Events of May 6, 2010 (Sept. 30,
2010).
The SEC's request for 780 new positions in FY2012
incorporates approximately 21 economists--10 in the Division of
Trading and Markets and 11 in Risk Fin. The agency hopes to
fill most, if not all, of those 21 positions with Ph.D.
economists. If that is not possible, other factors (including
analytical expertise and practical experience in key areas of
focus) would determine which individuals are selected for the
positions.
The SEC has a history of employing Ph.D. economists, and we
continue to believe that the breadth of training and depth of
experience entailed in earning a Ph.D. degree prepares an
economist particularly well for the range of work and complex
data sets at the SEC. The market for top quality Ph.D.
economists is, however, very competitive. The SEC is just one
of many entities, public and private, that compete in the
market for high quality Ph.D. economists each year. Given our
desire to strengthen the role and quality of economic analysis
at the SEC, as well as the additional demands placed on our
economists in connection with Dodd-Frank Act mandates, if we
could not fill all positions with Ph.D. economists, we would
have to consider whether we could meet our unmet staffing needs
by hiring at least some non-Ph.D. economists.
Q.25. The SEC has historically suffered from a culture of poor
management. If you get additional staff to help with your
increased workload under Dodd-Frank, what steps will you take
to ensure that the new staff are managed effectively? What are
you doing to monitor relative workloads of employees and to
redeploy those who are underworked to assist those who are
overworked?
A.25. The SEC has moved aggressively in recent years to develop
management tools and techniques to build a stronger management
culture. New leadership development programs have been put in
place at all levels of our leadership structure and a new
performance management system is being implemented agency-wide
that should be significantly more robust then previous systems
used at the agency. This system requires more effective
feedback and coaching for improvement where necessary at all
levels of the organization. It also proactively identifies
career growth and developmental needs, allowing the agency to
create flexibilities regarding job assignments when needed. The
current funding environment has limited the agency's ability to
fully execute these programs on an ongoing basis.
Q.26. The Dodd-Frank Act gave the SEC a number of new
enforcement powers. Which of these Dodd-Frank provisions do you
believe applies retroactively and why?
A.26. Because the Dodd-Frank Act contains many different types
of enforcement provisions that have different effects on prior
law, no single approach applies uniformly. In addition, the
Commission has not yet had occasion to address all of the
potential retroactivity issues that may arise. In general,
however, the Commission's approach is to follow case law
guidance concerning whether application of a statute would be
impermissibly retroactive.
With respect to provisions that change the legal standards
governing liability, we have not applied them to conduct that
occurred before the effective date of the statute absent a
clearly expressed Congressional intention for retroactive
application.
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RESPONSES TO WRITTEN QUESTIONS OF SENATOR REED
FROM MARY L. SCHAPIRO
Q.1. A serious topic of discussion in the financial markets
these past few days is the announcement of a proposed merger
between the NYSE-Euronext and the Deutsche Borse.
If this merger takes place, what will be the potential
impact on the implementation of the provisions of the Dodd-
Frank Act, particularly in respect to the trading and clearing
of derivatives?
Is there a potential that this merger will enhance the
availability of regulatory arbitrage by allowing market
participants the ability to circumvent the requirements of
Dodd-Frank by providing easier access to foreign trading and
clearing venues?
Should we be concerned with any anticompetitive
implications of this further consolidation of trading and
clearing platforms?
A.1. I do not anticipate that this proposed business
combination alone would have a significant impact on our
implementation of the Dodd-Frank Act. In developing rules that
would govern the trading and clearing of security-based swaps,
the Commission has sought to consider issues regarding the
derivatives markets broadly and without limiting its focus to
any specific entity's role in those markets.
Requirements regarding access to foreign trading and
clearing venues, including those under the Dodd-Frank Act, are
generally not determined or applied based on which entity owns
the trading or clearing venue. Accordingly, although the
Commission is sensitive to the issue, such proposed changes in
ownership alone would not typically increase the potential for
circumvention of the requirements of the Dodd-Frank Act. More
broadly, in connection with these cross-border combinations of
exchanges, each market has continued to operate as a separate
liquidity pool in its respective jurisdiction and has continued
to be regulated subject to its home country's requirements--
that is, European exchanges continue to be overseen by the
relevant European regulator, and the Commission continues to
oversee the U.S. exchanges. Currently, U.S. Federal securities
laws generally require all exchanges operating in the United
States, and all securities traded on those exchanges, to be
registered with--and regulated by--the Commission. However, as
U.S. and non-U.S. exchanges continue to seek increased
integration of their markets and foreign markets seek greater
direct access to U.S. investors, the potential regulatory
considerations increase. Accordingly, such direct access by
foreign markets to U.S. investors generally is not currently
permitted without registering with the Commission.
Competition is an important issue that the Commission will
be considering carefully as we proceed in our review of the
proposed business combination.
Q.2. To what extent is your agency working with your relevant
domestic and foreign counterparts in respect to the possible
merger between the New York Stock Exchange and the Deutsche
Borse? Are you working to ensure that arrangements will be in
place for cooperation in supervision and enforcement and for
information sharing, all of which will be required as a result
of this potential merger? Should we expect formal MOUs on
supervisory cooperation to precede a cross-border merger?
A.2. The Commission has existing Memoranda of Understanding
(MOUs) for consultation, cooperation, and the exchange of
information related to supervisory matters with both the
College of Euronext Regulators and the German federal
securities authority (German BaFin). The Commission also has
multilateral and bilateral arrangements in place for
enforcement cooperation with all five of the European
authorities that comprise the College, as well as with the
German BaFin. See, http://www.sec.gov/about/offices/oia/
oia_cooparrangements.shtml.
The Commission staff has been consulting regularly with its
European counterparts in relation to the possible merger
between NYSE Euronext and Deutsche Borse. The staff anticipates
that, if the merger goes through, cooperation between the
Commission and the relevant European regulators will continue
pursuant to existing or similar arrangements.
Q.3. The Securities, Insurance, and Investment Subcommittee
held a hearing in December that focused, in part, on the
increasing interconnectedness of today's modern markets and the
need for effective oversight of trading across products and
venues. Today's traders buy and sell options, futures, and
equities interchangeably in dozens of marketplaces around the
world. Yet, our regulatory oversight mechanism largely relies
on a model where each marketplace is primarily responsible for
policing the activities on its platform. Given the recently
announced potential merger of NYSE Euronext with Deutsche Borse
Group, it seems as though the trading marketplaces are only
becoming more interconnected. What are your thoughts regarding
how to implement an effective regulatory oversight
infrastructure to police trading done both by Americans around
the world and by traders around the world in our increasingly
interconnected and international marketplaces?
A.3. In recent years, several U.S. exchanges have combined with
non-U.S. exchanges, including NYSE's combination with Euronext,
Eurex's acquisition of ISE, and Nasdaq's combination with OMX.
In connection with these cross-border combinations of
exchanges, each market has continued to operate as a separate
liquidity pool in its respective jurisdiction and has continued
to be regulated subject to its home country's requirements--
that is, European exchanges continue to be overseen by the
relevant European regulator, and the Commission continues to
oversee the U.S. exchanges. In addition, the Commission seeks
to cooperate fully with the non-U.S. exchange's home regulator.
Currently, U.S. Federal securities laws generally require
all exchanges operating in the United States, and all
securities traded on those exchanges, to be registered with--
and regulated by--the Commission. However, as U.S. and non-U.S.
exchanges continue to seek increased integration of their
markets and foreign markets seek greater direct access to U.S.
investors, the potential regulatory considerations increase.
Accordingly, such direct access by foreign markets to U.S.
investors generally is not currently permitted without
registering with the Commission. Through our ongoing dialogue
with the EU and other foreign jurisdictions, we have sought to
improve our understanding of the differences and similarities
in the regulation of exchanges as practiced in the United
States and in foreign jurisdictions. In addition, we are
committed to developing globally consistent standards that
reduce the possibilities of regulatory arbitrage.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR MENENDEZ
FROM MARY L. SCHAPIRO
Q.1. Exchanges and Clearinghouses--I'm concerned that the
exchanges or clearinghouses, both for derivatives and
securities, could themselves become ``too big to fail'' and
systemically significant. What steps are you taking to ensure
that their size and risks are properly managed so that they do
not become ``too big to fail''?
A.1. Clearing Agencies--When structured and operated
appropriately, clearing agencies can provide benefits to the
markets such as improving the management of counterparty risk
and reducing outstanding exposures through multilateral netting
of trades. It is clear, however, that while playing a critical
role in the markets, clearing agencies need to appropriately
manage risk. To support its oversight of clearing agencies,
including their risk management practices, the Commission
recently began taking several actions, including:
Developing a clearing agency monitoring group
within our Division of Trading and Markets, which is an
effort in the early stages to more closely monitor and
evaluate clearing agency risk management and
operational systems;
Enhancing our examination program for clearing
agencies, including by developing dedicated staff for
the clearing agency exam program; and
Engaging in rulemaking, including proposing new
risk management, governance, and operational standards
for clearing agencies.
Specifically, in March, the Commission proposed rules that
seek to establish standards for the operation and governance of
clearing agencies, as well as appropriate standards for risk
management. We also are actively contributing to the work of
the Financial Stability Oversight Council, which has the
authority to recognize financial market utilities (FMUs) such
as clearing agencies that are determined to be, or are likely
to become, systemically important. Designated FMUs will be
subject to such additional risk management standards as may be
prescribed by the Federal Reserve Board, in consultation with
supervisory agencies like the Commission, as well as enhanced
examination and enforcement standards.
These new rules and standards are designed to help ensure
that risks at clearing agencies are properly managed. Our
ability to implement any such proposed rules or standards--as
well as implement other new initiatives and sustain our
oversight functions--depends heavily on adequate staffing and
resources.
Exchanges--Exchanges and similar trading platforms are
situated somewhat differently from clearing agencies with
respect to the risks they may pose. Structurally, the exchange
business in the United States is highly competitive and
interconnected. The vast majority of equity securities can
trade on multiple venues. As a result, if an exchange were to
fail, other exchanges would likely be available to pick up the
volume in securities previously traded in the failed exchange.
With respect to the relatively few equity securities that are
available to trade on only one exchange (for example, many
index options), the Commission has encouraged exchanges to
enter into reciprocal trading arrangements to enable those
securities to trade in other venues if the exchange trading
such a security were unable to trade following a disruption.
In addition, staff from the Division of Trading and
Market's Automation Review Policy program works regularly with
exchanges and certain other markets to review the capacity,
resiliency and security of their market-related systems. A
similar ``ARP'' program also is in place for clearing agencies.
Q.2. CEO to Median Worker Pay Disclosure--A provision I
successfully included in Dodd-Frank would require publicly
listed companies to disclose in their SEC filings the amount of
CEO pay, the median company worker pay at that company, and the
ratio of the two. Do you believe this information would be
useful for investors who want to know about a company's pay
practices and their effect on performance? Also for employees
or potential employees who want to know about their company's
pay practices relative to others in the industry?
A.2. As you know, we have a number of disclosure requirements
regarding executive compensation which have been updated from
time to time. Our rules do not currently require information of
the nature required by the provision I believe you were
referring to, Section 953(b) of the Dodd-Frank Act. Although
the Commission has not yet proposed a rule to implement Section
953(b), the staff currently is considering how this requirement
could be implemented in a manner consistent with the statutory
language. When we issue our proposed rule to implement this
provision, we expect to hear from issuers, investors and other
interested parties regarding the utility of the disclosure and
the costs of preparing it.
To facilitate public input on the Dodd-Frank Act, the
Commission has provided a series of e-mail links, organized by
topic, on its Web site at http://www.sec.gov/spotlight/
regreformcomments.shtml. The Commission already has received
many comments from the public on Section 953(b), available at
http://www.sec.gov/comments/df-title-ix/executive-compensation/
executive-compensation.shtml.
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RESPONSES TO WRITTEN QUESTIONS OF SENATOR TESTER
FROM MARY L. SCHAPIRO
Q.1. The Department of Labor recently announced new regulations
redefining fiduciary duty which would seem to have the
potential to undermine the thoughtful work that the SEC has
done to look at actually harmonizing standards of care for
different types of advisors. Have you been in conversations
with the Department of Labor on these issues or raised concerns
about potential inconsistencies and conflicts between your
efforts? Will the SEC take steps to address any further
inconsistency and uncertainty that could arise from the
Department of Labor's rulemaking for advisors?
A.1. The Commission and its staff are working hard to avoid
inconsistent regulatory standards among Government agencies. If
the Commission engages in rulemaking to address the
recommendations in its Dodd-Frank Act section 913 study to
implement a uniform fiduciary duty for broker-dealers and
investment advisers providing personalized investment advice
about securities to retail customers, we would do so in
consultation with the Department of Labor and other interested
regulators. In addition, since the Commission issued the
Section 913 study, Commission staff has received and reviewed
additional comments on the study and has continued to meet with
interested parties to discuss their reactions to it. As such,
the Commission's process leading up to any potential rulemaking
under Section 913 would take into account, with deliberation,
the views of all interested parties, and the potential impact
of such rules on the financial marketplace, as well as the
existing regulations and proposed actions of our fellow
regulators.
In addition, staff of the Department of Labor has consulted
with Commission staff regarding the Department of Labor's
proposed rulemaking on fiduciary status, and those discussions
and consultations are ongoing. Ultimately, however, the
definition of fiduciary under ERISA is for the Department of
Labor to decide.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARNER
FROM MARY L. SCHAPIRO
Q.1. For each of the witnesses, though the Office of Financial
Research does not have a Director, what are each of you doing
to assist OFR in harmonizing data collection, compatibility,
and analysis?
A.1. Over the past few months, Commission staff has
participated in the cross-agency meetings that Treasury has
organized related to OFR and data collection initiatives. The
staff also has worked on cataloguing existing Commission
databases and presented current and anticipated data
capabilities at such meetings, laying the foundations for
potential harmonization of data collection, compatibility, and
analysis. Commission staff also has worked directly with their
colleagues at the CFTC and staff at Treasury/OFR on harmonizing
published requirements for the production of legal entity
identifiers to be used by industry market participants that
identify counterparties to derivative transactions, with
potential applicability for the universal identification of all
legal entities engaging in financial transactions.
Q.2. Chairman Schapiro, can each of you explain what budget
cuts will mean for the ability of your agencies to ensure
markets are safe, protected from abuse, and don't create the
types of risks that nearly destroyed our economy?
A.2. For the first six and a half months of FY2011, the agency
already had curtailed its core program activities such as
technology, staff hiring, travel, and litigation support, to
name a few, to operate under its previous continuing resolution
level. Additionally, the SEC had begun to implement the Dodd-
Frank Act without additional funding, taking on significant new
rulemaking and other responsibilities almost entirely with
existing staff. This has taken staff time from base program
operations.
The SEC's budget for FY2011 contained within the broader
budget compromise would permit the SEC to continue reforms to
our operations and implement much-needed improvements to our
technology. However, if this budget were to be followed by
significant budget cuts, then such cuts would have a profound
impact on the SEC's ability to oversee the securities markets.
Depending on their magnitude, budget cuts could leave the SEC
further behind in its efforts to close the existing gap with
the rapidly growing markets. The SEC only now is returning to
the staffing levels of 2005, while during that time the
securities markets have grown significantly in size and
complexity. For example, in 2005, the SEC had 19 examiners for
each trillion dollars in investment advisor assets, and today
there are only 12 examiners per trillion dollars. Significant
budget cuts could also stymie efforts to modernize the SEC's
technology infrastructure, which continue to need significant
investments to improve risk assessment and operational
efficiency, support enforcement and examination processes, and
modernize EDGAR.
As you know, the SEC also has received sizable new
responsibilities in areas such as the oversight of the over-
the-counter derivatives market and hedge fund advisers;
registration of municipal advisors and security-based swap
market participants; enhanced supervision of nationally
recognized statistical rating organizations and clearing
agencies; heightened regulation of asset-backed securities; and
creation of a new whistleblower program. In acknowledgement of
this substantially increased workload, the Dodd-Frank Act
includes increased budget authorization levels for the SEC of
$1.3 billion in FY2011 and $1.5 billion in FY2012. If budget
cuts were enacted, then the SEC would be unable to add the
resources necessary to conduct enforcement, examine for
compliance, and analyze trends and risks in these new markets.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR MERKLEY
FROM MARY L. SCHAPIRO
Q.1. Repo and Prime Brokerage--During the financial crisis, the
instability of the triparty repurchase agreement (repo) markets
and prime brokerage relationships played critical roles in the
collapse of several major financial firms. As the quality of
the repo collateral began to decline and as both repo and prime
brokerage ``depositors'' began to doubt the stability of their
counterparties (because of the toxic positions in the trading
accounts of the counterparties), a classic bank run emerged,
only this time it was at the wholesale level. Please provide an
update on rulemaking and other policy changes designed to
reduce risks to our financial system in the repo markets and in
prime brokerage.
A.1. In the area of repos, the Commission is involved in a
number of initiatives that are designed to reduce risks to the
financial system. Commission staff has provided assistance to
the Tri-Party Repo Infrastructure Reform Task Force that was
formed at the request of the Federal Reserve Bank of New York
to address weaknesses that became visible over the course of
the 2008 financial crisis. This initiative is aimed at reducing
the intraday credit exposure of the clearing banks who act as
intermediaries in the triparty repo market, creating
efficiencies for both lenders and borrowers, and increasing
confidence in the use of this financing method. Further, in
connection with its ongoing monitoring of the risk management
processes of the largest broker-dealers, the Commission's staff
is focused on the potential liquidity needs of these firms in
times of market stress, as well as the adequacy of existing and
backstop liquidity arrangements.
In the prime brokerage area, the Commission is engaged in
additional initiatives designed to help reduce risks to the
financial system. Commission staff is undertaking a review of
prime brokerage margin practices at the largest broker-dealers.
This review is focused on the ability of the prime broker to
fund collateral in the repo market, and the prime broker's
reliance on that collateral to fund its business. It also
includes understanding the different collateral requirements
for liquid and illiquid assets, and reviewing the process for
entering into and managing margin agreements.
Finally, as you are aware, the Commission is no longer
engaged in consolidated supervision. The liquidity issues you
raise can impact an entire financial institution, however, and
the Commission coordinates regularly with the Federal Reserve
to facilitate cooperative approaches to addressing these
issues.
Q.2. Derivatives Oversight--Counterparty risk and other risks
associated with derivatives played a central role in the
financial crisis, especially in fueling the argument that firms
such as AIG were too big or too interconnected to fail. What
oversight systems do plan to have in place to ensure that any
accommodations made in the course of rulemaking for
nonfinancial commercial parties do not create holes in the
regulatory structure that permit the accumulation of hidden or
outsized risk to the U.S. financial system and economy.
A.2. The Dodd-Frank Act, through a variety of mechanisms,
provides regulators with authority to limit systemic risks
posed by activities of previously unregulated entities. In
particular, the Act provides the Commission, CFTC, and banking
regulators with authority to impose prudential limits on so-
called ``major security-based swap participants'' and ``major
swap participants''--a category that, broadly speaking, can
encompass otherwise unregulated entities that hold large
unhedged derivatives positions (such as AIG did). Such entities
would be subject to capital and margin requirements established
by regulators, which should help mitigate the accumulation of
hidden or outsized risks. The Commission and the CFTC proposed
joint rules last December to further define the scope of
entities that would fall under this regime, and I expect that
the Commission will propose rules in the near future concerning
the capital and margin requirements for major participants and
other intermediaries in the security-based swap market.
In addition, the Commission has proposed rules for the
reporting of security-based swap transactions to registered
data repositories, and the CFTC has proposed similar rules with
respect to the reporting of swap transactions. Assuming that
the agencies have adequate resources to analyze and monitor
this information, such reporting should increase the
transparency of these markets to regulators and help prevent
the accumulation of hidden risks.
Q.3. Derivatives Disclosure--One of the key exacerbating
factors in the financial crisis was that firms were hesitant to
do business with one another because they feared a potential
counterparty may be unable to fulfill its obligations. In
particular, they feared that their potential counterparty might
be financially constrained by liabilities from undisclosed and/
or uncleared derivatives transactions. Similarly, as the
bankruptcy examiner of Lehman Brothers reported, investors and
regulators are often also similarly unaware of the risks from
firms' derivatives positions.
Given what we have seen, do you believe that public
disclosure to shareholders and other market participants
regarding a company's derivatives positions should be improved?
If so, how do you plan to incorporate in that enhanced
disclosure regime the theme from the Dodd-Frank Act that
uncleared derivatives should be subject to additional
obligations?
A.3. Clear and transparent disclosure is critically important
to an investor's understanding of a company's financial
position. In this regard, we have a number of requirements in
our rules designed to elicit disclosure about a company's
ability to fulfill its commitments and obligations. For
example, Item 303 of Regulation S-K requires a company to
discuss, in its Management's Discussion and Analysis, any known
trends, demands, commitments, events or uncertainties it
reasonably expects to have a material favorable or unfavorable
impact on its results of operations, liquidity, and capital
resources. In effect, we require companies to allow investors
to see the company ``though the eyes of management.'' The rule
also requires a company to disclose its contractual obligations
in tabular format. In addition, Item 303 requires a company to
disclose off-balance sheet arrangements that have, or are
reasonably likely to have, a current or future effect on the
company's financial condition, revenues or expenses, results of
operations, liquidity, and capital expenditures. In doing so, a
company must disclose information necessary to an understanding
of the arrangements, including information about the nature and
business purpose of the arrangement and the importance of the
arrangement to the company. Additionally, Item 305 of
Regulation S-K requires a company to provide qualitative and
quantitative information about market risk.
In addition to these SEC rules, U.S. GAAP requires
extensive disclosures about a company's derivatives portfolio.
For example, companies must provide disclosures about:
how and why an entity uses derivative instruments;
how derivative instruments and related hedged items
are accounted for; and
how derivative instruments and related hedged items
affect an entity's financial position, financial
performance, and cash flows.
The disclosures provided are distinguished by derivative
instruments that are used for risk management purposes and
derivative instruments that are used for other purposes.
Information also is separately disclosed in the context of each
instrument's primary risk exposure, such as interest rate,
credit, foreign exchange, and overall price risk. While we
believe companies generally understand and comply with these
requirements, we will continue to monitor this area and
consider whether additional guidance is necessary, particularly
as we see how changes to the derivatives regulatory structure
may affect reporting companies.
Q.4. Markets Oversight--As you may know, Korean securities
regulators recently imposed a six month ban on a large European
bank from engaging in proprietary trading in Korean markets
after it came to light that the bank manipulated the Seoul
stock market. With the proposed acquisition of the New York
Stock Exchange by a European borse, markets are becoming more
international and interconnected than ever before. Do you feel
you have the tools you need to monitor trading across multiple
markets and across multiple products? If not, what steps do you
need to take and what additional tools do you need from
Congress to assist you in accomplishing your critical mission
of ensuring our markets operate with integrity?
A.4. Commission staff currently has access to a limited set of
tools to monitor trading in the United States, including the
ability to obtain and utilize information about trading from
the audit trails of the exchanges and FINRA. However, these
audit trails are limited in their scope, required data
elements, and format. Accordingly, the Commission proposed in
May 2010 to require the exchanges and FINRA to create and
implement a consolidated audit trail that captures customer and
order event information for all equities and options orders
across all markets--from the time of order inception through
routing, cancellation, modification, or execution. This
consolidated audit trail would create a single, comprehensive,
and readily accessible database of information about orders and
executions in the United States for regulators. If adopted, I
believe the consolidated audit trail would become a critical
tool and a significant first step toward more effectively
detecting and deterring illegal trading.
However, as you note, securities markets are becoming more
international and interconnected than ever before. To address
the issues arising from cross-border securities transactions,
the Commission pursues international regulatory and enforcement
cooperation, promotes the adoption of high regulatory standards
worldwide, and formulates technical assistance programs to
strengthen the regulatory infrastructure in global securities
markets. The Commission also works within our global network of
securities regulators and law enforcement authorities to
facilitate cross-border regulatory compliance and to ensure
that international borders are not used to escape detection and
prosecution of fraudulent securities activities.
In terms of Congressional support, the SEC is at an
especially critical juncture in its history. Not only does the
Dodd-Frank Act create significant additional work for the SEC,
both in the short and long term, but the agency also must
continue to carry out its longstanding core responsibilities to
prevent securities fraud, review public company disclosures and
financial statements, inspect the activities of investment
advisers and broker-dealers, and ensure fair and efficient
markets. The Commission must have adequate resources so that it
can fulfill these responsibilities and promote investor
confidence and trust in our financial institutions and markets.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO
FROM MARY L. SCHAPIRO
Q.1. SEC Commissioners Kathleen Casey and Troy Paredes issued a
statement calling for more rigorous analysis on the SEC staff
study on Investment Advisers and Broker-dealers required by
Dodd-Frank. The two commissioners stated: ``Indeed, the Study
does not identify whether retail investors are systematically
being harmed or disadvantaged under one regulatory regime as
compared to the other and, therefore, the Study lacks a basis
to reasonably conclude that uniform standard or harmonization
would enhance investor protection.'' Do you intend to gather
this type of economic analysis so that these kinds of questions
can be answered before proposing any new rule?
A.1. In the study required by Section 913 of the Dodd-Frank
Act, Commission staff recommended implementing a uniform
fiduciary standard that would accommodate different existing
business models and fee structures, preserve investor choice,
and not decrease investors' access to existing products,
services, or service providers. In preparing the study, the
staff considered the comment letters received in response to
the Commission's solicitation of comment and considered the
potential costs and other burdens associated with implementing
the recommended fiduciary standard. We will continue to be
mindful of the potential economic impact going forward. In
light of this ongoing focus, I have asked a core team of
economists from the Commission's Division of Risk, Strategy and
Financial Innovation (Risk Fin) to study, among other things,
data pertaining to the standards of conduct in place under the
existing broker-dealer and investment adviser regulatory
regimes to further inform the Commission.
Ultimately, if the Commission does engage in rulemaking
under Section 913, as with any proposed rulemaking, the
Commission would conduct an economic analysis regarding the
impact of any proposed rules. Such analysis would include the
views of Risk Fin, which has broad experience analyzing
economic and empirical data. The Commission would then consider
public comment on any such proposal, including public comment
on the Commission's analysis of costs and benefits. Any final
rulemaking would also take into account not only the views of
all interested parties, but also the potential impact of such
rules on the financial marketplace, including the impact on
retail investors and the advice they receive from financial
professionals.
Q.2. I understand that you and your staff are working very hard
and talking to each other during the proposal stage, but from
the outside it looks like too often the agencies are proposing
inconsistent approaches to the same rule sets. For instance, on
the Swap Execution Facility rules, the SEC seems to be taking a
more flexible approach relative to what you've developed. And
their approach seems to be more consistent with what the
Europeans are looking at so it will minimize the risk of
regulatory arbitrage. Rather than one agency jumping out in
front of the other agency the point of coordination should be
to propose consistent approaches to the same rule sets. How do
you intend to achieve great harmonization, timing, minimize
inconsistent rules and avoid regulatory arbitrage--specifically
with respect to the SEF?
A.2. Since the Dodd-Frank Act was passed last July, the
Commission staff has been engaged in ongoing discussions with
CFTC staff regarding our respective approaches to implementing
the statutory provisions for SEFs and security-based SEFs. In
many cases, these discussions have led to a common approach--
for example, both proposals have similar registration programs,
as well as similar filing processes for rule changes and new
products. As you note, however, there are differences in
certain areas, such as the treatment of requests for quotes,
block trades, and voice brokerage.
Our proposal reflects the Commission's preliminary views as
to how the Dodd-Frank Act would best be applied to the trading
of security-based swaps, which differ in certain ways from the
swaps that will be regulated by the CFTC. We look forward to
input from the public as to whether these differences are
adequately supported by functional distinctions in the trading
and liquidity characteristics of swaps and security-based
swaps, as well as comments as to how the agencies' rules may be
further harmonized. Based on this feedback, we plan to work
with the CFTC to achieve greater harmonization of the rules for
SEFs and security-based SEFs to the extent practicable.
Throughout this process, we are particularly mindful of the
potential burdens on entities that will be dually registered
with the Commission and the CFTC. To this end, we have
specifically requested comment in our proposal on the impact of
the overall regulatory regime for such registrants, such as
areas where differences in the Commission and the CFTC
approaches may be particularly burdensome. We are also
sensitive to the opportunity for regulatory arbitrage with
respect to non-U.S. markets, and my staff has been working
closely with their international colleagues to find common
ground with respect to the regulation of SEFs. We expect to
benefit from significant public input on both of these issues,
and we will carefully consider such input in crafting our final
rule.
Q.3. Dodd-Frank requires that risk retention be jointly
considered by the regulators for each different type of asset
and includes a specific statutory mandate related to any
potential reforms of the commercial mortgage-backed securities
to limit disruptions. Given the importance of rigorous cost-
benefit and economic impact analyses and the need for due
consideration of public comments, do your agencies need more
time than is provided by the looming April deadline?
A.3. As you note, the statute is fairly complex. The staff of
the agencies have worked together to develop a joint
recommendation, meeting multiple times a week for many months
in order to consider all the various issues and implications.
The agencies proposed rules at the end of March and the comment
period will close on June 10, 2011. The staff of the agencies
will then begin another deliberative process to consider the
comments received and to work to a consensus recommendation for
adoption of final rules. I recognize the importance of getting
these rules right and expect that we will take the time needed
to do that.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER
FROM MARY L. SCHAPIRO
Q.1. In 2010 the SEC issued proposed revisions to Regulation AB
(asset backed) that had several requirements that could impact
regulations required in Dodd-Frank. Are those regulations on
hold?
A.1. The April 2010 ABS proposals sought to address a number of
issues, some of which were subsequently referenced in the Dodd-
Frank Act, but others that were not.
Issues addressed in the ABS proposals also referenced in
the Dodd-Frank Act include:
repealing the current credit rating references in
shelf eligibility criteria for asset-backed issuers and
establishing new shelf eligibility criteria, including
a requirement that the sponsor of a shelf-eligible
offering retain five percent of the risk; and
requiring that, with some exceptions, prospectuses
for public offerings of ABS and ongoing Exchange Act
reports contain specified asset-level information
(i.e., loan level data) about each asset in the pool.
Under the Commission's proposal, the asset-level
information would be provided according to proposed
standards and in a tagged data format using eXtensible
Markup Language, or XML.
Issues addressed in the ABS proposals not referenced in the
Dodd-Frank Act include:
revising filing deadlines for ABS offerings to
provide investors with more time to consider
transaction-specific information, including information
about the pool assets;
requiring the filing of a computer program of the
contractual cash flow (i.e., the ``waterfall'')
provisions along with any prospectus filing; and
new information requirements for the safe harbors
for exempt offerings and resales of asset-backed
securities.
The staff of our Division of Corporation Finance is
reviewing all of the comments received on the April 2010 ABS
proposals and is in the process of developing recommendations
for the Commission. Those recommendations will necessarily take
into consideration the ABS provisions in Dodd-Frank.
Q.2. Will you commit to having your staff brief this committee
prior to issuing Regulation AB?
A.2. Yes. I would be happy to have our staff brief the
committee on the proposal, the comments we receive, and the
possible approaches to addressing the outstanding issues.
------
RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN JOHNSON
FROM GARY GENSLER
Q.1. Recently, some have voiced concerns that the timeframe for
the rulemakings required by the Dodd-Frank Wall Street Reform
and Consumer Protection Act (Dodd-Frank) is too short to allow
for adequate consideration of the various comments submitted or
to review how the new rules may impact our financial markets.
Does the current timeframe established by Dodd-Frank allow each
rulemaking to be completed in a thoughtful and deliberative
manner?
A.1. The Dodd-Frank Act has a deadline of 360 days after
enactment for completion of the bulk of our rulemakings--July
16, 2011. Both the Dodd-Frank Act and the Commodity Exchange
Act (CEA) give the CFTC the flexibility and authority to
address the issues relating to the effective dates of Title
VII. We have coordinated closely with the SEC on these issues
and issued a proposed order on June 14 to provide clarity.
First, a substantial portion of provisions only go into
effect once we finalize our rules and based on any
implementation phasing that we set.
Second, for many provisions that are not dependent upon a
final rule or are self-executing, we proposed exemptive relief
until no later than December 31, 2011.
This will provide relief for most of Title VII. We look
forward to hearing from the public and finalizing this
exemptive relief before July 16.
Q.2. In carrying out the required rulemaking under Title VII,
the SEC and the CFTC are instructed under Dodd-Frank to ``treat
functionally or economically similar products or entities . . .
in a similar manner.'' However, some of the rules defining the
key infrastructure for the new derivatives regime that have
been proposed by the SEC and CFTC contain some significant and
important differences, as is demonstrated by the different
definitions for rules governing Swap Execution Facilities. How
do your two agencies plan to reconcile these differences before
the final rules are adopted later this year?
A.2. The CFTC and SEC consult and coordinate extensively to
harmonize our rules to the greatest extent possible. These
continuing efforts began with the enactment of the Dodd-Frank
Act. This close coordination will benefit the rulemaking
process.
With regard to the SEF rulemakings, the CFTC's proposed
rule will provide all market participants with the ability to
execute or trade with other market participants. It will afford
market participants with the ability to make firm bids or
offers to all other market participants. It also will allow
them to make indications of interest--or what is often referred
to as ``indicative quotes''--to other participants.
Furthermore, it will allow participants to request quotes from
other market participants. These methods will provide hedgers,
investors, and Main Street businesses the flexibility to trade
using a number of methods, but also the benefits of
transparency and more market competition. The proposed rule's
approach is designed to implement Congress' mandates for a
competitive and transparent price discovery process.
The proposal also allows participants to issue requests for
quotes, with requests distributed to a minimum number of other
market participants. It also allows that, for block
transactions, swap transactions involving nonfinancial end-
users, swaps that are not ``made available for trading'' and
bilateral transactions, market participants can get the
benefits of the swap execution facilities' greater transparency
or, if they wish, could be executed by voice or other means of
trading.
In the futures world, the law and historical precedent is
that all transactions are conducted on exchanges, yet in the
swaps world many contracts are transacted bilaterally. While
the CFTC will continue to coordinate with the SEC to harmonize
approaches, the CFTC also will consider matters associated with
regulatory arbitrage between futures and swaps. The Commission
has received public comments on its SEF rule and will move
forward to consider a final rule only after staff has had the
opportunity to summarize them for consideration and after
Commissioners are able to discuss them and provide feedback to
staff.
Q.3. Please identify the key trends in the derivatives market
that your agencies are currently monitoring to ensure systemic
stability.
A.3. The Dodd-Frank Act lowers risk in the swaps marketplace by
directly regulating dealers for their swaps activities and by
moving standardized swaps into central clearing. The Act also
brings transparency to the swaps marketplace. The more
transparent a marketplace is the more liquid it is, the more
competitive it is and the lower costs will be for hedgers,
borrowers, and their customers. Increased transparency also
lowers risk by improving the reliability of the valuations of
open positions. With more swaps being cleared through
derivatives clearing organizations regulated by the CFTC, the
Commission also is working to ensure that clearinghouses have
robust risk management standards.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR SHELBY
FROM GARY GENSLER
Q.1. The Dodd-Frank Act requires an unprecedented number of
rulemakings over a short period of time. As a result, some
deadlines have already been missed and some agencies expect to
miss additional deadlines. It appears that many of the
deadlines in Dodd-Frank are not realistic. Which Dodd-Frank
deadlines do you anticipate not being able to meet? If Congress
extended the deadlines, would you object? If your answer is
yes, will you commit to meeting all of the statutory deadlines?
If Congress affords additional time for rulemaking under the
Dodd-Frank Act, will you be able to produce higher-quality,
better coordinated rules?
A.1. The Dodd-Frank Act has a deadline of 360 days after
enactment for completion of the bulk of our rulemakings--July
16, 2011. Both the Dodd-Frank Act and the Commodity Exchange
Act (CEA) give the CFTC the flexibility and authority to
address the issues relating to the effective dates of Title
VII. The CFTC has coordinated closely with the SEC on these
issues.
Section 754 of the Dodd-Frank Act states that Subtitle A of
Title VII--the Subtitle that provides for the regulation of
swaps--``shall take effect on the later of 360 days after the
date of the enactment of this subtitle or, to the extent a
provision of this subtitle requires a rulemaking, not less than
60 days after publication of the final rule or regulation
implementing such provisions of this subtitle.''
Thus, those provisions that require rulemakings will not go
into effect until the CFTC finalizes the respective rules. This
is a substantial portion of the derivatives provisions under
Dodd-Frank. Furthermore, they will only go into effect based on
the phased implementation dates included in the final rules.
The CFTC has posted a list of the provisions of the swaps
subtitle that require rulemakings to the agency's Web site.
There are other provisions of Title VII that do not require
rulemaking and will take effect on July 16. On June 14, 2011,
the CFTC issued a proposed order that would provide relief
until December 31, 2011, or when the definitional rulemakings
become effective, whichever is sooner, from certain provisions
that would otherwise apply to swaps or swap dealers on July 16.
This includes provisions that do not directly rely on a rule to
be promulgated, but do refer to terms that must be further
defined by the CFTC and SEC, such as ``swap'' and ``swap
dealer.''
The proposed order also would provide relief through no
later than December 31, 2011, from certain CEA requirements
that may result from the repeal, effective on July 16, 2011, of
some of sections 2(d), 2(e), 2(g), 2(h), and 5d. The proposed
order was published with a 14-day public comment period.
The CFTC will begin considering final rules only after
staff can analyze, summarize and consider public comments,
after the Commissioners are able to discuss the comments and
provide direction to staff, and after we consult with fellow
regulators on the rules.
Q.2. Secretary Geithner recently talked about the difficulty of
designating nonbank financial institutions as systemic. He
said, ``it depends too much on the state of the world at the
time. You won't be able to make a judgment about what's
systemic and what's not until you know the nature of the
shock.'' \1\ If it is impossible to know which firms are
systemic until a crisis occurs, the Financial Stability
Oversight Council will have a very difficult time objectively
selecting systemic banks and nonbanks for heightened
regulation. As a member of the Council, do you believe that
firms can be designated ex ante as systemic in a manner that is
not arbitrary? If your answer is yes, please explain how.
---------------------------------------------------------------------------
\1\ See, Special Inspector General for the Troubled Asset Relief
Program, ``Extraordinary Assistance Provided to Citigroup, Inc.''
(SIGTARP 11-002) (Jan. 13, 2011) (available at: http://www.sigtarp.gov/
reports/audit/2011/
Extraordinary%20Financial%20Assistance%20Provided%20to%20Citigroup,%20In
c.pdf), at 43.
A.2. The FSOC's proposed rulemaking on Authority to Require
Supervision of Certain Nonbank Financial Companies would
fulfill Congress' mandate by laying out a set of designation
criteria that the Council would use to determine whether
nonbank financial companies are systemically significant.
Effective regulation of systemically important nonbank
financial entities is essential to preventing the next AIG from
threatening the financial system.
The Dodd-Frank Act includes a specific list of factors to
consider in the designation process. These include: the extent
of the leverage of the company; the extent and nature of the
off balance sheet exposures of the company; transactions and
relationships of the company with other significant nonbank
financial companies and significant bank holding companies; the
extent to which assets are managed rather than owned by the
company; the extent to which ownership of assets under
management is diffuse; and other factors. I look forward to
working with fellow Council members to ensure that designations
are made according to these criteria and not arbitrarily.
Q.3. Section 112 of the Dodd-Frank Act requires the Financial
Stability Oversight Council to annually report to Congress on
the Council's activities and determinations, significant
financial market and regulatory developments, and emerging
threats to the financial stability of the United States. Each
voting member of the Council must submit a signed statement to
the Congress affirming that such member believes the Council,
the Government, and the private sector are taking all
reasonable steps to ensure financial stability and mitigate
systemic risk. Alternatively, the voting member shall submit a
dissenting statement. When does the Council expect to supply
the initial report to Congress?
A.3. The Council is expected to deliver the report sometime
later this year.
Q.4. Which provisions of Dodd-Frank create the most incentives
for market participants to conduct business activities outside
the United States? Have you done any empirical analysis on
whether Dodd-Frank will impact the competitiveness of U.S.
financial markets? If so, please provide that analysis.
A.4. As we work to implement the derivatives reforms in the
Dodd-Frank Act, we are actively coordinating with international
regulators to promote robust and consistent standards and avoid
conflicting requirements in swaps oversight. The Commission
participates in numerous international working groups regarding
swaps, including the International Organization of Securities
Commissions Task Force on OTC Derivatives, which the CFTC
cochairs with the Securities and Exchange Commission (SEC). The
CFTC, SEC, European Commission, and European Securities Market
Authority are coordinating through a technical working group.
The Dodd-Frank Act recognizes that the swaps market is
global and interconnected. It gives the CFTC the flexibility to
recognize foreign regulatory frameworks that are comprehensive
and comparable to U.S. oversight of the swaps markets in
certain areas. In addition, we have a long history of
recognition regarding foreign participants that are comparably
regulated by a home country regulator. The CFTC enters into
arrangements with international counterparts for access to
information and cooperative oversight. The Commission has
signed memoranda of understanding with regulators in Europe,
North America, and Asia.
Q.5. More than 6 months have passed since the passage of the
Dodd-Frank Act, and you are deeply involved in implementing the
Act's approximately 2,400 pages. Which provisions of the Dodd-
Frank Act are proving particularly difficult to implement? Have
you discovered any technical or substantive errors in the Dodd-
Frank legislation? If so, please describe them.
A.5. The CFTC is working deliberatively, efficiently, and
transparently to write rules to implement the Dodd-Frank Act.
At this point, the Commission has substantially completed the
proposal phase of rule writing. The public has had an
opportunity to comment on the entire mosaic of proposed rules
in a supplemental comment period of 30 days, which closed on
June 3.
We will begin considering final rules only after staff can
analyze, summarize, and consider comments, after the
Commissioners are able to discuss the comments and provide
feedback to staff, and after the Commission consults with
fellow regulators on the rules.
The Commission has scheduled public meetings in July,
August, and September to begin considering final rules under
Dodd-Frank. We envision having more meetings into the fall to
take up final rules.
Q.6. What steps are you taking to understand the impact that
your agency's rules under Dodd-Frank will have on the U.S.
economy and its competitiveness? What are the key ways in which
you anticipate that requirements under the Dodd-Frank Act will
affect the U.S. economy and its competitiveness? What are your
estimates of the effect that the Dodd-Frank Act requirements
will have on the jobless rate in the United States?
A.6. The 2008 financial crisis was very real. Millions more
Americans are out of work today than if not for the financial
crisis. Millions of homeowners now have homes worth less than
their mortgages. Millions of people have had to dig into their
savings; millions more haven't seen their investments regain
the value they had before the crisis. There remains significant
uncertainty in the economy.
Though there were many causes to the crisis, it is clear
that swaps played a central role. They added leverage to the
financial system with more risk being backed up by less
capital. They contributed, particularly through credit default
swaps, to the bubble in the housing market and helped to
accelerate the financial crisis. They contributed to a system
where large financial institutions were thought to be not only
too big to fail, but too interconnected to fail. Swaps--
initially developed to help manage and lower risk--actually
concentrated and heightened risk in the economy and to the
public.
The Dodd-Frank Act's derivatives reforms will increase
transparency, lower risk, and promote integrity in the swaps
markets. This will benefit derivatives users and the broader
economy.
Q.7. What steps are you taking to assess the aggregate costs of
compliance with each Dodd-Frank rulemaking? What steps are you
taking to assess the aggregate costs of compliance with all
Dodd-Frank rulemakings, which may be greater than the sum of
all of the individual rules' compliance costs? Please describe
all relevant reports or studies you have undertaken to quantify
compliance costs for each rule you have proposed or adopted.
Please provide an aggregate estimate of the compliance costs of
the Dodd-Frank rules that you have proposed or adopted to date.
A.7. The CFTC strives to include well-developed considerations
of costs and benefits in each of its proposed rulemakings.
Relevant considerations are presented not only in the cost-
benefit analysis section of the CFTC's rulemaking releases, but
also throughout the releases.
In addition, Commissioners and staff have met extensively
with market participants and other interested members of the
public to hear, consider and address their concerns regarding
each rulemaking. CFTC staff hosted a number of public
roundtables so that rules could be proposed in line with
industry practices and address compliance costs consistent with
the Dodd-Frank Act's regulatory requirements. Information about
each of these meetings, as well as full transcripts of the
roundtables, is available on the CFTC's Web site and has been
factored into each applicable rulemaking.
With each proposed rule, the Commission has sought public
comment regarding costs and benefits to better inform the
rulemaking process.
Q.8. Section 115 of the Dodd-Frank Act asks the Financial
Stability Oversight Council to make recommendations to the
Federal Reserve on establishing more stringent capital
standards for large financial institutions. In addition,
Section 165 requires the Fed to adopt more stringent standards
for large financial institutions relative to smaller financial
institutions. Chairman Bernanke's testimony for this hearing
implied that the Basel III framework satisfies the Fed's
obligation to impose more stringent capital on large financial
institutions. As a member of the Financial Stability Oversight
Council, do you agree with Chairman Bernanke that the Basel III
standards are sufficient to meet the Dodd-Frank Act requirement
for more stringent capital standards? Please explain the basis
for your answer.
A.8. On January 19, 2011, the Council issued a notice of
proposed rulemaking concerning the criteria that will inform,
and the processes and procedures established under the Dodd-
Frank Act for, the Council's designation of nonbank financial
companies that may be subject to more stringent capital
standards pursuant to Section 165. FSOC staff currently is
summarizing comments concerning that notice of proposed
rulemaking, and I look forward to reviewing the comments that
are submitted.
Q.9. The Fed, the SEC, the FDIC, and the CFTC are all
structured as boards or commissions. This means that before
they can implement a rule they must obtain the support of a
majority of their board members. How has your board or
commission functioned as you have been tackling the difficult
job of implementing Dodd-Frank? Have you found that the other
members of your board or commission have made positive
contributions to the process?
A.9. Each of the CFTC's commissioners, as well as their staffs,
has put in a great deal of hard work to implement the Dodd-
Frank Act. I believe that our rules, the markets and the
American public benefit from the CFTC's collaborative and
inclusive process of writing rules to oversee the swaps
markets.
Q.10. The SEC and CFTC are both spending many resources on
writing rules and initiating the oversight programs for over-
the-counter derivatives. These parallel efforts are in many
respects redundant, costly, and potentially damaging to the
market. Would a combined SEC-CFTC unit to deal with swaps and
security-based swaps reduce implementation costs, eliminate the
redundancy of having two sets of rules, and provide for a more
certain and effective regulatory regime?
A.10. The CFTC and the SEC are coordinating closely in writing
rules to implement the derivatives provisions of the Dodd-Frank
Act. We have jointly proposed rulemakings and coordinated and
consulted on each of the other rulemakings. This includes
sharing many of our memos, term sheets and draft work product.
This close working relationship has benefited the rulemaking
process.
Q.11. Title VIII of Dodd-Frank deals with more than
systemically important financial market utilities. Under Title
VIII, the SEC and CFTC are authorized to prescribe and enforce
regulations containing risk management standards for financial
institutions engaged in payment, clearance, and settlement
activities designated by the Financial Stability Oversight
Council as systemically important. Should the Council designate
any activities under Title VIII? If the Council designates any
activities as systemically important, what are the limits to
your authority under Title VIII with respect to your regulated
entities that engage in designated activities? What specific
actions are beyond the authority of the CFTC and SEC?
A.11. The CFTC has proposed several rules relating to clearing
organizations. One proposed rule regarding financial resources
for derivatives clearing organizations (DCOs) is an important
first step in fulfilling the requirements of the Dodd-Frank Act
to have robust oversight and risk management of clearinghouses.
The proposed rulemaking will reduce the potential for systemic
risk in the financial markets. The CFTC consulted with the
Securities and Exchange Commission (SEC) and the Federal
Reserve Board on this proposed rule. The Commission also has
worked to ensure that these proposed financial resource rules
are consistent with international standards in the newest draft
CPSS-IOSCO standards.
The Commission also has proposed regulations related to
compliance with DCO core principles regarding participant and
product eligibility, risk management, settlement procedures,
treatment of funds, default rules and procedures, and system
safeguards.
For DCOs that are designated by the FSOC as systemically
important DCOs (SIDCOs), the Commission proposed heightened
standards in the area of system safeguards supporting business
continuity and disaster recovery and a provision that would
implement the Commission's special enforcement authority over
SIDCOs.
Q.12. One of the purposes of joint rulemaking was to bring the
best minds of both agencies together to design a uniform
regulatory approach for OTC derivatives. In one recent joint
proposal, the SEC and CFTC took two different approaches to
further defining ``swap dealer'' and ``security-based swap
dealer.'' Specifically, the release applied the dealertrader
distinction that has been used to interpret the term ``dealer''
under the 1934 Act only to security-based swap dealers, not to
swap dealers. Does this violate the Dodd-Frank mandate that you
work together?
A.12. The Dodd-Frank Act provides that in adopting rules, the
CFTC and SEC shall treat functionally or economically similar
products or entities in a similar manner, but are not required
to treat them in an identical manner. In December 2010, the
CFTC and the SEC jointly issued a proposed rulemaking to
further define the terms ``swap dealer'' and ``security-based
swap dealer.'' Under the joint proposal, the CFTC and the SEC
recognize that the principles relevant to identifying dealing
activity involving swaps can differ from comparable principles
associated with security-based swaps. ``These differences are
due, in part, to differences in how those instruments are used.
For example, because security-based swaps may be used to hedge
or gain economic exposure to underlying securities, there is a
basis to build upon the same principles that are presently used
to identify dealers for other types of securities.''
Because security-based swaps are related to securities, the
CFTC and SEC joint reflects the understanding that the dealer-
trader distinction (which refers to the SEC's interpretation of
aspects of the Securities Exchange Act of 1934) is ``an
important analytical tool to assist in determining whether a
person is a `security-based swap dealer.' '' Swaps, unlike
security-based swaps, are related to financial and nonfinancial
commodities such as interest rates, currencies and
agricultural, energy, and metals commodities.
The joint proposed rule also reflects the understanding
that it would not necessarily be appropriate to use principles
developed to determine if a person is a securities dealer to
determine if a person is a dealer in commodity swaps. The
proposal requested comment on this interpretive approach. The
use of the dealer-trader distinction will be addressed in the
final rules relating to the swap dealer and security-based swap
dealer definitions, after taking the comments into account.
Q.13. One of the concerns of foreign regulators and foreign
market participants is a lack of clarity about the application
of your derivatives regulation. What are the limits of your
ability to regulate foreign swap participants and foreign
transactions in the swap market? Do you think that the CFTC and
SEC should define the bounds of their regulatory authority in a
formal rulemaking? If not, why not?
A.13. The derivatives provisions of the Dodd-Frank Act apply to
activities outside the U.S. if they have a ``direct and
significant connection with activities, or effect on,
commerce'' of the U.S. or contravene regulations the Commission
may promulgate as necessary to prevent evasion of the Act. In
particular proposed rules, the Commission provided guidance
with respect to treatment of activities outside of the United
States and sought public comment.
Q.14. In your written testimony, you noted that you ``are
working very closely with the SEC, the Federal Reserve, the
FDIC, the OCC, and other prudential regulators, which includes
sharing many of our memos, term sheets and draft work
product.'' Please give a specific example in which the CFTC has
changed its regulatory approach in response to input from each
of these agencies.
A.14. The CFTC's 31 Dodd-Frank staff rulemaking teams and the
Commissioners are all working closely with fellow regulators.
It is difficult to provide discrete examples of changes in this
regard because the effort has been so closely integrated on
each of the more than 50 proposed rules promulgated by the
Commission. CFTC staff have had more than 600 meetings with
their counterparts at other agencies and have hosted numerous
public roundtables with staff from other regulators to benefit
from the open exchange of ideas. Commission staff will continue
to engage with their colleagues at the other agencies as we
proceed to develop and consider final rules.
Q.15. The CFTC's proposals are routinely focused more on
highlighting anticipated societal benefits than rigorously
assessing potential compliance costs to market participants.
For example, in a recent proposal with respect to risk
management requirements for derivatives clearing organizations,
the CFTC estimated that it would cost DCOs $500 a year to
comply with these new requirements. It is hard to understand
how a DCO could ``maintain records of all activities related to
its business as a DCO'' for a mere $500 a year, even at the
bargain $10 hourly rate estimated by the CFTC. The CFTC,
however, concluded that even the $500 estimate might be too
high; it opined that ``the actual costs to many DCOs may be far
less'' than the CFTC's $500 estimate. Please explain how this
is a credible estimate and describe the basis for the estimate.
A.15. The proposed rule regarding risk management requirements
for DCOs specifically identified the record-keeping costs
associated with one discrete, new reporting requirement to be
$500 annually. This estimate references the same figure
estimated under Paperwork Reduction Act (PRA) computations. As
noted in the proposal, the $500 figure was not intended to be
an estimate of the total costs associated with compliance with
all the proposed risk management rules. Rather, the PRA costs
are a subset of overall costs. The Commission noted that the
estimate may be less because DCOs already may have in place
certain record-keeping procedures that would meet the proposed
requirements. In addition, public comment was specifically
requested with respect to costs and benefits to be considered
in connection with the proposed rule.
Q.16. The CFTC recently filled its Chief Economist position,
which had remained vacant for several months. Please describe
the Chief Economist's experience in conducting cost-benefit
analyses and the role that experience played in his being
selected for the position. During the time when the CFTC Chief
Economist position remained unfilled, how many regulatory
actions did the CFTC undertake without the benefit of a Chief
Economist to direct the required cost-benefit analyses? During
the time when the CFTC Chief Economist position was unfilled,
how many enforcement actions did the CFTC undertake without the
benefit of a Chief Economist to direct analytic support, such
as calculations of ill-gotten gains and investor harm? How has
the quality of regulatory cost-benefit analysis improved since
the hiring of a new Chief Economist? Please provide specific
examples. Given that much of the cost-benefit work is done by
members of the rulemaking teams, please describe the cost-
benefit analysis qualifications of the relevant staff members
charged with conducting cost-benefit analyses with respect to
the Dodd-Frank rulemakings.
A.16. On December 21, 2010, the CFTC announced the appointment
of Dr. Andrei Kirilenko as the Chief Economist. The Office of
the Chief Economist (OCE) is responsible for providing expert
economic advice to the Commission. Its functions include policy
analysis, economic research, expert testimony, education, and
training.
Dr. Kirilenko has been with the CFTC since 2008. Prior to
his appointment Dr. Kirilenko provided expert economic advice
to Commission staff working on rulemakings, including with
regard to cost-benefit analysis.
Prior to Dr. Kirilenko's appointment as Chief Economist,
the Acting Chief Economist was Dr. James Moser, the Deputy
Chief Economist, who ensured the continuing functioning of the
office. Dr. Moser's career has included work at the Federal
Reserve Bank of Chicago, the Chicago Mercantile Exchange and in
academia.
OCE staff economists play an integral role in the cost and
benefit considerations as well as other aspects of agency
rulemakings. OCE staff consists of both Ph.D. and pre-Ph.D.
economists trained in conducting policy analysis, economic
research, expert testimony, education, and training.
Q.17. Commissioner O'Malia issued a dissenting statement on the
President's budget request for the CFTC. Among other things, he
objected that the ``budget fails to outline a specific strategy
for implementation of the Dodd-Frank Act that utilizes
technology as a means to leverage budgetary and staff resources
in fulfilling the Commission's oversight and surveillance
responsibilities.'' Please explain how you are using technology
to reduce the number of full time employees that the CFTC
needs.
A.17. The CFTC's FY2012 budget request includes $66 million for
technology and allocates $25 million for Dodd-Frank
implementation. For pre-Dodd-Frank information technology
requirements, the Commission's FY2012 information technology
budget request would allow the Commission to continue its focus
on enhancing the Commission's technology to keep pace with the
futures marketplace by implementing:
Automated surveillance of the futures markets
through the development of trade practice and market
surveillance alerts,
The capability to create ownership and control
linkages between trading activity and aggregated
positions,
Computer forensics capability in support of
enforcement investigations,
Security controls to ensure continued compliance
with National Institute of Standards and Technology
(NIST) and Federal Information Security Management Act
(FISMA) requirements, and
Human resources systems to improve upon our
antiquated systems that have been unable to effectively
support recent FTE growth.
The Dodd-Frank Act for the first time sets up a new
registration category for swap data repositories. The bill
requires registrants--including swap dealers, major swap
participants, SEFs, and DCMs--to have robust record keeping and
reporting, including an audit trail, for swaps. The resources
requested will ensure that the Commission is able to integrate
its systems with swap repositories that are being established
in the United States and internationally. The Commission's
capacity to study and respond to ordinary trading practices or
technological trading innovations will be greatly enhanced.
Specific technological objectives include:
Adapting existing automated surveillance and
comprehensive analysis solutions to maximize the
utility of the data residing in swap repositories;
Establishing a robust technology infrastructure for
systems that provide reliable intelligence about our
markets and that assist the Commission in monitoring
voluminous transaction processing;
Standardizing the collection of order data for
disruptive trade practice analysis;
Advancing computing platforms for high-frequency
and algorithmic trading surveillance and enforcement;
Expanding data transparency through enhancements to
the CFTC.gov Web site; and
Implementing enhanced market and risk surveillance
technology to oversee positions across swaps, options,
and futures markets.
The CFTC, for the first time in its history, will need the
technological capability to aggregate position and trading data
across swaps and futures markets. The Commission also will need
to be able to aggregate the position, trading and other
information stored in SDRs as there may be more than one SDR
per asset class. The Dodd-Frank Act does not mandate any
registered repository or data warehouse for such data
aggregation purposes. However, the CFTC and other regulators
will need a comprehensive view of the entire derivatives
market, including combined futures and swaps data, to execute
their missions. These aggregate capabilities include the
ability to collect, store, readily access and analyze data for
market surveillance, risk surveillance, enforcement, and
position limit purposes.
Q.18. Chairman Gensler, at a recent derivatives conference, Dr.
Kay Swinburne, a member of the European Parliament's Economic
and Monetary Affairs Committee, observed ``I've probably seen
Gary Gensler and his team in the European Parliament more than
his ministers in the U.S., and it gives an indication of how
desperate they are that we actually stay in line with what they
already have as a framework, . . . . I have to say the more
they pressurize the European Parliament, the more likely it is
that they will push back and go in a slightly different
direction.'' \2\ If, in fact, the European Parliament decides
to go in a different direction, what impact will that have on
the competitiveness of U.S. financial markets? On which aspects
of derivatives regulation is it most important for the U.S. and
E.U. to have consistent regulations?
---------------------------------------------------------------------------
\2\ Rob McGlinchey, ``U.S., Industry Warned Over Lobbying E.U.
Over Derivatives'', Derivatives Week (Nov. 30, 2010).
A.18. In the process of implementing the derivatives reforms in
the Dodd-Frank Act, the Commission is actively coordinating
with international regulators to promote robust and consistent
standards and avoid conflicting requirements in swaps
oversight. As we do with domestic regulators, we are sharing
many of our memos, term sheets and draft work product with
international regulators. The Commision has been consulting
directly and sharing documentation with the European
Commission, the European Central Bank, the U.K. Financial
Services Authority, the new European Securities and Markets
Authority and regulators in Canada, France, Germany, and
Switzerland. Recently, I met with Michel Barnier, the European
Commissioner for Internal Market and Services, to discuss
ensuring consistency in swaps market regulation.
This close coordination will facilitate robust and
consistent standards, including with regard to central
clearing, trading on exchanges or electronic trading platforms,
reporting and higher capital requirements for noncleared swaps.
While the European Union should not be expected to adopt
identical regulations as the U.S., indications are that the
ultimate outcome of the European legislation will be consistent
with the objectives of Dodd-Frank in these four key areas.
Meetings with officials from the European Commission and
European Parliament at provide continued encouragement with
regard to U.S. and European Union cooperation.
Q.19. Some disharmonies appear to be arising between the SEC
and CFTC approaches. What is your plan for eliminating those
disparities, particularly because the two agencies regulate
many of the same market participants?
A.19. Section 712(a)(7) of the Dodd-Frank Act recognized the
differences between CFTC- and SEC-regulated products and
entities. It provides that, in adopting rules, the CFTC and SEC
shall treat functionally or economically similar products or
entities in a similar manner, but are not required to treat
them in an identical manner. The Commissions work towards
consistency in the agencies' respective rules to the extent
possible through consultation and coordination continually
carried out since the enactment of the Dodd-Frank Act. This
close coordination has benefited the rulemaking process and
will strengthen the markets for both swaps and security-based
swaps.
Q.20. The CFTC's Dodd-Frank rulemaking initiatives to date have
not been limited to items that are mandated by the Act, but
have also included some actions that are purely discretionary.
End-users and market participants are already spending
substantial amounts of time and money to come into compliance
with the mandatory provisions of the Dodd-Frank Act. Under your
approach, they will have to bear the additional costs of
complying with discretionary rules. Please describe the
analysis you did to determine whether end-users and market
participants can bear the compliance costs of so many new rules
in such a short period of time.
A.20. The CFTC strives to include well-developed considerations
of costs and benefits in each of its proposed rulemakings.
Relevant considerations are presented not only in the cost-
benefit analysis section of the CFTC's rulemaking releases, but
additionally are discussed throughout the release in compliance
with the Administrative Procedure Act, which requires the CFTC
to set forth the legal, factual and policy bases for its
rulemakings.
In addition, Commissioners and staff have met extensively
with market participants and other interested members of the
public to hear, consider and address their concerns in each
rulemaking. CFTC staff hosted a number of public roundtables so
that rules could be considered in line with industry practices
and address compliance costs consistent with the obligations of
the CFTC to promote market integrity, reduce risk, and increase
transparency and protect the public interest.
With each proposed rule, the Commission has sought public
comment regarding costs and benefits.
In enacting title VII of the Dodd-Frank Act, Congress gave
the CFTC latitude with respect to the effective dates of
particular requirements. In May, the Commission re-opened many
of its comment periods that had closed and extended some
existing comment periods so that the public could comment in
the context of the entire mosaic of proposed rules. This
opportunity was available with respect to all relevant proposed
rules, giving the public and market participants the
opportunity to comment on compliance costs and to make
recommendations regarding the schedule of implementation. That
extended comment period closed on June 3, 2011. In addition, on
May 2 and 3, 2011, CFTC and SEC staff held roundtable sessions
to obtain views of the public with regard to implementation
dates of the various rulemakings. Prior to the roundtable, on
April 29, CFTC staff released a document that set forth
concepts that the Commission may consider with regard to the
effective dates of final rules for swaps under the Dodd-Frank
Act. The Commission is also receiving written comments on that
subject. Since the beginning of the rulemaking process, the
Commission has worked closely with other Federal regulators and
will continue to do so.
Q.21. Chairman Gensler, the approach that the CFTC took with
respect to swap execution facilities (SEFs) is at odds with the
SEC's approach, which allows for a meaningful alternative to
exchange trading. Explain how your approach is consistent with
the statutory language. You have long called for bringing OTC
derivatives onto ``regulated exchanges or similar trading
venues.'' Do you believe that there is a role in the swaps
markets for a meaningful alternative to an exchange that
allows, for example, firms seeking to manage their risk to
choose whether to disseminate their requests for quotes to one
or more market participants?
A.21. The CFTC and SEC consult and coordinate extensively to
harmonize our rules to the greatest extent possible. These
continuing efforts began with the enactment of the Dodd-Frank
Act. This close coordination will benefit the rulemaking
process.
With regard to the SEF rulemakings, the CFTC's proposed
rule will provide all market participants with the ability to
execute or trade with other market participants. It will afford
market participants with the ability to make firm bids or
offers to all other market participants. It also will allow
them to make indications of interest--or what is often referred
to as ``indicative quotes''--to other participants.
Furthermore, it will allow participants to request quotes from
other market participants. These methods will provide hedgers,
investors, and Main Street businesses the flexibility to trade
using a number of methods, but also the benefits of
transparency and more market competition. The proposed rule's
approach is designed to implement Congress' mandates for a
competitive and transparent price discovery process.
The proposal also allows participants to issue requests for
quotes, with requests distributed to a minimum number of other
market participants. It also allows that, for block
transactions, swap transactions involving nonfinancial end-
users, swaps that are not ``made available for trading'' and
bilateral transactions, market participants can get the
benefits of the swap execution facilities' greater transparency
or, if they wish, could be executed by voice or other means of
trading.
In the futures world, the law and historical precedent is
that all transactions are conducted on exchanges, yet in the
swaps world many contracts are transacted bilaterally. While
the CFTC will continue to coordinate with the SEC to harmonize
approaches, the CFTC also will consider matters associated with
regulatory arbitrage between futures and swaps. The Commission
has received public comments on its SEF rule and will move
forward to consider a final rule only after staff has had the
opportunity to summarize them for consideration and after
Commissioners are able to discuss them and provide feedback to
staff.
Q.22. In contrast to the SEC's Title VII implementation, the
CFTC's implementation of Title VII to date has been marked by
divided votes. Do you believe that consensus is important to
ensure that the CFTC's regulations are balanced, targeted, and
effective? Under what circumstances do you believe it is
appropriate to adopt rules without the unanimous consent of the
Commission?
A.22. The majority of Commission votes on Dodd-Frank
rulemakings have been unanimous. The Commission rulemaking
process benefits greatly from the close consultation between
all of the Commissioners and their staffs. Commissioners work
together to achieve a common understanding and to reach
consensus wherever possible.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR REED
FROM GARY GENSLER
Q.1. A serious topic of discussion in the financial markets
these past few days is the announcement of a proposed merger
between the NYSE-Euronext and the Deutsche Borse.
If this merger takes place, what will be the
potential impact on the implementation of the
provisions of the Dodd-Frank Act, particularly in
respect to the trading and clearing of derivatives?
Is there a potential that this merger will enhance
the availability of regulatory arbitrage by allowing
market participants the ability to circumvent the
requirements of Dodd-Frank by providing easier access
to foreign trading and clearing venues?
Should we be concerned with any anticompetitive
implications of this further consolidation of trading
and clearing platforms?
A.1. The CFTC's implementation of the Dodd-Frank Act would be
unaffected by the merger.
The Dodd-Frank Act also broadened the CFTC's oversight to
include authority to register foreign boards of trade (FBOTs)
providing direct access to U.S. traders. To become registered,
FBOTs must be subject to regulatory oversight that is
comprehensive and comparable to U.S. oversight. This new
authority enhances the Commission's ability to ensure that U.S.
traders cannot avoid essential market protections by trading
contracts traded on FBOTs that are linked with U.S. contracts.
There are six FBOTs that are implicated by the merger.
Deutsch Boerse owns all or part of Eurex Deutschland, Eurex
Zurich and the European Energy Exchange. NYSE-Euronext owns
Liffe, Euronext Amsterdam and Euronext Paris. All six of these
FBOTs currently provide for direct access to their trading
systems from the U.S. pursuant to Commission staff no-action
letters and will be required to register if proposed rules are
made final.
As a general matter the anticompetitive implications of any
merger is a legitimate consideration and one that the CFTC is
required to take into account under the Commodity Exchange Act.
Q.2. To what extent is your agency working with your relevant
domestic and foreign counterparts in respect to the possible
merger between the New York Stock Exchange and the Deutsche
Borse? Are you working to ensure that arrangements will be in
place for cooperation in supervision and enforcement and for
information sharing, all of which will be required as a result
of this potential merger? Should we expect formal MOUs on
supervisory cooperation to precede a cross-border merger?
A.2. The Commission has an ongoing and productive working
relationship with Germany's Bundesanstalt fur
Finanzdienstleistungsaufsicht (BAFIN). Our agency is committed
to using that relationship to ensure adequate information
sharing and regulatory cooperation.
Q.3. The Securities, Insurance, and Investment Subcommittee
held a hearing in December that focused, in part, on the
increasing interconnectedness of today's modern markets and the
need for effective oversight of trading across products and
venues. Today's traders buy and sell options, futures, and
equities interchangeably in dozens of marketplaces around the
world. Yet, our regulatory oversight mechanism largely relies
on a model where each marketplace is primarily responsible for
policing the activities on its platform. Given the recently
announced potential merger of NYSE Euronext with Deutsche Borse
Group, it seems as though the trading marketplaces are only
becoming more interconnected. What are your thoughts regarding
how to an implement an effective regulatory oversight
infrastructure to police trading done both by Americans around
the world and by traders around the world in our increasingly
interconnected and international marketplaces?
A.3. Under the Commodity Exchange Act, futures exchanges are
required in the first instance to implement a robust market
surveillance program. The CFTC addresses these challenges
through surveillance on a cross-market basis. This allows the
CFTC to detect cross-market trading abuses.
The CFTC surveillance staff receives daily transaction and
position data for all trading that takes place on futures
exchanges registered with the CFTC. This information comes from
both the exchanges and brokers. As a result, even trades that
are initiated from foreign locations will be disclosed to the
CFTC.
FBOTs that permit the direct access of U.S. persons to
their trading of contracts that might have an impact on U.S.
exchange contracts are subject to surveillance. For example,
the CFTC has entered into a surveillance arrangement with the
United Kingdom Financial Services Authority (FSA) to share data
with respect to trading in energy contracts on ICE Futures U.K.
that settle off of the price of contracts on NYMEX. The CFTC's
FBOT proposed rules would require such surveillance
arrangements.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR MENENDEZ
FROM GARY GENSLER
Q.1. Exchanges and Clearinghouses. I'm concerned that the
exchanges or clearinghouses, both for derivatives and
securities, could themselves become ``too big to fail'' and
systemically significant. What steps are you taking to ensure
that their size and risks are properly managed so that they do
not become ``too big to fail''?
A.1. The Commission has proposed rules to establish regulatory
standards for CFTC-registered derivative clearing organizations
(DCOs) to comply with statutory core principles. The proposed
rule addresses requirements for a DCO's risk management
framework, chief risk officer, measurement of credit exposure,
margin requirements and other risk control mechanisms
(including risk limits, review of large trader reports, stress
tests, swaps portfolio compression, and reviews of clearing
members' risk management policies and procedures).
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARNER
FROM GARY GENSLER
Q.1. For each of the witnesses, though the Office of Financial
Research does not have a Director, what are each of you doing
to assist OFR in harmonizing data collection, compatibility,
and analysis?
A.1. The Commission has been working closely with the OFR to
help develop a strategy for managing initial data required by
the OFR to monitor and study systemic risk in the U.S.
financial markets. The CFTC also has coordinated with the OFR
in the development of a universal Legal Entity Identification
standard that is consistent with the Commission's and the SEC's
rulemakings.
In addition, to support the FSOC, the CFTC is providing
both data and expertise relating to a variety of systemic
risks, how those risks can spread through the financial system
and the economy and potential ways to mitigate those risks.
Commission staff also coordinates with Treasury and other
Council member agencies on each of the studies and proposed
rules issued by the FSOC.
Q.2. Chairman Shapiro and Chairman Gensler, can each of you
explain what budget cuts will mean for the ability of your
agencies to ensure markets are safe, protected from abuse, and
don't create the types of risks that nearly destroyed our
economy?
A.2. The CFTC must be adequately resourced to police the
markets and protect the public. The CFTC is taking on a
significantly expanded scope and mission. By way of analogy, it
is as if the agency previously had the role to oversee the
markets in the state of Louisiana and was just mandated by
Congress to extend oversight to Alabama, Kentucky, Mississippi,
Missouri, Oklahoma, South Carolina, and Tennessee.
With seven times the population to police, far greater
resources are needed for the public to be protected. The
President's FY2012 budget request of $308 million would provide
the CFTC with the personnel and IT resources estimated to be
needed to begin to undertake its expanded mission. Without
sufficient funding for the agency, our Nation cannot be assured
of effective enforcement of new rules in the swaps market to
promote transparency, lower risk, and protect against another
crisis. Insufficient funding would hamper our ability to seek
out fraud, manipulation, and other abuses at a time when
commodity prices are rising and volatile. Until the CFTC
completes its rule-writing process and implements and enforces
those new rules, the public remains unprotected.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR MERKLEY
FROM GARY GENSLER
Q.1. Derivatives Oversight. Counterparty risk and other risks
associated with derivatives played a central role in the
financial crisis, especially in fueling the argument that firms
such as AIG were too big or too interconnected to fail. What
oversight systems do you plan to have in place to ensure that
any accommodations made in the course of rulemaking for
nonfinancial commercial parties do not create holes in the
regulatory structure that permit the accumulation of hidden or
outsized risk to the U.S. financial system and economy.
A.1. In the Dodd-Frank Act, Congress recognized the different
levels of risk posed by transactions between financial entities
and those that involve nonfinancial entities, as reflected in
the nonfinancial end-user exception to clearing. The risk of a
crisis spreading throughout the financial system is greater the
more interconnected financial companies are to each other.
Interconnectedness among financial entities allows one entity's
failure to cause uncertainty and possible runs on the funding
of other financial entities, which can spread risk and economic
harm throughout the economy. Consistent with this, the CFTC's
proposed rules on margin requirements focus only on
transactions between financial entities rather than those
transactions that involve nonfinancial end-users.
The Dodd-Frank Act provides for comprehensive regulation of
dealers, which ensures that every derivatives transaction--
including those excepted from clearing and trading
requirements--will be regulated. The CFTC's proposed capital
rules take commercial end-user transactions into account to
ensure that swap dealers are adequately capitalized to help
prevent future failures. Furthermore, improved price
transparency through electronic trading platforms and real time
public reporting will help to ensure that positions held by
counterparties are properly valued and that exposures between
swap dealers and end-users are transparent to both sides.
Lastly, the requirement that the details of all transactions be
reported to swap data repositories will ensure that the
Commission and self-regulatory organizations have the data
needed to monitor risks in the derivatives markets.
Q.2. Markets Oversight. As you may know, Korean securities
regulators recently imposed a 6 month ban on a large European
bank from engaging in proprietary trading in Korean markets
after it came to light that the bank manipulated the Seoul
stock market. With the proposed acquisition of the New York
Stock Exchange by a European borse, markets are becoming more
international and interconnected than ever before. Do you feel
you have the tools you need to monitor trading across multiple
markets and across multiple products? If not, what steps do you
need to take and what additional tools do you need from
Congress to assist you in accomplishing your critical mission
of ensuring our markets operate with integrity?
A.2. In general, the Commission has ample experience monitoring
trading on a variety of platforms, across multiple markets and
across multiple products. The CFTC surveillance staff receives
daily transaction and position data for all trading that takes
place on registered futures exchanges. This information comes
not only from the exchanges but also from brokers. Even trades
that are initiated from foreign locations are disclosed to the
CFTC.
The CFTC also has taken measures to ensure that trading by
U.S. persons through direct electronic access arrangements on
foreign boards of trade (FBOT) in contracts that might have an
impact on U.S. exchange contracts are subject to specified
requirements. For example, the CFTC has entered into a
surveillance arrangement with the United Kingdom Financial
Services Authority (FSA) to share data with respect to trading
in energy contracts on ICE Futures U.K. that settle off of the
price of contracts on NYMEX. The CFTC's FBOT proposed rules
would require such surveillance arrangements.
The CFTC must be adequately resourced to police the
markets, including implementing the Dodd-Frank Act's provision
for registration of foreign boards of trade. The CFTC is taking
on a significantly expanded scope and mission. By way of
analogy, it is as if the agency previously had the role to
oversee the markets in the State of Louisiana and was just
mandated by Congress to extend oversight to Alabama, Kentucky,
Mississippi, Missouri, Oklahoma, South Carolina, and Tennessee.
With seven times the population to police, far greater
resources are needed for the public to be protected. Without
sufficient funding for the agency, our Nation cannot be assured
of effective enforcement of new rules in the swaps market to
promote transparency, lower risk, and protect against another
crisis. We need additional funding to seek out fraud,
manipulation, and other abuses at a time when commodity prices
are rising and volatile.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO
FROM GARY GENSLER
Q.1. CFTC Commissioners Michael Dunn, Scott O'Malia, and Jill
Sommers, have all commented on the lack of economic data on the
CFTC proposed rule on commodity speculative position limits.
Commissioner Michael Dunn stated: ``To date, CFTC staff has
been unable to find any reliable economic analysis to support
either the contention that excessive speculation is affecting
the markets we regulate, or that position limits will prevent
excessive speculation.'' Do you intend to hold off going
forward with the rule until you have the kind of economic data
that Commissioner stated was lacking?
A.1. Position limits have served since the Commodity Exchange
Act passed in 1936 as a tool to curb or prevent excessive
speculation that may burden interstate commerce. When the CFTC
set position limits in the past, the agency sought to ensure
that the markets were made up of a broad group of market
participants with a diversity of views. At the core of our
obligations is promoting market integrity, which the agency has
historically interpreted to include ensuring that markets do
not become too concentrated.
The CFTC's January position limits proposal would
reestablish position limits in agriculture, energy and metals
markets. It includes one position limits regime for the spot
month and another regime for single-month and all-months
combined limits. It would implement spot-month limits, which
are currently set in agriculture, energy, and metals markets,
sooner than the single-month or all-months-combined limits.
Single-month and all-months-combined limits, which currently
are only set for certain agricultural contracts, would be
reestablished in the energy and metals markets and be extended
to certain swaps. These limits will be set using the formula
proposed in January based upon data on the total size of the
swaps and futures market collected through the position
reporting rule the Commission hopes to finalize early next
year. It is only with the passage and implementation of the
Dodd-Frank Act that the Commission will have broad authority to
collect data in the swaps market.
Q.2. It is my understanding that under Title VII of Dodd-Frank,
the CFTC has initiated 40 rulemakings. Despite the abbreviated
comment periods, some commenters have done their own analysis
and identified flaws in agency cost-benefit analyses. For
example, a group of energy companies, in response to a proposed
rulemaking by the CFTC, estimated that the personnel costs for
swap dealers and major swap participants in connection with
implementing a comprehensive risk management plan would be at
least ``63 times greater than the Commission's estimate.'' How
do you intend to incorporate this feedback and others to adjust
these proposed rules to provide less costly alternatives and
not make this just a check the box exercise for a decision that
has already been made?
A.2. The Administrative Procedure Act (APA) requires the CFTC
to provide notice and an opportunity to comment before
finalizing rules that will impose new obligations on any person
or group of persons. The CFTC considers all of the comments it
receives to inform its final rulemaking. To ensure that its
final rulemakings have reasoned bases, the CFTC and its staff
will review all estimates of costs and benefits that are
received from commenters and any data supporting them. This
will enable the Commission to adopt rules as required by the
Dodd-Frank Act while ensuring that they do not impose
unnecessary costs on market participants and the public.
Q.3. I understand that you and your staff are working very hard
and talking to each other during the proposal stage, but from
the outside it looks like too often the agencies are proposing
inconsistent approaches to the same rule sets. For instance, on
the Swap Execution Facility rules, the SEC seems to be taking a
more flexible approach relative to what you've developed. And
their approach seems to be more consistent with what the
Europeans are looking at so it will minimize the risk of
regulatory arbitrage. Rather than one agency jumping out in
front of the other agency the point of coordination should be
to propose consistent approaches to the same rule sets. How do
you intend to achieve great harmonization, timing, minimize
inconsistent rules, and avoid regulatory arbitrage--
specifically with respect to the SEF?
A.3. The CFTC and SEC consult and coordinate extensively to
harmonize our rules to the greatest extent possible. These
continuing efforts began with the enactment of the Dodd-Frank
Act. This close coordination will continue and will benefit the
rulemaking process.
With regard to the SEF rulemakings, the CFTC's proposed
rule will provide all market participants with the ability to
execute or trade with other market participants. It will afford
market participants with the ability to make firm bids or
offers to all other market participants. It also will allow
them to make indications of interest--or what is often referred
to as ``indicative quotes''--to other participants.
Furthermore, it will allow participants to request quotes from
other market participants. These methods will provide hedgers,
investors, and Main Street businesses the flexibility to trade
using a number of methods, but also the benefits of
transparency and more market competition. The proposed rule's
approach is designed to implement Congress' mandates for a
competitive and transparent price discovery process.
The proposal also allows participants to issue requests for
quotes, with requests distributed to a minimum number of other
market participants. It also allows that, for block
transactions, swap transactions involving nonfinancial end-
users, swaps that are not ``made available for trading'' and
bilateral transactions, market participants can get the
benefits of the swap execution facilities' greater transparency
or, if they wish, could be executed by voice or other means of
trading.
In the futures world, the law and historical precedent is
that all transactions are conducted on exchanges, yet in the
swaps world many contracts are transacted bilaterally. While
the CFTC will continue to coordinate with the SEC to harmonize
approaches, the CFTC also will consider matters associated with
regulatory arbitrage between futures and swaps. The Commission
has received public comments on its SEF rule and will move
forward to consider a final rule only after staff has had the
opportunity to summarize them for consideration and after
Commissioners are able to discuss them and provide feedback to
staff.
Q.4. Dodd-Frank requires that risk retention be jointly
considered by the regulators for each different type of asset
and includes a specific statutory mandate related to any
potential reforms of the commercial mortgage-backed securities
to limit disruptions. Given the importance of rigorous cost-
benefit and economic impact analyses and the need for due
consideration of public comments, do your agencies need more
time than is provided by the looming April deadline?
A.4. Section 941 of the Dodd-Frank Act, pertaining to the
regulation of credit risk retention, is an amendment to the
Securities Exchange Act of 1934. It applies to the Securities
and Exchange Commission as well as the Office of the
Comptroller of the Currency, the Board of Governors of the
Federal Reserve System and the Federal Deposit Insurance
Corporation. The Dodd-Frank Act does not involve the CFTC in
this area.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER
FROM GARY GENSLER
Q.1. Chairman Gensler, during your appearance before the full
House Agriculture Committee last week, you stated that
``proposed rules on margin requirements should focus only on
transactions between financial entities rather than those
transactions that involve nonfinancial end-users.'' While this
was good news to end-users, there is still concern that
regulations could impact end-users if banks or other
counterparties to these contracts are required to post margin
and charge a fee to its end-user counterparties. How would you
address this concern? More generally, how do you believe the
CFTC can best fulfill Congress' intent to exempt end-users from
capital and margin requirements?
A.1. The CFTC's proposed margin rule does not require margin to
be paid or collected on transactions involving nonfinancial
end-users hedging or mitigating commercial risk.
Q.2. Under the Commodities Exchange Act (CEA), which was
repealed by Dodd-Frank, physical forwards were excluded from
the definition of swap. In the recent rule on agricultural
swaps, the CFTC ruled that a physical contract meets the
definition of swap. However, in your testimony before the full
House Agriculture Committee you indicated that the Rural
Electric Cooperatives were not dealing in swaps, but forwards
or forwards with embedded options. Would you please explain how
the definitions of ``swap'' and ``agricultural swap'' can be
reconciled given your comments? Do you believe that forwards
with embedded options, such as capacity contracts, reserve
sharing agreements, and all-requirements contracts will be
excluded from the draft definition of ``swap'' that you will be
releasing shortly?
A.2. In response to a Joint Advance Notice of Proposed
Rulemaking regarding definitions issued by the SEC and the CFTC
last year, a number of commenters requested that the forward
exclusion from the swap definition be clarified. Under the
Commodity Exchange Act, the CFTC does not regulate forward
contracts. Over the decades, market participants have come to
rely upon a series of orders, interpretations and cases
regarding the forward contract exclusion. Consistent with that
history, the Dodd-Frank Act excluded from the definition of
swaps ``any sale of a nonfinancial commodity or security for
deferred shipment or delivery, so long as the transaction is
intended to be physically settled.'' In its proposed rule on
product definitions, the Commission expressed the view that the
principles underlying its 1990 Statutory Interpretation
Concerning Forward Transactions should apply to the forward
exclusion from the swap definition with respect to nonfinancial
commodities as it does to futures contracts. Market
participants that regularly make or take delivery of the
referenced commodity in the ordinary course of their business,
where the book-out transaction is effectuated through a
subsequent, separately negotiated agreement, should qualify for
the forward exclusion from the swap definition. Forwards with
embedded options would likely qualify for the forward exclusion
so long as the optionality was not as to the obligation to
deliver.
Q.3. As you know, commercial end-users could be excluded from
the new clearing requirements under Dodd-Frank if they are
using the swap to hedge ``commercial risk'' something you
discussed in last week's House Agriculture Committee hearing.
Because end-users are merely using swaps to hedge risk, then
why subject them to CFTC jurisdiction? Could you also provide
insight to how broadly ``commercial risk'' will be defined
through CFTC regulation?
A.3. The CFTC's proposed rules do not require transactions
involving nonfinancial end-users hedging or mitigating
commercial risk to be cleared or traded on trading platforms.
Furthermore, the CFTC's proposed margin rule does not require
margin to be paid or collected on transactions involving
nonfinancial end-users hedging or mitigating commercial risk.
The CFTC and SEC issued a joint proposed rule to further
define the term ``major swap participant.'' The CFTC issued a
proposed rule related to the nonfinancial end-user exception
from the clearing requirement. Both proposals include
discussion meant to illuminate the conditions under which
positions are to be regarded as held for hedging or mitigating
commercial risk. Both proposals demonstrate the belief that
whether a position hedges or mitigates commercial risk should
be determined by the facts and circumstances at the time the
swap is entered into and should take into account the person's
overall hedging and risk mitigation strategies. The Commission
invited comment on a number of aspects important to this
consideration and is reviewing submitted comments.
Q.4. I have noticed that your rulemakings have failed to
account for or document the enormous costs that will be imposed
on the industry and in many cases fail to even note that the
agency will need to hire, train, and support a large number of
professional staff members to perform the work that your
proposed rule creates for the agency.
You have claimed, in recent Congressional testimony, that
section 15(a) of the CEA excuses you from performing a complete
cost and benefit analysis and allows you to justify your
rulemaking by speculating about benefits to the market. What is
your justification for ignoring your obligation to fully
analyze the costs imposed on third parties and on the agency by
your rulemaking?
SEC. 15. (7 U.S.C. 19) CONSIDERATION OF COSTS AND
BENEFITS AND ANTITRUST LAWS.
(a) COSTS AND BENEFITS.--
(1) IN GENERAL.--Before promulgating a regulation under
this Act or issuing an order (except as provided in
paragraph (3)), the Commission shall consider the costs
and benefits of the action of the Commission.
(2) CONSIDERATIONS.--The costs and benefits of the
proposed Commission action shall be evaluated in light
of--
(A) considerations of protection of market participants
and the public;
(B) considerations of the efficiency, competitiveness,
and financial integrity of futures markets;
(C) considerations of price discovery;
(D) considerations of sound risk management practices;
and
(E) other public interest considerations.
(3) APPLICABILITY.--This subsection does not apply to
the following actions of the Commission:
(A) An order that initiates, is part of, or is the
result of an adjudicatory or investigative process of
the Commission.
(B) An emergency action.
(C) A finding of fact regarding compliance with a
requirement of the Commission.
A.4. See response after Question 5.
Q.5. Many have raised concerns that the CFTC does not have
adequate funds to implement many of the rules it is proposing.
In fact, Commissioner Dunn made the following request at the
very first CFTC Open Meeting on Dodd-Frank rulemaking:
I would ask that staff provide an estimate of the cost
of each proposed regulation and an analysis detailing
whether the CFTC can delegate duties to SROs to fulfill
the mandates of Congress. Further, I would ask staff
working in concert with the Chairman to provide the
Commissioners with a list of prioritizing regulations
based on available funding.
Has the Commission performed or will it be performing a
cost benefit analysis of each of the various rules it is
proposing?
A.5. The CFTC strives to include well-developed considerations
of costs and benefits in each of its proposed rulemakings.
Relevant considerations are presented not only in the cost-
benefit analysis section of the CFTC's rulemaking releases, but
additionally are discussed throughout the release in compliance
with the Administrative Procedure Act, which requires the CFTC
to set forth the legal, factual, and policy bases for its
rulemakings.
In addition, Commissioners and staff have met extensively
with market participants and other interested members of the
public to hear, consider and address their concerns in each
rulemaking. CFTC staff hosted a number of public roundtables so
that rules could be proposed in line with industry practices
and address compliance costs consistent with the obligations of
the CFTC to promote market integrity, reduce risk, and increase
transparency as directed in Title VII of the Dodd-Frank Act.
Information from each of these meetings--including full
transcripts of the roundtables--is available on the CFTC's Web
site and has been factored into each applicable rulemaking.
With each proposed rule, the Commission has sought public
comment regarding costs and benefits.
Q.6. The CFTC's analysis for several of these rules seems
widely inconsistent with outside cost-benefit analysis for the
same rules. For instance, your business conduct standards rule
could increase costs for pension funds and municipalities
significantly. In performing the cost-benefit analysis for
proposed business conduct standards, did the CFTC quantify the
effect these additional regulatory burdens would have on the
market? Particularly, did the CFTC consider that these burdens
could compel dealers to choose not to enter into trades with
municipalities and other ``special entities'' such as pension
funds?
A.6. The Commission's proposed business conduct standards rules
track the statutory directive under the provisions of the Dodd-
Frank Act that create a higher standard of care for swap
dealers dealing with Special Entities, including municipalities
and pension funds. The Commission's proposed rules were drafted
following consultations with Special Entities and potential
swap dealers and were designed to enable swap dealers to comply
with their new duties in an efficient and effective manner. The
Commission is reviewing the comments it has received on the
proposed rules to ensure that the final rules achieve the
statutory purpose without imposing undue costs on market
participants. The proposed rulemaking release specifically asks
that the public provide comment regarding associated costs and
benefits.
Q.7. I'm concerned about the costs some of these rules are
going to place on end-users. While the Dodd-Frank Act requires
the CFTC to consider the special role of ``block trades'' when
adopting real-time swap reporting requirements, the CFTC's
real-time reporting proposal includes a very narrow definition
of ``block trade'' and a very short 15-minute delay for public
dissemination of block trade information. I'm concerned the
increased costs of this narrow interpretation could make it
costly for end-users to enter into the block trades they use to
hedge their own risks. Has the CFTC considered the impact these
increased costs have on end-user risk management?
A.7. The CFTC's proposed rules regarding real-time reporting of
swap transaction and pricing data defined ``large notional
swap'' and ``block trade'' and specified a delay of 15 minutes
for the public reporting of swap transaction data only for
block trades that are executed pursuant to the rules of a swap
execution facility or designated contract market. The proposed
rulemaking does not provide specific time delays for large
notional swaps that are not executed on a swap execution
facility or a designated contract market, such as those entered
into by nonfinancial end-users hedging or mitigating commercial
risk. The proposal seeks comment regarding the appropriate time
delay for these transactions.
------
RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN JOHNSON
FROM JOHN WALSH
Q.1. Recently, some have voiced concerns that the timeframe for
the rulemakings required by the Dodd-Frank Wall Street Reform
and Consumer Protection Act (Dodd-Frank) is too short to allow
for adequate consideration of the various comments submitted or
to review how the new rules may impact our financial markets.
Does the current timeframe established by Dodd-Frank allow each
rulemaking to be completed in a thoughtful and deliberative
manner?
A.1. We recognize that the deadlines established for many of
the rules required by the Dodd-Frank Act demonstrate Congress'
concern that the Act's regulatory reforms be promptly
implemented. This goal is in some tension with the time
necessary to resolve the novel and complex legal and practical
issues presented by a many of the statutory provisions and, in
many instances, the time necessary to comply with Congress'
direction for joint or coordinated rulemaking conducted by a
number of different agencies. We are working diligently toward
all of these goals, but getting the substance of the
rulemakings right is our primary objective.
Q.2. In defining the exemption for ``qualified residential
mortgages,'' are the regulators considering various measures of
a lower risk of default, so that there will not just be one
``bright line'' factor to qualify a loan as a Q.R.M.?
A.2. Section 941 provides a complete exemption from the credit
risk retention requirements for ABS collateralized solely by
qualified residential mortgages. The agencies' proposed rule
establishes the terms and conditions under which a residential
mortgage would qualify as a QRM. The proposed rule generally
would prohibit QRMs from having product features that
contributed significantly to the high levels of delinquencies
and foreclosures since 2007--such as failure to document
income, ``teaser'' rates, or terms permitting negative
amortization or interest-only payments--and also would
establish conservative underwriting standards designed to
ensure that QRMs are of high credit quality. These underwriting
standards include, among other things, maximum front-end and
back-end debt-to-income ratios of 28 percent and 36 percent,
respectively; a maximum loan-to-value (LTV) ratio of 80 percent
in the case of a purchase transaction; and a 20 percent down
payment requirement in the case of a purchase transaction.
If the agencies are persuaded by comments that the QRM
underwriting criteria are too restrictive on balance, the
preamble discusses several possible alternatives:
Permit the use of private mortgage insurance
obtained at origination of the mortgage for loans with
LTVs higher than the 80 percent level specified in the
proposed rule. The guarantee provided by private
mortgage insurance, if backed by sufficient capital,
lowers the credit risk to investors by covering the
unsecured losses attributable to the higher LTV ratio
once the borrower defaults and the loan is liquidated.
However, to include private mortgage insurance in the
QRM criteria, Congress required the agencies to
determine that the presence of private mortgage
insurance lowers the risk of default--not that it
reduces the ultimate amount of the loss. The OCC will
be interested in the information provided by Commenters
on this topic, and any data they can provide.
Impose less stringent QRM underwriting criteria,
but also impose more stringent risk retention
requirements on non-QRM loan ABS to incentivize
origination of the QRM loans and reflect the relatively
greater risk of the non-QRM loan market.
Create an additional residential mortgage loan
asset class along side the QRM exemption--such as the
underwriting asset classes for commercial loans,
commercial mortgages, and auto loans under the proposed
rule--with less stringent underwriting standards or
private mortgage insurance, subject to a risk retention
requirement set somewhere between 0 and 5 percent.
Q.3. What data are you using to help determine the definition
of a Qualified Residential Mortgage?
A.3. Section 941 requires the agencies to define qualified
residential mortgage ``taking into consideration underwriting
and product features that historical loan performance data
indicate result in a lower risk of default.'' Therefore, in
considering how to determine if a mortgage is of sufficient
credit quality, the agencies examined data from several
sources.
The agencies reviewed data on mortgage performance
supplied by the Applied Analytics division (formerly
McDash Analytics) of Lender Processing Services (LPS).
To minimize performance differences arising from
unobservable changes across products, and to focus on
loan performance through stressful environments, for
the most part, the agencies considered data for prime
fixed-rate loans originated from 2005 to 2008. This
data set included underwriting and performance
information on approximately 8.9 million mortgages.
The agencies also examined data from the 1992 to
2007 waves of the triennial Survey of Consumer Finances
(SCF) conducted by the Federal Reserve Board. Because
families' financial conditions will change following
the origination of a mortgage, the analysis of SCF data
focused on respondents who had purchased their homes
either in the survey year or the previous year.
The agencies also examined a combined data set of
loans purchased or securitized by the GSEs from 1997 to
2009. This data set consisted of more than 75 million
mortgages, and included data on loan products and
terms, borrower characteristics (e.g., income and
credit score), and performance data through the third
quarter of 2010.
Based on these and other data sets, and as supported by a
body of academic literature, the agencies believe that the
underwriting criteria for QRMs in the proposed rule have low
credit risk, even in severe economic conditions.
Q.4. Please discuss the current status and timeframe of
implementing the Financial Stability Oversight Council's (FSOC)
rulemaking on designating nonbank financial companies as being
systemically important. As a voting member of FSOC, to what
extent is the Council providing clarity and details to the
financial marketplace regarding the criteria and metrics that
will be used by FSOC to ensure such designations are
administered fairly? Is the intent behind designation decisions
to deter and curtail systemically risky activity in the
financial marketplace? Are diverse business models, such as the
business of insurance, being fully and fairly considered as
compared with other financial business models in this
rulemaking?
A.4. On January 18, 2011, the Council approved publication of a
notice of proposed rulemaking (NPRM) that outlines the criteria
that will inform the Council's designation of such firms and
the procedures the FSOC will use in the designation process.
The NPRM closely follows and adheres to the statutory factors
established by Congress for such designations. The framework
proposed in the NPRM for assessing systemic importance is
organized around six broad categories, each of which reflects a
different dimension of a firm's potential to experience
material financial distress, as well as the nature, scope,
size, scale, concentration, interconnectedness, and mix of the
company's activities. The six categories are: size,
interconnectedness, substitutability, leverage, liquidity, and
regulatory oversight.
The comment period for this NPRM closed on February 25,
2011, and staffs are in the process of reviewing the comments
received and making recommendations for upcoming discussions by
FSOC principals on how to proceed with implementing this
important provision of the Dodd-Frank Act. With regard to the
concerns voiced by some commenters and members of Congress, the
OCC is committed to ensuring that the Council strikes the
appropriate balance in providing sufficient clarity in our
rules and transparency in our designation process, while at the
same time avoiding overly simplistic approaches that fail to
recognize and consider the facts and circumstances of
individual firms and specific industries. Ensuring that firms
have appropriate due process throughout the designation process
will be critical in achieving this balance.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR SHELBY
FROM JOHN WALSH
Q.1. The Dodd-Frank Act requires an unprecedented number of
rulemakings over a short period of time. As a result, some
deadlines have already been missed and some agencies expect to
miss additional deadlines. It appears that many of the
deadlines in Dodd-Frank are not realistic. Which Dodd-Frank
deadlines do you anticipate not being able to meet? If Congress
extended the deadlines, would you object? If your answer is
yes, will you commit to meeting all of the statutory deadlines?
If Congress affords additional time for rulemaking under the
Dodd-Frank Act, will you be able to produce higher-quality,
better coordinated rules?
A.1. We recognize that the deadlines established for many of
the rules required by the Dodd-Frank Act demonstrate Congress'
concern that the Act's regulatory reforms be promptly
implemented. This goal is in some tension with the time
necessary to resolve the novel and complex legal and practical
issues presented by a many of the statutory provisions and, in
many instances, the time necessary to comply with Congress'
direction for joint or coordinated rulemaking conducted by a
number of different agencies. We are working diligently toward
all of these goals, but getting the substance of the
rulemakings right is our primary objective.
Q.2. Secretary Geithner recently talked about the difficulty of
designating nonbank financial institutions as systemic. He
said, ``it depends too much on the state of the world at the
time. You won't be able to make a judgment about what's
systemic and what's not until you know the nature of the
shock.'' \1\ If it is impossible to know which firms are
systemic until a crisis occurs, the Financial Stability
Oversight Council will have a very difficult time objectively
selecting systemic banks and nonbanks for heightened
regulation. As a member of the Council, do you believe that
firms can be designated ex ante as systemic in a manner that is
not arbitrary? If your answer is yes, please explain how.
---------------------------------------------------------------------------
\1\ See, Special Inspector General for the Troubled Asset Relief
Program, ``Extraordinary Assistance Provided to Citigroup, Inc.''
(SIGTARP 11-002) (Jan. 13, 2011) (available at: http://www.sigtarp.gov/
reports/audit/2011/
Extraordinary%20Financial%20Assistance%20Provided%20to%20Citigroup,%20In
c.pdf), at 43.
A.2. On January 18, 2011, the Council approved publication of a
notice of proposed rulemaking (NPRM) that outlines the criteria
that will inform the Council's designation of such firms and
the procedures the FSOC will use in the designation process.
The NPRM closely follows and adheres to the statutory factors
established by Congress for such designations. The framework
proposed in the NPRM for assessing systemic importance is
organized around six broad categories, each of which reflects a
different dimension of a firm's potential to experience
material financial distress, as well as the nature, scope,
size, scale, concentration, interconnectedness, and mix of the
company's activities. The six categories are: size,
interconnectedness, substitutability, leverage, liquidity, and
regulatory oversight.
The comment period for this NPRM closed on February 25,
2011, and staffs are in the process of reviewing the comments
received and making recommendations for upcoming discussions by
FSOC principals on how to proceed with implementing this
important provision of the Dodd-Frank Act. With regard to the
concerns voiced by some commenters and members of Congress, the
OCC is committed to ensuring that the Council strikes the
appropriate balance in providing sufficient clarity in our
rules and transparency in our designation process, while at the
same time avoiding overly simplistic approaches that fail to
recognize and consider the facts and circumstances of
individual firms and specific industries. Ensuring that firms
have appropriate due process throughout the designation process
will be critical in achieving this balance.
Q.3. Section 112 of the Dodd-Frank Act requires the Financial
Stability Oversight Council to annually report to Congress on
the Council's activities and determinations, significant
financial market and regulatory developments, and emerging
threats to the financial stability of the United States. Each
voting member of the Council must submit a signed statement to
the Congress affirming that such member believes the Council,
the Government, and the private sector are taking all
reasonable steps to ensure financial stability and mitigate
systemic risk. Alternatively, the voting member shall submit a
dissenting statement. When does the Council expect to supply
the initial report to Congress?
A.3. Discussions about the format and structure of this report
are underway by the FSOC members.
Q.4. Which provisions of Dodd-Frank create the most incentives
for market participants to conduct business activities outside
the United States? Have you done any empirical analysis on
whether Dodd-Frank will impact the competitiveness of U.S.
financial markets? If so, please provide that analysis.
A.4. The OCC has not done any analysis of this type.
Q.5. More than 6 months have passed since the passage of the
Dodd-Frank Act, and you are deeply involved in implementing the
Act's approximately 2,400 pages. Which provisions of the Dodd-
Frank Act are proving particularly difficult to implement? Have
you discovered any technical or substantive errors in the Dodd-
Frank legislation? If so, please describe them.
A.5. The attachment to these Questions and Answers describes
three areas where, as we have previously testified to the
Committee, clarifying amendments to the Dodd-Frank Act may be
appropriate: the requirement in section 939A that agencies
remove all references to credit ratings from their regulations;
the ambiguities in the requirement for leverage and risk-based
capital requirements in section 171; and the overlap in the
respective roles of the banking agencies and the CFPB with
respect to fair lending supervision.
Q.6. What steps are you taking to understand the impact that
your agency's rules under Dodd-Frank will have on the U.S.
economy and its competitiveness? What are the key ways in which
you anticipate that requirements under the Dodd-Frank Act will
affect the U.S. economy and its competitiveness? What are your
estimates of the effect that the Dodd-Frank Act requirements
will have on the jobless rate in the United States?
A.6. The OCC has not undertaken an analysis of the overall
impact that the requirements of the Dodd-Frank Act will have on
the U.S. economy or on the jobless rate in the United States.
At this time, we are not aware that such a study has been done
by any other Government agency.
Q.7. What steps are you taking to assess the aggregate costs of
compliance with each Dodd-Frank rulemaking? What steps are you
taking to assess the aggregate costs of compliance with all
Dodd-Frank rulemakings, which may be greater than the sum of
all of the individual rules' compliance costs? Please describe
all relevant reports or studies you have undertaken to quantify
compliance costs for each rule you have proposed or adopted.
Please provide an aggregate estimate of the compliance costs of
the Dodd-Frank rules that you have proposed or adopted to date.
A.7. Thus far, the OCC has published notices of proposed
rulemakings that would implement provisions of the Dodd-Frank
Act concerning: Incentive-Based Compensation Arrangements;
Retail Foreign Exchange Transactions; Credit Risk Retention;
Capital Floors; and Margin and Capital Requirements for Covered
Swap Entities. The OCC estimated the costs and burdens of these
rulemakings pursuant to the Unfunded Mandates Reform Act (UMRA)
and the Paperwork Reduction Act (PRA): UMRA requires the OCC to
prepare a budgetary impact statement before promulgating a rule
that includes a Federal mandate that may result in expenditure
by State, local, and tribal governments, in the aggregate, or
by the private sector of $100 million or more, adjusted for
inflation, in any 1 year. PRA requires the OCC to determine the
paperwork burden for requirements contained in its rules.
Please note that it is difficult to estimate these costs
with precision because these Dodd-Frank requirements are new
and may interact with other Dodd-Frank requirements in
unexpected ways. Thus, these estimates may change once we can
better evaluate these interactions. The UMRA and PRA estimates
for these rulemakings are set forth below:
Establishing a Floor for the Capital Requirements
Applicable to Large Internationally Active Banks
(Interagency NPRM implementing DFA section 171
published 12/30/10). The OCC determined under the UMRA
that the rulemaking would add no compliance costs for
national banks. The OCC also determined that the
proposal would change the basis for calculating a data
element that must be reported to the agencies under an
existing requirement and therefore would have no impact
under the PRA.
Incentive Compensation (Interagency NPRM
implementing DFA Section 956 published 4/14/11).
Pursuant to UMRA, the OCC determined that the proposed
interagency rule will not result in expenditures by
State, local, and tribal governments, or the private
sector, of $100 million or more in any 1 year. The OCC
also estimated that the total PRA burden for national
banks would be 17,800 hours (13,040 hours for initial
set-up and 4,760 hours for ongoing compliance).
Retail Foreign Exchange Transactions (NPRM
implementing DFA section 742 published 4/22/11). The
OCC determined pursuant to UMRA that the proposed rule
will not result in expenditures by State, local, and
tribal governments, or by the private sector, of $100
million or more in any 1 year. OCC also estimated that
the total PRA burden for national banks and service
providers would be 67,254 hours.
Credit Risk Retention (Interagency NPRM
implementing DFA section 941 published 4/29/11).
Pursuant to UMRA, the OCC estimated that national banks
would be required to retain approximately $2.8 billion
of credit risk, after taking into consideration the
proposed exemptions for qualified residential mortgages
and other qualified assets. The OCC also estimated the
paperwork burden of the various record keeping and
reporting requirements associated with the risk
retention proposal for national bank securitization
sponsors and creditors to be 20,483 hours.
Margin and Capital Requirements for Covered Swap
Entities (Interagency NPRM implementing DFA sections
731 and 764 to be published 5/11/11). The OCC estimated
that the initial margin cost of the proposed rule is
$25.6 billion. Record keeping and administrative costs
are estimated to be approximately $10.8 million. The
OCC estimated the paperwork burden of complying with
the various record keeping and reporting requirements
associated with the swap margin and capital proposal to
be 5,780 hours.
Q.8. Section 115 of the Dodd-Frank Act asks the Financial
Stability Oversight Council to make recommendations to the
Federal Reserve on establishing more stringent capital
standards for large financial institutions. In addition,
Section 165 requires the Fed to adopt more stringent standards
for large financial institutions relative to smaller financial
institutions. Chairman Bernanke's testimony for this hearing
implied that the Basel III framework satisfies the Fed's
obligation to impose more stringent capital on large financial
institutions. As a member of the Financial Stability Oversight
Council, do you agree with Chairman Bernanke that the Basel III
standards are sufficient to meet the Dodd-Frank Act requirement
for more stringent capital standards? Please explain the basis
for your answer.
A.8. While the FRB is still working on a proposed rulemaking to
implement this aspect of the Dodd-Frank Act, I generally concur
with Chairman Bernanke's assessment that the Basel III
standards provide a suitable framework for implementing the
enhanced prudential capital requirements for large institutions
required by section 165 of Dodd-Frank. As noted in my written
statement, the Basel III reforms focus on many of the same
issues and concerns that the Dodd-Frank Act sought to address.
Like Dodd-Frank, the Basel III reforms tighten the definition
of what counts as regulatory capital by placing greater
reliance on higher quality capital instruments; expand the
types of risk captured within the capital framework; establish
more stringent capital requirements; provide a more balanced
consideration of financial stability and systemic risks in bank
supervision practices and capital rules; and call for a new
international leverage ratio requirement and global minimum
liquidity standards. Because the Basel III enhancements can
take effect in the U.S. only through formal rulemaking by the
banking agencies, U.S. agencies have the opportunity to
integrate certain Basel III implementation efforts with the
heightened prudential standards required by Dodd-Frank. Such
coordination in rulemaking will ensure consistency in the
establishment of capital and liquidity standards for similarly
situated organizations, appropriately differentiate relevant
standards for less complex organizations, and consider broader
economic impact assessments in the development of these
standards.
Q.9. Numerous calls have arisen for a mandatory ``pause'' in
foreclosure proceedings during the consideration of a mortgage
modification. Currently, what is the average number of days
that customers of the institutions that you regulate are
delinquent at the time of the completed foreclosure? If
servicers were required to stop foreclosure proceedings while
they evaluated a customer for mortgage modification, what would
be the effect on the foreclosure process in terms of time and
cost. What effect would these costs have on the safety and
soundness of institutions within your regulatory jurisdiction.
Please differentiate between judicial and nonjudicial States in
your answers and describe the data that you used to make these
estimates.
A.9. OCC Mortgage Metrics data shows that the average
delinquency status of the 608,000 completed foreclosures in
2010 was 16.0 months--19.0 months in judicial States and 15.5
months in nonjudicial States. For the nearly 1.3 million loans
in process of foreclosure at December 21, 2010, the average
delinquency was 16.9 months--17.3 months in judicial States and
16.8 months in nonjudicial States. OCC Mortgage Metrics is a
monthly, loan-level data collection on nearly 33 million loans
serviced by nine of the largest U.S. mortgage servicing
institutions.
As stated in our testimony, the time to complete a
foreclosure process in most States can take 15 months or more
and in many cases can be as long as 2 years. While the OCC
cannot directly estimate the effects of pausing foreclosure
proceedings while a customer is being considered for a mortgage
modification, this has the potential to further extend the time
to complete foreclosures.
Servicers are likely to incur additional operational costs
with elimination of dual track as this will require changes to
business processes, systems, and staffing. However, the OCC
cannot directly estimate the cost to servicers associated with
pausing foreclosure proceedings because cost will be dependent
on a number of variables such as the amount of time it takes to
complete a loan modification, duration of the foreclosure
pause, and whether a modification can be accomplished.
In addition to increased operational cost, a mandatory
pause in foreclosure proceedings could, in certain cases, be
contrary to investor agreements, including requirements of the
GSEs. These conflicts could expose bank servicers to potential
damages and penalties. Also, additional costs associated with
introducing new procedural steps (pauses/resumptions) and time
delay into the foreclosure process has the potential to lessen
the net revenue stream from servicing. This may require bank
servicers to write down the value of the mortgage servicing
rights (MSR) carried on their balance sheet. As well, this may
reduce the fair value and liquidity of MSRs.
Q.10. The burden of complying with Dodd-Frank will not affect
all banks equally. Which new Dodd-Frank Act rules will have the
most significant adverse impact on small and community banks?
Which provisions of Dodd-Frank will have a disparate impact on
small banks as compared to large banks? Do you expect that the
number of small banks will continue to decline over the next
decade? If so, is the reason for this decline the Dodd-Frank
Act? Have you conducted any studies on the costs Dodd-Frank
will impose on small and community banks? If so, please
describe the results and provide copies of the studies.
A.10. While much of the focus of the reforms mandated by Dodd-
Frank is on larger financial institutions, the OCC recognizes
that community banks will also be affected by many provisions
of the Act. We have not conducted any specific studies on the
costs that Dodd-Frank will impose on small and community banks.
However, as we move forward with rulemakings to implement the
various provisions of Dodd-Frank, we will seek comment on the
effects of the rules on small entities as defined and provided
for in the Regulatory Flexibility Act.
The sheer scope and number of forthcoming regulations that
bankers will need to be aware of and respond to will be a
challenge for all banks, but even more so for community banks
with limited compliance, regulatory, and legal staff.
In her April 6, 2011, testimony before the Committee's
Financial Institutions Subcommittee, Senior Deputy Comptroller
Jennifer Kelly discussed some of the challenges presented for
community banks by Dodd-Frank. \2\ As she stated in her written
testimony, the challenges banks face have several dimensions:
new regulation--both new restrictions and new compliance
costs--on businesses they conduct, limits on revenues for
certain products, and additional regulators administering both
new and existing regulatory requirements. In the context of
community banks, a particular concern will be whether these
combine to create a tipping point causing banks to exit lines
of business that provide important diversification of their
business, and increase their concentration in other activities
that raise their overall risk profile.
---------------------------------------------------------------------------
\2\ Available at: http://www.occ.gov/news-issuances/congressional-
testimony/2011/pub-test-2011-42-written.pdf.
---------------------------------------------------------------------------
For example, the Dodd-Frank Act imposes a range of new
requirements on the retail businesses that are ``bread-and-
butter'' for many community banks. The costs associated with
small business lending will increase when new HMDA-style
reporting requirements become effective. Longstanding advisory
and service relationships with municipalities may cause the
bank to be deemed a ``municipal advisor'' subject to
registration with the Securities and Exchange Commission (SEC)
and rules issued by the SEC and the Municipal Securities
Rulemaking Board. Also, checking account relationships with
customers are likely to be reshaped to recover the costs
associated with providing debit cards if debit interchange fees
are restricted.
The new Consumer Financial Protection Bureau (CFPB) is
charged with implementing new requirements that will affect
banks of all sizes. These include new standards for mortgage
loan originators; minimum standards for mortgages themselves;
limits on charges for mortgage prepayments; new disclosure
requirements required at mortgage origination and in monthly
statements; a new regime of standards and oversight for
appraisers; and a significant expansion of the current HMDA
requirements for mortgage lenders to report and publicly
disclose detailed information about mortgage loans they
originate (13 new data elements).
The CFPB is also authorized to issue new regulations on a
broad range of topics, including, but not limited to:
additional disclosure requirements to ``ensure that
the features of any consumer financial product or
service, both initially and over the life of the
product, are fully, accurately, and effectively
disclosed to consumers in a manner that permits
consumers to understand the costs, benefits, and risks
associated with the product or service, in light of the
facts and circumstances'';
new regulations regarding unfair, deceptive, or
``abusive'' practices; and
standards for providing consumers with electronic
access to information (retrievable in the ordinary
course of the institution's business) about their
accounts and transactions with the institution.
While clearer, more meaningful, and accessible consumer
disclosures are clearly desirable, it is important to recognize
that the fixed costs associated with changing marketing and
other product-related materials will have a proportionately
larger impact on community banks due to their smaller revenue
base. The ultimate cost to community banks will depend on how
the CFPB implements its new mandate and the extent to which it
exercises its exemptive authority for community banks.
Community banks also may be particularly impacted by the
Dodd-Frank Act's directive that Federal agencies modify their
regulations to remove references to credit ratings as standards
for determining creditworthiness. This requirement impacts
standards in the capital regulations that are applicable to all
banks. National banks are also affected because ratings are
used in other places in the OCC's regulations, such as
standards for permissible investment securities. As a result,
institutions would be required to do more independent analysis
in categorizing assets for the purpose of determining
applicable capital requirements and whether debt securities are
permissible investments--a requirement that will tax especially
the more limited resources of community institutions.
Regardless of how well community banks adopt to Dodd-Frank
Act reforms in the long-term, in the near- to medium-term these
new requirements will raise costs and possibly reduce revenue
for community institutions. The immediate effects will be
different for different banks, depending on their current mix
of activities, so it is not possible to quantify those impacts
with accuracy. In the longer term, we expect to see banks
adjust their business models in a variety of ways. Some will
exit businesses where they find that associated regulatory
costs and risks are simply too high to sustain profitability,
or they will decide how much of the added costs can, or should,
be passed along to customers. Others will focus on providing
products and services to the least risky customers as a way to
manage their regulatory costs and risks. Some will elect to
concentrate more heavily in niche businesses that increase
revenues but also heighten their risk profile. While we know
there will be a process of adaptation, we cannot predict how
these choices will affect either individual institutions or the
future profile of community banking at this stage.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR REED
FROM JOHN WALSH
Q.1. Can you provide your view on the Basel III framework and
also the extent, if any, that Basel III may conflict with the
requirements of the Dodd-Frank Act and how are you responding
to these conflicts?
A.1. As noted in my written statement, the Basel III reforms
focus on many of the same issues and concerns that the Dodd-
Frank Act sought to address. These reforms of the Basel
Committee are designed to strengthen global capital and
liquidity standards governing large, internationally active
banks and promote a more resilient banking sector. Like Dodd-
Frank, the Basel III reforms tighten the definition of what
counts as regulatory capital by placing greater reliance on
higher quality capital instruments; expands the types of risk
captured within the capital framework; establishes more
stringent capital requirements; provides a more balanced
consideration of financial stability and systemic risks in bank
supervision practices and capital rules; and calls for a new
international leverage ratio requirement and global minimum
liquidity standards. Since the Basel III enhancements can take
effect in the U.S. only through formal rulemaking by the
banking agencies, U.S. agencies have the opportunity to
integrate certain Basel III implementation efforts with the
heightened prudential standards required by Dodd-Frank. Such
coordination in rulemaking will ensure consistency in the
establishment of capital and liquidity standards for similarly
situated organizations, appropriately differentiate relevant
standards for less complex organizations, and consider broader
economic impact assessments in the development of these
standards.
My September 30, 2010, testimony before this Committee \1\
and my January 19, 2011, speech before the Exchequer Club \2\
elaborated on the interplay between Basel III framework and
capital requirements under Dodd-Frank.
---------------------------------------------------------------------------
\1\ Available at: http://www.occ.gov/news-issuances/congressional-
testimony/2010/pub-test-2010-119-written.pdf.
\2\ Available at: http://www.occ.gov/news-issuances/speeches/2011/
pub-speech-2011-5.pdf.
---------------------------------------------------------------------------
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR MENENDEZ
FROM JOHN WALSH
Q.1. Capital, Leverage, and Liquidity Requirements for
Systemically Significant Firms. One of the most important
reforms in Dodd-Frank was requiring systemically significant
companies to hold more capital and have better liquidity to
prevent another crisis. The crisis would not have happened had
we not allowed big banks and some nonbanks to acquire so much
debt and leverage. What steps are being taken to ensure that
these capital, leverage, and liquidity requirements are
implemented robustly?
A.1. As noted in my written testimony, the Dodd-Frank Act
requires the banking agencies and Financial Stability Oversight
Council to develop numerous studies and regulations that will
materially affect the level and composition of capital and
liquidity for both banks and certain nonbank companies. The
requirements are similar to and reinforce actions taken by the
Basel Committee to strengthen global capital and liquidity
standards for large, internationally active banks (Basel III).
Together, these reforms tighten the definition of what counts
as regulatory capital; expand the types of risks captured
within the regulatory capital framework; increase overall
capital requirements; establish an international leverage ratio
applicable to global financial institutions that constrains
leverage from both on- and off-balance sheet exposures; and
provide for a more balanced consideration of financial
stability in bank supervision practices and capital rules. The
Basel reforms also introduce global minimum liquidity standards
that set forth explicit ratios that banks must meet to ensure
that they have adequate short-term liquidity to offset cash
outflows under acute short-term stresses and maintain a
sustainable maturity structure of assets and liabilities.
Because the Basel III enhancements can take effect in the
U.S. only through formal rulemaking by the banking agencies,
U.S. agencies have the opportunity to integrate certain Basel
III implementation efforts with the heightened prudential
standards required by Dodd-Frank. Such coordination in
rulemaking will ensure consistency in the establishment of
capital and liquidity standards for similarly situated
organizations, appropriately differentiate relevant standards
for less complex organizations, and consider broader economic
impact assessments in the development of these standards.
The Basel Committee is also developing a methodology to
identify and apply heightened capital standards for globally
significant financial institutions. As with other aspects of
the Basel reforms, one of the challenges that the OCC and other
U.S. banking agencies face is integrating and coordinating
these proposals with the capital-related requirements of Dodd-
Frank.
My written testimony also highlighted the other following
efforts underway to implement key capital related provisions of
Dodd-Frank:
Under Sections 115(a) and 115(b) of Dodd-Frank, in
order to prevent or mitigate risk to financial
stability, the FSOC may make recommendations to the FRB
\1\ concerning the establishment of prudential
standards applicable to nonbank financial companies
supervised by the FRB and certain large bank holding
companies. These prudential standards, which are to be
more stringent than those applicable to other companies
that do not pose similar risk to financial stability,
are expected to address risk-based capital
requirements, leverage limits, and liquidity
requirements, among other provisions.
---------------------------------------------------------------------------
\1\ Under section 165 of Dodd-Frank, the FRB, on its initiative or
pursuant to recommendations by FSOC under Sections 115(a) and 115(b),
shall establish prudential standards applicable to nonbank financial
companies supervised by the FRB and certain large bank holding
companies.
Section 171(b) of Dodd-Frank provides for a floor
for capital requirements going forward. On December 30,
2010, the banking agencies published a notice of
proposed rulemaking addressing the requirements of
section 171(b). The public comment period on this
proposal closed February 28, 2011, and the Agencies are
currently reviewing the comments and working on a final
---------------------------------------------------------------------------
rule.
Section 616(c) of Dodd-Frank amends the
International Lending Supervision Act of 1983 by
providing that each Federal banking agency shall seek
to make capital standards countercyclical, so that the
amount of required capital increases in times of
economic expansion and decreases in times of economic
contraction, consistent with safety and soundness.
Consistent with this provision, the agencies are
actively considering the establishment of
countercyclical capital requirements in proposed
regulations implementing the Basel III reforms.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN
FROM JOHN WALSH
Q.1. Safety and Soundness Concerns. In the last 2 years,
Congress passed the Credit CARD Act reining in unfair credit
card practices, and the Dodd-Frank Act which included new
capital rules for banks and interchange fee reform.
Can you please share the OCC's views of these proposals,
specifically their effects on capital levels at nationally
chartered banks?
A.1. As noted in my testimony, the various capital provisions
of the Dodd-Frank Act, when coupled with the capital reforms
that have been adopted by the Basel Committee on Banking
Supervision (referred to as Basel III), will result in higher
levels, and stronger components of required regulatory capital
for national banks. For example, Basel III and section 165 of
Dodd-Frank compel the establishment of more stringent
prudential standards for certain large companies, including
standards relating to risk-based capital, leverage, and
liquidity. In addition, both Basel III and section 171 of Dodd-
Frank limit the extent to which banking organizations may use
hybrid capital instruments, such as trust preferred securities,
as a component of their regulatory capital base. As a result,
both regimes will affect capital levels at nationally chartered
banks in various ways, including: effectively requiring banks
to hold more capital in the form of common equity; establishing
more stringent standards on the types of risks captured within
the regulatory capital framework; and requiring higher minimum
regulatory capital ratios. The OCC and other U.S. banking
agencies will be issuing a notice of proposed rulemaking that
sets forth a proposal on how these reforms would be applied in
the United States, and whether or not the reforms should apply
to all U.S. banking institutions.
Beyond changes to baseline capital standards, both Dodd-
Frank and Basel III will impose additional capital requirements
on systemically important financial institutions, with Dodd-
Frank focusing on institutions with total consolidated assets
of $50 billion and above.
Two other provisions of Dodd-Frank may also have a direct
effect on national banks' capital requirements going forward.
Section 171 provides for a floor for any capital standards
going forward. And, as noted in my written testimony, the
provisions of Section 939A regarding the use of credit ratings
in the agencies' regulations will also affect the agencies'
current and future risk-based capital standards and may
constrain our ability to incorporate, in a cost-efficient and
consistent manner, more granular risk-weights that reflect the
underlying risks of various types of assets.
The amount by which these provisions and other provisions
of the Dodd-Frank Act will require national banks to raise
their current capital levels will depend in part on adjustments
banks may make to their balance sheet compositions and business
activities. In general, we expect that many banks will need to
increase their capital levels by retaining more earnings and/or
seeking new capital. In addition, we also believe that these
and other changes--including the provisions of the Credit CARD
Act and interchange provisions of Dodd-Frank--are compelling
banks to revisit and make adjustments to their business models
to reflect higher capital hurdle rates and/or reduced
profitability for various business lines. Such adjustments may
result in a shift to lower risk activities that require less
capital or reductions in the amount of assets that banks choose
to hold.
Q.2. In your testimony, you note that ``[mortgage servicing]
deficiencies have resulted in violations of State and local
foreclosure laws, regulations, or rules'' but that ``loans were
seriously delinquent, and that servicers maintained
documentation of ownership and had a perfected interest in the
mortgage to support their legal standing to foreclose.'' There
have been recent news reports about a nationwide foreclosure
fraud settlement. One Wall Street Journal story stated, ``The
deal wouldn't create any new Government programs to reduce
principal. Instead, it would allow banks to devise their own
modifications or use existing Government programs[.]''
What specific laws, regulations, or rules were violated?
A.2. The Federal banking regulators conducted horizontal
examinations of foreclosure processing at 14 federally
regulated mortgage servicers during the fourth quarter of 2010.
The primary objective of each review was to evaluate the
adequacy of controls and governance over servicers' foreclosure
processes and assess servicers' authority to foreclose. The
reviews focused on issues related to foreclosure-processing
functions.
The reviews found critical weaknesses in servicers'
foreclosure governance processes, foreclosure document
preparation processes, and oversight and monitoring of third-
party vendors, including foreclosure attorneys. While findings
varied across institutions, the weaknesses at each servicer,
individually and collectively, resulted in unsafe and unsound
practices that included violations of applicable Federal and
State law and requirements. Our reviews found significant
weaknesses in document preparation: improper affidavits were
submitted and documents were notarized improperly. In many
cases, these weaknesses constituted violations of State
attestation and notarization requirements.
Q.3. Did the OCC's review specifically examine issues involving
misapplication of mortgage payments or lost modification
documents? These are the most persistent complaints that my
office receives and the anecdotal evidence suggests that these
problems may be widespread.
A.3. In connection with the reviews of documentation in
foreclosure files and assessments of servicers' custodial
activities, examiners found that borrowers whose files were
reviewed were seriously delinquent on their mortgage payments
at the time of foreclosure and that servicers generally had
sufficient documentation available to demonstrate authority to
foreclose on those borrowers' mortgages. Further, examiners
found evidence that servicers generally attempted to contact
distressed borrowers prior to initiating the foreclosure
process to pursue loss-mitigation alternatives, including loan
modifications. Documents in the foreclosure files may not have
disclosed certain facts that might have led examiners to
conclude that a foreclosure should not have proceeded however,
such as misapplication of payments that could have precipitated
a foreclosure action or oral communications between the
borrower and servicer staff that were not documented in the
foreclosure file.
Examiners did note cases in which foreclosures should not
have proceeded due to an intervening event or condition, such
as the borrower (a) was covered by the Servicemembers' Civil
Relief Act, (b) filed for bankruptcy shortly before the
foreclosure action, or (c) qualified for or was paying in
accordance with a trial modification.
Q.4. What will servicers receive in return for a national
mortgage foreclosure fraud settlement? Will they be provided
with immunity from any criminal prosecution?
A.4. The OCC's orders are separate from actions that could be
taken by other agencies and provide no immunity from criminal
prosecution.
The OCC based its enforcement actions on the findings of
examinations conducted as part of the interagency horizontal
reviews undertaken by the Federal banking regulators in the
fourth quarter of 2010. These enforcement actions do not
preclude determinations regarding assessment of civil money
penalties, which the OCC is holding in abeyance. As we gather
additional information from continuing exam work and the
``look-back'' required by our orders about the extent of harm
from processing failures, this will inform our decision on
civil money penalties.
Although the OCC coordinated closely with other Federal
agencies, the actions by the Federal banking regulators were
not part of the Federal/State settlement efforts that remain in
process. Having established the scope of problems in our area
of jurisdiction, the bank regulators had to move forward. It is
our mission to ensure both safety and soundness and fair
treatment of consumers, and meeting those objectives demanded
action. To delay further would have delayed providing financial
remediation to borrowers and left safety and soundness issues
of the banks not fully addressed.
Q.5. Will any mortgage modifications provided for in the
settlement include principal reduction? If so, according to
what standards?
A.5. This question relates to potential terms of the Federal/
State settlement involving multiple Federal agencies and State
Attorneys General. The OCC's order is not part of that
potential settlement.
Q.6. What is OCC's view of the effects of principal writedowns
for both banks and borrowers?
A.6. The OCC is sympathetic to the plight of homeowners who may
be facing financial difficulty in honoring their mortgage
obligations or who are now ``underwater'' with the current
value of the home less than what is due on their mortgage.
However, we have significant concerns about proposals that
would mandate a shift in mortgage modification efforts from a
focus on making mortgage payments affordable, based on an
analysis of the borrower's ability to repay, to one of
principal forgiveness based on whether they are ``underwater''
on their mortgage. To date, mortgage modification programs have
focused on providing borrowers with the opportunity to stay in
their homes by making the first mortgage payment
``affordable.'' This is done whenever the economics show it is
better to modify than foreclose. These modifications are
designed to solve for borrower capacity to pay rather than
willingness to pay, an approach we think is both balanced and
appropriate. These modifications generally do not provide for
debt forgiveness but lenders can and have forgiven mortgage
debts as part of certain modifications and in short sale or
deed-in-lieu transactions.
In contrast, Government mandates for servicers to engage in
principal forgiveness raises a number of fundamental concerns.
Such programs inevitably raise fairness issues with respect to
otherwise similarly situated homeowners whose home values have
declined. Consider the following example: two borrowers buy
homes in the same neighborhood for $400,000 each in 2006.
Borrower A financed 100 percent of the purchase; Borrower B put
50 percent down. Property values in the area have since
declined 50 percent. Borrower A obtains a loan modification
which includes principal forgiveness down to 100 percent loan-
to-value (LTV); Borrower B is not eligible for a modification
because his loan is already 100 percent LTV. Three years from
now both properties have appreciated and are worth $250,000.
Borrower A, with no funds at risk, now has equity of $50,000,
while Borrower B has a net loss of $150,000. As this example
illustrates; if not properly structured, a principal
forgiveness program will reward borrowers who speculated or
assumed excessive risk. Further, such programs could create
moral hazard by diminishing borrowers' willingness to continue
to make their mortgage payments should home values further
decline.
Proposals that call for mortgage servicers, rather than the
investors who own the underlying mortgage, to bear the bulk of
losses associated with any principal forgiveness program
likewise raise concerns about equitable treatment. It is the
investor, not the servicer, who assumed the risk when
purchasing the mortgage. Apart from the fees associated with
their role as servicer, the servicer does not receive and is
not entitled to returns (principal and interest) from the
mortgage, but yet under some proposals, would be forced to
assume much of the loss associated with principal write downs.
In summary, the mortgage market developed with all
established set of readily understood rules and practices which
are embedded in law and contracts. This includes lien
preferences, private mortgage insurance, and when borrowers are
responsible for deficiency balances. In proposing debt
forgiveness outside of these existing frameworks, one will
likely enrich some at the expense of others because existing
contracts/practices could not have envisioned the debt
forgiveness structure. The unintended consequences may well be
hard to anticipate or control.
If pursued, principal forgiveness should be tied to
borrower need based on verified capacity to repay. Providing
principal forgiveness in situations where a borrower will still
be unlikely or unwilling to make the new payments on a
sustained basis simply delays the recognition of loss and the
ultimate resolution of the underlying property.
Finally, it is important to stress that the issue of
principal forgiveness is distinct and separate from requiring
banks to recognize losses on mortgages that they hold. While
the OCC has and continues to encourage bankers to work
constructively with troubled borrowers by offering sustainable
mortgage modifications, we have been equally clear that bankers
must maintain systems to identify problem assets, estimate
incurred credit losses for those assets, and establish
appropriate loan loss reserves and/or initiate write-downs
sufficient to absorb estimated losses consistent with generally
accepted accounting principles and regulatory policies.
Q.7. Should banks be setting aside capital to cover investors'
mortgage-backed securities putback claims? What are the current
regulatory obstacles, if any, to their doing so?
A.7. We are directing national banks to maintain adequate
reserves for potential losses and other contingencies and to
make appropriate disclosures, consistent with applicable U.S.
generally accepted accounting principles and Securities and
Exchange Commission's disclosure rules. We do not believe there
are any regulatory obstacles that prevent banks from taking
such actions.
Q.8. Please describe your agencies' views of the risks related
the banks' servicing divisions, including:
The losses stemming from the servicing divisions of the
banks that you regulate.
A.8. The costs to service loans have increased as a result of
the dramatic increase in loan defaults and associated loss
mitigation activities. For example, the average annual cost to
service a loan with capitalized mortgage servicing rights has
increased from $81 per loan in 4Q2009 to $105 in 4Q2010, an
increase of 30 percent. In addition, the cost to service will
further increase as servicers implement remedial actions to
address well publicized foreclosure documentation and
processing deficiencies. These rising costs, when not offset by
servicing income and fees, may have an adverse effect on
mortgage banking profitability. In addition, a prolonged
decline in net servicing income may depress the value and
marketability of mortgage servicing rights (MSR) assets, a
significant component of bank Tier 1 capital at banks with
large mortgage servicing operations.
Q.9. What further losses, if any, do you expect.
A.9. Increased cost to service, particularly on delinquent or
defaulted loans and loans in foreclosure, is likely a permanent
change to the mortgage banking business model. In addition,
reforms effected through uniform national servicing standards
may further add to servicer costs due to required changes in
staffing, processes, and systems needed to implement the new
standards. While some of this higher cost may be variable,
depending on the volume of mortgage delinquencies and
foreclosures, much of the additional cost will be fixed.
Mortgage banking companies likely will attempt to recover the
additional costs through higher servicing fees to the extent
permissible by law and investor guidelines, which in turn may
be passed on to borrowers in the form of higher interest rates
and loan fees.
Q.10. How have your agencies have changed your examination
procedures relating to banks' servicing divisions.
A.10. In the coming months, OCC examiners will be assessing
adequacy of action plans related to the enforcement actions
taken against the eight largest national bank mortgage
servicers, and validating implementation of required remedial
actions, including customer restitution when necessary. This
supervisory assessment of compliance with formal enforcement
actions will result in increased regulatory oversight and
supervision over mortgage servicing operations.
Q.11. Whether there will be uniform standards for servicing
examination across all Federal banking agencies.
A.11. The OCC, along with the other Federal banking agencies,
is currently engaged in an effort to establish national
mortgage servicing standards to promote the safe and sound
operation of mortgage servicing and foreclosure processing,
including standards for accountability and responsiveness to
borrower issues. These national standards will improve the
transparency, oversight, and regulation of mortgage servicing
and foreclosure processing, and establish additional thresholds
for responsible management and operation of mortgage servicing
activities. Uniform national mortgage servicing and foreclosure
processing standards that are consistently applied and enforced
across the industry would reduce the complexity and risk
associated with the current servicing environment, help promote
accountability and appropriateness in dealing with consumers,
and strengthen the housing finance market. This initiative to
develop and enforce uniform national servicing standards will
require close coordination among the agencies and will include
engaging the Government-sponsored enterprises (GSEs), private
investors, consumer groups, the servicing industry, and other
regulators.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARNER
FROM JOHN WALSH
Q.1. For each of the witnesses, though the Office of Financial
Research does not have a Director, what are each of you doing
to assist OFR in harmonizing data collection, compatibility,
and analysis?
A.1. The OCC continues to work closely with staff within the
Department of Treasury responsible for standing up the Office
of Financial Research (OFR). Senior OCC officials have
participated in regular meetings at Treasury, sharing
information, commenting on proposals, and providing other input
based on the OCC's experience working with supervisory and
other banking data.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR MERKLEY
FROM JOHN WALSH
Q.1. Community Banks and Economic Growth. I have heard from
some of my local community banks that certain capital,
accounting, and examination rules may be working at cross
purposes with the ability of community banks to serve the
economic growth needs of the families and small businesses they
serve in their communities, especially when compared to
standards applied to the largest national banks. I wish to
bring several to your attention and ask that you comment:
The Financial Accounting Standards Board's proposed
exposure draft on ``Troubled Debt Restructurings''
(TDRs) has been pointed out as possibly creating a
capital disincentive for banks to engage in work-outs
and modifications with their business borrowers because
of the effect of immediately having to declare those
loans ``impaired.'' In addition, for banks over $10
billion in asset size, there may be additional direct
costs for FDIC premiums based on a formula that
considers TDR activity.
The disallowance to Risk-Based Capital of the
amount of Allowance for Loan Losses (ALLL) in excess of
1.25 percent of Risk Weighted Assets has been flagged
as a challenge in this environment, where some firms
have ALLL that significantly exceeds that threshold.
This may serve to understate the risk-based capital
strength of the bank, adding to costs and negatively
impacting customer and investor perceptions of the
bank's strength.
It has been reported that examiners have rejected
appraisals that are less than 9 months old when
regulatory guidance calls for accepting appraisals of
up to 12 months.
Community banks are subject to examination in some
cases as frequently as every 3 months. In contrast,
some suggest that our largest national banks may not
ever undergo an examination as thorough, with the
challenges surrounding loan documentation, foreclosure,
and MERS as a glaring example of the results.
Are there regulatory or supervisory adjustments in these or
related areas that need to be made to facilitate community
banks' abilities to serve their communities?
In addition, have you considered ways in which capital
charges, accounting rules, and examination rules for community
banks in particular can be adapted to be less procyclical, such
that they do not become stricter into an economic downturn and
lighter at the top of an upturn?
Finally, what procedures do you have in place to ensure
that our community banks and our largest national banks are not
subject to differing examination standards, even when they are
examined by different regulators?
A.1. The OCC is mindful of the economic challenges, and the
regulatory and compliance burdens facing community banks. As we
develop regulations, supervisory policies, and examination
standards, we strive to provide sufficient flexibility in the
application of those standards to reflect the size and
complexity of the institution. To put it a different way, while
all national banks are generally held to the same set of
standards and regulations, the methods and controls they use to
implement those standards may vary, based on their size and
complexity. \1\ As the complexity and scope of a bank's
activities increase, so do our expectations for their internal
controls and risk management systems.
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\1\ There are some instances where we apply different standards.
For example, under the OCC's risk-based capital rules, the largest
national banks are subject to the so-called advanced approaches rule
for computing risk-based capital for credit risk and are also subject
to an operational risk capital component.
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The OCC applies the same risk-based supervisory philosophy
for community and large bank examinations for evaluating risk,
identifying material and emerging problems, and ensuring that
individual banks take corrective action before problems
compromise their safety and soundness. The OCC's Bank
Supervision Process examination handbook establishes a common
examination philosophy and structure that is used at all
national banks. This structure includes a common risk
assessment system that evaluates each bank's risk profile
across eight risk areas--compliance, credit, interest rate,
liquidity, operational, price, reputation, and strategic--and
assigns an overall composite and component ratings on a bank's
capital adequacy, asset quality, management, earnings,
liquidity, and sensitivity to market risks using the
interagency Uniform Financial Institution Rating System
(CAMELS).
With respect to specific issues you raised for comment:
The Financial Accounting Standards Board (FASB) Proposed Exposure Draft
on Troubled Debt Restructurings
When the FASB first issued the exposure draft on troubled
debt restructurings, we had concerns about their interpretation
that potentially created automatic triggers of TDR
determinations based on credit availability in the market to
borrowers. We believe the proposal would have caused a
significant increase in the number of troubled debt
restructurings reported by our banks. However, after receiving
comments from the public including our comment letter, the FASB
changed its position to be consistent with the way our
examiners currently evaluate modifications. As a result, we
expect that the final guidance from the FASB will have very
little impact on our national banks.
Cap on the Amount of Allowance for Loan and Lease Losses (ALLL) Allowed
in Risk-Based Capital
Under the agencies' risk-based capital rules, a bank may
include as a component of their Tier 2 capital, their ALLL up
to a maximum of 1.25 percent of risk-weighted assets. Part of
the rationale for this limitation is that ALLL covers losses
that a bank expects to incur, whereas the purpose of holding
capital is to cover unforeseen or unexpected losses. Given
these relatively distinct functions, the U.S. banking agencies
have historically limited the amount of ALLL that can be
counted towards a bank's capital base. Nevertheless, we
recognize the challenges this limitation has created for many
banks and will consider this issue as we move forward with
revising our capital regulations.
Frequency of Appraisals
The agencies' real estate lending regulations and
guidelines set forth the requirement that banks should have
policies and procedures that address the type and frequency of
collateral valuations. The frequency of such valuations is case
specific and will depend upon market conditions and the nature
and status of the collateral being financed. For properties or
projects that are performing as planned, prudent guidelines
might specify obtaining periodic updated valuations for
portfolio risk monitoring. The October 2009 interagency Policy
Statement on Prudent Commercial Real Estate Loan Workouts
stated:
As the primary sources of loan repayment decline, the
importance of the collateral's value as a secondary
repayment source increases in analyzing credit risk and
developing an appropriate workout plan. The institution
is responsible for reviewing current collateral
valuations (i.e., an appraisal or evaluation) to ensure
that their assumptions and conclusions are reasonable.
Further, the institution should have policies and
procedures that dictate when collateral valuations
should be updated as part of its ongoing credit review,
as market conditions change, or a borrower's financial
condition deteriorates.
For loans that are experiencing financial difficulty or
being restructured or worked out, we would expect a bank to
understand its collateral risk by having or obtaining current
valuations of the collateral supporting the loan and workout
plan.
The OCC has emphasized these concepts in our guidance to
examiners. In a September 2008 memorandum we explained:
There are no standard criteria for determining the
useful life of an appraisal (may be less than a year;
may be more than a year). Considerations for
reappraisal should include the age of the original
appraisal, the condition of the underlying property,
and changes in market conditions. Some factors that may
necessitate the ordering of a new or updated appraisal
include: measurable deterioration in the performance of
the project, marked deterioration in market conditions,
material variance between actual conditions and
original appraisal assumptions, volatility of the local
market, change in project specifications (condo to
apartment; single tenant to multitenant; etc.), loss of
significant lease or take-down commitment, increase in
presales fallout, inventory of competing properties,
and changes in zoning or environmental contamination.
Frequency of Examinations
The frequency of on-site examinations of insured depository
institutions is prescribed by 12 U.S.C. 1820(d). Under these
provisions, national banks must receive a full-scope, on-site
examination at least once during each 12-month period. This
requirement may be extended to 18 months if all of the
following criteria are met:
Bank has total assets of less than $500 million.
Bank is well capitalized as defined in 12 CFR 6.
At the most recent examination, the OCC assigned
the bank a rating of 1 or 2 for management as part of
the bank's rating under UFIRS and assigned the bank a
composite UFIRS rating of 1 or 2.
Bank is not subject to a formal enforcement
proceeding or order by the FDIC, OCC, or the Federal
Reserve System.
No person acquired control of the bank during the
preceding 12-month period in which a full-scope, on-
site examination would have been required but for this
section.
The frequency of our on-site examinations for community
banks follows these statutory provisions, with on-site
examinations occurring every 12 to 18 months, depending on the
bank's size and condition. The scope of these examinations is
set forth in the OCC's Community Bank Supervision handbook and
requires sufficient examination work to complete the core
assessment activities in that handbook, and determine the
bank's Risk Assessment and CAMELS ratings. The depth and
specific areas of examination focus are determined by the level
and nature of the bank's risks. More frequent examinations may
be conducted if the bank is operating under all enforcement
action, if there have been material changes in the bank's
condition or activities, or if it is a troubled institution.
For all community banks, on-site activities are supplemented by
off-site monitoring and quarterly analyses to determine if
significant changes have occurred in the bank's condition or
activities.
For the largest national banks, the OCC maintains an on-
site resident examination staff that conducts ongoing
supervisory activities and targeted examinations of specific
areas of focus. As in our community bank program, examiners
must also conduct sufficient work to complete the core
assessment activities set forth in the OCC's Large Bank
Supervision handbook, and determine the bank's Risk Assessment
and CAMELS ratings.
Procyclical Accounting and Capital Requirements
The OCC, both independently and as part of discussions
within the Basel Committee and other groups, has considered
ways to make capital charges, accounting rules, and examination
rules less procyclical for banks, including community banks.
For example, as part of the Basel III enhancements announced in
December, the Basel Committee is introducing a number of
measures to address procyclicality and raise the resilience of
the banking sector in good times. These measures have the
following key objectives:
constrain leverage in the banking system through
the introduction of all international leverage ratio;
dampen any excess cyclicality of the minimum
capital requirement;
promote more forward-looking loan loss provisions;
and
conserve capital to build buffers at individual
banks and the banking sector that can be used in
stress.
As it relates to efforts to constrain procyclicality of
loan loss provisioning, the OCC has been a strong proponent of
the need to make the ALLL more forward looking so that banks
can appropriately build their reserves when their credit risk
is increasing, rather than waiting until such losses have been
incurred. The OCC has been actively engaged in efforts by the
FASB and the International Accounting Standards Board (IASB) to
revise the current impairment model for recognizing loan losses
to provide for more forward-looking reserves. As part of this
effort, OCC staff has served as the U.S. banking agencies'
representative on the IASB's Expert Advisory Panel on
Impairment.
In addition, section 616(c) of the Dodd-Frank Act requires
the Federal banking agencies to seek to make capital standards
and other provisions of Federal law countercyclical. The
Agencies will continue efforts to mitigate procyclicality in
regulations and guidance, consistent with this statutory
mandate, including those requirements adversely affecting
community banks.
Q.2. Our largest financial firms today operate across many
national boundaries. Some firms are aiming to conduct 50
percent or more of their business internationally. Can you
update the Committee on the status and any challenges regarding
the establishment of mechanisms, plans, and other aspects of
coordination between international regulatory bodies to ensure
that financial firms operating internationally can be
effectively placed into the Dodd-Frank resolution regime and
are not otherwise able to attain ``too big to fail'' status
through international regulatory arbitrage?
A.2. There are a number of significant efforts, domestically
and internationally, that have taken place or are in process to
address the difficult issue of cross-border resolution of
financial institutions. A major challenge in resolving cross-
border firms is the disparate nature of jurisdictional
resolution laws and procedures along with the jurisdictional
nature of costs associated with the resolution of such firms.
As the issues are quite complex, solutions are being sought on
multiple fronts, as follows:
Crisis Management Groups (CMGs) have been
established and operational for over a year for the
world's largest banks. The CMGs are comprised of the
home and major host supervisors of such institutions
and are working with the firms to develop recovery and
resolution plans (RRPs). RRPs detail contingency plans
to address situations of severe distress and failure of
these global firms.
The U.S. regulators (primarily the FDIC) are
holding bilateral meetings with foreign jurisdictions
to identify solutions to resolution issues (e.g.,
requirements to recognize a bridge bank) that have been
identified at the CMG meetings.
The Financial Stability Board (FSB) is developing
guidance on the essential elements of recovery and
resolution plans and criteria for authorities to assess
the resolvability of individual institutions. U.S.
regulators are also currently engaged in writing
regulations for the implementation of Section 165(d) of
the Dodd-Frank Act, which requires designated firms to
submit resolution plans.
The Basel Committee on Banking Supervision (BCBS)
has developed recommendations for cross-border
resolutions, and is currently surveying members on
implementation of those recommendations.
The FSB is also developing guidance on cross-border
resolutions that will identify the essential resolution
tools and powers, including: sector-specific attributes
of resolution regimes that are necessary to protect
depositors, policy holders, and investors, as well as
restructuring mechanisms, which may include contractual
and/or statutory debt-equity conversion and write-down
tools; critical framework conditions for effective
cross-border cooperation and information sharing in
managing and resolving a distressed financial
institution; and essential elements of institution-
specific cross-border cooperation agreements.
The FSB and BCBS are evaluating the feasibility of
contractual and statutory bail-ins to serve as a loss-
absorption instrument and resolution tool in the
national context and in the context of systemic cross-
border firms.
Q.3. Please also update the Committee on the status of the
regulation of international payments systems and other internal
systemic financial market utilities so that the entities that
manage or participate in them are not able to avoid the
resolution regime through international regulatory arbitrage.
A.3. Section 804 of the Dodd-Frank Act provides the Financial
Stability Oversight Council (the Council or FSOC) with the
authority to identify and designate as systemically important a
financial market utility (FMU) if the Council determines that
the failure of the FMU could create or increase the risk of
significant liquidity or credit problems spreading among
financial institutions or markets and thereby threaten the
stability of the U.S. financial system. At its March 18, 2011,
meeting, the Council approved the publication of a NPRM that
describes the criteria, analytical framework, and process and
procedures the Council proposes to use to designate an FMU as
systemically important. The NPRM includes the statutory factors
the Council is required to take into consideration and adds
subcategories under each of the factors to provide examples of
how those factors will be applied. The NPRM also outlines a
two-stage process for evaluating and designating an FMU as
systemically important.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO
FROM JOHN WALSH
Q.1. Dodd-Frank requires that risk retention be jointly
considered by the regulators for each different type of asset
and includes a specific statutory mandate related to any
potential reforms of the commercial mortgage-backed securities
to limit disruptions. Given the importance of rigorous cost-
benefit and economic impact analyses and the need for due
consideration of public comments, do your agencies need more
time than is provided by the looming April deadline?
A.1. The agencies published a proposed rule to implement the
Dodd-Frank credit risk retention requirements on April 29,
2011; public comments on the proposal are due on June 10, 2011.
The fact that the agencies did not issue final rules by the
April, 2011, statutory deadline reflects the complexity of the
rulemaking and the care necessary to strike the right balance
among the various public policy objectives of the statute. The
OCC and the other agencies intend to proceed promptly to
consider the comments and prepare a final regulation once the
comment period has closed.